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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
10-K/A
(Amendment No. 1)
10-K
☒
ANNUAL REPORT PURSUANT TO SECTION
 
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended
December 31, 2020
2021
☐
TRANSITION REPORT PURSUANT TO SECTION
 
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 
For the transition period from __ to __
Commission File Number
:
 
001-35236
Orchid Island Capital, Inc.
(Exact name of registrant as specified in its charter)
Maryland
27-3269228
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3305 Flamingo Drive
,
Vero Beach
,
Florida
32963
(Address of principal executive offices) (Zip Code)
 
(
772
)
231-1400
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol:
Name of Each Exchange on Which
Registered
Common Stock, $0.01 par value
ORC
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
☐
 
No
☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
 
Yes
☐
 
No
☒
Indicate by check
 
check mark
whether the
 
registrant (1) has filed
 
filed all
reports required
 
to be filed
 
filed by
Section 13 or
 
15(d) of the
 
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.
 
Yes
☒
 
No
☐
Indicate by check
mark whether the registrant
 
the registrant has submitted electronically every
 
every Interactive Data File required
 
to be submitted pursuant to
 
to Rule 405
of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
 
(ormonths (or for such shorter period that the registrant was required
 
required to submit such
files).
 
Yes
☒
 
No
☐
Indicate by check mark
whether the
registrant is a large accelerated
 
filer, anlarge accelerated filer,
 
an accelerated filer, a
non-accelerated filer, a
 
smaller reporting company or
an emerging growth company.
 
See the definitions of “large accelerated
 
accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth
company” in Rule 12b-2
of the Exchange Act.
 
Large accelerated filer
☐
Accelerated filer
☒
Non-accelerated filer
☐
 
Smaller reporting company
☐
 
 
Emerging growth company
☐
If an emerging growth company,
 
indicate by check mark if the registrant has elected
 
elected not to use the extended transition period
for complying with
any
new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
 
Indicate by check mark
 
mark whether the
registrant has filed
 
filed a report on and
 
attestation to its
management's assessment of
 
of the effectiveness of
 
its internal
control over financial
 
financial reporting
under Section
 
404(b) of the
 
the Sarbanes-Oxley
Act (15
 
U.S.C. 7262(b)) by
 
by the
registered public
 
accounting firm
that
prepared or issued its audit report.
☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
Yes
☐
 
No
☒
 
As of June 30, 20202021 the aggregate market value of the common stock held by nonaffiliates was $
298,895,633
595,104,430
Number of shares outstanding at March 11, 2021:February 25, 2022:
94,321,365
176,993,049
DOCUMENTS INCORPORATED
 
BY REFERENCE:
Portions of the Registrant's definitive
 
definitive Proxy Statement, to be issued
 
issued in connection with the 2021
 
the 2022 Annual Meeting
of Stockholders
of the Registrant, are incorporated by reference
 
into Part III of this Annual Report on Form 10-K.10-K (this “Report”).
EXPLANATORY
ORCHID ISLAND
CAPITAL, INC.
TABLE OF CONTENTS
INDEX
Page
PART I
ITEM 1. Business
2
ITEM 1A.
Risk Factors
12
ITEM 1B.
Unresolved
Staff Comments
43
ITEM 2. Properties
43
ITEM 3. Legal
Proceedings
43
ITEM 4. Mine
Safety Disclosures
43
PART II
ITEM 5. Market
for Registrant's
Common Equity,
Related Stockholder
Matters and
Issuer Purchases
of Equity
Securities
44
ITEM 6. [Reserved]
46
ITEM 7. Management's
Discussion
and Analysis
of Financial
Condition
and Results
of Operations
47
ITEM 7A.
Quantitative
and Qualitative
Disclosures
About Market
Risk
75
ITEM 8. Financial
Statements
and Supplementary
Data
79
ITEM 9. Changes
in and Disagreements
with Accountants
on Accounting
and Financial
Disclosure
105
ITEM 9A.
Controls
and Procedures
105
ITEM 9B.
Other Information
109
ITEM 9C.
Disclosure
Regarding
Foreign Jurisdictions
that Prevent
Inspections
109
PART III
ITEM 10.
Directors,
Executive
Officers and
Corporate
Governance
110
ITEM 11. Executive
Compensation
110
ITEM 12.
Security
Ownership
of Certain
Beneficial
Owners and
Management
and Related
Stockholder
Matters
110
ITEM 13.
Certain Relationships
and Related
Transactions,
and Director
Independence
110
ITEM 14.
Principal
Accountant
Fees and
Services
110
PART IV
ITEM 15.
Exhibits,
Financial
Statement
Schedules
111
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this Report that are subject to risks and uncertainties.
These forward-looking statements
include information about possible or assumed future results of our business, financial
condition, liquidity, results of operations, plans
and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,”
“intend,” “should,” “may,” “plans,” “projects,” “will,”
or similar expressions, or the negative of these words, we intend to identify forward-looking
statements. Statements regarding the
following subjects are forward-looking by their nature:
●
our business and investment strategy;
●
our expected operating results;
●
our ability to acquire investments on attractive terms;
●
the effect of U.S. government actions on interest rates, fiscal policy and the housing and
credit markets;
●
the effect of rising interest rates on inflation, unemployment, and mortgage supply and
demand;
●
the effect of 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 the Federal National Mortgage Association
(“Fannie Mae”) and the Federal Home Loan
Mortgage Corporation (“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;
●
market trends;
●
our ability to make distributions to our stockholders in the future;
●
our understanding of our competition and our ability to compete effectively;
●
our ability to quantify risk based on historical experience;
●
our ability to maintain our qualification as a real estate investment trust (“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;
●
the effect of actual or proposed actions of the U.S. Federal Reserve (the “Fed”), the Federal
Housing Finance Agency (the
“FHFA”), the Federal Open Market Committee (the “FOMC”) and the U.S. Treasury with respect to monetary policy or interest
rates;
●
the ongoing effect of the coronavirus (COVID-19) pandemic and the potential future outbreak
of other highly infectious or
contagious diseases on the Agency RMBS market and on our results of future operations,
financial position, and liquidity;
●
geo-political events, such as the crisis in Ukraine, government responses
to such events and the related impact on the
economy both nationally and internationally;
●
expected capital expenditures;
●
the impact of technology on our operations and business; and
●
the eventual phase-out of the London Interbank Offered Rate (“LIBOR”) index, transition from LIBOR
to an alternative
reference rate and the impact on our LIBOR sensitive assets, liabilities and funding
hedges.
The forward-looking statements are based on our beliefs, assumptions
and expectations of our future performance, taking into
account all information currently available to us. You should not place undue reliance on these forward-looking statements.
These
beliefs, assumptions and expectations can change as a result of many possible events
or factors, not all of which are known to us.
Some of these factors are described under the caption ‘‘Risk Factors’’ in this Report and any subsequent Quarterly
Reports on Form
10-Q.
If a change occurs, our business, financial condition, liquidity and results
of operations may vary materially from those
expressed in our forward-looking statements. Any forward-looking statement speaks only
as of the date on which it is made. New risks
and uncertainties arise from time to time, and it is impossible for us to predict those
events or how they may affect us. Except as
required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as
a result of
new information, future events or otherwise.
 
On February 26, 2021, 2
PART I
ITEM 1. BUSINESS
Our Company
Orchid Island Capital, Inc., a Maryland corporation (“Orchid,” the “Company,” “we” or “us”), is a specialty finance
company that
invests in residential mortgage-backed securities (“RMBS”). The principal and
interest payments of these RMBS are guaranteed by
Fannie Mae, Freddie Mac or the Government National Mortgage Association (“Ginnie
Mae” and, collectively with Fannie Mae and
Freddie Mac, “GSEs”) and are backed primarily by single-family residential mortgage
loans. We refer to these types of RMBS as
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 and collateralized mortgage
obligations (“CMOs”) issued by the
GSEs 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.
Our website is located at
http://ir.orchidislandcapital.com
.
Information on our website is not part of this Report. Our common stock is
listed on the New York Stock Exchange (“NYSE”) and trades
under the symbol “ORC.”
We are organized and conduct our operations to qualify to be taxed as a REIT for U.S.
federal income tax purposes.
As such,
we are required to distribute 90% of our REIT taxable income,
determined without regard to the deductions
for dividends paid and
excluding any net capital gain, annually. We generally will not be subject to U.S. federal income tax on our REIT taxable income to the
extent we currently distribute our net taxable income to our stockholders
and maintain our REIT qualification.
It is our intention to
distribute 100% of our taxable income, after application of available tax attributes, within
the limits prescribed by the Internal Revenue
Code of 1986, as amended (the “Company”“Code”), which may extend into the subsequent
taxable year.
Our Manager
Bimini Capital Management, Inc. (sometimes referred to herein as “Bimini”) filedmanaged
our portfolio from our inception through the
completion of our initial public offering on February 20, 2013.
Upon completion of the offering, we became externally managed by
Bimini Advisors, LLC (“Bimini Advisors,” or our “Manager”) pursuant to a management
agreement. Our Manager is an investment
advisor registered with the Securities and Exchange Commission (“SEC”).
Additionally, our Manager is a Maryland limited liability
company that is a wholly-owned subsidiary of Bimini, which has a long track record
of managing investments in Agency RMBS. Bimini
commenced active investment management operations in 2003, and self-manages its
own portfolio.
We believe our relationship with
our Manager enables us to leverage our Manager’s established
portfolio management resources for each of our targeted asset classes
and its infrastructure supporting those resources.
Additionally, we have benefitted and expect to continue to benefit from our
Manager’s finance and administration functions, which address legal,
compliance, investor relations and operational matters, including
portfolio management, trade allocation and execution, securities valuation, repurchase
agreement trading and clearing, risk
management, cybersecurity, information technologies and environmental, social and governance considerations in connection with the
performance of its duties.
Our Manager is responsible for administering our business activities and day-to-day
operations.
Pursuant to the terms of the
management agreement, our Manager provides us with our management team,
including our officers, along with appropriate support
personnel.
Our Manager is at all times subject to the supervision and oversight of our board
of directors (the “Board of Directors”) and
has only such functions and authority as we delegate to it.
Our Investment and Capital Allocation Strategy
Investment Strategy
3
Our business objective is to provide attractive risk-adjusted total returns to our investors
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 pass-through Agency RMBS and structured
Agency RMBS. We seek to generate income
from (i) the net interest margin on our leveraged pass-through Agency 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 also seek to minimize the volatility of both the net asset value of, and
income from, our portfolio through a process which
emphasizes capital allocation, asset selection, liquidity and active interest rate
risk management.
We fund our pass-through Agency RMBS and certain of our structured Agency RMBS through
repurchase agreements.
However, we generally do not employ leverage on our structured Agency RMBS that have no principal
balance, such as IOs and IIOs,
because those securities contain structural leverage. We may pledge a portion of these assets to
increase our cash balance, but we do
not intend to invest the cash derived from pledging the assets.
Our target asset categories and principal assets in which we intend to
invest are as follows:
Pass-through Agency RMBS
We invest in pass-through securities, which are securities secured by residential real property
in which payments of both interest
and principal on the securities are generally made monthly. In effect, these securities pass through the monthly payments
made by the
individual borrowers on the mortgage loans that underlie the securities, net of fees
paid to the loan servicer and the guarantor of the
securities. Pass-through certificates can be divided into various categories
based on the characteristics of the underlying mortgages,
such as the term or whether the interest rate is fixed or variable.
The payment of principal and interest on mortgage pass-through securities
issued by Ginnie Mae, but not the market value, is
guaranteed by the full faith and credit of the federal government. Payment of
principal and interest on mortgage pass-through
certificates issued by Fannie Mae and Freddie Mac, but not the market value,
is guaranteed by the respective agency issuing the
security.
A key feature of most mortgage loans is the ability of the borrower to repay principal
earlier than scheduled. This is called a
prepayment. Prepayments arise primarily due to sale of the underlying property, refinancing, foreclosure, or accelerated
amortization
by the borrower. Prepayments result in a return of principal to pass-through certificate holders. This may result
in a lower or higher rate
of return upon reinvestment of principal. This is generally referred to as
prepayment uncertainty. If a security purchased at a premium
prepays at a higher-than-expected rate, then the value of the premium would
be eroded at a faster-than-expected rate. Similarly, if a
discount mortgage prepays at a lower-than-expected rate, the amortization towards
par would be accumulated at a slower-than-
expected rate. The possibility of these undesirable effects is sometimes referred to as “prepayment
risk.”
In general, declining interest rates tend to increase prepayments, and
rising interest rates tend to slow prepayments. Like other
fixed-income securities, when interest rates rise, the value of Agency RMBS
generally declines. The rate of prepayments on underlying
mortgages will affect the price and volatility of Agency RMBS and may shorten or
extend the effective maturity of the security beyond
what was anticipated at the time of purchase. If interest rates rise, our holdings
of Agency RMBS may experience reduced spreads
over our funding costs if the borrowers of the underlying mortgages pay off their mortgages
later than anticipated. This is generally
referred to as “extension risk.”
We may also invest in To-Be-Announced Forward Contracts ("TBAs"). A TBA security is a forward contract for the purchase or
sale of Agency RMBS at a predetermined price, face amount, issuer, coupon and stated maturity on an agreed-upon future
date. The
specific Agency RMBS to be delivered into the contract are not known until
shortly before the settlement date. We may choose, prior to
settlement, to move the settlement of these securities out to a later date by
entering into an offsetting TBA position, net settling the
offsetting positions for cash, and simultaneously purchasing or selling a similar TBA
contract for a later settlement date (together
4
referred to as a "dollar roll transaction"). The Agency RMBS purchased or sold
for a forward settlement date are typically priced at a
discount to equivalent securities settling in the current month. This difference, or
"price drop," is the economic equivalent of interest
income on the underlying Agency RMBS, less an implied funding cost, over the forward
settlement period (referred to as "dollar roll
income"). Consequently, forward purchases of Agency RMBS and dollar roll transactions represent a form of off-balance sheet
financing. These TBAs are accounted for as derivatives and marked to market
through the income statement and are not included in
interest income.
The mortgage loans underlying pass-through certificates can generally be classified
into the following categories:
●
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”) are also common. 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
. Adjustable-Rate Mortgages (“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.
Collateral Mortgage Obligation RMBS
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 pools 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 RMBS 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.
Structured Agency RMBS
We also invest in structured Agency RMBS, which include IOs, IIOs and POs. The payment
of principal and interest, as
appropriate, on structured Agency RMBS issued by Ginnie Mae, but not the
market value, is guaranteed by the full faith and credit of
the federal government. Payment of principal and interest, as appropriate,
on structured Agency RMBS issued by Fannie Mae and
Freddie Mac, but not the market value, is guaranteed by the respective
agency issuing the security. The types of structured Agency
RMBS in which we invest are described below.
5
●
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 that
underlie RMBS, 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, the coupon interest rate (i.e. 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.
Our investment strategy consists of the following components:
●
investing in pass-through Agency RMBS and certain structured Agency RMBS 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 TBAs;
●
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.
6
We rely on our Manager’s expertise in identifying assets within our target
asset class.
Our Manager makes investment
decisions based on various factors, including, but not limited to, relative value,
expected cash yield, supply and demand, costs of
hedging, costs of financing, liquidity requirements, expected future interest rate
volatility and the overall shape of the U.S. Treasury and
interest rate swap yield curves. We do not attribute any particular quantitative significance
to any of these factors, and the weight we
give to these factors depends on market conditions and economic trends.
Over time, we will modify our investment strategy as market conditions
change to seek to maximize the returns from our
investment portfolio.
We believe that this strategy, combined with our Manager’s experience, will enable us to provide attractive long-
term returns to our stockholders.
Capital Allocation Strategy
The percentage of capital invested in our two asset categories will vary
and will be 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. Long positions in TBAs are considered a component of the pass-through
Agency RMBS category. Typically,
pass-through
Agency RMBS and structured Agency RMBS exhibit materially different sensitivities
to movements in interest rates. Declines in the
value of one portfolio may be offset by appreciation in the other, although we cannot assure you that this will be the
case. Additionally,
our Manager will seek to maintain adequate liquidity as it allocates capital.
We allocate our capital to assist our interest rate risk management efforts. The unleveraged portfolio does
not require
unencumbered cash or cash equivalents to be maintained in anticipation of possible
margin calls. To the extent more capital is
deployed in the unleveraged portfolio, our liquidity needs will generally be
less.
During periods of rising interest rates, refinancing opportunities available to borrowers typically
decrease because borrowers are
not able to refinance their current mortgage loans with new mortgage loans at
lower interest rates. In such instances, securities that are
highly sensitive to refinancing activity, such as IOs and IIOs, typically increase in value. Our capital allocation strategy allows us to
redeploy our capital into such securities when and if we believe interest rates will be
higher in the future, thereby allowing us to hold
securities, the value of which we believe is likely to increase as interest rates rise.
Also, by being able to re-allocate capital into
structured Agency RMBS, such as IOs, during periods of rising interest rates, we may
be able to offset the likely decline in the value of
our pass-through Agency RMBS, which are negatively impacted by rising interest
rates.
We intend to operate in a manner that will not subject us to regulation under the Investment
Company Act. In order to rely on the
exemption provided by Section 3(c)(5)(C) under the Investment Company
Act, we must maintain at least 55% of our assets in
qualifying real estate assets. For purposes of this test, structured Agency RMBS are
non-qualifying real estate assets. Accordingly,
while we have no explicit limitation on the amount of our capital that we will
deploy to the unleveraged structured Agency RMBS
portfolio, we will deploy our capital in such a way so as to maintain our exemption
from registration under the Investment Company Act.
Financing Strategy
We borrow against our Agency RMBS using short term repurchase agreements. A
repurchase (or "repo") agreement transaction
acts as a financing arrangement under which we effectively pledge our investment
securities as collateral to secure a loan. Our
borrowings through repurchase transactions are generally short-term and have maturities
ranging from one day to one year but may
have maturities up to five or more years. Our financing rates are typically impacted
by the U.S. Federal Funds rate and other short-term
benchmark rates and liquidity in the Agency RMBS repo and other short-term funding
markets.
The terms of our master repurchase
agreements generally conform to the terms in the standard master repurchase
agreement as published by the Securities Industry and
Financial Markets Association ("SIFMA") as to repayment, margin requirements
and the segregation of all securities sold under the
repurchase transaction. In addition, each lender may require that we include
supplemental terms and conditions to the standard master
repurchase agreement to address such matters as additional margin
maintenance requirements, cross default and other provisions.
7
The specific provisions may differ for each lender and certain terms may not be determined
until we engage in individual repurchase
transactions.
We may use other sources of leverage, such as secured or unsecured debt or issuances
of preferred stock. We do not have a
policy limiting the amount of leverage we may incur. However, we generally expect that the ratio of our total liabilities compared to our
equity, which we refer to as our leverage ratio, will be less than 12 to 1. Our amount of leverage may vary depending on
market
conditions and other factors that we deem relevant.
We allocate our capital between two sub-portfolios. The pass-through Agency RMBS
portfolio will be leveraged generally through
repurchase agreement funding. The structured Agency RMBS portfolio generally
will not be leveraged. The leverage ratio is calculated
by dividing our total liabilities by total stockholders’ equity at the end of each
period. Long positions in TBAs are considered a
component of the pass-through Agency RMBS category. While there is no explicit leverage applied to TBAs via repurchase
agreement
borrowings, as is the case with pass-through securities, to accurately reflect
our reported leverage ratio, we calculate our leverage both
with and without the market value of the net futures contract as a component
of our total leverage exposure for purposes of reporting
our leverage ratio and other risk metrics. We include our net TBA position in our measure
of leverage because a forward contract to
acquire Agency RMBS in the TBA market carries similar risks to Agency RMBS
purchased in the cash market and funded with on-
balance sheet liabilities. Similarly, a TBA contract for the forward sale of Agency RMBS has substantially the same effect as selling the
underlying Agency RMBS and reducing our on-balance sheet funding commitments.
The amount of leverage typically will be a function of the capital allocated to the
pass-through Agency RMBS portfolio and the
amount of haircuts required by our lenders on our borrowings. When the capital allocation
to the pass-through Agency RMBS portfolio
is high, we expect that the leverage ratio will be high because more capital is
being explicitly leveraged and less capital is un-
leveraged. If the haircuts, which are a percentage of the market value of the collateral
pledged, required by our lenders on our
borrowings are higher, all else being equal, our leverage will be lower because our lenders will lend less against the
value of the capital
deployed to the pass-through Agency RMBS portfolio. The allocation of capital
between the two portfolios will be a function of several
factors:
●
The relative durations of the respective portfolios — We generally seek to have a combined
hedged duration at or near zero. If
our pass-through securities have a longer duration, we will allocate more
capital to the structured security portfolio or hedges
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 and subject to
maintaining our qualification for exemption
under the Investment Company Act.
●
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 typically 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.
Risk Management
We invest in Agency RMBS to mitigate credit risk. Additionally, our Agency RMBS are backed by a diversified base of mortgage
loans to mitigate geographic, loan originator and other types of concentration risks.
Interest Rate Risk Management
8
We believe that the risk of adverse interest rate movements represents the most significant
risk to our portfolio. This risk arises
because (i) the interest rate indices used to calculate the interest rates on the
mortgages underlying our assets may be different from
the interest rate indices used to calculate the interest rates on the related borrowings
and (ii) interest rate movements affecting our
borrowings may not be reasonably correlated with interest rate movements affecting our assets.
We attempt to mitigate our interest
rate risk by using the techniques described below:
Agency RMBS Backed by ARMs
. We seek to minimize the differences between interest rate indices and interest rate adjustment
periods of our Agency RMBS backed by ARMs and related borrowings.
At the time of funding, we typically align (i) the underlying
interest rate index used to calculate interest rates for our Agency RMBS backed
by ARMs and the related borrowings and (ii) the
interest rate adjustment periods for our Agency RMBS backed by ARMs and the
interest rate adjustment periods for our related
borrowings. As our borrowings mature or are renewed, we may adjust the index
used to calculate interest expense, the duration of the
reset periods and the maturities of our borrowings.
Agency RMBS Backed by Fixed-Rate Mortgages
. As interest rates rise, our borrowing costs increase; however, the income on our
Agency RMBS backed by fixed-rate mortgages remains unchanged. Subject
to qualifying and maintaining our qualification as a REIT,
we may seek to limit increases to our borrowing costs through the use of interest rate
swap or cap agreements, options, put or call
agreements, futures contracts, forward rate agreements or similar financial instruments
to economically convert our floating-rate
borrowings into fixed-rate borrowings.
Agency RMBS Backed by Hybrid ARMs
. During the fixed-rate period of our Agency RMBS backed by
hybrid ARMs, the security is
similar to Agency RMBS backed by fixed-rate mortgages. During this period,
subject to qualifying and maintaining our qualification as a
REIT, we may employ the same hedging strategy that we employ for our Agency RMBS backed by fixed-rate mortgages. Once our
Agency RMBS backed by hybrid ARMs convert to floating rate securities, we may employ
the same hedging strategy as we employ for
our Agency RMBS backed by ARMs.
Derivative Instruments.
We enter into derivative instruments to economically hedge against
the possibility that rising rates may
adversely impact the cost of our repurchase agreement liabilities.
The principal
instruments
that the
Company has
used to date
are
Treasury Note
(“T-Note”),
Fed Funds
and Eurodollar
futures contracts,
interest rate
swaps, options
to enter
in interest
rate swaps
(“interest
rate swaptions”)
and TBA
securities
transactions,
but the Company
may enter
into other
derivatives
in the future.
A futures contract is a legally binding agreement to buy or sell a financial instrument
in a designated future month at a price agreed
upon at the
initiation of the contract by the buyer and seller.
A futures contract differs from an option in that an option gives one of the
counterparties a right, but not the obligation, to buy or sell, while a futures contract represents
an obligation of both counterparties to
buy or sell a financial instrument at a specified price.
We engage in interest rate swaps as a means of managing our interest rate risk on forecasted
interest expense associated with
repurchase agreement borrowings for the term of the swap contract.
An interest rate swap is a contractual agreement entered into
by
two counterparties, under which each agrees to make periodic interest payments to
the other (one pays a fixed rate of interest, while
the other pays a floating rate of interest) for an agreed period of time based upon
a notional amount of principal.
Interest rate swaptions provide us the option to enter into an interest rate
swap agreement for a predetermined notional amount,
stated term and pay and receive interest rates in the future. We may enter into swaption agreements
that provide us the option to enter
into a pay fixed rate interest rate swap ("payer swaptions"), or swaption
agreements that provide us the option to enter into a receive
fixed interest rate swap ("receiver swaptions").
Additionally, our structured Agency RMBS generally exhibit sensitivities to movements in interest rates different than our pass-
through Agency RMBS. To the extent they do so, our structured Agency RMBS may protect us against declines in the market value of
our combined portfolio that result from adverse interest rate movements, although we
cannot assure you that this will be the case.
9
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.
Prepayment Risk Management
The risk of mortgage prepayments is another significant risk to our portfolio.
When prevailing interest rates fall below the current
interest rate of a mortgage, mortgage prepayments are likely to increase.
Conversely, when prevailing interest rates increase above the
coupon rate of a mortgage, mortgage prepayments are likely to decrease.
When prepayment rates increase, we may not be able to reinvest the money received
from prepayments at yields comparable to
those of the securities prepaid. Additionally, some of our structured Agency RMBS, such as IOs and IIOs, may be negatively
affected
by an increase in prepayment rates because their value is wholly contingent
on the underlying mortgage loans having an outstanding
principal balance.
A decrease in prepayment rates may also have an adverse effect on our portfolio. For example,
if we invest in POs, the purchase
price of such securities will be based, in part, on an assumed level of prepayments
on the underlying mortgage loan. Because the
returns on POs decrease the longer it takes the principal payments on the underlying
loans to be paid, a decrease in prepayment rates
could decrease our returns on these securities.
Prepayment risk also affects our hedging activities. When an Agency RMBS backed by
a fixed-rate mortgage or hybrid ARM is
acquired with borrowings, we may cap or fix our borrowing costs for a period
close to the anticipated average life of the fixed-rate
portion of the related Agency RMBS. If prepayment rates are different than our projections,
the term of the related hedging instrument
may not match the fixed-rate portion of the security, which could cause us to incur losses.
Because our business may be adversely affected if prepayment rates are different than our
projections, we seek to invest in
Agency RMBS backed by mortgages with well-documented and predictable prepayment
histories. To protect against increases in
prepayment rates, we invest in Agency RMBS backed by mortgages that we believe
are less likely to be prepaid. For example, we
invest in Agency RMBS backed by mortgages (i) with loan balances low enough
such that a borrower would likely have little incentive
to refinance, (ii) extended to borrowers with credit histories weak enough to not
be eligible to refinance their mortgage loans, (iii) that
are newly originated fixed-rate or hybrid ARMs or (iv) that have interest rates low
enough such that a borrower would likely have little
incentive to refinance. To protect against decreases in prepayment rates, we may also invest in Agency RMBS backed by mortgages
with characteristics opposite to those described above, which would typically
be more likely to be refinanced. We may also invest in
certain types of structured Agency RMBS as a means of mitigating our portfolio-wide
prepayment risks. For example, certain tranches
of CMOs are less sensitive to increases in prepayment rates, and we
may invest in those tranches as a means of hedging against
increases in prepayment rates.
Liquidity Management Strategy
Because of our use of leverage, we manage liquidity to meet our lenders’ margin
calls by maintaining cash balances or
unencumbered assets well in excess of anticipated margin calls and making
margin calls on our lenders when we have an excess of
collateral pledged against our borrowings.
We also attempt to minimize the number of margin calls we receive by:
●
Deploying capital from our leveraged Agency RMBS portfolio to our unleveraged
Agency RMBS portfolio;
●
Investing in TBAs in lieu of leveraged Agency RMBS to reduce margin calls from
our lenders associated with monthly
prepayments;
10
●
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 result in margin calls by lenders; and
●
Reducing our overall amount of leverage.
To the
extent we are unable to adequately manage our interest rate exposure and
are subjected to substantial margin calls, we
may be forced to sell assets at an inopportune time, which in turn could impair
our liquidity and reduce our borrowing capacity and book
value.
Tax Structure
We have elected to be taxed as a REIT for U.S. federal income tax purposes. Our qualification
as a REIT, and the maintenance
of such qualification, will depend upon our ability to meet, on a continuing basis,
various complex requirements under the Code relating
to, among other things, the sources of our gross income, the composition and
values of our assets, our distribution levels and the
concentration of ownership of our capital stock. We believe that we have been organized
and have operated in conformity with the
requirements for qualification and taxation as a REIT under the Code, and
we intend to continue to operate in a manner that will enable
us to continue to meet the requirements for qualification and taxation as a REIT.
As a REIT, we generally will not be subject to U.S. federal income tax on the REIT taxable income that we currently distribute to
our stockholders.
Taxable income generated by any taxable REIT subsidiary (“TRS”) that we may form or acquire will be subject to
U.S. federal, state and local income tax. Under the Code, REITs are subject to numerous organizational and operational requirements,
including a requirement that they distribute annually at least 90% of their REIT
taxable income, determined without regard to the
deductions for dividends paid and excluding any net capital gains. If we fail to qualify
as a REIT in any calendar year and do not qualify
for certain statutory relief provisions, our income would be subject to U.S.
federal income tax, and we would likely be precluded from
qualifying for treatment as a REIT until the fifth calendar year following the
year in which we failed to qualify. Even if we continue to
qualify as a REIT, we may still be subject to certain U.S. federal, state and local taxes on our income and assets and to U.S. federal
income and excise taxes on our undistributed income.
Investment Company Act Exemption
We operate our business so that we are exempt from registration under the Investment Company
Act. We rely on the exemption
provided by Section 3(c)(5)(C) of the Investment Company Act, which applies
to companies in the business of purchasing or otherwise
acquiring mortgages and other liens on, and interests in, real estate. In order to
rely on the exemption provided by Section 3(c)(5)(C),
we must maintain at least 55% of our assets in qualifying real estate assets. For
the purposes of this test, structured Agency RMBS are
non-qualifying real estate assets. We monitor our portfolio continuously and prior to each
investment to confirm that we continue to
qualify for the exemption. To qualify for the exemption, we make investments so that at least 55% of the assets we own consist of
qualifying mortgages and other liens on and interests in real estate, which we
refer to as qualifying real estate assets, and so that at
least 80% of the assets we own consist of real estate-related assets, including
our qualifying real estate assets.
We treat whole-pool pass-through Agency RMBS as qualifying real estate assets based
on no-action letters issued by the staff of
the SEC. In August 2011, the SEC, through a concept release, requested comments on interpretations of Section 3(c)(5)(C).
To the
extent that the SEC or its staff publishes new or different guidance with respect to these matters, we may
fail to qualify for this
exemption. Our Manager manages our pass-through Agency RMBS portfolio such that
we have sufficient whole-pool pass-through
Agency RMBS to ensure we maintain our exemption from registration under the
Investment Company Act. At present, we generally do
not expect that our investments in structured Agency RMBS will constitute qualifying
real estate assets,
but will constitute real estate-
related assets for purposes of the Investment Company Act.
11
Employees and Human Capital Resources
We have no employees.
We are externally managed and advised by our Manager pursuant to a management
agreement as
discussed below.
Competition
Our net income largely depends on our ability to acquire Agency RMBS at favorable
spreads over our borrowing costs.
When we
invest in Agency RMBS and other investment assets, we compete with a variety
of institutional investors, including other REITs,
insurance companies, mutual funds, pension funds, investment banking firms, banks
and other financial institutions that invest in the
same types of assets, the Federal Reserve Bank and other governmental entities
or government-sponsored entities. Many of these
investors have greater financial resources and access to lower costs of capital
than we do. The existence of these competitive entities,
as well as the possibility of additional entities forming in the future, may increase
the competition for the acquisition of mortgage related
securities, resulting in higher prices and lower yields on assets.
Distributions
To maintain our qualification as a REIT,
we must distribute at least 90% of our REIT taxable income, determined without
regard to
the deductions for dividends paid and excluding net capital gains, to our stockholders each
year.
We plan to continue to declare and
pay regular monthly dividends to our stockholders.
Available Information
Our investor relations website is www.orchidislandcapital.com.
We make available on the website under “Financials/SEC filings,"
free of charge, our annual report on Form 10-K, for the fiscal year ended
December 31, 2020 (“2020 Form 10-K”). The Company is filing this Amendment No. 1our quarterly reports on Form 10-K/A (“Amendment No. 1”) solely10-Q,
our current reports on Form 8-K and any other
reports (including any amendments to such reports) as soon as reasonably practicable
after we electronically file or furnish such
materials to the SEC. Information on our website, however, is not part of this Report.
In addition, all of our filed reports can be obtained
at the SEC’s website at http://www.sec.gov.
12
ITEM 1A.
RISK FACTORS
Summary of Risk Factors
Below is a summary of the principal factors that make an investment in our common
stock speculative or risky. This summary
does not address all of the risks that we face. Additional discussion of the risks
summarized in this risk factor summary, and
other risks
that we face, can be found below under the heading “Risk Factors” and should
be carefully considered, together with other information
in this Report and our other filings with the SEC, before making an investment
decision regarding our common stock.
●
Increases in interest rates may negatively affect the value of our investments and increase
the cost of our borrowings, which could
result in reduced earnings or losses and materially adversely affect our ability to
pay distributions to our stockholders.
●
An increase in interest rates may also cause a decrease in the volume of
newly issued, or investor demand for, Agency RMBS,
which could materially adversely affect our ability to acquire assets that satisfy our investment
objectives and our business,
financial condition and results of operations and our ability to pay distributions
to our stockholders.
●
Interest rate mismatches between our Agency RMBS and our borrowings may
reduce our net interest margin during periods of
changing interest rates, which could materially adversely affect our business, financial condition
and results of operations and our
ability to pay distributions to our stockholders.
●
Although structured Agency RMBS are generally subject to the same risks
as our pass-through Agency RMBS, certain types of
risks may be enhanced depending on the type of structured Agency RMBS
in which we invest.
●
Differences in the stated maturity of our fixed rate assets, or in the timing of interest
rate adjustments on our adjustable-rate
assets, and our borrowings may adversely affect our profitability.
●
Changes in the levels of prepayments on the mortgages underlying our Agency RMBS
might decrease net interest income or
result in a net loss, which could materially adversely affect our business, financial condition
and results of operations and our
ability to pay distributions to our stockholders.
●
Interest rate caps on the ARMs and hybrid ARMs backing our Agency RMBS
may reduce our net interest margin during periods of
rising interest rates, which could materially adversely affect our business, financial condition
and results of operations and our
ability to pay distributions to our stockholders.
●
Volatile market conditions for mortgages and mortgage-related assets as well as the broader financial markets
can result in a
significant contraction in liquidity for mortgages and mortgage-related assets, which
may adversely affect the value of the assets in
which we invest.
●
Failure to procure adequate repurchase agreement financing, or to renew
or replace existing repurchase agreement financing as it
matures, could materially adversely affect our business, financial condition and results of operations
and our ability to make
distributions to our stockholders.
●
Adverse market developments could cause our lenders to require us to pledge
additional assets as collateral. If our assets were
insufficient to meet these collateral requirements, we might be compelled to liquidate particular
assets at inopportune times and at
unfavorable prices, which could materially adversely affect our business, financial condition
and results of operations and our
ability to pay distributions to our stockholders.
●
Hedging against interest rate exposure may not completely insulate us from
interest rate risk and could materially adversely affect
our business, financial condition and results of operations and our ability to pay distributions
to our stockholders.
●
Our use of leverage could materially adversely affect our business, financial condition
and results of operations and our ability to
correct typographical errorspay distributions to our stockholders.
●
It may be uneconomical to "roll" our TBA dollar roll transactions or we may be
unable to meet margin calls on our TBA contracts,
which could negatively affect our financial condition and results of operations.
●
Our forward settling transactions, including TBA transactions, subject us to
certain risks, including price risks and counterparty
risks.
●
We rely on analytical models and other data to analyze potential asset acquisition and disposition
opportunities and to manage our
portfolio. Such models and other data may be incorrect, misleading or incomplete, which
could cause us to purchase assets that resulted during
do not meet our expectations or to make asset management decisions that are not
in line with our strategy.
13
●
Valuations of some of our assets are inherently uncertain, may be based on estimates, may fluctuate over short periods
of time
and may differ from the creationvalues that would have been used if a ready market for these assets
existed. As a result, the values of
some of our assets are uncertain.
●
If our lenders default on their obligations to resell the Agency RMBS back to us at
the end of the EDGAR versionrepurchase transaction term, if the
value of the 2020 Form 10-K. These typographical errors
are limited to correctingAgency RMBS has declined by the numberingend of the notes repurchase transaction
term or if we default on our obligations under the
repurchase transaction, we will lose money on these transactions, which,
in turn, may materially adversely affect our business,
financial condition and results of operations and our ability to pay distributions
to our stockholders.
●
Clearing facilities or exchanges upon which some of our hedging instruments
are traded may increase margin requirements on our
hedging instruments in the event of adverse economic developments.
●
We may change our investment strategy, investment guidelines and asset allocation without notice or stockholder consent, which
may result in riskier investments.
●
A prolonged economic slowdown, a lengthy or severe recession or declining real estate
values could impair our investments and
harm our operations.
●
New laws may be passed affecting the relationship between Fannie Mae and Freddie Mac,
on the one hand, and the federal
government, on the other, which could adversely affect the price of, or our ability to invest in and finance, Agency RMBS.
●
The management agreement with our Manager was not negotiated on an
arm’s-length basis and the terms, including fees payable
and our inability to terminate, or our election not to renew, the management agreement based on our Manager’s
poor performance
without paying our Manager a significant termination fee, except for a termination
of the Manager with cause, may not be as
favorable to us as if it were negotiated with an unaffiliated third party.
●
We have no employees, and our Manager is responsible for making all of our investment decisions.
None of our or our Manager’s
officers are required to devote any specific amount of time to our business, and each of them
may provide their services to Bimini,
which could result in conflicts of interest.
●
We are completely dependent upon our Manager and certain key personnel of Bimini who provide
services to us through the
management agreement, and we may not find suitable replacements for our
Manager and these personnel if the management
agreement is terminated or such key personnel are no longer available to us.
●
If we elect to not renew the management agreement without cause, we would
be required to pay our Manager a substantial
termination fee. These and other provisions in our management agreement
make non-renewal of our management agreement
difficult and costly.
●
We have not established a minimum distribution payment level, and we cannot assure
you of our ability to make distributions to
our stockholders in the future.
●
Loss of our exemption from regulation under the Investment Company Act would negatively
affect the value of shares of our
common stock and our ability to pay distributions to our stockholders.
●
Failure to obtain and maintain an exemption from being regulated as a commodity
pool operator could subject us to additional
regulation and compliance requirements and may result in fines and other penalties
which could materially adversely affect our
business and financial condition.
●
Our ownership limitations and certain other provisions of applicable law
and our charter and bylaws may restrict business
combination opportunities that would otherwise be favorable to our stockholders.
●
Our failure to maintain our qualification as a REIT would subject us to U.S. federal
income tax, which could adversely affect the
value of the shares of our common stock and would substantially reduce the
cash available for distribution to our stockholders.
●
We cannot predict the effect that government policies, laws and plans adopted in response
to the financial statements included in Item 8.COVID-19 pandemic and the
global recessionary economic conditions will have on us.
Except asRisk Factors
You should carefully consider the risks described above, no changes have been made to the 2020 Form 10-K,below and this Amendment No. 1 does not modify,
amend or update in any way any of the financial orall other information contained in this Report, including our annual
financial statements and related notes thereto, before making an investment decision
regarding our common stock. Our business,
financial condition or results of operations could be harmed by any of these risks.
Similarly, these risks could cause the market price of
our common stock to decline and you might lose all or part of your investment.
Our forward-looking statements in this Report are
14
subject to the following risks and uncertainties. Our actual results could differ materially from
those anticipated by our forward-looking
statements as a result of the risk factors below.
Risks Related to Our Business
Increases in interest rates may negatively affect the value of our investments and increase
the cost of our borrowings, which
could result in reduced earnings or losses and materially adversely affect our ability to pay
distributions to our stockholders.
Under normal market conditions,
an investment in Agency RMBS will decline in value if interest rates increase.
In addition, net
interest income could decrease if the yield curve becomes inverted or flat. While
Fannie Mae, Freddie Mac or Ginnie Mae guarantee
the principal and interest payments related to the Agency RMBS we
own, this guarantee does not protect us from declines in market
value caused by changes in interest rates. Declines in the market value of our investments
may ultimately result in losses to us, which
may reduce earnings and negatively affect our ability to pay distributions to our stockholders.
Significant increases in both long-term and short-term interest rates pose a substantial
risk associated with our investment in
Agency RMBS. If long-term rates were to increase significantly, the market value of our Agency RMBS would decline, and
the duration
and weighted average life of the investments would increase. We could realize a loss
if the securities were sold. At the same time, an
increase in short-term interest rates would increase the amount of interest
owed on our repurchase agreements used to finance the
purchase of Agency RMBS, which would decrease cash available for distribution
to our stockholders. Using this business model, we
are particularly susceptible to the effects of an inverted yield curve, where short-term rates
are higher than long-term rates. Although
rare in a historical context, the U.S. and many countries in Europe have experienced
inverted yield curves. Given the volatile nature of
the U.S. economy and potential future increases in short-term interest rates, there can
be no guarantee that the yield curve will not
become and/or remain inverted. If this occurs, it could result in a decline in the
value of our Agency RMBS, our business, financial
position and results of operations and our ability to pay distributions to our stockholders
could be materially adversely affected.
An increase in interest rates may also cause a decrease in the volume of
newly issued, or investor demand for, Agency RMBS,
which could materially adversely affect our ability to acquire assets that satisfy our investment
objectives and our business,
financial condition and results of operations and our ability to pay distributions
to our stockholders.
Rising interest rates generally reduce the demand for consumer credit, including
mortgage loans, due to the higher cost of
borrowing. A reduction in the volume of mortgage loans may affect the volume
of Agency RMBS available to us, which could affect our
ability to acquire assets that satisfy our investment objectives. Rising interest rates
may also cause Agency RMBS that were issued
prior to an interest rate increase to provide yields that exceed prevailing market interest
rates. If rising interest rates cause us to be
unable to acquire a sufficient volume of Agency RMBS or Agency RMBS with a yield that exceeds
our borrowing costs, our ability to
satisfy our investment objectives and to generate income and pay dividends,
our business, financial condition and results of operations,
and our ability to pay distributions to our stockholders may be materially adversely affected.
Interest rate mismatches between our Agency RMBS and our borrowings may
reduce our net interest margin during periods of
changing interest rates, which could materially adversely affect our business, financial condition
and results of operations and our
ability to pay distributions to our stockholders.
Our portfolio includes Agency RMBS backed by ARMs, hybrid ARMs and
fixed-rate mortgages, and the mix of these securities in
the portfolio may be increased or decreased over time. Additionally, the interest rates on ARMs and hybrid ARMs may vary
over time
based on changes in a short-term interest rate index, of which there are many.
We finance our acquisitions of pass-through Agency RMBS with short-term financing. During
periods of rising short-term interest
rates, the income we earn on these securities will not change (with respect to Agency
RMBS backed by fixed-rate mortgage loans) or
15
will not increase at the same rate (with respect to Agency RMBS backed by ARMs and
hybrid ARMs) as our related financing costs,
which may reduce our net interest margin or result in losses.
We invest in structured Agency RMBS, including IOs, IIOs and POs. Although structured Agency RMBS
are generally subject to
the same risks as our pass-through Agency RMBS, certain types of risks
may be enhanced depending on the type of structured
Agency RMBS in which we invest.
The structured Agency RMBS in which we invest are securitizations (i)
issued by Fannie Mae, Freddie Mac or Ginnie Mae, (ii)
collateralized by Agency RMBS and (iii) divided into various tranches that have
different characteristics (such as different maturities or
different coupon payments). These securities may carry greater risk than an investment
in pass-through Agency RMBS. For example,
certain types of structured Agency RMBS, such as IOs, IIOs and POs, are more sensitive
to prepayment risks than pass-through
Agency RMBS. If we were to invest in structured Agency RMBS that were
more sensitive to prepayment risks relative to other types of
structured Agency RMBS or pass-through Agency RMBS, we may increase our
portfolio-wide prepayment risk.
Differences in the stated maturity of our fixed rate assets, or in the timing of interest rate adjustments
on our adjustable-rate
assets, and our borrowings may adversely affect our profitability.
We rely primarily on short-term and/or variable rate borrowings to acquire fixed-rate securities with
long-term maturities. In
addition, we may have adjustable-rate assets with interest rates that vary
over time based upon changes in an objective index, such as
LIBOR, the U.S. Treasury rate or the Secured Overnight Financing Rate (“SOFR”).
These indices generally reflect short-term interest
rates but these assets may not reset in a manner that matches our borrowings.
The relationship between short-term and longer-term interest rates is often
referred to as the "yield curve." Ordinarily, short-term
interest rates are lower than longer-term interest rates. If short-term interest rates rise
disproportionately relative to longer-term interest
rates (a "flattening" of the yield curve), our borrowing costs may increase more rapidly
than the interest income earned on our assets.
Because our investments generally bear interest at longer-term rates than we pay on
our borrowings, a flattening of the yield curve
would tend to decrease our net interest income and the market value
of our investment portfolio. Additionally, to the extent cash flows
from investments that return scheduled and unscheduled principal are reinvested,
the spread between the yields on the new
investments and available borrowing rates may decline, which would likely decrease
our net income. It is also possible that short-term
interest rates may exceed longer-term interest rates (a yield curve "inversion"),
in which event our borrowing costs may exceed our
interest income and result in operating losses.
Purchases and sales of Agency RMBS by the Fed may adversely affect the price and return associated
with Agency RMBS.
The Fed owns approximately $2.6 trillion of Agency RMBS as of December 31,
2021. Although the Fed’s Agency RMBS holdings
nearly doubled as a result of its COVID-19 policy response, growing from $1.4 trillion
in March of 2020 Form 10-K.to $2.6 trillion in December of
2021, the minutes of the FOMC meeting in December of 2021 indicate that the
Fed likely intends to begin reducing its Agency RMBS
holdings shortly after it begins to raise the federal funds rate.
On January 26, 2022, the FOMC reaffirmed its intention to phase out its
net asset purchases by early March of 2022 and indicated that it would soon be
appropriate to begin raising the federal funds rate.
While it is very difficult to predict the impact of the Fed portfolio runoff on the prices and liquidity of Agency
RMBS, returns on Agency
RMBS may be adversely affected.
Increased levels of prepayments on the mortgages underlying our Agency RMBS
might decrease net interest income or result in
a net loss, which could materially adversely affect our business, financial condition and results
of operations and our ability to pay
distributions to our stockholders.
In the case of residential mortgages, there are seldom any restrictions on borrowers’
ability to prepay their loans. Prepayment
rates generally increase when interest rates fall and decrease when interest rates
rise. Prepayment rates also may be affected by other
16
factors, including, without limitation, conditions in the housing and financial markets,
governmental action, general economic conditions
and the relative interest rates on ARMs, hybrid ARMs and fixed-rate mortgage loans. With
respect to pass-through Agency RMBS,
faster-than-expected prepayments could also materially adversely affect our business,
financial condition and results of operations and
our ability to pay distributions to our stockholders in various ways, including the
following:
●
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.
When we acquire structured Agency RMBS, we anticipate that the underlying
mortgages will prepay at a projected rate,
generating an expected yield. When the prepayment rates on the mortgages
underlying our structured Agency RMBS are higher than
expected, our returns on those securities may be materially adversely affected. For example,
the value of our IOs and IIOs are
extremely sensitive to prepayments because holders of these securities do
not have the right to receive any principal payments on the
underlying mortgages. Therefore, if the mortgage loans underlying our IOs and
IIOs are prepaid, such securities would cease to have
any value, which, in turn, could materially adversely affect our business, financial condition
and results of operations and our ability to
pay distributions to our stockholders.
While we seek to minimize prepayment risk, we must balance prepayment risk
against other risks and the potential returns of
each investment. No strategy can completely insulate us from prepayment
or other such risks.
A decrease in prepayment rates on the mortgages underlying our Agency
RMBS might decrease net interest income or result in
a net loss, which could materially adversely affect our business, financial condition
and results of operations and our ability to pay
distributions to our stockholders.
Certain of our structured Agency RMBS may be adversely affected by a decrease in prepayment
rates. For example, because
POs are similar to zero-coupon bonds, our expected returns on such securities
will be contingent on our receiving the principal
payments of the underlying mortgage loans at expected intervals that assume
a certain prepayment rate. If prepayment rates are lower
than expected, we will not receive principal payments as quickly as we
anticipated and, therefore, our expected returns on these
securities will be adversely affected, which, in turn, could materially adversely affect our business, financial
condition and results of
operations and our ability to pay distributions to our stockholders.
While we seek to minimize prepayment risk, we must balance prepayment risk
against other risks and the potential returns of
each investment. No strategy can completely insulate us from prepayment
or other such risks.
Failure to procure adequate repurchase agreement financing, or to renew
or replace existing repurchase agreement financing as
it matures, could materially adversely affect our business, financial condition and results of
operations and our ability to make
distributions to our stockholders.
We intend to maintain master repurchase agreements with several counterparties. We cannot assure you
that any, or sufficient,
repurchase agreement financing will be available to us in the future on terms that are
acceptable to us. Any decline in the value of
Agency RMBS, or perceived market uncertainty about their value, would make
it more difficult for us to obtain financing on favorable
terms or at all, or maintain our compliance with the terms of any financing arrangements
already in place. We may be unable to
diversify the credit risk associated with our lenders. In the event that we
cannot obtain sufficient funding on acceptable terms, our
17
business, financial condition and results of operations and our ability to pay distributions
to our stockholders may be materially
adversely affected.
Furthermore, because we intend to rely primarily on short-term borrowings to fund
our acquisition of Agency RMBS, our ability to
achieve our investment objectives
will depend not only on our ability to borrow money in sufficient amounts and on
favorable terms, but
also on our ability to renew or replace on a continuous basis our maturing short-term
borrowings. If we are not able to renew or replace
maturing borrowings, we will have to sell some or all of our assets, possibly under
adverse market conditions. In addition, if the
regulatory capital requirements imposed on our lenders change, they may be required
to significantly increase the cost of the financing
that they provide to us. Our lenders also may revise their eligibility requirements
for the types of assets they are willing to finance or the
terms of such financings,
based on, among other factors, the regulatory environment and their management
of perceived risk.
Adverse market developments could cause our lenders to require us to pledge
additional assets as collateral. If our assets were
insufficient to meet these collateral requirements, we might be compelled to liquidate particular
assets at inopportune times and
at unfavorable prices, which could materially adversely affect our business, financial
condition and results of operations and our
ability to pay distributions to our stockholders.
Adverse market developments, including a sharp or prolonged rise
in interest rates, a change in prepayment rates or increasing
market concern about the value or liquidity of one or more types of Agency
RMBS, might reduce the market value of our portfolio,
which might cause our lenders to initiate margin calls. A margin call means
that the lender requires us to pledge additional collateral to
re-establish the ratio of the value of the collateral to the amount of the borrowing.
The specific collateral value to borrowing ratio that
would trigger a margin call is not set in the master repurchase agreements
and not determined until we engage in a repurchase
transaction under these agreements. Our fixed-rate Agency RMBS generally are more
susceptible to margin calls as increases in
interest rates tend to more negatively affect the market value of fixed-rate securities. If we
are unable to satisfy margin calls, our
lenders may foreclose on our collateral. The threat or occurrence of a margin call
could force us to sell, either directly or through a
foreclosure, our Agency RMBS under adverse market conditions. Because of the
significant leverage we expect to have, we may incur
substantial losses upon the threat or occurrence of a margin call, which could materially
adversely affect our business, financial
condition and results of operations and our ability to pay distributions to our stockholders.
Additionally, the liquidation of collateral may
jeopardize our ability to maintain our qualification as a REIT, as we must comply with requirements regarding our assets and our
sources of gross income. Our failure to maintain our qualification as a REIT would
cause us to be subject to U.S. federal income tax
(and any applicable state and local taxes) on all of our net taxable income.
Hedging against interest rate exposure may not completely insulate us from
interest rate risk and could materially adversely
affect our business, financial condition and results of operations and our ability to pay distributions
to our stockholders.
To the
extent consistent with maintaining our qualification as a REIT, we may enter into interest rate cap or swap agreements or
pursue other hedging strategies, including the purchase of puts, calls or other
options and futures contracts in order to hedge the
interest rate risk of our portfolio. In general, our hedging strategy depends on our
view of our entire portfolio consisting of assets,
liabilities and derivative instruments, in light of prevailing market conditions. We could
misjudge the condition of our investment portfolio
or the market. Our hedging activity will vary in scope based on the level and volatility
of interest rates and principal prepayments, the
type of Agency RMBS we hold and other changing market conditions. Hedging
may fail to protect or could adversely affect us because,
among other things:
●
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 the U.S. federal income tax provisions
governing REITs;
18
●
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.
There are no perfect hedging strategies, and interest rate hedging may fail to protect
us from loss. Alternatively, we may fail to
properly assess a risk to our investment portfolio or may fail to recognize a risk entirely, leaving us exposed to losses without the
benefit of any offsetting hedging activities. The derivative financial instruments we
select may not have the effect of reducing our
interest rate risk. The nature and timing of hedging transactions may influence
the effectiveness of these strategies. Poorly designed
strategies or improperly executed transactions could actually increase our risk
and losses. In addition, hedging activities could result in
losses if the event against which we hedge does not occur.
Because of the foregoing risks, our hedging activity could materially adversely affect our business,
financial condition and results
of operations and our ability to pay distributions to our stockholders.
Our use of certain hedging techniques may expose us to counterparty risks.
To the
extent that our hedging instruments are not traded on regulated exchanges,
guaranteed by an exchange or its
clearinghouse, or regulated by any U.S. or foreign governmental authorities,
there may not be requirements with respect to record
keeping, financial responsibility or segregation of customer funds and positions. Furthermore,
the enforceability of agreements
underlying hedging transactions may depend on compliance with applicable statutory,
exchange and other regulatory requirements
and, depending on the domicile of the counterparty, applicable international requirements. Consequently, if any of these issues causes
a counterparty to fail to perform under a derivative agreement we could incur a
significant loss.
For example, if a swap exchange utilized in an interest rate swap agreement that
we enter into as part of our hedging strategy
cannot perform under the terms of the interest rate swap agreement, we
may not receive payments due under that agreement, and,
thus, we may lose any potential benefit associated with the interest rate swap. Additionally, we may also risk the loss of any collateral
we have pledged to secure our obligations under these swap agreements if
the exchange becomes insolvent or files for bankruptcy.
Similarly, if an interest rate swaption counterparty fails to perform under the terms of the interest rate swaption agreement,
in addition
to not being able to exercise or otherwise cash settle the agreement, we
could also incur a loss for the premium paid for that
swaption.
Our use of leverage could materially adversely affect our business, financial condition
and results of operations and our ability to
pay distributions to our stockholders.
We calculate our leverage ratio by dividing our total liabilities by total equity at the end of each period.
Under normal market
conditions, we generally expect our leverage ratio to be less than 12 to
1, although at times our borrowings may be above or below this
level. We incur this indebtedness by borrowing against a substantial portion of the market
value of our pass-through Agency RMBS and
a portion of our structured Agency RMBS. Our total indebtedness, however, is not expressly limited by our policies and
will depend on
our prospective lenders’ estimates of the stability of our portfolio’s cash flow. As a result, there is no limit on the amount of
leverage that
we may incur. We face the risk that we might not be able to meet our debt service obligations or a lender’s
margin requirements from
our income and, to the extent we cannot, we might be forced to liquidate some of our
Agency RMBS at unfavorable prices. Our use of
leverage could materially adversely affect our business, financial condition and results
of operations and our ability to pay distributions
to our stockholders. For example:
●
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
19
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.
If we experience losses as a result of our use of leverage, such losses
could materially adversely affect our business, results of
operations and financial condition and our ability to make distributions to our stockholders.
It may be uneconomical to "roll" our TBA dollar roll transactions or we may be
unable to meet margin calls on our TBA contracts,
which could negatively affect our financial condition and results of operations.
We may utilize TBA dollar roll transactions as a means of investing in and financing Agency
RMBS. TBA contracts enable us to
purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of collateral,
but the
particular Agency RMBS to be delivered are not identified until shortly
before the TBA settlement date. Prior to settlement of the TBA
contract we may choose to move the settlement of the securities out to a later date
by entering into an offsetting position (referred to as
a "pair off"), net settling the paired off positions for cash, and simultaneously purchasing a similar
TBA contract for a later settlement
date, collectively referred to as a "dollar roll." The Agency RMBS purchased for a
forward settlement date under the TBA contract are
typically priced at a discount to Agency RMBS for settlement in the current
month. This Amendment No. 1 doesdifference (or discount) is referred to as the
"price drop." The price drop is the economic equivalent of net interest income
earned from carrying the underlying Agency RMBS over
the roll period (interest income less implied financing cost). Consequently, dollar roll transactions and such forward purchases of
Agency RMBS represent a form of off-balance sheet financing and increase our "at risk" leverage.
Under certain market conditions, TBA dollar roll transactions may result in negative
carry income whereby the Agency RMBS
purchased for a forward settlement date under the TBA contract are priced at a premium
to Agency RMBS for settlement in the current
month. Additionally, sales of some or all of the Fed's holdings of Agency RMBS, or declines in purchases of Agency RMBS
by the Fed
could adversely impact the dollar roll market. Under such conditions, it may
be uneconomical to roll our TBA positions prior to the
settlement date and we could have to take physical delivery of the underlying
securities and settle our obligations for cash. We may not
have sufficient funds or alternative financing sources available to settle such obligations.
In addition, pursuant to the margin provisions
established by the Mortgage-Backed Securities Division ("MBSD") of the Fixed Income
Clearing Corporation, we are subject to margin
calls on our TBA contracts. Further, our clearing and custody agreements may require us to post additional margin above
the levels
established by the MBSD. Negative carry income on TBA dollar roll transactions
or failure to procure adequate financing to settle our
obligations or meet margin calls under our TBA contracts could result in
defaults or force us to sell assets under adverse market
conditions and adversely affect our financial condition and results of operations.
Interest rate caps on the ARMs and hybrid ARMs backing our Agency RMBS may reduce
our net interest margin during periods
of rising interest rates, which could materially adversely affect our business, financial
condition and results of operations and our
ability to pay distributions to our stockholders.
ARMs and hybrid ARMs are typically subject to periodic and lifetime interest rate
caps. Periodic interest rate caps limit the
amount an interest rate can increase during any given period. Lifetime interest
rate caps limit the amount an interest rate can increase
through the maturity of the loan. Our borrowings typically are not subject
to similar restrictions. Accordingly, in a period of rapidly
increasing interest rates, our financing costs could increase without limitation
while caps could limit the interest we earn on the ARMs
and hybrid ARMs backing our Agency RMBS. This problem is magnified for ARMs
and hybrid ARMs that are not fully indexed because
such periodic interest rate caps prevent the coupon on the security from fully reaching
the specified rate in one reset. Further, some
ARMs and hybrid ARMs may be subject to periodic payment caps that result
in a portion of the interest being deferred and added to the
principal outstanding. As a result, we may receive less cash income
on Agency RMBS backed by ARMs and hybrid ARMs than
20
necessary to pay interest on our related borrowings. Interest rate caps on Agency
RMBS backed by ARMs and hybrid ARMs could
reduce our net interest margin if interest rates were to increase beyond the
level of the caps, which could materially adversely affect
our business, financial condition and results of operations and our ability to pay distributions
to our stockholders.
Volatile market conditions for mortgages and mortgage-related assets as well as the broader financial markets
can result in a
significant contraction in liquidity for mortgages and mortgage-related assets, which
may adversely affect the value of the assets
in which we invest.
Our results of operations are materially affected by conditions in the markets for mortgages
and mortgage-related assets,
including Agency RMBS, as well as the broader financial markets and the
economy generally.
Significant adverse changes in financial market conditions can result in a
deleveraging of the global financial system and the
forced sale of large quantities of mortgage-related and other financial assets.
Concerns over economic recession, geopolitical issues
including events such as the COVID-19 pandemic, policy priorities of a new U.S. presidential
administration, trade wars,
unemployment, the availability and cost of financing, the mortgage market and
a declining real estate market or prolonged government
shutdown may contribute to increased volatility and diminished expectations for
the economy and markets.
Increased volatility and deterioration in the markets for mortgages and mortgage-related
assets as well as the broader financial
markets may adversely affect the performance and market value of our Agency RMBS.
If these conditions exist, institutions from which
we seek financing for our investments may tighten their lending standards, increase
margin calls or become insolvent, which could
make it more difficult for us to obtain financing on favorable terms or at all.
Our profitability and financial condition may be adversely
affected if we are unable to obtain cost-effective financing for our investments.
Our forward settling transactions, including TBA transactions, subject us to
certain risks, including price risks and counterparty
risks.
We purchase some of our Agency RMBS through forward settling transactions, including
TBAs. In a forward settling transaction,
we enter into a forward purchase agreement with a counterparty to purchase
either (i) an identified Agency RMBS, or (ii) a TBA, or to-
be-issued, Agency RMBS with certain terms. As with any forward purchase
contract, the value of the underlying Agency RMBS may
decrease between the trade date and the settlement date. Furthermore, a transaction
counterparty may fail to deliver the underlying
Agency RMBS at the settlement date. If any of these risks were to occur, our financial condition and results of operations
may be
materially adversely affected.
The implementation of the Single Security Initiative may adversely affect our results and financial
condition.
The Single Security Initiative is a joint initiative of Fannie Mae and Freddie
Mac (the “Enterprises”), under the direction of the
FHFA, the Enterprises’ regulator and conservator, to develop a common, single mortgage-backed security issued by the Enterprises.
On June 3, 2019, with the implementation of Release 2 of the common
securitization platform, Freddie Mac and Fannie Mae
commenced use of a common, single mortgage-backed security, known as the Uniform Mortgage-Backed Security (“UMBS”).
Fannie
Mae pools are now eligible for conversion into UMBS pools and Freddie Mac
pools can be exchanged for UMBS pools. The conversion
is not mandatory. UMBS is intended to enhance liquidity in the TBA market as the two GSEs’ floats are combined, eliminating or
reducing the market pricing subsidy that Freddie Mac currently provides
to lenders to pool their loans with Freddie Mac instead of
Fannie Mae, and pave the way for future GSE reform by allowing new entrants
to enter the MBS guarantee market.
The current float of Gold Participation Certificates (“Gold PCs”) issued by
Freddie Mac is materially smaller than the float of
Fannie Mae securities.
To the extent Gold PCs are converted into UMBS, the float will contract further. A further decline could impact
the liquidity of Gold PCs not converted into UMBS. Secondly, the TBA deliverable has appeared to deteriorate as the Fannie
Mae and
21
Freddie Mac pools with the worst prepayment characteristics are delivered
into new TBA securities, concentrating the poorest pools
into the TBA deliverable, which has negatively impacted their performance.
To the extent investors recognize the relative performance
of Fannie Mae or Freddie Mac pools over the other, they may stipulate that they only wish to be delivered TBA securities
with pools
from the better performing GSE.
By bifurcating the TBA deliverable, liquidity in the TBA market could be negatively
impacted.
Our liquidity is typically reduced each month when we receive margin calls related
to factor changes, and typically increased
each month when we receive payment of principal and interest on Fannie
Mae and Freddie Mac securities. Legacy Freddie Mac
securities pay principal and interest earlier in the month than Fannie Mae and
UMBS, meaning that legacy Freddie Mac positions
reduce the period of time between meeting factor-related margin calls and receiving
principal and interest. The percentage of legacy
Freddie Mac positions in the market and in our portfolio will likely decrease over time
as those securities are converted to UMBS or
paid off.
We rely on analytical models and other data to analyze potential asset acquisition and disposition
opportunities and to manage
our portfolio. Such models and other data may be incorrect, misleading or incomplete,
which could cause us to purchase assets
that do not meet our expectations or to make asset management decisions that are
not in line with our strategy.
We rely on analytical models, and information and other data supplied by third parties.
These models and data may be used to
value assets or potential asset acquisitions and dispositions and in connection
with our asset management activities. If our models and
data prove to be incorrect, misleading or incomplete, any decisions made in
reliance thereon could expose us to potential risks.
Our reliance on models and data may induce us to purchase certain assets
at prices that are too high, to sell certain other assets
at prices that are too low or to miss favorable opportunities altogether. Similarly, any hedging activities that are based on faulty models
and data may prove to be unsuccessful.
Some models, such as prepayment models, may be predictive in nature. The
use of predictive models has inherent risks. For
example, such models may incorrectly forecast future behavior, leading to potential losses. In addition, the
predictive models used by
us may differ substantially from those models used by other market participants, resulting in
valuations based on these predictive
models that may be substantially higher or lower for certain assets than actual market
prices. Furthermore, because predictive models
are usually constructed based on historical data supplied by third parties, the
success of relying on such models may depend heavily
on the accuracy and reliability of the supplied historical data, and, in the case of
predicting performance in scenarios with little or no
historical precedent (such as extreme broad-based declines in home prices, or deep
economic recessions or depressions), such
models must employ greater degrees of extrapolation and are therefore
more speculative and less reliable.
All valuation models rely on correct market data input. If incorrect market data
is entered into even a well-founded valuation
model, the resulting valuations will be incorrect. However, even if market data is inputted correctly, “model prices” will often differ
substantially from market prices, especially for securities with complex characteristics
or whose values are particularly sensitive to
various factors. If our market data inputs are incorrect or our model prices
differ substantially from market prices, our business, financial
condition and results of operations and our ability to make distributions to our
stockholders could be materially adversely affected.
Valuations of some of our assets are inherently uncertain, may be based on estimates, may fluctuate over short periods of time
and may differ from the values that would have been used if a ready market for these assets
existed. As a result, the values of
some of our assets are uncertain.
While in many cases our determination of the fair value of our assets is
based on valuations provided by third-party dealers and
pricing services, we can and do value assets based upon our judgment, and
such valuations may differ from those provided by third-
party dealers and pricing services. Valuations of certain assets are often difficult to obtain or are unreliable. In general, dealers and
pricing services heavily disclaim their valuations. Additionally, dealers may claim to furnish valuations only as an accommodation
and
without special compensation, and so they may disclaim any and all liability for
any direct, incidental or consequential damages arising
22
out of any inaccuracy or incompleteness in valuations, including any act of negligence
or breach of any warranty. Depending on the
complexity and illiquidity of an asset, valuations of the same asset can vary substantially
from one dealer or pricing service to another.
The valuation process during times of market distress can be particularly difficult and unpredictable
and during such time the disparity
of valuations provided by third-party dealers can widen.
Our business, financial condition and results of operations and our ability to
make distributions to our stockholders could be
materially adversely affected if our fair value determinations of these assets were
materially higher than the values that would exist if a
ready market existed for these assets.
Because the assets that we acquire might experience periods of illiquidity, we might be prevented from selling our Agency RMBS
at favorable times and prices, which could materially adversely affect our business, financial
condition and results of operations
and our ability to pay distributions to our stockholders.
Agency RMBS might experience periods of illiquidity. Such conditions are more likely to occur for structured Agency RMBS
because such securities are generally traded in markets much less liquid than
the pass-through Agency RMBS market. As a result, we
may be unable to dispose of our Agency RMBS at advantageous times
and prices or in a timely manner. The lack of liquidity might
result from the absence of a willing buyer or an established market for these
assets as well as legal or contractual restrictions on
resale. The illiquidity of Agency RMBS could materially adversely affect our business, financial
condition and results of operations and
our ability to pay distributions to our stockholders.
Our use of repurchase agreements may give our lenders greater rights in
the event that either we or any of our lenders file for
bankruptcy, which may make it difficult for us to recover our collateral in the event of a bankruptcy filing.
Our borrowings under repurchase agreements may qualify for special treatment
under the bankruptcy code, giving our lenders
the ability to avoid the automatic stay provisions of the bankruptcy code
and to take possession of and liquidate our collateral under the
repurchase agreements without delay if we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under
the
bankruptcy code may make it difficult for us to recover our pledged assets in the event that
any of our lenders files for bankruptcy.
Thus, the use of repurchase agreements exposes our pledged assets to risk in the
event of a bankruptcy filing by either our lenders or
us. In addition, if the lender is a broker or dealer subject to the Securities Investor
Protection Act of 1970, or an insured depository
institution subject to the Federal Deposit Insurance Act, our ability to exercise
our rights to recover our investment under a repurchase
agreement or to be compensated for any damages resulting from the
lender’s insolvency may be further limited by those
statutes.
If our lenders default on their obligations to resell the Agency RMBS back to us at
the end of the repurchase transaction term, or
if the value of the Agency RMBS has declined by the end of the repurchase
transaction term or if we default on our obligations
under the repurchase transaction, we will lose money on these transactions, which,
in turn, may materially adversely affect our
business, financial condition and results of operations and our ability to pay distributions
to our stockholders.
When we engage in a repurchase transaction, we initially sell securities to the
financial institution under one of our master
repurchase agreements in exchange for cash, and our counterparty is obligated
to resell the securities to us at the end of the term of
the transaction, which is typically from 24 to 90 days but may be up to 364 days
or more. The cash we receive when we initially sell the
securities is less than the value of those securities, which is referred to as the
haircut. Many financial institutions from which we may
obtain repurchase agreement financing have increased their haircuts in the past
and may do so again in the future. If these haircuts are
increased, we will be required to post additional cash or securities as collateral for
our Agency RMBS. If our counterparty defaults on its
obligation to resell the securities to us, we would incur a loss on the transaction
equal to the amount of the haircut (assuming there was
no change in the value of the securities). We would also lose money on a repurchase transaction
if the value of the underlying
securities had declined as of the end of the transaction term, as we would have
to repurchase the securities for their initial value but
would receive securities worth less than that amount. Any losses we incur on our repurchase
transactions could materially adversely
affect our business, financial condition and results of operations and our ability to pay
distributions to our stockholders.
23
If we default on one of our obligations under a repurchase transaction, the
counterparty can terminate the transaction and cease
entering into any other repurchase transactions with us. In that case, we would
likely need to establish a replacement repurchase
facility with another financial institution in order to continue to leverage our portfolio
and carry out our investment strategy. There is no
assurance we would be able to establish a suitable replacement facility on
acceptable terms or at all.
Clearing facilities or exchanges upon which some of our hedging instruments
are traded may increase margin requirements on
our hedging instruments in the event of adverse economic developments.
In response to events having or expected to have adverse economic consequences
or which create market uncertainty, clearing
facilities or exchanges upon which some of our hedging instruments, such as
T-Note, Fed Funds and Eurodollar futures contracts and
interest rate swaps, are traded may require us to post additional collateral
against our hedging instruments. In the event that future
adverse economic developments or market uncertainty result in increased margin
requirements for our hedging instruments, it could
materially adversely affect our liquidity position, business, financial condition and results of
operations.
We may change our investment strategy, investment guidelines and asset allocation without notice or stockholder consent, which
may result in riskier investments. In addition, our charter provides that our Board
of Directors may revoke or otherwise terminate
our REIT election, without the approval of our stockholders.
Our Board of Directors has the authority to change our investment strategy
or asset allocation at any time without notice to or
consent from our stockholders. To the extent that our investment strategy changes in the future, we may make investments that are
different from, and possibly riskier than, the investments described in this Report. A change
in our investment strategy may increase
our exposure to interest rate and real estate market fluctuations. Furthermore,
a change in our asset allocation could result in our
allocating assets in a different manner than as described in this Report.
In addition, our charter provides that our Board of Directors may revoke or otherwise
terminate our REIT election, without the
approval of our stockholders, if it determines that it is no longer in our best
interests to qualify as a REIT. These changes could
materially adversely affect our business, financial condition, results of operations, the market
value of our common stock and our ability
to make distributions to our stockholders.
A prolonged economic slowdown, a lengthy or severe recession or declining real estate
values could impair our investments and
harm our operations.
We believe the risks associated with our business will be more severe during periods
of economic slowdown or recession,
especially if these periods are accompanied by declining real estate
values. Declining real estate values will likely reduce the level of
new mortgage and other real estate-related loan originations since borrowers often
use appreciation in the value of their existing
properties to support the purchase of or investment in additional properties. Borrowers
may also be less able to pay principal and
interest on our loans if the value of real estate weakens. Further, declining real estate values significantly increase
the likelihood that
we will incur losses on our loans in the event of default because the
value of our collateral may be insufficient to cover its cost on the
loan. Any sustained period of increased payment delinquencies, foreclosures
or losses could adversely affect our Manager’s ability to
invest in, sell and securitize loans, which would materially and adversely affect our results
of operations, financial condition, liquidity
and business and our ability to pay dividends to stockholders.
Market disruptions in a single country could cause a worsening of conditions
on a regional and even global level, and economic
problems in a single country are increasingly affecting other markets and economies. A continuation
of this trend could result in
problems in one country adversely affecting regional and even global economic conditions
and markets. For example, concerns about
the fiscal stability and growth prospects of certain European countries in the
last economic downturn had a negative impact on most
24
economies of the Eurozone and global markets. The occurrence of similar crises in
the future could cause increased volatility in the
economies and financial markets of countries throughout a region, or even globally.
Additionally, global trade disruption, significant introductions of trade barriers and bilateral trade frictions, together with any
future
downturns in the global economy resulting therefrom, could adversely affect our performance.
Competition might prevent us from acquiring Agency RMBS at favorable yields, which
could materially adversely affect our
business, financial condition and results of operations and our ability to pay distributions
to our stockholders.
We operate in a highly competitive market for investment opportunities. Our net income
largely depends on our ability to acquire
Agency RMBS at favorable spreads over our borrowing costs. In acquiring
Agency RMBS, we compete with a variety of institutional
investors, including other REITs, investment banking firms, savings and loan associations, banks, insurance companies, mutual funds,
other lenders, other entities that purchase Agency RMBS, the Federal Reserve,
other governmental entities and government-
sponsored entities, many of which have greater financial, technical, marketing and
other resources than we do. Some competitors may
have a lower cost of funds and access to funding sources that may not be available
to us, such as funding from the U.S. government.
Additionally, many of our competitors are not subject to REIT tax compliance or required to maintain an exemption from
the Investment
Company Act. In addition, some of our competitors may have higher risk tolerances
or different risk assessments, which could allow
them to consider a wider variety of investments. Furthermore, competition for investments
in Agency RMBS may lead the price of such
investments to increase, which may further limit our ability to generate desired returns.
As a result, we may not be able to acquire
sufficient Agency RMBS at favorable spreads over our borrowing costs, which would
materially adversely affect our business, financial
condition and results of operations and our ability to pay distributions to our stockholders.
We are highly dependent on communications and information systems operated by third
parties, and systems failures could
significantly disrupt our business, which may, in turn, adversely affect our business, financial condition and results of operations
and our ability to pay distributions to our stockholders.
Our business is highly dependent on communications and information systems
that allow us to monitor, value, buy, sell, finance
and hedge our investments. These systems are operated by third parties and, as
a result, we have limited ability to ensure their
continued operation. In the event of a systems failure or interruption, we will have
limited ability to affect the timing and success of
systems restoration. Any failure or interruption of our systems could cause delays or
other problems in our securities trading activities,
including Agency RMBS trading activities, which could have a material
adverse effect on our business, financial condition and results of
operations and our ability to pay distributions to our stockholders.
Computer malware, ransomware, viruses, and computer hacking and
phishing attacks have become more prevalent in the
financial services industry and may occur on our or certain of our third party
service providers' systems in the future. We rely heavily on
our Manager’s financial, accounting and other data processing systems.
Although we have not detected a breach to date, financial
services institutions have reported breaches of their systems, some of which
have been significant. During the COVID-19 pandemic, a
portion of our Manager’s employees have worked remotely, which has caused us to rely more on virtual communication
and may
increase our exposure to cybersecurity risks. Even with all reasonable security
efforts, not every breach can be prevented or even
detected. It is possible that we, our Manager or certain of our third-party
service providers have experienced an undetected breach,
and it is likely that other financial institutions have experienced more
breaches than have been detected and reported. There is no
assurance that we, our Manager, or certain of the third parties that facilitate our and our Manager’s
business activities, have not or will
not experience a breach. It is difficult to determine what, if any, negative impact may directly result from any specific interruption or
cyber-attacks or security breaches of our networks or systems (or the networks
or systems of certain third parties that facilitate our
business activities) or any failure to maintain performance, reliability and security of
our or our certain third-party service providers'
technical infrastructure, but such computer malware, ransomware, viruses,
and computer hacking and phishing attacks may negatively
affect our operations.
25
Changes in banks’ inter-bank lending rate reporting practices or the method pursuant
to which LIBOR is determined may
adversely affect the value of the financial obligations to be held or issued by us that are linked
to LIBOR.
LIBOR and other indices which are deemed “benchmarks” are the subject
of national, international, and other regulatory
guidance and proposals for reform. Some of these reforms are already effective while others are still
to be implemented. These reforms
may cause such benchmarks to perform differently than in the past, or have other consequences
which cannot be predicted. In
particular, regulators and law enforcement agencies in the U.K. and elsewhere are conducting criminal and civil
investigations into
whether the banks that contributed information to the British Bankers’ Association
(“BBA”) in connection with the daily calculation of
LIBOR may have been under-reporting or otherwise manipulating or attempting to
manipulate LIBOR. A number of BBA member banks
have entered into settlements with their regulators and law enforcement agencies
with respect to this alleged manipulation of LIBOR.
Actions by the regulators or law enforcement agencies, as well as ICE Benchmark
Administration (the current administrator of LIBOR),
may result in changes to the manner in which LIBOR is determined
or the establishment of alternative reference rates.
The development of alternative reference rates is complex.
In the United States,
a committee was formed in 2014 to study the
process and come up with an alternative reference rate. The Alternative Reference
Rate Committee (the “ARRC”) selected the SOFR,
an overnight secured U.S. Treasury repo rate, as the new rate and adopted a Paced Transition Plan (“PTP”),
which provides a
framework for the transition from LIBOR to SOFR. SOFR is published daily at 8:00
a.m. Eastern Time by the NY Federal Reserve Bank
for the previous business day’s trades. However, since SOFR is an overnight rate and many forms of loans or instruments used
for
hedging have much longer terms, there is a need for a term structure for the new
reference rate. Various central banks, including the
Fed, as well as the ARRC are in the process of developing term rates to support
cash markets that currently use LIBOR. Examples of
the cash market would be floating rate notes, syndicated and bilateral corporate
loans, securitizations, secured funding transactions
and various mortgage and consumer loans – including many of the securities
the Company owns from time to time such as IIOs.
The
Company also uses derivative securities tied to LIBOR to hedge its funding costs.
Development of term rates for derivatives is being
conducted by the International Swaps and Derivatives Association (“ISDA”).
However, ARRC and ISDA may utilize different
mechanisms to develop term rates which may cause potential mismatches
between cash products or assets of the Company and
hedge instruments.
The process for determining term rates by both ARRC and ISDA is not
finalized at this time.
On December 31, 2021, the one week and two month USD LIBOR tenors phased
out, and on June 30, 2023 all other USD
LIBOR tenors will phase out. On November 30, 2020, the United States Federal Reserve
concurrently issued a statement advising
banks to stop new USD LIBOR issuances by the end of 2021, and on October 20, 2021,
the Office of the Comptroller of the Currency,
Board of Governors of the Federal Reserve System, Federal Deposit Insurance
Corporation, Consumer Financial Protection Bureau
(the “CFPB”) and National Credit Union Administration advised banks that entering
into new contracts that use LIBOR as a reference
rate after December 31, 2021 would create safety and soundness risks. In
light of these recent announcements, the future of LIBOR at
this time is uncertain and any changes in the methods by which LIBOR is determined or
regulatory activity related to LIBOR’s phaseout
could cause LIBOR to perform differently than in the past or cease to exist. Although regulators
and IBA have clarified that the recent
announcements should not be read to say that LIBOR has ceased or will
cease, in the event LIBOR does cease to exist, the risks
associated with the transition to an alternative reference rate will be accelerated
and magnified.
As of December 31, 2020, Fannie Mae and Freddie Mac stopped issuing most LIBOR-indexed
products and stopped purchasing
LIBOR-based loans. On August 3, 2020, Fannie Mae started accepting whole loan and
MBS deliveries of ARMs indexed to SOFR, and
Freddie Mac announced that it priced its first SOFR linked offering on October 16, 2020. On
October 19, 2021, Fannie Mae priced its
first credit risk transfer transaction linked to SOFR, and on January 19, 2022
it priced its first multifamily real estate mortgage
investment conduit using SOFR.
More generally, any of the above changes or any other consequential changes to LIBOR or any other “benchmark” as
a result of
international, national or other proposals for reform or other initiatives or investigations,
or any further uncertainty in relation to the
timing and manner of implementation of such changes, could have a material adverse
effect on the value of and return on any
securities based on or linked to a “benchmark.”
26
New laws may be passed affecting the relationship between Fannie Mae and Freddie Mac,
on the one hand, and the federal
government, on the other, which could adversely affect the price of, or our ability to invest in and finance, Agency RMBS.
The interest and principal payments we expect to receive on the Agency RMBS
in which we invest are guaranteed by Fannie
Mae, Freddie Mac or Ginnie Mae. Principal and interest payments on Ginnie
Mae certificates are directly guaranteed by the U.S.
government. Principal and interest payments relating to the securities issued by
Fannie Mae and Freddie Mac are only guaranteed by
each respective GSE.
In September 2008, Fannie Mae and Freddie Mac were placed into the conservatorship
of the FHFA, their federal regulator,
pursuant to its powers under The Federal Housing Finance Regulatory Reform
Act of 2008, a part of the Housing and Economic
Recovery Act of 2008 (the “Recovery Act”). In addition to the FHFA becoming the conservator of Fannie Mae
and Freddie Mac, the
U.S. Treasury entered into Preferred Stock Purchase Agreements (“PSPAs”) with the FHFA and have taken various actions intended to
provide Fannie Mae and Freddie Mac with additional liquidity in an effort to ensure their
financial stability. In September 2019, the
FHFA and the U.S. Treasury agreed to modifications to the PSPAs that will permit Fannie Mae and Freddie Mac to maintain capital
reserves of $25 billion and $20 billion, respectively. As of September 30, 2020, Fannie Mae and Freddie Mac had retained
equity
capital of approximately $21 billion and $14 billion, respectively.
In December 2020, a final rule was published in the federal register
regarding GSE capital framework (the “December rule”), which requires Tier 1 capital in
excess of 4% (approximately $265 billion) and
a risk-weight floor of 20% for residential mortgages.
On January 14, 2021, the U.S. Treasury and the FHFA executed letter
agreements (the “January agreement”) allowing the GSEs to continue to retain
capital up to their regulatory minimums, including
buffers, as prescribed in the December rule.
These letter agreements provide, in part, (i) there will be no exit from conservatorship
until
all material litigation is settled and the GSE has common equity Tier 1 capital of at least 3%
of its assets, (ii) the GSEs will comply with
the FHFA’s
regulatory capital framework, (iii) higher-risk single-family mortgage
acquisitions will be restricted to current levels, and (iv)
the U.S. Treasury and the FHFA will establish a timeline and process for future GSE reform.
On September 14, 2021, the U.S.
Treasury and the FHFA suspended certain policy provisions in the January agreement, including limits on loans acquired for cash
consideration, multifamily loans, loans with higher risk characteristics and
second homes and investment properties.
On September
15, 2021, the FHFA announced a notice of proposed rulemaking for the purpose of amending the December rule to,
among other
things, reduce the Tier 1 capital and risk-weight floor requirements.
Shortly after Fannie Mae and Freddie Mac were placed in federal conservatorship,
the Secretary of the U.S. Treasury suggested
that the guarantee payment structure of Fannie Mae and Freddie Mac in
the U.S. housing finance market should be re-examined. The
future roles of Fannie Mae and Freddie Mac could be significantly reduced and
the nature of their guarantees could be eliminated or
considerably limited relative to historical measurements. The U.S. Treasury could also stop
providing credit support to Fannie Mae and
Freddie Mac in the future. Any changes to the nature of the guarantees provided
by Fannie Mae and Freddie Mac could redefine what
constitutes an Agency RMBS and could have broad adverse market implications. If Fannie
Mae or Freddie Mac was eliminated, or their
structures were to change in a material manner that is not compatible with
our business model, we would not be able to acquire
Agency RMBS from these entities, which could adversely affect our business operations.
On June 23, 2021, the Supreme Court ruled in Collins v. Mnuchin, a case presenting a question of the constitutionality
of the
FHFA and its director’s protection from being replaced at will by the President.
The Supreme Court held that the FHFA did not exceed
its powers or functions as a conservator under the Recovery Act, and that
the President may replace the director at will. On June 23,
2021, President Biden appointed Sandra Thompson as acting director of the
FHFA.
Risks Related to Conflicts of Interest in Our Relationship with Our
Manager and Bimini
The management agreement with our Manager was not negotiated
on an arm’s-length basis and the terms, including fees
payable and our inability to terminate, or our election not to renew, the management agreement based on our Manager’s
poor
performance without paying our Manager a significant termination fee, except
for a termination of the Manager with cause, may
not be as favorable to us as if it were negotiated with an unaffiliated third party.
27
The management agreement with our Manager was negotiated between related
parties, and we did not have the benefit of
arm’s-length negotiations of the type normally conducted with an unaffiliated third party. The terms of the management agreement with
our Manager, including fees payable and our inability to terminate, or our election not to renew, the management agreement based on
our Manager’s poor performance without paying our Manager
a significant termination fee, except for a termination of the Manager with
cause, may not reflect eventsthe terms we may have received if it was negotiated with
an unrelated third party. In addition, as a result of the
relationship with our Manager, we may choose not to enforce, or to enforce less vigorously, our rights under the management
agreement because of our desire to maintain our ongoing relationship with our Manager.
We have no employees and our Manager is responsible for making all of our investment decisions.
None of our or our Manager’s
officers are required to devote any specific amount of time to our business, and each of them
may provide their services to
Bimini, which could result in conflicts of interest.
Our Manager is responsible for making all of our investments. We do not have any employees,
and we are completely reliant on
our Manager to provide us with investment advisory services. Each
of our and our Manager’s officers is an employee of Bimini and
none of them will devote their time to us exclusively. Each of Messrs. Cauley and Haas, who are the members of our Manager’s
investment committee, is an officer of Bimini and has significant responsibilities
to Bimini. Due to the fact that each of our officers is
responsible for providing services to Bimini, they may not devote sufficient time to the
management of our business operations. At
times when there are turbulent conditions in the mortgage markets
or distress in the credit markets or other times when we will need
focused support and assistance from our executive officers and our Manager, Bimini and its affiliates will likewise require greater focus
and attention from them. In such situations, we may not receive the level of
support and assistance that we otherwise would likely have
received if we were internally managed or if such executives were not otherwise
committed to provide support to Bimini.
Our Board of Directors has adopted investment guidelines that require that any investment
transaction between us and Bimini or
any affiliate of Bimini receive the prior approval of a majority of our independent directors.
However, this policy will not eliminate the
conflicts of interest that our officers will face in making investment decisions on behalf of Bimini
and us. Further, we do not have any
agreement or understanding with Bimini that would give us any priority over Bimini
or any of its affiliates. Accordingly, we may compete
for access to the benefits that we expect our relationship with our Manager and
Bimini to provide.
We are completely dependent upon our Manager and certain key personnel of Bimini who provide
services to us through the
management agreement, and we may not find suitable replacements for our
Manager and these personnel if the management
agreement is terminated or such key personnel are no longer available to us.
We are completely dependent on our Manager to conduct our operations pursuant to the
management agreement. Because we
do not have any employees or separate facilities, we are reliant on our
Manager to provide us with the personnel, services and
resources necessary to carry out our day-to-day operations. Our management
agreement does not require our Manager to dedicate
specific personnel to our operations or a specific amount of time to our business.
Additionally, because we are affiliated with Bimini, we
may be negatively impacted by an event or factors that negatively impacts or
could negatively impact Bimini’s business or financial
condition.
Our management agreement is automatically renewed in accordance with the
terms of the agreement, each year, on February
20.
Upon the expiration of any automatic renewal term, our Manager
may elect not to renew the management agreement without
cause, and without penalty, on 180-days’ prior written notice to us. If we elect not to renew the management agreement without
cause,
we would have to pay a termination fee equal to three times the average annual
management fee earned by our Manager during the
prior 24-month period immediately preceding the most recently completed
calendar quarter prior to the effective date of termination.
During the term of the management agreement and for two years after its expiration
or termination, we may not, without the consent of
our Manager, employ any employee of the Manager or any of its affiliates or any person who has been employed by our
Manager or
any of its affiliates at any time within the two-year period immediately preceding the
date on which the person commences employment
28
with us. We do not have retention agreements with any of our officers. We believe that the successful implementation
of our investment
and financing strategies depends to a significant extent upon the experience of
Bimini’s executive officers. None of these individuals’
continued service is guaranteed. If the management agreement is terminated or
these individuals leave Bimini, we may be unable to
execute our business plan.
We, Bimini and other accounts managed by our Manager may compete for opportunities to
acquire assets, which are allocated in
accordance with the Investment Allocation Agreement by and among Bimini, our
Manager and us.
From time to time Bimini may seek to purchase for itself the same or similar
assets that our Manager seeks to purchase for us, or
our Manager may seek to purchase the same or similar assets for us as it does for other
accounts that may have occurred subsequentbe managed by our
Manager in the future. In such an instance, our Manager has no duty to February 26, 2021. Accordingly, this Amendment No. 1 should be readallocate
such opportunities in a manner that preferentially
conjunction favors us. Bimini and our Manager make available to us opportunities to acquire
assets that they determine, in their reasonable and
good faith judgment, based on our objectives, policies and strategies, and other relevant
factors, are appropriate for us in accordance
with the 2020 Form 10-K.Investment Allocation Agreement.
Because many of our targeted assets are typically available only in specified quantities
and because many of our targeted assets
Pursuantare also targeted assets for Bimini and may be targeted assets for other accounts
our Manager may manage in the future, neither
Bimini nor our Manager may be able to Rule 12b-15 underbuy as much of any given asset as required
to satisfy the Securities Exchange Actneeds of 1934, as amended, this Amendment No. 1 also contains newBimini, us and any other
certificationsaccount our Manager may manage in the future. In these cases, the Investment Allocation
Agreement will require the allocation of such
assets to multiple accounts in proportion to their needs and available capital. The
Investment Allocation Agreement will permit
departure from such proportional allocation when (i) allocating purchases of whole-pool
Agency RMBS, because those securities
cannot be divided into multiple parts to be allocated among various
accounts, and (ii) such allocation would result in an inefficiently
small amount of the Company’ssecurity being purchased for an account. In that case, the Investment
Allocation Agreement allows for a protocol of
allocating assets so that, on an overall basis, each account is treated equitably.
There are conflicts of interest in our relationships with our Manager and Bimini, which
could result in decisions that are not in the
best interests of our stockholders.
We are subject to conflicts of interest arising out of our relationships with Bimini and our Manager. All of our executive officers are
employees of Bimini. As a result, our officers may have conflicts between their duties
to us and their duties to Bimini or our Manager.
We may acquire or sell assets in which Bimini or its affiliates have or may have an interest. Similarly, Bimini or its affiliates may
acquire or sell assets in which we have or may have an interest. Although
such acquisitions or dispositions may present conflicts of
interest, we nonetheless may pursue and consummate such transactions. Additionally, we may engage in transactions directly with
Bimini or its affiliates, including the purchase and sale of all or a portion of a portfolio asset.
The officers of Bimini and our Manager devote as much time to us as our Manager deems
appropriate. However, these officers
may have conflicts in allocating their time and services among us, Bimini and
our Manager. During turbulent conditions in the mortgage
industry, distress in the credit markets or other times when we will need focused support and assistance from our Manager’s
officers
and Bimini’s employees, Bimini and other entities for which our Manager may serve as a manager
in the future will likewise require
greater focus and attention, placing our Manager’s and Bimini’s resources in high
demand. In such situations, we may not receive the
necessary support and assistance we require or would otherwise receive if we were
internally managed.
Mr. 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. Mr. Haas, our Chief Financial Officer, Chief
Investment Officer, Secretary and a member of our Board of Directors, also serves as the President, Chief Financial Officer, Chief
Investment Officer and Treasurer of Bimini and owns shares of common stock of Bimini. Accordingly, Messrs. Cauley and Haas may
have a conflict of interest with respect to actions by our Board of Directors that
relate to Bimini or our Manager.
29
As of February 25, 2022, Bimini owned approximately 1.5% of our outstanding
shares of common stock. In evaluating
opportunities for us and other management strategies, this may lead our
Manager to emphasize certain asset acquisition, disposition or
management objectives over others, such as balancing risk or capital preservation
objectives against return objectives. This could
increase the risks or decrease the returns of your investment.
If we elect to not renew the management agreement without cause, we would
be required to pay our Manager a substantial
termination fee. These and other provisions in our management agreement
make non-renewal of our management agreement
difficult and costly.
Electing not to renew the management agreement without cause would be difficult
and costly for us. Our management
agreement is automatically renewed in accordance with the terms of the agreement,
each year, on February 20. However, with the
consent of the majority of our independent directors, we may elect not to renew
our management agreement in subsequent years upon
180-days’ prior written notice. If we elect to not renew the agreement because of
a decision by our Board of Directors that the
management fee is unfair, our Manager has the right to renegotiate a mutually agreeable management fee. If we
elect to not renew the
management agreement without cause, we are required to pay our Manager
a termination fee equal to three times the average annual
management fee earned by our Manager during the prior 24-month period immediately
preceding the most recently completed
calendar quarter prior to the effective date of termination. These provisions may increase
the effective cost to us of electing to not
renew the management agreement, thereby adversely affecting our inclination to end our
relationship with our Manager even if we
believe our Manager’s performance is unsatisfactory.
Our Manager’s management fee is payable regardless of our
performance.
Our Manager is entitled to receive a management fee from us that is based on
the amount of our equity (as defined in the
management agreement), regardless of the performance of our investment portfolio.
For example, we would pay our Manager a
management fee for a specific period even if we experienced a net loss
during the same period. Our Manager’s entitlement to
substantial non-performance-based compensation may reduce its incentive to
devote sufficient time and effort to seeking investments
that provide attractive risk-adjusted returns for our investment portfolio. This in
turn could materially adversely affect our business,
financial condition and results of operations and our ability to make distributions
to our stockholders.
Our Manager will not be liable to us for any acts or omissions performed
in accordance with the management agreement,
including with respect to the performance of our investments.
Our Manager has not assumed any responsibility other than to render the services
called for under the management agreement
in good faith and is not responsible for any action of our Board of Directors in
following or declining to follow its advice or
recommendations, including as set forth in the investment guidelines. Our
Manager and its affiliates, and the directors, officers,
employees, members and stockholders of our Manager and its affiliates, will not be liable
to us, our Board of Directors or our
stockholders for any acts or omissions performed in accordance with and pursuant
to the management agreement, except by reason of
acts constituting bad faith, willful misconduct, gross negligence or reckless
disregard of their respective duties under the management
agreement. We have agreed to indemnify our Manager and its affiliates, and the directors, officers, employees, members
and
stockholders of our Manager and its affiliates, with respect to all expenses, losses, damages,
liabilities, demands, charges and claims
in respect of or arising from any acts or omissions of our Manager, its affiliates, and the directors, officers, employees, members and
stockholders of our Manager and its affiliates, performed in good faith under the management
agreement and not constituting bad faith,
willful misconduct, gross negligence, or reckless disregard of their respective
duties. Therefore, our stockholders have no recourse
against our Manager with respect to the performance of investments made in
accordance with the management agreement.
Risks Related to Our Common Stock
30
Investing in our common stock may involve a high degree of risk.
The investments we make in accordance with our investment objectives
may result in a high amount of risk when compared to
alternative investment options and volatility or loss of principal. Our investments
may be highly speculative and aggressive, and
therefore an investment in our common stock may not be suitable for someone
with lower risk tolerance.
We have not established a minimum distribution payment level, and we cannot assure you
of our ability to make distributions to
our stockholders in the future.
We intend to continue to make monthly distributions to our stockholders in amounts such that
we distribute all or substantially all
of our REIT taxable income in each year, subject to certain adjustments. We have not established a minimum distribution
payment
level, and our ability to make distributions might be harmed by the risk factors
described herein. All distributions will be made at the
discretion of our Board of Directors out of funds legally available therefor and
will depend on our earnings, our financial condition,
maintaining our qualification as a REIT and such other factors as our Board of
Directors may deem relevant from time to time. We
cannot assure you that we will have the ability to make distributions to our
stockholders in the future. To the extent that we decide to
pay distributions from the proceeds of a securities offering, such distributions would generally
be considered a return of capital for U.S.
federal income tax purposes. A return of capital reduces the basis of a stockholder’s
investment in our common stock to the extent of
such basis and is treated as capital gain thereafter.
Shares of our common stock eligible for future sale may harm our share price.
We cannot predict the effect, if any, of future sales of shares of our common stock, or the availability of shares for future sales,
on the market price of our common stock. Sales of substantial amounts of these
shares of our common stock, or the perception that
these sales could occur, may harm prevailing market prices for our common stock. The 2021 Equity Incentive Plan
provides for grants
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
award, subject to a maximum aggregate number of shares of common stock
that may be issued under the 2021 Equity Incentive Plan
of 4,000,000 shares of common stock plus 3,366,623 shares of our common stock that
remained available for issuance under the 2012
Equity Incentive Plan as of the date of the Board’s adoption of the 2021 Equity Incentive Plan.
As of February 25, 2022, Bimini owns
2,595,357 shares of our common stock. If Bimini sells a large number of our
securities in the public market, the sale could reduce the
market price of our common stock and could impede our ability to raise future capital.
We may be subject to adverse legislative or regulatory changes that could reduce the market
price of our common stock.
At any time, laws or regulations, or the administrative interpretations of those
laws or regulations, which impact our business and
Maryland corporations may be amended. In addition, the markets for RMBS
and derivatives, including interest rate swaps, have been
the subject of intense scrutiny in recent years. We cannot predict when or if any
new law, regulation or administrative interpretation, or
any amendment to any existing law, regulation or administrative interpretation, will be adopted or promulgated or will become
effective.
Additionally, revisions to these laws, regulations or administrative interpretations could cause us to change our investments.
We could
be materially adversely affected by any such change to any existing, or any new, law, regulation or administrative interpretation, which
could reduce the market price of our common stock.
In addition, at any time, the U.S. federal income tax laws or regulations
governing REITs or the administrative interpretations of
those laws or regulations may be amended. We cannot predict when or if any new U.S.
federal income tax law, regulation or
administrative interpretation, or any amendment to any existing U.S. federal
income tax law, regulation or administrative interpretation,
will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and
our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or
administrative interpretation. Prospective stockholders are urged to consult with their
tax advisors with respect to any legislative,
regulatory or administrative developments and proposals and their potential
effect on investment in our common stock.
31
Risks Related to Our Organization and Structure
Loss of our exemption from regulation under the Investment Company Act would
negatively affect the value of shares of our
common stock and our ability to pay distributions to our stockholders.
We have operated and intend to continue to operate our business so as to be exempt from
registration under the Investment
Company Act, because we are “primarily engaged in the business of purchasing
or otherwise acquiring mortgages and other liens on
and interests in real estate.” Specifically, we invest and intend to continue to invest so that at least 55% of the assets that
we own on
an unconsolidated basis consist of qualifying mortgages and other liens
and interests in real estate, which are filedcollectively referred to as exhibits hereto.
“qualifying real estate assets,” and so that at least 80% of the assets we own on an unconsolidated
basis consist of real estate-related
assets (including our qualifying real estate assets). We treat Fannie Mae, Freddie Mac
and Ginnie Mae whole-pool residential
mortgage pass-through securities issued with respect to an underlying pool of
mortgage loans in which we hold all of the certificates
issued by the pool as qualifying real estate assets based on no-action letters issued
by the SEC. To the extent that the SEC publishes
new or different guidance with respect to these matters, we may fail to qualify for this exemption.
If we fail to qualify for this exemption, we could be required to restructure
our activities in a manner that, or at a time when, we
would not otherwise choose to do so, which could negatively affect the value of shares of
our common stock and our ability to distribute
dividends. For example, if the market value of our investments in CMOs or
structured Agency RMBS, neither of which are qualifying
real estate assets for Investment Company Act purposes, were to increase by
an amount that resulted in less than 55% of our assets
being invested in pass-through Agency RMBS, we might have to sell CMOs
or structured Agency RMBS in order to maintain our
exemption from the Investment Company Act. The sale could occur during
adverse market conditions, and we could be forced to
accept a price below that which we believe is acceptable.
Alternatively, if we fail to qualify for this exemption, we may have to register under the Investment Company Act and we
could
become subject to substantial regulation with respect to our capital structure
(including our ability to use leverage), management,
operations, transactions with affiliated persons (as defined in the Investment Company Act),
portfolio composition, including restrictions
with respect to diversification and industry concentration, and other matters.
We may be required at times to adopt less efficient methods of financing certain of our securities, and we
may be precluded from
acquiring certain types of higher yielding securities. The net effect of these factors would be
to lower our net interest income. If we fail
to qualify for an exemption from registration as an investment company or an exclusion
from the definition of an investment company,
our ability to use leverage would be substantially reduced, and we would not be able to
conduct our business as described herein. Our
business will be materially and adversely affected if we fail to qualify for and maintain
an exemption from regulation pursuant to the
Investment Company Act.
Failure to obtain and maintain an exemption from being regulated as a commodity
pool operator could subject us to additional
regulation and compliance requirements and may result in fines and other penalties
which could materially adversely affect our
business and financial condition.
The Dodd-Frank Act established a comprehensive new regulatory framework
for derivative contracts commonly referred to as
“swaps.” As a result, any investment fund that trades in swaps may be considered
a “commodity pool,” which would cause its operators
(in some cases the fund’s directors) to be regulated as “commodity pool operators” (“CPOs”).
Under new rules adopted by the U.S.
Commodity Futures Trading Commission (the “CFTC”), those funds that become commodity pools solely
because of their use of swaps
must register with the National Futures Association (the “NFA”). Registration requires compliance with the CFTC’s regulations and the
NFA’s
rules with respect to capital raising, disclosure, reporting, recordkeeping
and other business conduct. However, the CFTC’s
Division of Swap Dealer and Intermediary Oversight issued a no-action letter saying,
although it believes that mortgage REITs are
properly considered commodity pools, it would not recommend that the CFTC take
enforcement action against the operator of a
32
mortgage REIT who does not register as a CPO if, among other things, the
mortgage REIT limits the initial margin and premiums
required to establish its swaps, futures and other commodity interest positions to not
more than five percent (5%) of its total assets, the
mortgage REIT limits the net income derived annually from those commodity
interest positions which are not qualifying hedging
transactions to less than five percent (5%) of its gross income and interests
in the mortgage REIT are not marketed to the public as or
in a commodity pool or otherwise as or in a vehicle for trading in the commodity futures,
commodity options or swaps markets.
We use hedging instruments in conjunction with our investment portfolio and related borrowings
to reduce or mitigate risks
associated with changes in interest rates, mortgage spreads, yield curve shapes
and market volatility. These hedging instruments may
include interest rate swaps, interest rate futures and options on interest rate
futures. We do not currently engage in any speculative
derivatives activities or other non-hedging transactions using swaps, futures
or options on futures. We do not use these instruments for
the purpose of trading in commodity interests, and we do not consider the Company
or its operations to be a commodity pool as to
which CPO registration or compliance is required. We have claimed the relief afforded by the
above-described no-action letter.
Consequently, we will be restricted to operating within the parameters discussed in the no-action letter and will not enter into
hedging
transactions covered by the no-action letter if they would cause us to exceed
the limits set forth in the no-action letter. However, there
can be no assurance that the CFTC will agree that we are entitled to the no-action
letter relief claimed.
The CFTC has substantial enforcement power with respect to violations of the laws
over which it has jurisdiction, including their
anti-fraud and anti-manipulation provisions. For example, the CFTC may suspend
or revoke the registration of or the no-action relief
afforded to a person who fails to comply with commodities laws and regulations, prohibit
such a person from trading or doing business
with registered entities, impose civil money penalties, require restitution
and seek fines or imprisonment for criminal violations. In the
event that the CFTC asserts that we are not entitled to the no-action letter relief
claimed, we may be obligated to furnish additional
disclosures and reports, among other things. Further, a private right of action exists against those who
violate the laws over which the
CFTC has jurisdiction or who willfully aid, abet, counsel, induce or procure
a violation of those laws. In the event that we fail to comply
with statutory requirements relating to derivatives or with the CFTC’s rules thereunder, including the no-action letter described
above,
we may be subject to significant fines, penalties and other civil or governmental
actions or proceedings, any of which could have a
materially adverse effect on our business, financial condition and results of operations
and our ability to pay distributions to our
stockholders.
Our ownership limitations and certain other provisions of applicable law
and our charter and bylaws may restrict business
combination opportunities that would otherwise be favorable to our stockholders.
Our charter and bylaws and Maryland law contain provisions that may delay, defer or prevent a change in control or other
transaction that might involve a premium price for our common stock or otherwise
be in the best interests of our stockholders, including
business combination provisions, supermajority vote and cause requirements for
removal of directors, provisions that vacancies on our
Board of Directors may be filled only by the remaining directors for the full
term of the directorship in which the vacancy occurred, the
power of our Board of Directors to increase or decrease the aggregate number
of authorized shares of stock or the number of shares of
any class or series of stock, to cause us to issue additional shares of stock
of any class or series and to fix the terms of one or more
classes or series of stock without stockholder approval, the restrictions
on ownership and transfer of our stock and advance notice
requirements for director nominations and stockholder proposals.
To assist
us in qualifying as a REIT, among other purposes, ownership of our stock by any person will generally be limited to
9.8% in value or number of shares, whichever is more restrictive, of any
class or series of our stock. Additionally, our charter will
prohibit beneficial or constructive ownership of our stock that would otherwise
result in our failure to qualify as a REIT. The ownership
rules in our charter are complex and may cause the outstanding stock owned by
a group of related individuals or entities to be deemed
to be owned by one individual or entity. As a result, these ownership rules could cause an individual or entity to unintentionally own
shares beneficially or constructively in excess of our ownership limits. Any
attempt to own or transfer shares of our common stock or
preferred stock in excess of our ownership limits without the consent of our
Board of Directors will result in such shares being
transferred to a charitable trust. These provisions may inhibit market activity
and the resulting opportunity for our stockholders to
33
receive a premium for their stock that might otherwise exist if any person were
to attempt to assemble a block of shares of our stock in
excess of the number of shares permitted under our charter and that
may be in the best interests of our security holders.
Our Board of Directors may, without stockholder approval, amend our charter to increase or decrease the aggregate number
of
our shares or the number of shares of any class or series that we have the authority
to issue and to classify or reclassify any unissued
shares of common stock or preferred stock, and set the preferences, rights
and other terms of the classified or reclassified shares. As a
result, our Board of Directors may take actions with respect to our common
stock or preferred stock that may have the effect of
delaying or preventing a change in control, including transactions at a premium
over the market price of our shares, even if
stockholders believe that a change in control is in their interest. These provisions,
along with the restrictions on ownership and transfer
contained in our charter and certain provisions of Maryland law described below, could discourage unsolicited acquisition
proposals or
make it more difficult for a third party to gain control of us, which could adversely affect the
market price of our securities.
Our rights and the rights of our stockholders to take action against our directors
and officers are limited, which could limit your
recourse in the event of actions not in your best interests.
Our charter limits the liability of our directors and officers to us and our stockholders for money
damages, except for liability
resulting from:
●
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.
We have entered into indemnification agreements with our directors and executive officers that obligate
us to indemnify them to
the maximum extent permitted by Maryland law. In addition, our charter authorizes the Company to obligate itself to indemnify
our
present and former directors and officers for actions taken by them in those and other
capacities to the maximum extent permitted by
Maryland law. Our bylaws require us, to the maximum extent permitted by Maryland law, to indemnify each present and former director
or officer in the defense of any proceeding to which he or she is made, or threatened to
be made, a party by reason of his or her
service to us. In addition, we may be obligated to advance the defense costs
incurred by our directors and officers. As a result, we and
our stockholders may have more limited rights against our directors and officers than
might otherwise exist absent the provisions in our
charter, bylaws and indemnification agreements or that might exist with other companies.
Certain provisions of Maryland law could inhibit changes in control.
Certain provisions of the Maryland General Corporation Law (the “MGCL”),
may have the effect of inhibiting a third party from
making a proposal to acquire us or impeding a change of control under
circumstances that otherwise could provide our stockholders
with the opportunity to realize a premium over the then-prevailing market price of
our common stock, including:
●
“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)
34
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.
We have elected to opt-out of these provisions of the MGCL, in the case of the business
combination provisions, by resolution of
our Board of Directors (provided that such business combination is first approved
by our Board of Directors, including a majority of our
directors who are not affiliates or associates of such person), and in the case of the control
share provisions, pursuant to a provision in
our bylaws. However, our Board of Directors may by resolution elect to repeal the foregoing opt-out from the business combination
provisions of the MGCL, and we may, by amendment to our bylaws, opt-in to the control share provisions of the MGCL in the future.
Our bylaws designate the Circuit Court for Baltimore City, Maryland as the sole and exclusive forum for certain types of actions
and proceedings that may be initiated by our stockholders, which could
limit stockholders' ability to obtain a favorable judicial
forum for disputes with us or our directors or officers and could discourage lawsuits
against us and our directors and officers.
Our bylaws provide that, unless we consent in writing to the selection
of an alternative forum, the Circuit Court for Baltimore City,
Maryland, or, if that court does not have jurisdiction, the United States District Court for the District of Maryland,
Baltimore Division, will
be the sole and exclusive forum for (a) any Internal Corporate Claim, as such term
is defined in the MGCL, (b) any derivative action or
proceeding brought on our behalf, (c) any action asserting a claim of breach
of any duty owed by any of our directors or officers to us or
to our stockholders, (d) any action asserting a claim against us or any of our
directors or officers arising pursuant to any provision of the
MGCL or our charter or bylaws or (e) any other action asserting a claim against
us or any of our directors or officers that is governed by
the internal affairs doctrine.
This exclusive forum provision may limit the ability of our stockholders to
bring a claim in a judicial forum that such stockholders
find favorable for disputes with us or our directors or officers, which may discourage such lawsuits against
us and our directors and
officers. Alternatively, if a court were to find the choice of forum provisions contained in our bylaws to be inapplicable or unenforceable
in an action, we may incur additional costs associated with resolving such action
in other jurisdictions, which could materially adversely
affect our business, financial condition, and operating results.
U.S. Federal Income Tax Risks
Your investment has various U.S. federal income tax risks.
This summary of certain tax risks is limited to the U.S. federal income tax risks
addressed below. Additional risks or issues may
exist that are not addressed in this Form 10-K and that could affect the U.S. federal income
tax treatment of us or our stockholders.
This summary is not intended to be used and cannot be used by any stockholder
to avoid penalties that may be imposed on
stockholders under the Code. We strongly urge you to seek advice based on your particular
circumstances from your tax advisor
concerning the effects of U.S. federal, state and local income tax law on an investment
in our common stock and on your individual tax
situation.
Our failure to maintain our qualification as a REIT would subject us to U.S. federal income
tax, which could adversely affect the
value of the shares of our common stock and would substantially reduce
the cash available for distribution to our stockholders.
We believe that commencing with our short taxable year ended December 31, 2013,
we have been organized and have operated
in conformity with the requirements for qualification as a REIT under the Code, and
we intend to operate in a manner that will enable us
to continue to meet the requirements for qualification and taxation as a REIT.
However, we cannot assure you that we will remain
qualified as a REIT.
Moreover, our qualification and taxation as a REIT will depend upon our ability to meet on a continuing
basis,
through actual annual operating results, certain qualification tests set forth
in the U.S. federal tax laws. Accordingly, given the complex
nature of the rules governing REITs, the ongoing importance of factual determinations, including the potential tax treatment of
35
investments we make, and the possibility of future changes in our circumstances,
no assurance can be given that our actual results of
operations for any particular taxable year will satisfy such requirements.
If we fail to qualify as a REIT in any calendar year, we would be required to pay U.S. federal income tax
(and any applicable state
and local tax) on our taxable income at regular corporate rates, and dividends
paid to our stockholders would not be deductible by us in
computing our taxable income. Further, if we fail to qualify as a REIT, we might need to borrow money or sell assets in order to pay any
resulting tax. Our payment of income tax would decrease the amount of our
income available for distribution to our stockholders.
Furthermore, if we fail to maintain our qualification as a REIT, we no longer would be required under U.S. federal tax laws to distribute
substantially all of our REIT taxable income to our stockholders. Unless our failure
to qualify as a REIT was subject to relief under U.S.
federal tax laws, we could not re-elect to qualify as a REIT until the fifth
calendar year following the year in which we failed to qualify.
Complying with REIT requirements may cause us to forego or liquidate otherwise
attractive investments.
To
continue to qualify as a REIT, we must satisfy various tests regarding the sources of our income, the nature and diversification
of our assets, the amounts we distribute to our stockholders and the ownership
of our stock. In order to meet these tests, we may be
required to forego investments we might otherwise make. Thus, compliance with the
REIT requirements may hinder our investment
performance.
In particular, we must ensure that at the end of each calendar quarter, at least 75% of the value of our total assets consists of
cash, cash items, government securities and qualified REIT real estate assets, including
Agency RMBS. The remainder of our
investment in securities (other than government securities and qualified real estate
assets) generally cannot include more than 10% of
the outstanding voting securities of any one issuer or more than 10% of the total
value of the outstanding securities of any one issuer.
In addition, in general, no more than 5% of the value of our total assets (other than
government securities, TRS securities, and qualified
real estate assets) can consist of the securities of any one issuer, no more than 20% of the value of our total
assets can be
represented by securities of one or more TRSs and no more than 25%
of the value of our assets can be represented by debt of
“publicly offered REITs” (i.e., REITs
that are required to file annual and period reports with the SEC under the
Exchange Act) that is not
secured by real property or interests in real property. Generally, if we fail to comply with these requirements at the end of any calendar
quarter, we must correct the failure within 30 days after the end of such calendar quarter or qualify for certain statutory relief
provisions
to avoid losing our REIT qualification and becoming subject to U.S. federal income tax (and
any applicable state and local taxes) on all
of our income. As a result, we may be required to liquidate from our portfolio
otherwise attractive investments or contribute such
investments to a TRS. These actions could have the effect of reducing our income and amounts
available for distribution to our
stockholders.
Failure to make required distributions would subject us to tax, which
would reduce the cash available for distribution to our
stockholders.
To continue to qualify as a REIT,
we must distribute to our stockholders each calendar year at least 90%
of our REIT taxable
income (including certain items of non-cash income), determined without
regard to the deductions for dividends paid and excluding net
capital gain. To the extent that we satisfy the 90% distribution requirement but distribute less than 100% of our taxable income, we will
be subject to U.S. federal corporate income tax on our undistributed
income. In addition, we will incur a 4% nondeductible excise tax on
the amount, if any, by which our distributions in any calendar year are less than the sum of:
●
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
We intend to distribute our REIT taxable income to our stockholders in a manner intended to
satisfy the 90% distribution
requirement and to avoid both U.S. federal corporate income tax and the 4% nondeductible
excise tax.
36
Our taxable income may be substantially different than our net income as determined based
on generally accepted accounting
principles in the United States (“GAAP”), because, for example, realized capital
losses will be deducted in determining our GAAP net
income but may not be deductible in computing our taxable income. In addition,
unrealized portfolio gains and losses are included in
GAAP net income, but are not included in REIT taxable income.
Also, we may invest in assets that generate taxable income in excess
of economic income or in advance of the corresponding cash flow from the assets.
As a result of the foregoing, we may generate less
cash flow than taxable income in a particular year. To the extent that we generate such non-cash taxable income in a taxable year, we
may incur U.S. federal corporate income tax and the 4% nondeductible excise tax on
that income if we do not distribute such income to
stockholders in that year. In that event, we may be required to use cash reserves, incur debt, sell assets,
make taxable distributions of
our stock or debt securities or liquidate non-cash assets at rates or at times that
we regard as unfavorable to satisfy the distribution
requirement and to avoid U.S. federal corporate income tax and the 4% nondeductible
excise tax in that year.
Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flows.
Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and
assets, including taxes on any undistributed income, tax on income from
some activities conducted as a result of a foreclosure, and
state or local income, property and transfer taxes. In addition, any TRSs we form
will be subject to regular corporate U.S. federal, state
and local taxes. Any of these taxes would decrease cash available for distributions
to stockholders.
The failure of Agency RMBS subject to a repurchase agreement to qualify as real
estate assets would adversely affect our ability
to continue to qualify as a REIT.
We have entered and intend to continue to enter into repurchase agreements under which
we nominally sell certain of our
Agency RMBS to a counterparty and simultaneously enter into an agreement
to repurchase the sold assets. We believe that for U.S.
federal income tax purposes these transactions will be treated as
secured debt and we will be treated as the owner of the Agency
RMBS that are the subject of any such agreement,
notwithstanding that such agreements
may transfer record ownership of such
assets to the counterparty during the term of the agreement. It is possible,
however, that the IRS could successfully assert that we do
not own the Agency RMBS during the term of the repurchase agreement, in
which case we could fail to qualify as a REIT.
Our ability to invest in and dispose of forward settling contracts, including
TBA securities, could be limited by the requirements
necessary to continue to qualify as a REIT, and we could fail to qualify as a REIT as a result of these investments.
We may purchase Agency RMBS through forward settling contracts, including TBA
securities transactions. We may recognize
income or gains on the disposition of forward settling contracts. For example, rather
than take delivery of the Agency RMBS subject to
a TBA, we may dispose of the TBA through a “roll” transaction in which we agree
to purchase similar securities in the future at a
predetermined price or otherwise, which may result in the recognition of income
or gains. The law is unclear regarding whether forward
settling contracts will be qualifying assets for the 75% asset test and whether
income and gains from dispositions of forward settling
contracts will be qualifying income for the 75% gross income test.
Until we receive a favorable private letter ruling from the IRS or we
are advised by counsel that forward settling contracts should
be treated as qualifying assets for purposes of the 75% asset test, we will limit
our investment in forward settling contracts and any
non-qualifying assets to no more than 25% of our total gross assets at the end
of any calendar quarter and will limit the forward settling
contracts issued by any one issuer to no more than 5% of our total gross assets
at the end of any calendar quarter. Further, until we
receive a favorable private letter ruling from the IRS or we are advised by counsel
that income and gains from the disposition of forward
settling contracts should be treated as qualifying income for purposes of the 75% gross
income test, we will limit our income and gains
from dispositions of forward settling contracts and any non-qualifying income to
no more than 25% of our gross income for each
calendar year. Accordingly, our ability to purchase Agency RMBS through forward settling contracts and to dispose of forward settling
contracts through
roll transactions or otherwise, could be limited.
37
Moreover, even if we are advised by counsel that forward settling contracts should be treated as qualifying assets
or that income
and gains from dispositions of forward settling contracts should be treated as qualifying
income, it is possible that the IRS could
successfully take the position that such assets are not qualifying assets and such
income is not qualifying income. In that event, we
could be subject to a penalty tax or we could fail to qualify as a REIT if (i) the value
of our forward settling contracts, together with our
other non-qualifying assets for purposes of the 75% asset test, exceeded 25%
of our total gross assets at the end of any calendar
quarter, (ii) the value of our forward settling contracts, including TBAs, issued by any one issuer exceeded 5%
of our total assets at the
end of any calendar quarter, or (iii) our income and gains from the disposition of forward settling contracts, together
with our other non-
qualifying income for purposes of the 75% gross income test, exceeded 25%
of our gross income for any taxable year.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Code substantially limit our ability to hedge.
Our aggregate gross income from non-qualifying hedges,
fees, and certain other non-qualifying sources cannot exceed 5% of our
annual gross income. As a result, we might have to limit our
use of advantageous hedging techniques or implement those hedges through
a TRS. Any hedging income earned by a TRS would be
subject to U.S. federal, state and local income tax at regular corporate rates.
This could increase the cost of our hedging activities or
expose us to greater risks associated with changes in interest rates than we would otherwise
want to bear.
Our ownership of and relationship with any TRSs that we form will be
limited and a failure to comply with the limits would
jeopardize our REIT qualification and may result in the application of a 100%
excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A
TRS may earn income that would not be qualifying income if
earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A corporation
(other than a REIT) of which a TRS directly or indirectly owns more than 35%
of the voting power or value of the stock will
automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT’s total
assets may consist of stock or securities of
one or more TRSs. A domestic TRS will pay U.S. federal, state and
local income tax at regular corporate rates on any income that it
earns. In addition, the Code limits the deductibility of interest paid or accrued
by a TRS to its parent REIT to ensure that the TRS is
subject to an appropriate level of corporate taxation. The rules also impose
a 100% excise tax on certain transactions between a TRS
and its parent REIT that are not conducted on an arm’s length basis. Any domestic TRS
that we may form will pay U.S. federal, state
and local income tax on its taxable income, and its after-tax net income will be
available for distribution to us (but is not required to be
distributed to us unless necessary to maintain our REIT qualification).
We may pay taxable dividends in cash and our common stock, in which case stockholders
may sell shares of our common stock
to pay tax on such dividends, placing downward pressure on the market price of
our common stock.
We may make taxable dividends that are payable partly in cash and partly in our common
stock. The IRS has issued Revenue
Procedure 2017-45 authorizing elective cash/stock dividends to be made
by publicly offered REITs. Pursuant to Revenue Procedure
2017-45 the IRS will treat the distribution of stock pursuant to an elective cash/stock
dividend as a distribution of property under
Section 301 of the Code (i.e., a dividend), as long as at least 20% of the total dividend
is available in cash and certain other parameters
detailed in the Revenue Procedure are satisfied. On November 30, 2021, the IRS issued
Revenue Procedure 2021-53, which
temporarily reduces (through June 30, 2022) the minimum amount of the total distribution
that must be available in cash to 10%.
Although we have no current intention of paying dividends in our own stock, if in
the future we choose to pay dividends in our own
stock, our stockholders may be required to pay tax in excess of the cash that they
receive. If a U.S. stockholder sells the shares that it
receives as a dividend in order to pay this tax, the sales proceeds may be less than
the amount included in income with respect to the
dividend, depending on the market price of our common stock at the time of the
sale. Furthermore, with respect to certain non-U.S.
stockholders, we may be required to withhold U.S. federal income tax with respect
to such dividends, including in respect of all or a
portion of such dividend that is payable in common stock. If we pay dividends
in our common stock and a significant number of our
38
stockholders determine to sell shares of our common stock in order to pay taxes
owed on dividends, it may put downward pressure on
the trading price of our common stock.
Our ownership limitations may restrict change of control or business combination opportunities
in which our stockholders might
receive a premium for their stock.
In order for us to qualify as a REIT for each taxable year after 2013, no more
than 50% in value of our outstanding stock may be
owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” for this purpose include
natural persons, private foundations, some employee benefit plans and trusts,
and some charitable trusts. In order to assist us in
qualifying as a REIT, among other purposes, ownership of our stock by any person is generally limited to 9.8% in value or number of
shares, whichever is more restrictive, of any class or series of our stock.
These ownership limitations could have the effect of discouraging a takeover or other transaction
in which holders of our common
stock might receive a premium for their common stock over the then-prevailing
market price or which holders might believe to be
otherwise in their best interests.
Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.
The maximum tax rate applicable to “qualified dividend income” payable to U.S.
stockholders that are taxed at individual rates
may be lower than ordinary income tax rates. Dividends payable by REITs, however, are generally not eligible for the reduced rates on
qualified dividend income. Rather, ordinary REIT dividends constitute “qualified business income” and thus
a 20% deduction is
available to individual taxpayers with respect to such dividends.
To qualify for this deduction, the U.S. stockholder receiving such
dividends must hold the dividend-paying REIT stock for at least 46 days
(taking into account certain special holding periods) of the 91-
day period beginning 45 days before the stock becomes ex-dividend and
cannot be under an obligation to make related payments with
respect to a position in substantially similar or related property. The 20% deduction results in a 29.6% maximum U.S. federal
income
tax rate (plus the 3.8% surtax on net investment income, if applicable) for individual U.S.
stockholders. Without further legislative
action, the 20% deduction applicable to ordinary REIT dividends will expire on January 1,
2026. The more favorable rates applicable to
regular corporate qualified dividends could cause investors who are taxed at
individual rates to perceive investments in REITs to be
relatively less attractive than investments in the stock of non-REIT corporations that
pay dividends, which could adversely affect the
value of the shares of REITs, including our common stock.
Certain financing activities may subject us to U.S. federal income tax and could have
negative tax consequences for our
stockholders.
We currently do not intend to enter into any transactions that could result in all, or a portion,
of our assets being treated as a
taxable mortgage pool for U.S. federal income tax purposes. If we enter into such
a transaction in the future, we will be taxable at the
highest corporate income tax rate on a portion of the income arising from
a taxable mortgage pool, referred to as “excess inclusion
income,” that is allocable to the percentage of our stock held in record name by
disqualified organizations (generally tax-exempt entities
that are exempt from the tax on unrelated business taxable income, such as
state pension plans, charitable remainder trusts and
government entities). In that case, under our charter, we will reduce distributions to such stockholders by the amount of
tax paid by us
that is attributable to such stockholder’s ownership.
If we were to realize excess inclusion income, IRS guidance indicates that the
excess inclusion income would be allocated
among our stockholders in proportion to our dividends paid. Excess inclusion
income cannot be offset by losses of our stockholders. If
the stockholder is a tax-exempt entity and not a disqualified organization, then this
income would be fully taxable as unrelated business
taxable income under Section 512 of the Code. If the stockholder is a foreign
person, it would be subject to U.S. federal income tax at
the maximum tax rate and withholding will be required on this income without reduction
or exemption pursuant to any otherwise
applicable income tax treaty.
39
Our recognition of “phantom” income may reduce a stockholder’s after-tax
return on an investment in our common stock.
We may recognize taxable income in excess of our economic income, known as phantom
income, in the first years that we hold
certain investments, and experience an offsetting excess of economic income over our taxable
income in later years. As a result,
stockholders at times may be required to pay U.S. federal income tax on distributions
that economically represent a return of capital
rather than a dividend. These distributions would be offset in later years by distributions
representing economic income that would be
treated as returns of capital for U.S. federal income tax purposes. Taking into account the time value of money, this acceleration of
U.S. federal income tax liability may reduce a stockholder’s
after-tax return on his or her investment to an amount less than the after-
tax return on an investment with an identical before-tax rate of return that did
not generate phantom income.
Liquidation of our assets may jeopardize our REIT qualification.
To maintain our qualification as a REIT,
we must comply with requirements regarding our assets and our sources
of income. If
we are compelled to liquidate our assets to repay obligations to our lenders, we
may be unable to comply with these requirements,
thereby jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are
treated as inventory or property held primarily for sale to customers
in the ordinary course of business.
Our qualification as a REIT and exemption from U.S. federal income tax with respect
to certain assets may be dependent on the
accuracy of legal opinions or advice rendered or given or statements by the issuers
of assets that we acquire, and the inaccuracy
of any such opinions, advice or statements may adversely affect our REIT qualification and
result in significant corporate-level
tax.
When purchasing securities, we may rely on opinions or advice of counsel for the issuer
of such securities, or statements made
in related offering documents, for purposes of determining whether such securities
represent debt or equity securities for U.S. federal
income tax purposes, the value of such securities, and the extent to which those
securities constitute qualified real estate assets for
purposes of the REIT asset tests and produce income that qualifies under the
75% gross income test. The inaccuracy of any such
opinions, advice or statements may adversely affect our REIT qualification and result in
significant corporate-level tax.
Risks Related to COVID-19
The market and economic disruptions caused by COVID-19 have negatively impacted
our business.
The COVID-19 pandemic has caused and continues to cause significant disruptions
to the U.S. and global economies and has
contributed to volatility, illiquidity and dislocations in the financial markets. The COVID-19 outbreak has led governments and other
authorities around the world to impose measures intended to control
its spread, including restrictions on freedom of movement and
business operations such as travel bans, border closings, closing non-essential
businesses, quarantines and shelter-in-place orders.
The market and economic disruptions caused by COVID-19 have negatively impacted
and could further negatively impact our
business.
Beginning in mid-March 2020, Agency RMBS markets experienced significant volatility
and sharp declines in liquidity, which
negatively impacted our portfolio. Our portfolio was pledged as collateral under
daily mark-to-market repurchase agreements.
Fluctuations in the value of our Agency RMBS resulted in margin calls, requiring
us to post additional collateral with our lenders under
these repurchase agreements. These fluctuations and requirements to post additional
collateral were material.
The Agency RMBS market largely stabilized after 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. The Fed continued to increase
its holdings of U.S.
Treasuries and Agency RMBS throughout 2020 and 2021 to sustain smooth functioning of markets for these
securities; however, in
40
response to growing inflation concerns in late 2021, the FOMC began tapering
its net asset purchases and announced on January 26,
2022 that it would completely phase them out by early March 2022. If the COVID-19
outbreak continues or worsens, or if the current
policy response changes or is ineffective, the Agency RMBS market may experience
significant volatility, illiquidity and dislocations in
the future, which may adversely affect our results of operations and financial condition.
Our inability to access funding or the terms on which such funding is available
could have a material adverse effect on our financial
condition, particularly in light of ongoing market dislocations resulting from the COVID-19
pandemic.
Our ability to fund our operations, meet financial obligations and finance
asset acquisitions is dependent upon our ability to secure
and maintain our repurchase agreements with our counterparties. Because repurchase
agreements are short-term commitments of
capital, lenders may respond to market conditions in ways that make it more difficult for
us to renew or replace on a continuous basis
our maturing short-term borrowings and have imposed and may continue to impose
more onerous terms when rolling such financings.
If we are not able to renew our existing repurchase agreements or arrange for
new financing on terms acceptable to us, or if we are
required to post more collateral or face larger haircuts, we may have to curtail
our asset acquisition activities and/or dispose of assets.
Issues related to financing are exacerbated in times of significant dislocation
in the financial markets, such as those experienced
related to the COVID-19 pandemic. It is possible our lenders will become unwilling
or unable to provide us with financing, and we could
be forced to sell our assets at an inopportune time when prices are depressed.
In addition, if the regulatory capital requirements
imposed on our lenders change, they may be required to significantly increase
the cost of the financing that they provide to us. Our
lenders also have revised and may continue to revise the terms of such financings,
including haircuts and requiring additional collateral
in the form of cash, based on, among other factors, the regulatory environment
and their management of actual and perceived risk.
Moreover, the amount of financing we receive under our repurchase agreements will be directly related to our
lenders’ valuation of our
assets that collateralize the outstanding borrowings. Typically, repurchase agreements grant the lender the absolute right to re-
evaluate the fair market value of the assets that cover outstanding borrowings
at any time. If a lender determines in its sole discretion
that the value of the assets has decreased, the lender has the right to initiate a
margin call. These valuations may be different than the
values that we ascribe to these assets and may be influenced by recent asset sales at
distressed levels by forced sellers. A margin call
requires us to transfer additional assets to a lender without any advance of funds from
the lender for such transfer or to repay a portion
of the outstanding borrowings. Significant margin calls could have a
material adverse effect on our results of operations, financial
condition, business, liquidity and ability to make distributions to our stockholders, and
could cause the value of our common stock to
decline. In addition, we experienced an increase in haircuts on financings we have rolled.
As haircuts are increased, we are required to
post additional collateral. We may also be forced to sell assets at significantly depressed
prices to meet such margin calls and to
maintain adequate liquidity. As a result of the ongoing COVID-19 pandemic, we experienced margin calls in 2020 well beyond historical
norms. As of December 31, 2021, we had met all margin call requirements,
but a sufficiently deep and/or rapid increase in margin calls
or haircuts will have an adverse impact on our liquidity.
We cannot predict the effect that government policies, laws and plans adopted in response to the COVID-19
pandemic and the
global recessionary economic conditions will have on us.
Governments have adopted, and may continue to adopt, policies, laws and plans
intended to address the COVID-19 pandemic
and adverse developments in the economy and continued functioning of
the financial markets. We cannot assure you that these
programs will be effective, sufficient or will otherwise have a positive impact on our business.
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 or prepayments
on Agency RMBS. To the extent the financial or mortgage
markets do not respond favorably to any of these actions, such actions do not function
as intended, or prepayments increase materially
as a result of these actions,
our business, results of operations and financial condition may
continue to be materially adversely affected.
Measures intended to prevent the spread of COVID-19 have disrupted our ability to
operate our business.
41
In response to the outbreak of COVID-19 and the federal and state mandates implemented
to control its spread, some of our
Manager’s employees worked remotely until June of 2021. If
our Manager’s employees are unable to work effectively as a result
of
COVID-19, including because of illness, quarantines, office closures, ineffective remote work arrangements
or technology failures or
limitations, our operations would be adversely impacted. Further, remote work arrangements may increase
the risk of cybersecurity
incidents, data breaches or cyber-attacks, which could have a material adverse
effect on our business and results of operations, due
to, among other things, the loss of proprietary data, interruptions or delays in the operation
of our business and damage to our
reputation.
General Risk Factors
The occurrence of cyber-incidents, or a deficiency in our cybersecurity or in those
of any of our third party service providers could
negatively impact our business by causing a disruption to our operations, a
compromise or corruption of our confidential
information or damage to our business relationships or reputation, all of which
could negatively impact our business and results
of operations.
A cyber-incident is considered to be any adverse event that threatens the
confidentiality, integrity,
or availability of our
information resources or the information resources of our third party service providers.
More specifically, a cyber-incident is an
intentional attack or an unintentional event that can include gaining unauthorized
access to systems to disrupt operations, corrupt data,
or steal confidential information. As our reliance on technology has increased, so have
the risks posed to our systems, both internal
and those we have outsourced. The primary risks that could directly result from
the occurrence of a cyber-incident include operational
interruption and private data exposure. We have implemented processes, procedures and
controls to help mitigate these risks, but
these measures, as well as our focus on mitigating the risk of a cyber-incident,
do not guarantee that our business and results of
operations will not be negatively impacted by such an incident.
We face possible risks associated with the effects of climate change and severe weather.
We cannot predict the rate at which climate change will progress. However, the physical effects of climate change could have a
material adverse effect on our operations and business. Our headquarters and our Manager
are located very close to the Florida
coastline. To the extent that climate change impacts changes in weather patterns, our headquarters and our Manager could experience
severe weather, including hurricanes and coastal flooding due to increases in storm intensity and rising sea
levels. Such weather
events could disrupt our operations or damage our headquarters. There
can be no assurance that climate change and severe weather
will not have a material adverse effect on our operations or business.
If we issue debt securities, our operations may be restricted and we will
be exposed to additional risk.
If we decide to issue debt securities in the future, it is likely that such securities
will be governed by an indenture or other
instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we
issue in the future may have rights, preferences and privileges more favorable
than those of our common stock. We, and indirectly our
stockholders, will bear the cost of issuing and servicing such securities. Holders
of debt securities may be granted specific rights,
including but not limited to, the right to hold a perfected security interest in certain of our
assets, the right to accelerate payments due
under the indenture, rights to restrict dividend payments, and rights to approve the
sale of assets. Such additional restrictive covenants
and operating restrictions could have a material adverse effect on our business, financial
condition and results of operations and our
ability to pay distributions to our stockholders.
There may not be an active market for our common stock, which may cause our
common stock to trade at a discount and make it
difficult to sell the common stock you purchase.
42
Our common stock is listed on the NYSE under the symbol “ORC.” Trading on the NYSE does not
ensure that there will continue
to be an actual market for our common stock. Accordingly, no assurance can be given as to:
●
the likelihood that an actual market for our common stock will continue;
●
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.
Future offerings of debt securities, which would be senior to our common stock upon liquidation,
or equity securities, which would
dilute our existing stockholders and may be senior to our common stock for the
purposes of distributions, may harm the value of
our common stock.
In the future, we may attempt to increase our capital resources by making additional
offerings of debt or equity securities,
including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common
stock, as well
as warrants to purchase shares of common stock or convertible preferred stock.
Upon the liquidation of the Company, holders of our
debt securities and shares of preferred stock and lenders with respect to
other borrowings will receive a distribution of our available
assets prior to the holders of our common stock. Additional equity offerings by us
may dilute the holdings of our existing stockholders or
reduce the market value of our common stock, or both. Our preferred stock,
if issued, would have a preference on distributions that
could limit our ability to make distributions to the holders of our common
stock. Furthermore, our Board of Directors may, without
stockholder approval, amend our charter to increase the aggregate number
of shares or the number of shares of any class or series
that we have the authority to issue, and to classify or reclassify any unissued
shares of common stock or preferred stock. Because our
decision to issue securities in any future offering will depend on market conditions and other
factors beyond our control, we cannot
predict or estimate the amount, timing or nature of our future securities offerings. Our
stockholders are therefore subject to the risk of
our future securities offerings reducing the market price of our common stock and diluting
their common stock.
The market value of our common stock may be volatile.
The market value of shares of our common stock may be based primarily upon
current and expected future cash dividends and
our book value. The market price of shares of our common stock may be influenced
by the dividends on those shares relative to market
interest rates. Rising interest rates may lead potential buyers of our common stock to
expect a higher dividend rate, which could
adversely affect the market price of shares of our common stock. In addition, our book
value could decrease, which could reduce the
market price of our common stock to the extent our common stock trades
relative to our book value. As a result, the market price of our
common stock may be highly volatile and subject to wide price fluctuations.
In addition, the trading volume in our common stock may
fluctuate and cause significant price variations to occur. Some of the factors that could negatively affect the share price
or trading
volume of our common stock include:
●
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;
●
the market valuations of Agency RMBS;
●
increases in market interest rates that lead purchasers of our common stock
to expect a higher dividend yield;
●
government action or regulation;
●
changes in our book value;
●
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.
43
We cannot make any assurances that the market price of our common stock will not fluctuate
or decline significantly in the future.
We are subject to risks related to corporate social responsibility.
Our business faces public scrutiny related to environmental, social and governance
(“ESG”) activities. We risk damage to our
reputation if we or our Manager fail to act responsibly in a number of areas, such as
diversity and inclusion, environmental stewardship,
support for local communities, corporate governance and transparency and considering
ESG factors in our investment processes.
Adverse incidents with respect to ESG activities could impact the cost of our
operations and relationships with investors, all of which
could adversely affect our business and results of operations. Additionally, new legislative or regulatory initiatives related to ESG could
adversely affect our business.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We do not own any real property. Our offices are owned by Bimini, the parent of our Manager, and are located at 3305 Flamingo
Drive, Vero Beach, Florida 32963.
We consider this property to be adequate for our business as currently conducted.
Our telephone
number is (772) 231-1400.
ITEM 3.
LEGAL PROCEEDINGS
We are not party to any material pending legal proceedings as described in Item 103
of Regulation S-K.
ITEM 4.
MINE SAFETY
DISCLOSURES
Not Applicable.
44
PART II
ITEM 5. MARKET
FOR REGISTRANT'S
COMMON EQUITY, RELATED
STOCKHOLDER
MATTERS AND ISSUER
PURCHASES
OF
EQUITY SECURITIES
Market Information
and Holders
Our common stock trades on the NYSE under the symbol “ORC.”
As of February 14, 2022, we had 176,993,049 shares of
common stock issued and outstanding which were held by 14 stockholders of record
and 67,045 beneficial owners whose shares were
held in “street name” by brokers and depository institutions.
Dividend
Distribution
Policy
We intend to continue to make regular monthly cash distributions to our stockholders, as more
fully described below. To
maintain
our qualification as a REIT, we must distribute annually to our stockholders an amount at least equal to 90% of our REIT taxable
income, determined without regard to the deductions
for dividends paid and excluding any net capital gain. We will be subject to
income tax on our taxable income that is not distributed and to an excise tax
to the extent that certain percentages of our taxable
income are not distributed by specified dates. Income as computed for purposes
of the foregoing tax rules will not necessarily
correspond to our income as determined for financial reporting purposes pursuant
to GAAP.
Any additional distributions we make will be authorized by and at the discretion
of our Board of Directors based upon a variety of
factors deemed relevant by our directors, which
may include:
●
actual results of operations;
●
our financial condition;
●
our level of retained cash flows;
●
our capital requirements;
●
any debt service requirements;
●
our taxable income;
●
the annual distribution requirements under the REIT provisions of the Code;
●
applicable provisions of Maryland law; and
●
other factors that our Board of Directors may deem relevant.
We have not established a minimum distribution payment level, and we cannot assure
you of our ability to make distributions to
our stockholders in the future.
Our charter authorizes us to issue preferred stock that could have a
preference over our common stock with respect to
distributions. If we issue any preferred stock, the distribution preference on the
preferred stock could limit our ability to make
distributions to the holders of our common stock.
Our ability to make distributions to our stockholders will depend upon the
performance of our investment portfolio, and, in turn,
upon our Manager’s management of our business. To the extent that our cash available for distribution is less than the amount required
to be distributed under the REIT provisions of the Code, we may consider various
funding sources to cover any shortfall, including
selling certain of our assets, borrowing funds or using a portion of the net proceeds
we receive in future securities
offerings (and thus
all or a portion of such distributions may constitute a return of capital for U.S.
federal income tax purposes). We also may elect to pay
all or a portion of any distribution in the form of a taxable distribution of our
stock or debt securities.
In addition, our Board of Directors
may change our distribution policy in the future.
 
 
1
 
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45
80
100
120
140
160
180
200
220
240
260
12/31/2016
12/31/2017
12/31/2018
12/31/2019
12/31/2020
12/31/2021
Total Return Performance
Orchid Island Capital, Inc.
NAREIT Mortgage REIT TRR Index
S&P 500 Total Return
Index
Agency REIT Peer Group
Performance
Graph
Set forth below is a graph comparing the yearly percentage change in
the cumulative total return on our common stock, with the
cumulative total return of the S&P 500 Total Return Index, the FTSE NAREIT Mortgage REIT Index and an index of selected issuers in
our Agency REIT Peer Group (composed of AGNC Investment Corp., Annaly Capital
Management, Inc., Anworth Mortgage Asset
Corporation, Arlington Asset Investment Corp., ARMOUR Residential REIT, Inc., Capstead Mortgage Corporation, Cherry Hill
Mortgage Investment Corporation and Dynex Capital, Inc.) for the period beginning
December 31, 2016, and ending December 31,
2021, assuming the investment of $100 on December 31, 2016 and the reinvestment
of dividends.
The information in the performance chart and the table below has been obtained
from sources believed to be reliable, but its
accuracy nor its completeness can be guaranteed.
The historical information set forth below is not necessarily indicative
of future
performance.
12/31/16
12/31/17
12/31/18
12/31/19
12/31/20
12/31/21
Orchid Island Capital, Inc.
100.00
101.13
80.57
86.10
90.62
90.75
Agency REIT Peer Group
100.00
112.90
102.32
105.99
96.18
101.49
NAREIT Mortgage REIT TRR Index
100.00
119.79
116.77
141.67
115.08
133.08
S&P 500 Total
Return Index
100.00
121.83
116.49
153.17
181.35
233.41
Securities Authorized for Issuance under Equity Compensation Plans
Information about securities authorized for issuance under our equity
compensation plans required for this Item 5 is incorporated
by reference to our definitive Proxy Statement to be filed in connection with our 2022 annual
meeting of stockholders.
Unregistered Sales of Equity Securities
The Company
did not issue
or sell equity
securities
that were
not registered
under the
Securities
Act during
the year
ended December
31, 2021.
Issuer Purchases
of Equity
Securities
46
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.
On December
9, 2021,
the Board
of Directors
approved
an increase
in the number
of
shares of
the Company’s
common stock
available
in the stock
repurchase
program for
up to an
additional
16,861,994
shares, bringing
the
remaining authorization
under the
stock repurchase
program to
up to 17,699,305
shares, representing
approximately
10% of the
Company’s then
outstanding
shares of
common stock.
Unless modified
or revoked
by the Board,
the authorization
does not
expire. The
Company did
not repurchase
any shares
of its common
stock during
the three
months ended
December
31, 2021.
ITEM 8.6.
RESERVED.
47
ITEM 7. MANAGEMENT’S
DISCUSSION
AND ANALYSIS OF FINANCIAL
 
STATEMENTS AND SUPPLEMENTARY DATA
CONDITION
 
AND RESULTS OF
Index
OPERATIONS
The following discussion of our financial condition and results of operations should
be read in conjunction with the financial
statements and notes to Financialthose statements included in Item 8 of this Form 10-K.
 
StatementsThe discussion may contain certain forward-looking
statements that involve risks and uncertainties. Forward-looking statements
 
Pageare those that are not historical in nature. As a result of
Reportmany factors, such as those set forth under “Risk Factors” in this Form 10-K,
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”.
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, after commissions and fees,
prior to its termination in July 2019.
On July 30, 2019, we entered into an underwriting agreement (the “2019 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 the Company’s common stock at a price to the public of
 
Independent$6.55 per share. The underwriters
48
purchased the shares pursuant to the 2019 Underwriting Agreement at a price of
 
Registered$6.3535 per share. The closing of the offering of
7,000,000 shares of common stock occurred on August 2, 2019, with net
 
Public Accountingproceeds 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
 
Firm2020 Equity Distribution Agreement”) with
2three 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
Balance Sheetsof our common stock in transactions that were deemed to be “at the market”
offerings and privately negotiated transactions.
We issued
4a total of 3,170,727 shares under the January 2020 Equity Distribution Agreement for aggregate
gross proceeds of $19.8 million, and
Statementsnet proceeds of approximately $19.4 million, after 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 could offer and sell, from time to time, up to an aggregate
amount of $150,000,000 of shares of our
common stock in transactions that were deemed to be “at the market” offerings and privately
negotiated transactions. We issued a total
of 27,493,650 shares under the August 2020 Equity Distribution Agreement for
aggregate gross proceeds of approximately $150.0
million, and net proceeds of approximately $147.4 million, after commissions
and fees, prior to its termination in June 2021.
On January 20, 2021, we entered into an underwriting agreement (the “January 2021
Underwriting Agreement”) with J.P. Morgan
Securities LLC (“J.P. Morgan”), relating to the offer and sale of 7,600,000 shares of our common stock. J.P.
Morgan purchased the
shares of our common stock from the Company pursuant to the January 2021
Underwriting Agreement at $5.20 per share. In addition,
we granted J.P.
Morgan a 30-day option to purchase up to an additional 1,140,000 shares
of our common stock on the same terms and
conditions, which J.P. Morgan exercised in full on January 21, 2021. The closing of the offering of 8,740,000 shares of our common
stock occurred on January 25, 2021, with proceeds to us of approximately $45.2
million, net of offering expenses.
On March 2, 2021, we entered into an underwriting agreement (the “March 2021 Underwriting
Agreement”) with J.P. Morgan,
relating to the offer and sale of 8,000,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from
the Company pursuant to the March 2021 Underwriting Agreement at $5.45 per share.
In addition, we granted J.P. Morgan a 30-day
option to purchase up to an additional 1,200,000 shares of our common stock
on the same terms and conditions, which J.P. Morgan
exercised in full on March 3, 2021. The closing of the offering of 9,200,000 shares of our common
stock occurred on March 5, 2021,
with proceeds to us of approximately $50.0 million, net of offering expenses.
On June 22, 2021, we entered into an equity distribution agreement (the “June 2021
Equity Distribution Agreement”) with four
sales agents pursuant to which we could offer and sell, from time to time, up to an aggregate
amount of $250,000,000 of shares of our
common stock in transactions that were deemed to be “at the market” offerings and privately
negotiated transactions. We issued a total
of 49,407,336 shares under the June 2021 Equity Distribution Agreement for aggregate
gross proceeds of approximately $250.0
million, and net proceeds of approximately $246.2 million, after commissions
and fees,
prior to its termination in October 2021.
On October 29, 2021, we entered into an equity distribution agreement (the “October
2021 Equity Distribution Agreement”) with
four sales agents pursuant to which we may offer and sell, from time to time, up to an aggregate
amount of $250,000,000 of shares of
our common stock in transactions that are deemed to be “at the market” offerings and privately negotiated
transactions. Through
December 31, 2021, we issued a total of 15,835,700 shares under the October 2021 Equity
Distribution Agreement for aggregate gross
proceeds of approximately $78.3 million, and net proceeds of approximately
$77.0 million, after commissions and fees.
Stock Repurchase Program
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
49
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 then
outstanding share count. On December 9, 2021, the Board of Directors approved an
increase in the number of shares of the
Company’s common stock available in the stock repurchase program for up to an additional
16,861,994 shares, bringing the remaining
authorization under the stock repurchase program to 17,699,305 shares, representing
approximately 10% of the Company’s currently
outstanding shares of common stock. This stock repurchase program has no
termination date.
From the inception of the stock repurchase program through December 31, 2021,
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 year ended December 31, 2020, the Company repurchased a
total of 19,891 shares at an aggregate cost of
approximately
$0.1 million, including commissions and fees, for a weighted average
price of $3.42 per share. There were no shares
repurchased during the year ended December 31, 2021.
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;
●
increases in our cost of funds resulting from increases in the Federal Funds rate that
are controlled by the Fed and are likely
to occur in 2022;
●
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 Housing Administration (the “FHA”), the Federal Open Market Committee (the
“FOMC”) and
the U.S. Treasury;
●
prepayment rates on mortgages underlying our Agency RMBS and credit
trends insofar as they affect prepayment rates; and
●
other market developments.
In addition, a variety of factors relating to our business may also impact our results
of operations and financial condition. These
factors include:
●
our degree of leverage;
●
our access to funding and borrowing capacity;
●
our borrowing costs;
●
our hedging activities;
●
the market value of our investments; 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
5
StatementsDescribed
 
of Stockholders’below are
 
Equity
6
Statementsthe Company’s
 
results of Cash Flows
7
Notes to Financial
 
Statements
8
operations
 
for the
years ended
December
31, 2021,
as compared
to the Company’s
results of
operations
for the years
ended December
31, 2020
and 2019.
Net (Loss)
Income Summary
Net loss
for the year
ended December
31, 2021
was $64.8
million, or
$0.54 per
share. Net
income for
the year ended
December
31,
 
2
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Orchid Island Capital, Inc.
Vero Beach, Florida
 
 
Opinion on the Financial Statements
We have audited the accompanying balance sheets of Orchid Island Capital, Inc. (the “Company”) as of December
31, 2020 and
2019, the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2020, and the related notes (collectively referred to as the “financial statements”).
In our opinion, the financial
statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and
the
results of its operations and its cash flows for each of the three years in the period ended
December 31, 2020
,
in conformity with
accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States)
(“PCAOB”), the Company's internal control over financial reporting as of December 31,
2020, based on criteria established in
Internal
Control – Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
and our report dated February 26, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility
is to express an opinion on the
Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB
and are required to
be independent with respect to the Company in accordance with the U.S. federal
securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards
require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement, whether due to error or
fraud.
Our audits included performing procedures to assess the risks of material misstatement
of the financial statements, whether due to
error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence
regarding the amounts and disclosures in the financial statements. Our audits also
included evaluating the accounting principles used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe
that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current
period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that: (1)
relates to accounts or disclosures that are material
to the financial statements and (2) involved our especially challenging, subjective,
or complex judgments. The communication
of the critical audit matter does not alter in any way our opinion on the financial statements,
taken as a whole, and we are not, by
communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts
or disclosures
to which it relates.
Valuation of Investments in Mortgage-Backed Securities
As described in Notes
1
and
12
to the financial statements, the Company
accounts for its
Level 2
mortgage-backed securities at fair
value, which
totaled
$3.7
billion at December 31, 2020.
The fair value of mortgage-backed securities is
based on independent pricing
sources and/or third-party broker
quotes, when available. Because the price estimates may vary, management must make certain
judgments and assumptions about the appropriate price to use to calculate the fair
values based on various techniques including
observing the most recent market for like or identical assets (including security
coupon rate, maturity, yield, prepayment speed), market
credit spreads, and model driven approaches.
3
 
 
We identified the valuation of mortgage-backed securities
 
as
 
a critical audit matter.
 
The principal considerations for our determination
are: (i)
 
the potential for bias in how management subjectively selects the price from
multiple pricing sources to determine the fair value
of the mortgage-backed securities and (ii)
 
the audit effort involved, including the use of
 
valuation
 
professionals with specialized skill and
knowledge.
 
 
The primary procedures we performed to address this critical audit matter included:
 
 
●
 
Testing the
 
design and operating50
2020 was
 
effectiveness of
$2.1 million,
 
controls
or $0.03
 
per share.
relating
Net income
for the year
ended December
31, 2019
was $24.3
million, or
$0.43 per
share. The
components
of net (loss)
income for
the years
ended December
31, 2021,
2020 and
2019 are
presented
in the table
below:
(in thousands)
2021
2020
2019
Interest income
$
134,700
$
116,045
$
142,324
Interest expense
(7,090)
(25,056)
(83,666)
Net interest income
127,610
90,989
58,658
Losses on RMBS and derivative contracts
(177,119)
(78,317)
(24,008)
Net portfolio (loss) income
(49,509)
12,672
34,650
Expenses
(15,251)
(10,544)
(10,385)
Net (loss) income
$
(64,760)
$
2,128
$
24,265
GAAP and
Non-GAAP
Reconciliations
In addition
to the valuation of mortgaged-backed securities,
including
results
 
controls over
presented
 
management’s
in accordance
 
process to select the price from multiple pricing sources.
with GAAP, our results
 
of operations
 
discussed
 
●
below include
 
certain non-GAAP
Reviewing
financial
 
the
information,
 
range of values used for each investment position,
including
 
“Net Earnings
Excluding
Realized
and Unrealized
Gains and
Losses”,
“Economic
Interest
Expense”
and
assessing
“Economic
 
the price selected
Net Interest
 
for management biasIncome.”
by comparing the price
Net Earnings
 
to the high, low and average of the range of pricing sources.
Excluding
 
Realized
 
and Unrealized
 
●
Gains and
 
Testing the reasonableness of fair values determined by management by comparing the fair value of certain securities to
recent transactions, if applicable.
●
Utilizing
a
third-party valuation specialist
to
develop an independent estimate of the fair value of each investment
position
by considering the stated security coupon rate, yield, maturity, and prepayment speeds, and comparing to the fair
value used by management.
/s/ BDO USA, LLP
Certified Public Accountants
Losses
We have served as the Company's auditor since 2011.
elected
 
West Palm Beach, Florida
February 26, 2021
to account
 
for our
 
Agency RMBS
under the
fair value
option. Securities
held under
the fair
value option
are
recorded
at estimated
fair value,
with changes
in the fair
value recorded
as unrealized
gains or
losses through
the statements
of
operations.
In addition,
we have not
designated
our derivative
financial
instruments
used for
hedging purposes
as hedges
for accounting
purposes,
but rather
hold them
for economic
hedging purposes.
Changes in
fair value
of these
instruments
are presented
in a separate
line item
in the Company’s
statements
of operations
and are not
included in
interest
expense.
As such,
for financial
reporting
purposes,
interest
expense and
cost of funds
are not impacted
by the fluctuation
in value of
the derivative
instruments.
Presenting
net earnings
excluding
realized and
unrealized
gains and
losses allows
management
to: (i) isolate
the net interest
income
and other
expenses of
the Company
over time,
free of all
fair value
adjustments
and (ii)
assess the
effectiveness
of our funding
and
hedging strategies
on our capital
allocation
decisions
and our
asset allocation
performance.
Our funding
and hedging
strategies,
capital
allocation
and asset
selection
are integral
to our risk
management
strategy, and therefore
critical to
the management
of our portfolio.
We
believe that
the presentation
of our net
earnings
excluding
realized
and unrealized
gains is useful
to investors
because it
provides a
means
of comparing
our results
of operations
to those
of our peers
who have not
elected the
same accounting
treatment.
Our presentation
of net
earnings
excluding
realized and
unrealized
gains and
losses may
not be comparable
to similarly-titled
measures of
other companies,
who
may use different
calculations.
As a result,
net earnings
excluding
realized and
unrealized
gains and
losses should
not be considered
as a
substitute
for our GAAP
net income
(loss) as
a measure
of our financial
performance
or any measure
of our liquidity
under GAAP.
The
table below
presents
a reconciliation
of our net
income (loss)
determined
in accordance
with GAAP
and net earnings
excluding realized
and unrealized
gains and
losses.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
4
ORCHID ISLAND CAPITAL, INC.
BALANCE SHEETS
($ in thousands, except per share data)
December 31, 2020
December 31, 2019
ASSETS:
Mortgage-backed securities, at fair value
Pledged to counterparties
$
3,719,906
$
3,584,354
Unpledged
6,989
6,567
Total mortgage
-backed securities
3,726,895
3,590,921
Cash and cash equivalents
220,143
193,770
Restricted cash
79,363
84,885
Accrued interest receivable
9,721
12,404
Derivative assets, at fair value
20,999
0
Receivable for securities sold, pledged to counterparties
414
0
Other assets
516
100
Total Assets
$
4,058,051
$
3,882,080
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements
$
3,595,586
$
3,448,106
Dividends payable
4,970
5,045
Derivative liabilities, at fair value
33,227
20,658
Accrued interest payable
1,157
11,101
Due to affiliates
632
622
Other liabilities
7,188
1,041
Total Liabilities
3,642,760
3,486,573
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $
0.01
par value;
100,000,000
shares authorized; no shares issued
and outstanding as of December 31, 2020 and December 31, 2019
0
0
Common Stock, $
0.01
par value;
500,000,000
shares authorized,
76,073,317
shares issued and outstanding as of December 31, 2020 and
63,061,781
shares issued
and outstanding as of December 31, 2019
761
631
Additional paid-in capital
432,524
414,998
Accumulated deficit
(17,994)
(20,122)
Total Stockholders' Equity
415,291
395,507
Total Liabilities
and Stockholders' Equity
$
4,058,051
$
3,882,080
See Notes to Financial Statements
5
ORCHID ISLAND CAPITAL, INC.
STATEMENTS
OF OPERATIONS
For the Years Ended December 31, 2020,
2019 and 2018
($ in thousands, except per share data)
2020
2019
2018
Interest income
$
116,045
$
142,324
$
154,581
Interest expense
(25,056)
(83,666)
(70,360)51
Net interest income
90,989
58,658
84,221
Earnings Excluding Realized losses on mortgage-backed securities
(24,986)
(10,877)
(30,289)
and Unrealized gains (losses) on mortgage-backed securities
25,761
38,045
(110,668)
(Losses) gains on derivative instruments
(79,092)
(51,176)
24,311
Net portfolio income (loss)
12,672
34,650
(32,425)
Expenses:
Management fees
5,281
5,528
6,204
Allocated overhead
1,514
1,380
1,567
Accrued incentive compensation
38
115
407
Directors' feesGains and liability insurance
998
998
968
Audit, legal and other professional fees
1,045
1,105
851
Direct REIT operating expenses
1,057
997
1,631
Other administrative
611
262
334
Total expenses
10,544
10,385
11,962
Net income (loss)
$
2,128
$
24,265
$
(44,387)
Basic and diluted net income (loss) per share
$
0.03
$
0.43
$
(0.85)
Weighted Average Shares Outstanding
67,210,815
56,328,027
52,198,175
See Notes to Financial Statements
6
ORCHID ISLAND CAPITAL, INC.
STATEMENT
OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2020,
2019 and 2018Losses
(in thousands, except per share data)
AdditionalPer Share
Retained
Common Stock
Paid-in
Net Earnings
SharesNet Earnings
Par ValueExcluding
CapitalExcluding
(Deficit)Realized and
TotalRealized and
Balances, January 1, 2018Realized and
53,062Realized 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
December 31, 2021
$
531(44,564)
$
461,680(82,597)
$
038,033
$
462,211(0.27)
Net loss$
-(0.49)
0$
00.22
(44,387)September 30, 2021
(44,387)26,038
Cash dividends declared, $1.07 per share(2,887)
-28,925
00.20
(55,814)(0.02)
00.22
(55,814)June 30, 2021
Stock based compensation(16,865)
49(40,844)
023,979
492(0.17)
0(0.41)
4920.24
Shares repurchased and retiredMarch 31, 2021
(3,979)(29,369)
(40)(50,791)
(26,383)21,422
0(0.34)
(26,423)(0.60)
Balances, 0.26
December 31, 20182020
49,13216,479
491(4,605)
379,97521,084
(44,387)0.23
336,079(0.07)
Net income0.30
-September 30, 2020
028,076
05,745
24,26522,331
24,2650.42
Cash dividends declared, $0.96 per share0.09
-0.33
0June 30, 2020
(54,421)48,772
028,749
(54,421)20,023
Issuance of common stock pursuant to public offerings, net0.74
14,3770.43
1450.31
92,169March 31, 2020
0(91,199)
92,314(108,206)
Stock based compensation17,007
23(1.41)
0(1.68)
2940.27
0
294
Shares repurchased and retired
(470)
(5)
(3,019)
0
(3,024)
Balances, December 31, 2019
63,06218,612
6313,840
414,99814,772
(20,122)0.29
395,5070.06
Net income0.23
-September 30, 2019
0(8,477)
0(19,431)
2,12810,954
2,128(0.14)
Cash dividends declared, $0.79 per share(0.32)
-0.18
0June 30, 2019
(53,570)3,533
0(7,670)
(53,570)11,203
Issuance of common stock pursuant to public offerings, net0.07
13,019(0.15)
1300.22
70,920March 31, 2019
010,597
71,050(747)
Stock based compensation11,344
120.22
0(0.02)
2440.24
0Years Ended
244December 31, 2021
Shares repurchased and retired$
(20)(64,760)
0$
(68)(177,119)
0$
(68)112,359
Balances, $
(0.54)
$
(1.46)
$
0.92
December 31, 2020
76,0732,128
$(78,317)
76180,445
$0.03
432,524(1.17)
$1.20
(17,994)December 31, 2019
$24,265
415,291(24,008)
See Notes 48,273
0.43
(0.43)
0.86
(1)
Includes realized
and unrealized
gains (losses)
on RMBS and derivative
financial instruments,
including net
interest income
or expense on
interest
rate swaps.
Economic
Interest
Expense and
Economic
Net Interest
Income
We use derivative
and other
hedging instruments,
specifically
Eurodollar, Fed
Funds and
T-Note futures
contracts,
short positions
in
U.S. Treasury
securities,
interest
rate swaps
and swaptions,
to Financial Statementshedge
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
52
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.
The Company
may invest
in TBAs,
which are
forward contracts
for the purchase
or sale of
Agency RMBS
at a predetermined
price,
face amount,
issuer, coupon
and stated
maturity on
an agreed-upon
future date.
The specific
Agency RMBS
to be delivered
into the
contract
are not known
until shortly
before the
settlement
date. We may
choose, prior
to settlement,
to move the
settlement
of these
securities
out to a
later date
by entering
into a dollar
roll transaction.
The Agency
RMBS purchased
or sold for
a forward
settlement
date
are typically
priced at
a discount
to equivalent
securities
settling
in the current
month. Consequently,
forward
purchases
of Agency
RMBS
and dollar
roll transactions
represent
a form of
off-balance
sheet financing.
These TBAs
are accounted
for as derivatives
and marked
to
market through
the income
statement.
Gains or losses
on TBAs
are included
with gains
or losses
on other
derivative
contracts
and are not
included in
interest
income for
purposes of
the discussions
below.
We believe
that economic
interest
expense and
economic
net interest
income provide
meaningful
information
to consider, in
addition
to the respective
amounts prepared
in accordance
with GAAP. The non-GAAP
measures help
management
to evaluate
its financial
position and
performance
without the
effects of
certain transactions
and GAAP
adjustments
that are
not necessarily
indicative
of our
current investment
portfolio
or operations.
The unrealized
gains or
losses on
derivative
instruments
presented
in our statements
of
operations
are not necessarily
representative
of the total
interest
rate expense
that we will
ultimately
realize. This
is because
as interest
rates move
up or down
in the future,
the gains
or losses
we ultimately
realize, and
which will
affect our
total interest
rate expense
in future
periods,
may differ
from the
unrealized
gains or
losses recognized
as of the
reporting
date.
Our presentation
of the economic
value of our
hedging strategy
has important
limitations.
First, other
market participants
may
calculate
economic
interest
expense and
economic net
interest
income differently
than the
way we calculate
them. Second,
while we
believe that
the calculation
of the economic
value of our
hedging
strategy
described
above helps
to present
our financial
position
and
performance,
it may be
of limited
usefulness
as an analytical
tool. Therefore,
the economic
value of
our investment
strategy should
not be
viewed in
isolation
and is not
a substitute
for interest
expense and
net interest
income computed
in accordance
with GAAP.
The tables
below present
a reconciliation
of the adjustments
to interest
expense shown
for each
period relative
to our derivative
instruments,
and the income
statement
line item,
gains (losses)
on derivative
instruments,
calculated
in accordance
with GAAP
for the
years ended
December
31, 2021,
2020 and
2019 and
each quarter
during 2021,
2020 and
2019.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7
ORCHID ISLAND CAPITAL, INC.
STATEMENTS
OF CASH FLOWS
For the Years Ended December 31, 2020,
2019 and 2018
($ in thousands)
2020
2019
2018
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net income (loss)
$
2,128
$
24,265
$
(44,387)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Stock based compensation
244
294
492
Realized and unrealized (gains) losses on mortgage-backed securities
(775)
(27,168)
140,957
Realized and unrealized losses on interest rate swaptions
2,972
1,379
1,502
Realized and unrealized losses (gains) on interest rate swaps
59,055
39,471
(1,027)
Realized and unrealized losses on U.S. Treasury Securities
95
0
0
Realized (gains) losses on forward settling to-be-announced securities
(3,231)
4,357
(4,527)
Changes in operating assets and liabilities:
Accrued interest receivable
2,683
837
1,203
Other assets
(446)
80
(3)
Accrued interest payable
(9,944)
4,656
(71)
Other liabilities
2,583
22
4
Due to affiliates
10
(32)
(143)
NET CASH PROVIDED BY OPERATING
ACTIVITIES
55,374
48,161
94,000
CASH FLOWS FROM INVESTING ACTIVITIES:
From mortgage-backed securities investments:
Purchases
(4,859,434)
(4,241,822)
(3,893,828)
Sales
4,200,536
3,321,206
3,885,817
Principal repayments
523,699
594,833
373,934
Payments on U.S. Treasury securities
(139,807)
0
0
Proceeds from U.S. Treasury securities
139,712
0
0
Net proceeds from reverse repurchase agreements
30
0
0
(Payments on) proceeds from net settlement of to-be-announced securities
(881)
(8,423)
7,292
Purchase of derivative financial instruments, net of margin cash received
(63,195)
(20,600)
6,805
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES
(199,340)
(354,806)
380,020
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements
33,140,625
45,595,010
52,096,292
Principal payments on repurchase agreements
(32,993,145)
(45,171,956)
(52,605,026)
Cash dividends
(53,645)
(53,307)
(59,312)
Proceeds from issuance of common stock, net of issuance costs
71,050
92,314
0
Common stock repurchases
(68)
(3,024)
(26,423)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
164,817
459,037
(594,469)
NET INCREASE (DECREASE) IN CASH, CASH EQUIVALENTS
AND RESTRICTED
CASH
20,851
152,392
(120,449)
CASH, CASH EQUIVALENTS AND
RESTRICTED CASH, beginning of the period
278,655
126,263
246,712
CASH, CASH EQUIVALENTS AND
RESTRICTED CASH, end of the period
$
299,506
$
278,655
$
126,263
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid during the period for:
Interest
$
35,000
$
79,010
$
70,431
SUPPLEMENTAL DISCLOSURE OF
NONCASH INVESTING ACTIVITIES:
Securities sold settled in later period
$
0
$
0
$
220,655
See Notes to Financial Statements
8
ORCHID ISLAND
CAPITAL, INC.
NOTES TO FINANCIAL
STATEMENTS
DECEMBER
31, 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 $
125,000,000
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
15,123,178
shares under the August 2017 Equity Distribution Agreement for aggregate
gross proceeds of approximately $
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, Orchid entered into an underwriting agreement (the “2019 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 the Company’s common stock at a price to the public of $
6.55
per share. The underwriters
purchased the shares pursuant to the 2019 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 the Company
of approximately $
44.2
million after
deduction 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 $
200,000,000
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
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, 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 $
150,000,000
of
shares of the Company’s common stock in transactions that are deemed to be “at the market”
offerings and privately negotiated
transactions.
Through December 31, 2020, the Company issued a total of
9,848,513
shares under the August 2020 Equity Distribution
Agreement for aggregate gross proceeds of approximately $
52.5
million, and net proceeds of approximately $
51.6
million, net of
commissions and fees. Subsequent to December 31, 2020 through February 26, 2021,
the Company issued a total of
308,048
shares
under the August 2020 Equity Distribution Agreement for aggregate gross proceeds of approximately
$
1.6
million.
COVID-19
Impact
Beginning
in mid-March
2020, the
global pandemic
associated
with the novel
coronavirus
(“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
9
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.
During this
period, we
sold approximately
$
1.1
billion
of Agency
RMBS, resulting
in losses of
approximately
$
31.4
million.
Also during
this period,
we terminated
interest rate
swap positions
with an aggregate
notional value
of $
860.0
million and
incurred
approximately
$
45.0
million in
fair value
losses on the
positions
through the
date of the
respective
terminations.
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 December
31, 2020,
we had timely
satisfied all
margin calls.
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 2021.
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.
As certain
time limits
imposed in
the CARES
Act programs
began to expire,
on December
27, 2020,
President
Trump
signed into
law an additional
coronavirus
aid package
as part of
the Consolidated
Appropriations
Act, 2021,
providing for
extensions of
many of the
CARES Act
policies and
programs as
well as billions
of dollars
of additional
relief. The
Company has
evaluated the
provisions
of the CARES
Act and the
Consolidated
Appropriations
Act, 2021
and has determined
that it will
not have a
material effect
on the
Company’s business,
results of
operations
and financial
condition.
Basis of
Presentation
and Use of
Estimates
The accompanying
financial
statements
have been
prepared in
accordance
with accounting
principles
generally accepted
in the
United States
(“GAAP”).
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 December
31, 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 December
31, 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
10
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)
December 31, 2020
December 31, 2019
Cash and cash equivalents
$
220,143
$
193,770
Restricted cash
79,363
84,885
Total cash, cash equivalents
and restricted cash
$
299,506
$
278,655
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
residential
mortgage backed
certificates
issued by Freddie
Mac, 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 Financial Instruments
11
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
and other
hedging instruments
in the future.
The Company
accounts for
TBA securities
as derivative
instruments.
Gains and losses
associated
with TBA
securities
transactions
are reported
in gain (loss)
on derivative
instruments
in the accompanying
statements
of operations.
Derivative
and other
hedging instruments
are carried
at fair value,
and changes
in fair value
are recorded
in earnings
for each period.
The Company’s
derivative
financial
instruments
are not designated
as hedge accounting
relationships,
but rather
are used as
economic
hedges of
its portfolio
assets and
liabilities.
Holding derivatives
creates exposure
to credit
risk related
to the potential
for failure
on the part
of counterparties
and exchanges
to
honor their
commitments.
In the event
of default
by a counterparty,
the Company
may have difficulty
recovering
its collateral
and may not
receive payments
provided for
under the
terms of the
agreement.
The Company’s
derivative
agreements
require it
to post or
receive
collateral
to mitigate
such risk.
In addition,
the Company
uses only
registered
central clearing
exchanges and
well-established
commercial
banks as counterparties,
monitors positions
with individual
counterparties
and adjusts
posted collateral
as required.
Financial
Instruments
The fair value
of financial
instruments
for which
it is practicable
to estimate
that value
is disclosed,
either in
the body of
the financial
statements
or in the
accompanying
notes. RMBS,
Eurodollar,
Fed Funds
and T-Note
futures contracts,
interest rate
swaps, interest
rate
swaptions
and TBA securities
are accounted
for at fair
value in the
balance sheets.
The methods
and assumptions
used to estimate
fair
value for
these instruments
are presented
in Note 12
of the financial
statements.
The estimated
fair value
of cash and
cash equivalents,
restricted
cash, accrued
interest receivable,
receivable
for securities
sold,
other assets,
due to affiliates,
repurchase
agreements,
payable for
unsettled securities
purchased,
accrued interest
payable and
other
liabilities
generally approximates
their carrying
values as of
December
31, 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
12
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 REIT under 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
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.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
53
13
In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate
ReformGains (Losses) on Financial Reporting.”
Derivative Instruments
ASU 2020-04 provides optional expedients and exceptions to GAAP requirements for
modifications
on debt instruments, leases, derivatives, and other contracts, related to the expected market
transition from the London Interbank
Offered Rate (“LIBOR”), and certain other floating rate benchmark indices, or collectively, IBORs, to alternative reference rates. ASU
2020-04 generally considers contract modifications related to reference rate reform to
be an event that does not require contract
remeasurement at the modification date nor a reassessment of a previous accounting
determination. The guidance in ASU 2020-04 is
optional and may be elected over time, through December 31, 2022, as reference
rate reform activities occur. The Company does not
believe the adoption of this ASU will have a material impact on its financial statements.
In January 2021, the FASB issued ASU 2021-01 “Reference Rate Reform (Topic 848).
ASU 2021-01 expands the scope of ASC
848 to include all affected derivatives and give market participants the ability to apply certain
aspects of the contract modification and
hedge accounting expedients to derivative contracts affected by the discounting transition. In
addition, ASU 2021-01 adds
implementation guidance to permit a company to apply certain optional expedients
to modifications of interest rate indexes used for
margining, discounting or contract price alignment of certain derivatives as a result
of reference rate reform initiatives and
extends
optional expedients to account for a derivative contract modified as a continuation of
the existing contract and to continue hedge
accounting when certain critical terms of a hedging relationship change to modifications
made as part of the discounting transition. The
guidance in ASU 2021-01 is effective immediately and available generally through December
31, 2022, as reference rate reform
activities occur. The Company does not believe the adoption of this ASU will have a material impact on its financial statements.
NOTE 2.
MORTGAGE-BACKED SECURITIES
The following
table presents
the Company’s
RMBS portfolio
as of December
31, 2020 and
December 31,
2019:
(in thousands)
Economic Hedges
Recognized in
Attributed to
Attributed to
Income
U.S. Treasury and TBA
Current
Future
Statement
Securities Gain (Loss)
Period
Periods
(GAAP)
(Short Positions)
(Long Positions)
(Non-GAAP)
(Non-GAAP)
Three Months Ended
December 31, 2021
$
10,945
$
2,568
$
-
$
(7,949)
$
16,326
September 30, 2021
5,375
(2,306)
-
(1,248)
8,929
June 30, 2021
(34,915)
(5,963)
-
(5,104)
(23,848)
March 31, 2021
45,472
9,133
(8,559)
(4,044)
48,942
December 31, 2020
8,538
(436)
5,480
(5,790)
9,284
September 30, 2020
4,079
131
3,336
(6,900)
7,512
June 30, 2020
(8,851)
582
1,133
(5,751)
(4,815)
March 31, 2020
(82,858)
(7,090)
-
(4,900)
(70,868)
December 31, 2019
Pass-Through RMBS Certificates:10,792
Adjustable-rate Mortgages(512)
-
3,823
7,481
September 30, 2019
(8,648)
572
1,907
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)
Years Ended
December 31, 2021
$
026,877
$
1,014
Fixed-rate Mortgages
3,560,746
3,206,013
Fixed-rate CMOs
137,453
299,205
Total Pass-Through
Certificates
3,698,199
3,506,232
Structured RMBS Certificates:
Interest-Only Securities
28,696
60,986
Inverse Interest-Only Securities
0
23,703
Total Structured
RMBS Certificates
28,696
84,689
Total3,432
$
3,726,895(8,559)
$
3,590,921
(18,345)
$
NOTE 3.
REPURCHASE AGREEMENTS
The Company
pledges certain
of its RMBS
as collateral
under repurchase
agreements
with financial
institutions.
Interest rates
are
generally fixed
based on prevailing
rates corresponding
to the terms
of the borrowings,
and interest
is generally
paid at the
termination
of a
borrowing.
If the fair
value of the
pledged securities
declines,
lenders will
typically require
the Company
to post additional
collateral
or pay
down borrowings
to re-establish
agreed upon
collateral
requirements,
referred to
as "margin
calls." Similarly,
if the fair
value of the
pledged
securities
increases,
lenders may
release collateral
back to the
Company. As of December
31, 2020,
the Company
had met all
margin call
requirements.
As of December
31, 2020 and
2019, the
Company’s repurchase
agreements
had remaining
maturities
as summarized
below:
($ in thousands)
OVERNIGHT
BETWEEN 2
BETWEEN 31
GREATER
(1 DAY OR
AND
AND
THAN
14
LESS)
30 DAYS
90 DAYS
90 DAYS
TOTAL50,349
December 31, 2020
Fair market value of securities pledged, including(79,092)
accrued interest receivable(6,813)
$9,949
0(23,341)
$
2,112,969
$
1,560,798
$
55,776
$
3,729,543
Repurchase agreement liabilities associated with
these securities
$
0
$
2,047,897
$
1,494,500
$
53,189
$
3,595,586
Net weighted average borrowing rate
-
0.23%
0.22%
0.30%
0.23%(58,887)
December 31, 2019
Fair market value of securities pledged, including(51,176)
accrued interest receivable(6,265)
1,907
8,958
(55,776)
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, 2021
$
044,421
$
2,470,2632,023
$
1,005,517(7,949)
$
120,9419,972
$
3,596,721
Repurchase agreement liabilities associated with
these securities42,398
$
034,449
September 30, 2021
34,169
1,570
(1,248)
2,818
32,599
31,351
June 30, 2021
29,254
1,556
(5,104)
6,660
27,698
22,594
March 31, 2021
26,856
1,941
(4,044)
5,985
24,915
20,871
December 31, 2020
25,893
2,011
(5,790)
7,801
23,882
18,092
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
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
Years Ended
December 31, 2021
$
2,361,378134,700
$
964,3687,090
$
122,360(18,345)
$
3,448,10625,435
Net weighted average borrowing rate$
0127,610
2.04%$
1.94%109,265
2.60%December 31, 2020
2.03%116,045
25,056
(23,341)
48,397
90,989
67,648
December 31, 2019
142,324
83,666
8,958
74,708
58,658
67,616
(1)
Reflects the effect of derivative instrument hedges for only the period
 
In addition,
cash pledged
to counterparties
as collateral
for repurchase
agreements
was approximately
$presented.
58.8(2)
million and
$
65.9
million
asCalculated by adding the effect of December
31, 2020 and
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 loanedderivative instrument hedges attributed
 
to the Companyperiod presented to GAAP interest expense.
plus interest(3)
due to the
counterparty
andCalculated by adding the fair
valueeffect of the
collateral
pledged to
such lender,
including the accrued interest receivable
and cash posted by the Company as collateral. At December
31, 2020,
the Company
had an aggregate
amount at
risk (the difference
between the
amount loanedderivative instrument hedges attributed
 
to the Company,
includingperiod presented to GAAP net 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
$
176.3
million.
The Company
did not have
an amount
at risk with
any individual
counterparty
greater than
10% of the
Company’s equity
at
December 31,
2020 and 2019
.
income.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15
 
54
Net Interest Income
During the
year ended
December
31, 2021,
we generated
$127.6 million
of net interest
income, consisting
of $134.7
million of
interest
income from
RMBS assets
offset by $7.1
million of
interest
expense on
borrowings.
For the comparable
period ended
December
31,
2020, we
generated
$91.0 million
of net interest
income, consisting
of $116.0 million
of interest
income from
RMBS assets
offset by $25.1
million of
interest
expense on
borrowings.
The $18.7
million increase
in interest
income was
driven by
a $1,569.3
million increase
in
average RMBS
that was
partially offset
by a 72 basis
point ("bps")
decrease
in yield on
average
RMBS. The
$18.0 million
decrease
in
interest
expense for
the year
ended December
31, 2021
was driven
by a 63 bps
decrease
in the average
cost of funds,
offset by
a
$1,510.5
million increase
in average
borrowings.
For the year
ended December
31, 2019,
we generated
$58.7 million
of net interest
income, consisting
of $142.3
million of
interest
income from
RMBS assets
offset by $83.7
million of
interest
expense on
borrowings.
The $26.3
million decrease
in interest
income for
the
year ended
December
31, 2020,
compared
to the year
ended December
31, 2019,
was due to
a 69 bps
decrease in
yield on
average
RMBS,
combined with
a $71.6 million
decrease
in average
RMBS during
the period.
The $58.6
million decrease
in interest
expense for
the
year ended
December
31, 2020
was due to
a $114.7 million
decrease
in average
borrowings,
combined with
a 175 bps
decrease
in the
average cost
of funds.
On an economic
basis, our
interest
expense on
borrowings
for the years
ended December
31, 2021,
2020 and
2019 was
$25.4
million, $48.4
million and
$74.7 million,
respectively, resulting
in $109.3
million, $67.6
million and
$67.6 million
of economic
net interest
income, respectively.
The tables
below provide
information
on our portfolio
average balances,
interest
income, yield
on assets,
average borrowings,
interest
expense, cost
of funds,
net interest
income and
net interest
spread for
each quarter
in 2021, 2020
and 2019
and for the
years ended
December
31, 2021,
2020 and
2019 on both
a GAAP and
economic basis.
($ 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
December 31, 2021
$
6,056,259
$
44,421
2.93%
$
5,728,988
$
2,023
$
9,972
0.14%
0.70%
September 30, 2021
5,136,331
34,169
2.66%
4,864,287
1,570
2,818
0.13%
0.23%
June 30, 2021
4,504,887
29,254
2.60%
4,348,192
1,556
6,660
0.14%
0.61%
March 31, 2021
4,032,716
26,856
2.66%
3,888,633
1,941
5,985
0.20%
0.62%
December 31, 2020
3,633,631
25,893
2.85%
3,438,444
2,011
7,801
0.23%
0.91%
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%
Years Ended
December 31, 2021
$
4,932,548
$
134,700
2.73%
$
4,707,525
$
7,090
$
25,435
0.15%
0.54%
December 31, 2020
3,363,208
116,045
3.45%
3,197,034
25,056
48,397
0.78%
1.51%
December 31, 2019
3,434,850
142,324
4.14%
3,311,705
83,666
74,708
2.53%
2.26%
NOTE 4. DERIVATIVE AND OTHER HEDGING INSTRUMENTS
 
55
($ in thousands)
Net Interest Income
Net Interest Spread
GAAP
Economic
GAAP
Economic
Basis
Basis
(2)
Basis
Basis
(4)
Three Months Ended
December 31, 2021
$
42,398
$
34,449
2.79%
2.23%
September 30, 2021
32,599
31,351
2.53%
2.43%
June 30, 2021
27,698
22,594
2.46%
1.99%
March 31, 2021
24,915
20,871
2.46%
2.04%
December 31, 2020
23,882
18,093
2.62%
1.94%
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%
Years Ended
December 31, 2021
$
127,610
$
109,265
2.58%
2.19%
December 31, 2020
90,989
67,649
2.67%
1.94%
December 31, 2019
58,658
67,616
1.61%
1.88%
(1)
Portfolio yields and costs of borrowings presented in the tables above and the
tables on pages 60 and 61 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 61 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 years
ended December
31, 2021
and 2020
was $134.7
million and
$116.0 million,
respectively.
We had
average RMBS
holdings of
$4,932.5
million and
$3,363.2
million for
the years
ended December
31, 2021
and 2020,
respectively.
The
yield on our
portfolio
was 2.73%
and 3.45%
for the years
ended December
31, 2021
and 2020,
respectively. For
the year
ended
December
31, 2021
as compared
to the year
ended December
31, 2020,
there was
a $18.7 million
increase in
interest
income due
to a
$1,569.3
million increase
in average
RMBS, offset
by a 72 bps
decrease
in the yield
on average
RMBS.
For the year
ended December
31, 2019,
we had interest
income of
$142.3 million
and average
RMBS holdings
of $3,434.9
million,
resulting
in a yield
on our portfolio
of 4.14%.
For the year
ended December
31, 2020,
as compared
to the year
ended December
31, 2019,
there was
a $26.3 million
decrease
in interest
income due
to a $71.6
million decrease
in average
RMBS, combined
with a 69
bps decrease
in the yield
on average
RMBS.
The table
 
below summarizespresents
 
fair valuethe average
 
informationportfolio
 
about our
derivativesize, income
 
and otheryields
 
hedging instrumentsof our respective
 
assets andsub-portfolios,
 
liabilitiesconsisting
 
as of structured
RMBS
and PT RMBS
for the years
ended December
31, 2021,
 
2020 and
2019 and
for each
quarter during
2021, 2020
and 2019.
 
56
($ in thousands)
Derivative and Other Hedging InstrumentsAverage RMBS Held
Balance Sheet LocationInterest Income
Realized Yield on Average RMBS
PT
Structured
PT
Structured
PT
Structured
RMBS
RMBS
Total
RMBS
RMBS
Total
RMBS
RMBS
Total
Three Months Ended
December 31, 2021
$
5,878,376
$
177,883
$
6,056,259
$
42,673
$
1,748
$
44,421
2.90%
3.93%
2.93%
September 30, 2021
5,016,550
119,781
5,136,331
33,111
1,058
34,169
2.64%
3.53%
2.66%
June 30, 2021
4,436,135
68,752
4,504,887
29,286
(32)
29,254
2.64%
(0.18)%
2.60%
March 31, 2021
3,997,965
34,751
4,032,716
26,869
(13)
26,856
2.69%
(0.15)%
2.66%
December 31, 2020
3,603,885
29,746
3,633,631
25,933
(40)
25,893
2.88%
(0.53)%
2.85%
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%
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
Assets3,611,461
Interest rate swaps94,459
Derivative assets, at fair value3,705,920
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%
Years Ended
December 31, 2021
$
74,832,257
$
0
Payer swaptions (long positions)
Derivative assets, at fair value
17,433
0
TBA securities
Derivative assets, at fair value
3,559
0
Total derivative
assets, at fair value100,291
$
20,9994,932,548
$
0
Liabilities
Interest rate swaps
Derivative liabilities, at fair value131,939
$
24,7112,761
$
20,146134,700
Payer swaptions (short positions)2.73%
Derivative liabilities, at fair value2.75%
7,7302.73%
0December 31, 2020
TBA securities3,322,248
Derivative liabilities, at fair value40,960
7863,363,208
512115,244
Total derivative
liabilities, at fair value801
$116,045
33,2273.47%
$1.96%
20,6583.45%
Margin Balances Posted to (from) CounterpartiesDecember 31, 2019
Futures contracts3,317,732
Restricted cash117,118
$3,434,850
489138,252
$4,072
1,338142,324
TBA securities4.17%
Restricted cash3.48%
284
246
TBA securities
Other liabilities
(2,520)
04.14%
Interest rate swaption contractsExpense and the Cost of Funds
Other liabilities
(3,563)
0
Interest rate swap contracts
Restricted cash
19,761
17,450
Total marginWe had average
 
balances on derivative contracts
$
14,451
$
19,034
outstanding
 
Eurodollar, Fedborrowings
 
Fundsof $4,707.5
million and
 
T-Note futures$3,197.0 million
and total
interest
expense of
$7.1 million
and $25.1
million for
the years
ended December
31, 2021
and 2020,
respectively. Our
average cost
of funds
was 0.15%
for the year
ended
December
31, 2021,
compared
to 0.78%
for the comparable
period in
2020.
There was
a $1,510.5
million increase
in average
outstanding
borrowings
during the
year ended
December
31, 2021
as compared
to the year
ended December
31, 2020.
For the year
ended December
31, 2019,
we had average
borrowings
of $3,311.7 million
and total
interest
expense of
$83.7 million,
resulting
in an average
cost of funds
of 2.53%.
There was
a 175 bps
decrease
in the average
cost of funds
and an $114.7 million
decrease
in average
outstanding
borrowings
during the
year ended
December
31, 2020
as compared
to the year
ended December
31,
2019.
Our economic
interest
expense
was $25.4
million, $48.4
million and
$74.7 million
for the years
ended December
31, 2021,
2020 and
2019, respectively.
There was
a 97 bps
decrease
in the average
economic cost
of funds to
0.54% for
the year
ended December
31, 2021
from 1.51%
for the year
ended December
31, 2020.
The reason
for the decrease
in economic
cost of funds
is primarily
due to the
lower
cost of our
borrowings
noted above,
offset by the
negative performance
of our hedging
activities
during the
period. There
was a 75 bps
decrease
in the average
economic
cost of funds
to 1.51%
for the year
ended December
31, 2020
from 2.26%
for the year
ended
December
31, 2019.
Since all
of our repurchase
agreements
 
are cash settledshort-term,
 
futures contractschanges in
 
on anmarket rates
directly affect
our interest
 
rate, withexpense. Our
 
gains and lossesaverage
 
creditedcost
of funds
 
or
charged to
the Company’s
cash accountscalculated
 
on a dailyGAAP
 
basis. Abasis was
 
minimum balance,5 bps above
 
or “margin”,average
 
is requiredone-month
LIBOR and
9 bps below
average six-month
LIBOR for
the
quarter ended
December
31, 2021.
Our average
economic cost
of funds
was equal
 
to be maintainedaverage
 
in the accountone-month
 
on
a daily basis.LIBOR and
 
47 bps above
average six-month
LIBOR for
the quarter
ended December
31, 2021.
The average
term to maturity
of the outstanding
repurchase
agreements
was 27 days
and 31 days
at December
31, 2021 and
2020, respectively.
The tables
 
below present
 
informationthe average
 
related tobalance of
 
the Company’sborrowings
 
Eurodollaroutstanding,
interest
expense and
average cost
of funds,
 
and T-Note futuresaverage
one-month
 
positions atand six-month
LIBOR rates
for each
quarter in
2021, 2020
and 2019
and for the
years ended
 
December
31, 2021,
2020 and 2019.
2019 on both
 
a GAAP and
 
($ in thousands)
December 31, 2020
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
Eurodollar Futures Contracts (Short Positions)
2021
$
50,000
1.03%
0.18%
$
(424)
U.S. Treasury Note Futures Contracts
(Short Position)
(2)
March 2021 5-year T-Note futures
(Mar 2021 - Mar 2026 Hedge Period)
$
69,000
0.72%
0.67%
$
(186)
economic basis.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
16
 
($ 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
$
500,000
2.97%
1.67%
$
(6,505)
U.S. Treasury Note Futures Contracts
(Short Position)
(2)
March 2020 5 year T-Note futures
(Mar 2020 - Mar 2025 Hedge Period)
$
69,000
1.96%
2.06%
$
302
 
(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 $
126.16
at December 31, 2020 and $
118.61
at December 31, 2019.
The contract values of
the short positions were $
87.1
million and $
81.8
million at December 31, 2020 and December 31, 2019, respectively.
 
Under our
interest rate
swap agreements,
we typically
pay a fixed
rate and receive
a floating
rate based
on 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 December
31, 2020 and
2019.
 
57
($ in thousands)
Average
Net
FixedInterest Expense
Average Cost of Funds
EstimatedBalance of
AverageGAAP
NotionalEconomic
PayGAAP
ReceiveEconomic
FairBorrowings
MaturityBasis
AmountBasis
RateBasis
RateBasis
ValueThree Months Ended
(Years)December 31, 2021
$
5,728,988
$
2,023
$
9,972
0.14%
0.70%
September 30, 2021
4,864,287
1,570
2,818
0.13%
0.23%
June 30, 2021
4,348,192
1,556
6,660
0.14%
0.61%
March 31, 2021
3,888,633
1,941
5,985
0.20%
0.62%
December 31, 2020
Expiration > 3 to ≤ 5 years3,438,444
$2,011
620,000
1.29%
0.22%
$
(23,760)
3.6
Expiration > 5 years
$
200,000
0.67%7,801
0.23%
$0.91%
(944)September 30, 2020
6.43,228,021
$2,043
820,0008,943
1.14%0.25%
0.23%1.11%
$June 30, 2020
(24,704)2,992,494
4.34,479
10,230
0.60%
1.37%
March 31, 2020
3,129,178
16,523
21,423
2.11%
2.74%
December 31, 2019
Expiration > 1 to ≤ 3 years3,631,042
20,022
16,199
2.21%
1.78%
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%
Years Ended
December 31, 2021
$
360,0004,707,525
2.05%$
7,090
$
25,435
0.15%
0.54%
December 31, 2020
3,197,034
25,056
48,397
0.78%
1.51%
December 31, 2019
3,311,705
83,666
74,708
2.53%
2.26%
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
December 31, 2021
0.09%
0.23%
0.05%
(0.09)%
0.61%
0.47%
September 30, 2021
0.09%
0.16%
0.04%
(0.03)%
0.14%
0.07%
June 30, 2021
0.10%
0.18%
0.04%
(0.04)%
0.51%
0.43%
March 31, 2021
0.13%
0.23%
0.07%
(0.03)%
0.49%
0.39%
December 31, 2020
0.15%
0.27%
0.08%
(0.04)%
0.76%
0.64%
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%
(3,680)0.31%
2.30.23%
Expiration > 3 to ≤ 5 years(0.12)%
910,000(0.20)%
2.03%September 30, 2019
1.93%2.22%
(16,466)2.18%
4.40.28%
$0.32%
1,270,0000.14%
2.03%0.18%
1.92%June 30, 2019
$2.45%
(20,146)2.49%
3.80.45%
0.41%
0.26%
0.22%
March 31, 2019
2.51%
2.77%
0.06%
(0.20)%
(0.27)%
(0.53)%
Years Ended
December 31, 2021
0.10%
0.20%
0.05%
(0.05)%
0.44%
0.34%
December 31, 2020
0.55%
0.69%
0.23%
0.09%
0.96%
0.82%
December 31, 2019
2.27%
2.35%
0.26%
0.18%
(0.01)%
(0.09)%
 
58
Gains or Losses
The table
 
below presents
 
informationour gains
 
related toor losses
for the years
ended December
31, 2021,
2020 and
2019.
(in thousands)
2021
2020
2019
Realized losses on sales of RMBS
$
(5,542)
$
(24,986)
$
(10,877)
Unrealized (losses) gains on RMBS
(198,454)
25,761
38,045
Total (losses)
gains on RMBS
(203,996)
775
27,168
Losses on interest rate futures
(856)
(13,044)
(18,858)
Gains (losses) on interest rate swaps
23,613
(66,212)
(26,582)
Gains (losses) on payer swaptions (short positions)
9,062
(3,070)
(1,379)
(Losses) gains on payer swaptions (long positions)
(2,580)
98
-
Gains on interest rate floors
2,765
-
-
Gains (losses) on TBA securities (short positions)
3,432
(6,719)
(6,264)
(Losses) gains on TBA securities (long positions)
(8,559)
9,950
1,907
Losses on U.S. Treasury securities
-
(95)
-
Total
$
(177,119)
$
(78,317)
$
(24,008)
We invest in
RMBS with
 
the Company’sintent
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 rate
 
swaption positionsrates,
federal government
 
programs
or general
economic conditions
or to manage
our balance
sheet as part
of our asset/liability
management
strategy. During
the years
ended December
31, 2021,
2020 and
2019, the
Company received
proceeds
of $2,851.7
million, $4,200.5
million and
$3,321.2
million,
respectively, from
the sales
of RMBS.
Approximately
$1.1 billion
of the sales
during the
year ended
December
31,
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.
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 2021,
2020 and
2019.
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)
December 31, 2021
1.26%
1.51%
2.35%
3.10%
0.21%
September 30, 2021
1.00%
1.53%
2.18%
2.90%
0.12%
June 30, 2021
0.87%
1.44%
2.27%
2.98%
0.13%
March 31, 2021
0.94%
1.75%
2.39%
3.08%
0.19%
December 31, 2020
0.36%
0.92%
2.22%
2.68%
0.23%
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.
59
Expenses
Total operating expenses
were $15.3
million, $10.5
million and
$10.4 million
for the years
ended December
31, 2021,
2020 and 2019,
respectively.
The table
below provides
a breakdown
of operating
expenses for
the years
ended December
31, 2021,
2020 and
2019.
(in thousands)
2021
2020
2019
Management fees
$
8,156
$
5,281
$
5,528
Overhead allocation
1,632
1,514
1,380
Accrued incentive compensation
1,132
38
115
Directors fees and liability insurance
1,169
998
998
Audit, legal and other professional fees
1,112
1,045
1,105
Direct REIT operating expenses
1,475
1,057
997
Other administrative
575
611
262
Total expenses
$
15,251
$
10,544
$
10,385
We are externally managed and advised by Bimini Advisors, LLC (the “Manager”) pursuant
to the terms of a management
agreement. The management agreement has been renewed through February
20, 2023 and provides for automatic one-year extension
options thereafter and is subject to certain termination rights.
Under the terms of the management agreement, the Manager is
responsible for administering the business activities and day-to-day operations of
the Company.
The Manager receives a monthly
management fee in the amount of:
●
One-twelfth of 1.5% of the first $250 million of the Company’s month end equity, as defined in the management agreement,
●
One-twelfth of 1.25% of the Company’s month end equity that is greater than $250
million and less than or equal to $500
million, and
●
One-twelfth of 1.00% of the Company’s month end equity that is greater than $500
million.
The Company is obligated to reimburse the Manager for any direct expenses
incurred on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management
agreement.
The Company has contracted with AVM, L.P.
(“AVM”) to provide repurchase agreement trading, clearing and administrative
services to the Company. Commencing in 2022, the Manager will begin performing these functions and the contracted relationship
with
AVM may be reduced or eliminated. Following the termination of the arrangements with AVM, the Company will pay the Manager
additional fees for its performance of repurchase agreement funding transaction
services and related clearing and operational services
as set forth in the management agreement, as amended.
Should the Company terminate the management agreement without cause,
it will pay the Manager a termination fee equal to three
times the average annual management fee, as defined in the management
agreement, before or on the last day of the term of the
agreement.
The following table summarizes the management fee and overhead allocation
expenses for each quarter in 2021, 2020 and 2019
and for the years ended December 31, 2021, 2020 and 2019.
60
($ in thousands)
Average
Average
Advisory Services
Orchid
Orchid
Management
Overhead
Three Months Ended
MBS
Equity
Fee
Allocation
Total
December 31, 2021
$
6,056,259
$
806,382
$
2,587
$
443
$
3,030
September 30, 2021
5,136,331
672,384
2,156
390
2,546
June 30, 2021
4,504,887
542,679
1,792
395
2,187
March 31, 2021
4,032,716
456,687
1,621
404
2,025
December 31, 2020
3,633,631
387,503
1,384
442
1,826
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
Years Ended
December 31, 2021
$
4,932,548
$
619,533
$
8,156
$
1,632
$
9,788
December 31, 2020
3,363,208
373,464
5,281
1,514
6,795
December 31, 2019
3,434,850
383,993
5,528
1,380
6,908
Financial
Condition:
Mortgage-Backed Securities
As of December
31, 2021,
our RMBS
portfolio
consisted
of $6,511.1 million
of Agency
RMBS at
fair value
and had a
weighted
average coupon
on assets
of 3.03%.
During the
year ended
December
31, 2021,
we received
principal
repayments
of $591.1
million
compared
to $523.7
million for
the year
ended December
 
31, 2020.
 
There wereThe average
 
no
open swaptionthree month
 
positions atprepayment
 
speeds for
the quarters
ended
December
31, 2021
and 2020
were 11.4% and
20.1%, respectively.
The following
table presents
the 3-month
constant prepayment
rate (“CPR”)
experienced
on our structured
and PT RMBS
sub-
portfolios,
on an annualized
basis, for
the quarterly
periods presented.
CPR is a
method of
expressing
the prepayment
rate for
a mortgage
pool that
assumes that
a constant
fraction
of the remaining
principal
is prepaid
each month
or year. Specifically,
the CPR
in the chart
below represents
the three
month prepayment
rate of the
securities
in the respective
asset
category.
Structured
PT RMBS
RMBS
Total
Three Months Ended
Portfolio (%)
Portfolio (%)
Portfolio (%)
December 31,
2019.
2021
9.0
24.6
($ in thousands)11.4
OptionSeptember 30, 2021
Underlying Swap9.8
Weighted25.1
Average12.4
WeightedJune 30, 2021
Average10.9
Average29.9
Adjustable12.9
AverageMarch 31, 2021
Fair9.9
Months to40.3
Notional
Fixed
Rate
Term
Expiration
Cost
Value
Expiration
Amount
Rate
(LIBOR)
(Years)12.0
December 31, 2020
Payer Swaptions (long positions)16.7
≤ 1 year44.3
$20.1
3,450September 30, 2020
$14.3
540.4
2.517.0
500,000June 30, 2020
0.95%13.9
3 Month35.3
4.016.3
> 1 year ≤ 2 years
13,410
17,428
17.4
675,000
1.49%
3 Month
12.8
$
16,860
$
17,433
11.0
$
1,175,000
1.26%
3 Month
9.0
Payer Swaptions (short positions)
≤ 1 year
$
(4,660)
$
(7,730)
5.4
$
507,700
1.49%
3 Month
12.8
The following table summarizes our contracts to purchase and sell TBA
securities as of DecemberMarch 31, 2020 and 2019.
9.8
22.9
11.9
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
17
 
 
61
The following
tables summarize
certain characteristics
of the Company’s
PT RMBS
and structured
RMBS as of
December 31,
2021
and 2020:
($ in thousands)
NotionalWeighted
NetPercentage
AmountAverage
Costof
MarketWeighted
CarryingMaturity
Long (Short)Fair
(1)Entire
BasisAverage
(2)in
Longest
Asset Category
Value
(3)Portfolio
ValueCoupon
(4)Months
Maturity
December 31, 2021
Fixed Rate RMBS
$
6,298,189
96.7%
2.93%
342
1-Dec-51
Total Mortgage-backed Pass-through
6,298,189
96.7%
2.93%
342
1-Dec-51
Interest-Only Securities
210,382
3.2%
3.40%
263
25-Jan-52
Inverse Interest-Only Securities
2,524
0.1%
3.75%
300
15-Jun-42
Total Structured RMBS
212,906
3.3%
3.41%
264
25-Jan-52
Total Mortgage Assets
$
6,511,095
100.0%
3.03%
325
25-Jan-52
December 31, 2020
30-Year TBA securities:
2.0%Fixed Rate RMBS
$
465,0003,560,746
95.5%
3.09%
339
1-Jan-51
Fixed Rate CMOs
137,453
3.7%
4.00%
312
15-Dec-42
Total Mortgage-backed Pass-through
3,698,199
99.2%
3.13%
338
1-Jan-51
Interest-Only Securities
28,696
0.8%
3.98%
268
25-May-50
Total Structured RMBS
28,696
0.8%
3.98%
268
25-May-50
Total Mortgage Assets
$
479,5313,726,895
$100.0%
483,0903.19%
$333
3,5591-Jan-51
3.0%
(328,000)
(342,896)
(343,682)
(786)
Total
($
137,000
$
136,635
$
139,408
$
2,773 in thousands)
December 31, 20192021
30-Year TBA securities:December 31, 2020
4.5%Percentage of
Percentage of
Agency
Fair Value
Entire Portfolio
Fair Value
Entire Portfolio
Fannie Mae
$
(300,000)4,719,349
72.5%
$
(315,426)2,733,960
73.4%
Freddie Mac
1,791,746
27.5%
992,935
26.6%
Total Portfolio
$
(315,938)6,511,095
100.0%
$
(512)3,726,895
Total100.0%
December 31, 2021
December 31, 2020
Weighted Average Pass-through Purchase Price
$
(300,000)107.19
$
(315,426)107.43
Weighted Average Structured Purchase Price
$
(315,938)15.21
$
(512)
20.06
Weighted Average Pass-through Current Price
$
105.31
$
108.94
Weighted Average Structured Current Price
$
14.08
$
10.87
Effective Duration
(1)
3.390
Notional amount represents2.360
(1)
Effective duration is the parapproximate percentage change in price
for a 100 bps change in rates.
An effective duration of 3.390 indicates that an
interest rate increase of 1.0% would be expected to cause a 3.390% decrease in the value (or principal balance)
of the RMBS in the Company’s investment portfolio
at December 31, 2021.
 
underlying Agency RMBS.
(2)
An effective duration of 2.360 indicates that an interest rate increase
 
Cost basis represents the forward priceof 1.0% would be expected to be paid (received) forcause a 2.360%
decrease in the
underlying Agency RMBS.
(3)
Market value represents the current market value of the TBA securitiesRMBS in the Company’s investment portfolio
 
(orat December 31, 2020. These figures include the structured securities
in the portfolio, but do not include the effect of the underlying Agency RMBS) as of period-end.
(4)
Company’s funding
 
Net carrying value represents the difference between the marketcost hedges.
 
value and the cost basis of the TBA securities as of period-endEffective duration quotes for individual investments are
obtained from The Yield Book, Inc.
 
and is reported
in derivative assets (liabilities), at fair value in our balance sheets.
 
 
Gain (Loss) From Derivative and Other Hedging Instruments, Net
 
62
The following
table presents
a summary
of portfolio
assets acquired
during the
years ended
December
31, 2021
and 2020.
($ in thousands)
2021
2020
Total Cost
Average
Price
Weighted
Average
Yield
Total Cost
Average
Price
Weighted
Average
Yield
Pass-through RMBS
$
6,224,819
$
106.68
1.63%
$
4,858,602
$
107.71
1.38%
Structured RMBS
205,906
13.61
3.88%
832
12.96
2.80%
Borrowings
As of December
31, 2021,
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
23 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 December
31, 2021,
we had obligations
outstanding
under the
repurchase
agreements
of approximately
$6,244.1
million with
a
net weighted
average borrowing
cost of 0.15%.
The remaining
maturity of
our outstanding
repurchase
agreement
obligations
ranged from
5 to 257
days, with
a weighted
average remaining
maturity of
27 days.
Securing
the repurchase
agreement
obligations
as of December
31, 2021
are RMBS
with an estimated
fair value,
including
accrued
interest,
of approximately
$6,525.2
million and
a weighted
average
maturity of
345 months,
and cash
pledged to
counterparties
of approximately
$57.3 million.
Through
February
25, 2022,
we have been
able to maintain
our repurchase
facilities
with comparable
terms to
those that
existed at
December
31, 2021
with maturities
extending
to
various dates
through September
14, 2022.
The table below presents information about our period end,
maximum and average balances of borrowings for each quarter in
2021 and 2020.
($ 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
December 31, 2021
$
6,244,106
$
6,419,689
$
5,728,988
$
515,118
8.99%
September 30, 2021
5,213,869
5,214,254
4,864,287
349,582
7.19%
June 30, 2021
4,514,704
4,517,953
4,348,192
166,512
3.83%
March 31, 2021
4,181,680
4,204,935
3,888,633
293,047
7.54%
December 31, 2020
3,595,586
3,597,313
3,438,444
157,142
4.57%
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)
(1)
The lower ending balance relative to the average balance during the quarter
ended March 31, 2020 reflects the sale 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.
We have both
internal
and external
sources of
liquidity. However,
our material
unused sources
of liquidity
include cash
balances,
unencumbered
assets and
our ability
to sell encumbered
assets to
raise cash.
At the
63
onset of
the COVID-19
pandemic in
the spring
of 2020,
the markets
the Company
operates
in were severely
disrupted
and the Company
was forced
to rely on
these sources
of liquidity. Our
balance sheet
also generates
liquidity
on an on-going
basis through
payments
of
principal
and interest
we receive
on our RMBS
portfolio.
Management
believes that
we currently
have sufficient
liquidity
and capital
resources
available
for (a) the
acquisition
of additional
investments
consistent
with the
size and
nature of
our existing
RMBS portfolio,
(b)
the repayments
on borrowings
and (c) the
payment of
dividends
to the extent
required
for our continued
qualification
as a REIT.
We may
also generate
liquidity
from time
to time by
selling our
equity or
debt securities
in public
offerings
or private
placements.
Internal
Sources of
Liquidity
Our internal
sources of
liquidity
include our
cash balances,
unencumbered
assets and
our ability
to liquidate
our encumbered
security
holdings.
Our balance
sheet also
generates
liquidity
on an on-going
basis through
payments
of principal
and interest
we receive
on our
RMBS portfolio.
Because our
PT RMBS portfolio
consists entirely
of government
and agency
securities,
we do not
anticipate
having
difficulty converting
our assets
to cash should
our liquidity
needs ever
exceed our
immediately
available
sources of
cash.
Our structured
RMBS portfolio
also consists
entirely of
governmental
agency securities,
although
they typically
do not trade
with comparable
bid / ask
spreads as
PT RMBS.
However, we anticipate
that we would
be able to
liquidate
such securities
readily, even in
distressed
markets,
although
we would
likely do
so at prices
below where
such securities
could be sold
in a more
stable market.
To enhance our liquidity
even
further, we may
pledge a
portion of
our structured
RMBS as
part of a
repurchase
agreement
funding,
but retain
the cash in
lieu of acquiring
additional
assets.
In this way
we can, at
a modest
cost, retain
higher levels
of cash on
hand and
decrease
the likelihood
we will
have to
sell assets
in a distressed
market in
order to
raise cash.
Our strategy
for hedging
our funding
costs typically
involves
taking short
positions
in interest
rate futures,
treasury
futures,
interest
rate
swaps, interest
rate swaptions
or other
instruments.
When the
market causes
these short
positions
to decline
in value we
are required
to
meet margin
calls with
cash.
This can
reduce our
liquidity
position
to the extent
other securities
in our portfolio
move in price
in such a
way
that we do
not receive
enough cash
via margin
calls to
offset the
derivative
related margin
calls. If
this were
to occur
in sufficient
magnitude,
the loss of
liquidity
might force
us to reduce
the size
of the levered
portfolio,
pledge additional
structured
securities
to raise
funds or
risk operating
the portfolio
with less
liquidity.
External
Sources of
Liquidity
Our primary
external
sources of
liquidity
are our ability
to (i) borrow
under master
repurchase
agreements,
(ii) use
the TBA
security
market and
(iii) sell
our equity
or debt
securities
in public
offerings
or private
placements.
Our borrowing
capacity will
vary over
time as the
market value
of our interest
earning assets
varies.
Our master
repurchase
agreements
have no
stated expiration,
but can be
terminated
at
any time at
our option
or at the
option of
the counterparty.
However, once
a definitive
repurchase
agreement
under a master
repurchase
agreement
has been
entered into,
it generally
may not be
terminated
by either
party.
A negotiated
termination
can occur, but
may involve
a fee to
be paid by
the party
seeking to
terminate
the repurchase
agreement
transaction.
Under our
repurchase
agreement
funding arrangements,
we are required
to post margin
at the initiation
of the borrowing.
The margin
posted represents
the haircut,
which is a
percentage
of the market
value of the
collateral
pledged.
To the extent the
market value
of the
asset collateralizing
the financing
transaction
declines,
the market
value of our
posted margin
will be insufficient
and we will
be required
to
post additional
collateral.
Conversely, if
the market
value of the
asset pledged
increases
in value,
we would
be over collateralized
and we
would be
entitled to
have excess
margin returned
to us by the
counterparty.
Our lenders
typically
value our
pledged securities
daily to
ensure the
adequacy of
our margin
and make margin
calls as
needed, as
do we.
Typically, but not
always, the
parties agree
to a minimum
threshold
amount for
margin calls
so as to avoid
the need
for nuisance
margin calls
on a daily
basis.
Our master
repurchase
agreements
do not specify
the haircut;
rather haircuts
are determined
on an individual
repurchase
transaction
basis. Throughout
the year
ended
December
31, 2021,
haircuts on
our pledged
collateral
remained
stable and
as of December
31, 2021,
our weighted
average haircut
was
approximately
4.9% of the
value of
our collateral.
TBAs
represent
a form of
off-balance
sheet financing
and are
accounted
for as derivative
instruments.
(See Note
4 to our
Financial
64
Statements
in this Form
10-K for
additional
details on
of our TBAs).
Under certain
market conditions,
it may be
uneconomical
for us to
roll
our TBAs
into future
months and
we may need
to take or
make physical
delivery
of the underlying
securities.
If we were
required
to take
physical delivery
to settle
a long TBA,
we would
have to fund
our total
purchase
commitment
with cash
or other
financing
sources and
our
liquidity
position could
be negatively
impacted.
Our TBAs
are also
subject to
margin requirements
governed
by the Mortgage-Backed
Securities
Division ("MBSD")
of the FICC
and
by our master
securities
forward
transaction
agreements,
which may
establish
margin levels
in excess
of the MBSD.
Such provisions
require that
we establish
an initial
margin based
on the notional
value of the
TBA, which
is subject
to increase
if the estimated
fair value
of
our TBAs
or the estimated
fair value
of our pledged
collateral
declines.
The MBSD
has the sole
discretion
to determine
the value
of our
TBAs
and of the
pledged collateral
securing such
contracts.
In the event
of a margin
call, we
must generally
provide additional
collateral
on
the same
business day.
Settlement
of our TBA
obligations
by taking
delivery of
the underlying
securities
as well as
satisfying
margin requirements
could
negatively
impact our
liquidity
position.
However, since
we do not
use TBA dollar
roll transactions
as our primary
source of
financing,
we
believe that
we will have
adequate
sources of
liquidity
to meet
such obligations.
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.
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 December
31, 2021,
we had cash
and cash equivalents
of $385.1
million.
We generated
cash flows
of
$716.5 million
from principal
and interest
payments on
our RMBS
and had average
repurchase
agreements
outstanding
of $4,707.5
million
during the
year ended
December
31, 2021.
As described more fully below, we may also access liquidity by selling our equity or debt securities in public offerings or private
placements.
Stockholders’
Equity
On August 2, 2017, we entered into 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, after commissions and fees, prior to its termination in July 2019.
On July 30, 2019, we entered into the 2019 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 the Company’s common stock at a price to the public of $6.55 per share. The underwriters
purchased the shares pursuant to
the 2019 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 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
65
the January 2020 Equity Distribution Agreement for aggregate gross proceeds
of $19.8 million, and net proceeds of approximately
$19.4 million, after commissions and fees, prior to its termination in August
2020.
On August 4, 2020, we entered into the August 2020 Equity Distribution Agreement
with four sales agents pursuant to which we
could offer and sell, from time to time, up to an aggregate amount of $150,000,000
of shares of our common stock in transactions that
were deemed to be “at the market” offerings and privately negotiated transactions. We issued a total
of 27,493,650 shares under the
August 2020 Equity Distribution Agreement for aggregate gross proceeds
of approximately $150.0 million, and net proceeds of
approximately $147.4 million, after commissions and fees,
prior to its termination in June 2021.
On January 20, 2021, we entered into the January 2021 Underwriting Agreement
with J.P. Morgan Securities LLC (“J.P.
Morgan”),
relating to the offer and sale of 7,600,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from
the Company pursuant to the January 2021 Underwriting Agreement at $5.20
per share. In addition, we granted J.P. Morgan a 30-day
option to purchase up to an additional 1,140,000 shares of our common stock
on the same terms and conditions, which J.P. Morgan
exercised in full on January 21, 2021. The closing of the offering of 8,740,000 shares of our
common stock occurred on January 25,
2021, with proceeds to us of approximately $45.2 million, net of offering expenses.
On March 2, 2021, we entered into the March 2021 Underwriting Agreement
with J.P. Morgan, relating to the offer and sale of
8,000,000 shares of our common stock. J.P. Morgan purchased the shares of our common stock from the Company pursuant to the
March 2021 Underwriting Agreement at $5.45 per share. In addition, we
granted J.P. Morgan a 30-day option to purchase up to an
additional 1,200,000 shares of our common stock on the same terms
and conditions, which J.P. Morgan exercised in full on March 3,
2021. The closing of the offering of 9,200,000 shares of our common stock occurred on
March 5, 2021, with proceeds to us of
approximately $50.0 million, net of offering expenses.
On June 22, 2021, we entered into the June 2021 Equity Distribution Agreement with four
sales agents pursuant to which we could
offer and sell, from time to time, up to an aggregate amount of $250,000,000 of shares
of our common stock in transactions that were
deemed to be “at the market” offerings and privately negotiated transactions. We issued a
total of 49,407,336 shares under the June
2021 Equity Distribution Agreement for aggregate gross proceeds of
approximately $250.0 million, and net proceeds of approximately
$246.2 million, after commissions and fees, prior to its termination in October
2021.
On October 29, 2021, we entered into the October 2021 Equity Distribution
Agreement with four sales agents pursuant to which
we may offer and sell, from time to time, up to an aggregate amount of $250,000,000 of
shares of our common stock in transactions
that are deemed to be “at the market” offerings and privately negotiated transactions. Through
December 31, 2021, we issued a total of
15,835,700 shares under the October 2021 Equity Distribution Agreement for aggregate
gross proceeds of approximately $78.3 million,
and net proceeds of approximately $77.0
million, after commissions and fees.
Outlook
Economic Summary
COVID-19 continued to impact the United States and the rest of the world during the fourth
quarter of 2021 and into the first
quarter of 2022.
The most recent variant, Omicron, spreads much more readily
than past variants, but also tends to be much less
severe.
Instances of new cases spiked rapidly, starting in December of 2021 and peaked, in the U.S., the week ended January 16,
2022 at 5.58 million.
Since then cases have declined fairly rapidly, as have hospitalizations, which have also tended to involve much
shorter stays in the hospital, especially in comparison to the Delta variant.
Despite the Omicron wave, the economy added 467,000
jobs in January 2022 and retail sales also rose well above estimates at 3.8%,
causing the markets and the Fed to meaningfully revise
expectations for the path of monetary policy in 2022 and beyond.
66
The rationale for the shift in expectations for monetary policy was found in the
economic data that was released during the fourth
quarter of 2021.
There were several economic indicators that reached milestone
levels and made it clear the economy had more than
recovered from the pandemic.
The Fed focuses on two areas of economic performance – inflation and the labor
market – tied to their
dual mandates of stable prices and maximum employment.
With respect to inflation, the year-over-year consumer price index reading
increased from the 4% increase reported in September of 2021
to 5.43% in December of 2021. Core personal consumption
expenditures – the Fed’s preferred inflation measure – increased from 3.7% year-over-year
to 4.85% between September and
December of 2021.
In the latter case, this was the highest reading since the early 1980s.
The producer price index was also increasing
rapidly – approaching 7% year over year in December of 2021.
This led the Fed to formally declare that their assessment of inflation
as “transitory” was no longer the case.
Labor market indicators
also reached new milestones. Initial claims for unemployment insurance
breached the 200,000 level
during the fourth quarter of 2021–
the first time this happened since the late 1960s.
Continuing claims for unemployment insurance
reached levels even lower than the lows reached prior to the pandemic, and the
unemployment rate reached 3.9% in December, still
0.4% above the lowest level reached prior to the pandemic but below the Fed’s long-term target
level and their proxy for full
employment.
The final piece of information was gross domestic product growth of 6.9%
for the fourth quarter, released in January of
2022.
The Fed’s outlook for monetary policy pivoted materially beginning in November
of 2021.
The economic data has strengthened further in early 2022.
In particular, measures of inflation have accelerated from the trend of
late 2021 and are very broad based, as prices for essentially every category
of goods and services are accelerating.
The employment
data has also been very strong, exhibiting little effect from the Omicron variant. The combination
of accelerating inflation well above the
Fed’s target level and a very tight labor market have led the market to anticipate the Fed will
react aggressively soon. The Fed has
signaled they are about to start an accelerated removal of the extreme monetary accommodation
necessitated by the pandemic.
In
January of 2022 the FOMC announced they would end their asset purchases
in March of 2022 and were likely to start decreasing the
reinvestment of their U.S. Treasury and RMBS assets as they matured or were repaid starting shortly
after their first rate hike.
The first
rate hike is likely to be in March as well. Current pricing in the futures
market indicates
the Fed will increase the Fed Funds rate at least
six times by January of 2023 and by approximately 75 basis points more in 2023.
There is a potentially significant geo-political development in the outlook as well.
Russia appears to be threatening to take military
action in the Ukraine.
They have moved over 100,000 troops and significant other military assets
such as tanks, combat aircraft,
missile systems, naval forces and medical personnel into areas on the
north, east and south of Ukraine. The situation has been
developing since late 2021 and diplomatic efforts to ease tensions in the area do not appear
to be working.
The United States and
several NATO allies have sent troops to the region and military supplies to Ukraine.
There is also the possibility hostilities may not be
limited to direct military confrontation.
This may have begun already as reports of cyber attacks throughout Ukraine
and other forms of
non-military intervention have occurred. Should the situation deteriorate further
and military action lead to a protracted war, there would
likely be an economic impact on Europe and therefore indirectly in the U.S., potentially
slowing economic activity at the margin and
possibly lessening the need for the Fed to remove monetary policy as
aggressively as expected otherwise.
Legislative Response and the Federal Reserve
Congress passed the CARES Act (described below) quickly in response to
the pandemic’s emergence during the spring of 2020.
As provisions of the CARES Act expired and the effects of the pandemic continued
to adversely impact the country, the federal
government passed an additional stimulus package in late December of 2020.
Further, on March 11, 2021, President Biden signed into
law an additional $1.9 trillion coronavirus aid package as part of the American
Rescue Plan Act of 2021.
This law provided for, among
other things, direct payments to most Americans with a gross income of
less than $75,000 a year, expansion of the child tax credit,
extension of expanded unemployment benefits through September 6, 2021, funding
for procurement of vaccines and health providers,
loans to qualified businesses, funding for rental and mortgage assistance and
funding for schools. The expanded federal
unemployment benefits expired on September 6, 2021.
In addition, the Fed provided as much support to the markets and the economy
as it could within the constraints of its mandate.
67
During the third quarter of 2020, the Fed unveiled a new monetary policy framework
focused on average inflation rate targeting
that allows the Fed Funds rate to remain quite low, even if inflation is expected to temporarily surpass the 2% target
level. Further, the
Fed stated they would 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.
As mentioned above, this policy shift will not likely have an effect on current
monetary policy as inflation is now running
considerably higher than the Fed’s 2% target level and the Fed appears likely to move
quickly to remove the extreme monetary
accommodation they provided as the pandemic emerged in the U.S. in the
spring of 2020.
Interest Rates
At the beginning of 2021,
interest rates were still close to the lowest levels ever observed
in 2020.
As the country and economy
emerged from the effects of the pandemic and the federal government and the Fed took unprecedented
actions to buttress the
economy from the effects of the pandemic, interest rates increased over the course of
the year.
Increases in interest rates were not
uniform over the year as shorter maturity rates, typically more sensitive to anticipated
increases in short term rates controlled by the
Fed, increased more than longer term rates.
As inflation accelerated in the fourth quarter of 2021, and even more so
in early 2022, this
trend intensified and currently the spread between certain intermediate rates
– such as 5-year and 7-year maturities – trade at yields
only marginally below longer-term rates such as 10-year U.S. Treasuries.
This flattening of the rates curve is typical as the economy
strengthens and the market anticipates increases in short-term rates by the Fed. As
economic and/or inflation data strengthen and the
market anticipates progressively more increases in short-term rates, this flattening
effect intensifies as well. Eventually the rates curve
could actually invert, whereby the intermediate rates mentioned above actually yield
more than longer-term rates.
This would occur
when the market anticipates the increases to short-term rates by the Fed will actually
slow the economy too much in the future and a
possible recession is on the horizon.
Given the unprecedented nature of the monetary and fiscal stimulus
needed to combat the
pandemic and the related supercharged effect on the economy, the current recovery and pending rate increase cycle will be difficult to
manage by the Fed and we expect that such an outcome is more likely to occur
than in past cycles.
The Agency RMBS Market
As was anticipated,
the Fed announced a tapering of their U.S. Treasury and Agency RMBS
asset purchases at their November
2021 meeting.
As described above, the forthcoming data was likely to necessitate an accelerated
pace of accommodation removal
and in December of 2021,
and again in January of 2022, the Fed announced revised schedules
for tapering.
This means a material
source of demand for Agency RMBS is about to leave the market.
Given Fed purchases are a source of reserves into the banking
system, this also means banks, which have also been a material source
for Agency RMBS, may also be buying fewer securities.
However, the securities that were the focus of the Fed and bank buying, namely production coupon securities, performed
relatively well
during the fourth quarter of 2021.
Total
returns for Agency RMBS for the fourth quarter and full year of 2021 were -0.4%
and -1.2%, respectively.
Agency RMBS
returns generally trailed other major domestic fixed income categories.
High yield debt returned 0.7% and 5.4% for the fourth quarter
and full year of 2021, respectively.
Investment grade returns for the same two periods were 0.2% and -1.0%.
Legacy non-Agency
RMBS returns were equal to or exceeded high yield returns.
Relative to comparable duration U.S. Treasuries Agency RMBS returns
were -1.0% and -1.6%, respectively for the same two periods.
Again, these returns trailed the same other major domestic fixed-income
categories and by comparable amounts.
Within the Agency RMBS 30-year coupons, production coupons – 2.0%
and 2.5% -
outperformed higher, liquid securities – 3.0% and 3.5%, both on an absolute and relative to comparable duration U.S.
Treasury basis
for the fourth quarter of 2021.
Recent Legislative and Regulatory Developments
68
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 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. The Federal Open Market Committee (“FOMC”) continued
to reaffirm this commitment at all subsequent
meetings through December of 2021, 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.
On January 26, 2022, the FOMC reiterated its goals of maximum
employment and a 2% long-run inflation rate and stated that, with a strong labor market
and inflation well above 2%, it expected it
would soon be appropriate to raise the target federal funds rate.
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. Through November of 2021, the Fed
was committed to purchasing $80 billion of U.S. Treasuries and $40 billion of Agency MBS each month. In November
of 2021, it began
tapering its net asset purchases each month, reducing them to $70 billion,
$60 billion and $40 billion of U.S. Treasuries and $35 billion,
$30 billion and $20 billion of Agency MBS in November of 2021, December of
2021 and January of 2022, respectively.
On January 26,
2022, the FOMC announced that it would continue to increase its holdings of U.S. Treasuries by $20 billion per
month and its holdings
of Agency RMBS by $10 billion per month for February of 2022 and would end
its net asset purchases entirely by early March of 2022.
The CARES Act was passed by Congress and signed into law by President Trump on March 27, 2020.
The CARES Act provided
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). 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 December 27, 2020, President Trump signed into law an additional $900 billion coronavirus aid package
as part of the
Consolidated Appropriations Act, 2021, providing for extensions of many
of the CARES Act policies and programs as well as additional
relief. The package provided for, among other things, direct payments to most Americans with a gross income of less
than $75,000 a
year, extension of unemployment benefits through March 14, 2021, funding for procurement of vaccines and health
providers, loans to
qualified businesses, funding for rental assistance and funding for schools.
On January 29, 2021, the CDC issued guidance extending
eviction moratoriums for covered persons through March 31, 2021. The FHFA subsequently extended the foreclosure
moratorium
begun under the CARES Act for loans backed by Fannie Mae and Freddie
Mac and the eviction moratorium for real estate owned by
69
Fannie Mae and Freddie Mac until July 31, 2021 and September 30, 2021, respectively. The U.S. Housing and Urban Development
Department subsequently extended the FHA foreclosure and eviction moratoria to
July 31, 2021 and September 30, 2021, respectively.
Despite the expirations of these foreclosure moratoria, a final rule adopted
by the CFPB on June 28, 2021 effectively prohibited
servicers from initiating a foreclosure before January 1, 2022 in most instances.
On March 11, 2021, President Biden signed into law an additional $1.9 trillion coronavirus aid package as part of the
American
Rescue Plan Act of 2021.
This law provided for, among other things, direct payments to most Americans with a gross income of less
than $75,000 a year, expansion of the child tax credit, extension of expanded unemployment benefits through September
6, 2021,
funding for procurement of vaccines and health providers, loans to qualified businesses,
funding for rental and mortgage assistance
and funding for schools. The expanded federal unemployment benefits expired on September
6, 2021.
In January 2019, the Trump administration made statements of its plans to work with Congress
to overhaul Fannie Mae and
Freddie Mac and expectations to announce a framework for the development of
a policy for comprehensive housing finance reform
soon. On September 30, 2019, the FHFA announced that Fannie Mae and Freddie Mac were allowed
to increase their capital buffers
to $25 billion and $20 billion, respectively, from the prior limit of $3 billion each. This step could ultimately lead to Fannie Mae and
Freddie Mac being privatized and represents the first concrete step on the road to
GSE reform.
On June 30, 2020, the FHFA released
a proposed rule on a new regulatory framework for the GSEs which seeks to implement
both a risk-based capital framework and
minimum leverage capital requirements. The final rule on the new capital framework
for the GSEs was published in the federal register
in December 2020.
On January 14, 2021, the U.S. Treasury and the FHFA executed letter agreements allowing the GSEs to continue
to retain capital up to their regulatory minimums, including buffers, as prescribed in the December
rule.
These letter agreements
provide, in part, (i) there will be no exit from conservatorship until all
material litigation is settled and the GSE has common equity Tier 1
capital of at least 3% of its assets, (ii) the GSEs will comply with
the FHFA’s
regulatory capital framework, (iii) higher-risk single-family
mortgage acquisitions will be restricted to current levels, and (iv) the U.S. Treasury and the FHFA will establish a timeline and process
for future GSE reform. However, no definitive proposals or legislation have been released or enacted with respect
to ending the
conservatorship, unwinding the GSEs, or materially reducing the roles of the GSEs
in the U.S. mortgage market.
On September 14,
2021, the U.S. Treasury and the FHFA suspended certain policy provisions in the January agreement, including limits on loans
acquired for cash consideration, multifamily loans, loans with higher risk
characteristics and second homes and investment properties.
On September 15, 2021, the FHFA announced a notice of proposed rulemaking for the purpose of amending the December
rule to,
among other things, reduce the Tier 1 capital and risk-weight floor requirements.
In 2017, policymakers announced that LIBOR will be replaced by December
31, 2021. The directive was spurred by the fact that
banks are uncomfortable contributing to the LIBOR panel given the shortage of underlying
transactions on which to base levels and the
liability associated with submitting an unfounded level. However, the ICE Benchmark Administration, in its
capacity as administrator of
USD LIBOR, has announced that it intends to extend publication of USD LIBOR (other
than one-week and two-month tenors) by 18
months to June 2023.
Notwithstanding this possible extension, a joint statement by key regulatory
authorities calls on banks to cease
entering into new contracts that use USD LIBOR as a reference rate by no
later than December 31, 2021. The ARRC,
a steering
committee comprised of large U.S. financial institutions, has proposed replacing
USD-LIBOR with a new SOFR, a rate based on U.S.
repo trading. Many banks believe that it may take four to five years to complete
the transition to SOFR, despite the December 31, 2021
deadline. We will monitor the emergence of SOFR carefully as it appears likely to become
the new benchmark for hedges and a range
of interest rate investments. At this time, however, no consensus exists as to what rate or rates may become accepted alternatives
to
LIBOR.
On December 7, 2021, the CFPB released a final rule that amends Regulation
Z, which implemented the Truth in Lending Act,
aimed at addressing cessation of LIBOR for both closed-end (e.g., home mortgage) and
open-end (e.g., home equity line of credit)
products. The rule, which mostly becomes effective in April of 2022, establishes requirements
for the selection of replacement indices
for existing LIBOR-linked consumer loans. Although the rule does not mandate
the use of SOFR as the alternative rate, it identifies
SOFR as a comparable rate for closed-end products and states that for open-end products,
the CFPB has determined that ARRC’s
recommended spread-adjusted indices based on SOFR for consumer products
to replace the one-month, three-month, or six-month
70
USD LIBOR index “have historical fluctuations that are substantially similar to
those of the LIBOR indices that they are intended to
replace.” The CFPB reserved judgment, however, on a SOFR-based spread-adjusted replacement
index to replace the one-year USD
LIBOR until it obtained additional information.
On December 8, 2021, the House of Representatives passed the Adjustable Interest
Rate (LIBOR) Act of 2021 (H.R. 4616) (the
“LIBOR Act”), which provides for a statutory replacement benchmark rate for contracts
that use LIBOR as a benchmark and do not
contain any fallback mechanism independent of LIBOR. Pursuant to the LIBOR
Act, SOFR becomes the new benchmark rate by
operation of law for any such contract. The LIBOR Act establishes a safe harbor from
litigation for claims arising out of or related to the
use of SOFR as the recommended benchmark replacement. The LIBOR Act
makes clear that it should not be construed to disfavor the
use of any benchmark on a prospective basis.
The LIBOR Act also attempts to forestall challenges that it is impairing
contracts. It provides that the discontinuance of LIBOR and
the automatic statutory transition to a replacement rate neither impairs or
affects the rights of a party to receive payment under such
contracts, nor allows a party to discharge their performance obligations or to declare
a breach of contract. It amends the Trust
Indenture Act of 1939 to state that the “the right of any holder of any
indenture security to receive payment of the principal of and
interest on such indenture security shall not be deemed to be impaired or
affected” by application of the LIBOR Act to any indenture
security.
On December 9, 2021, the United States Senate referred the LIBOR Act to
the Committee on Banking, Housing and Urban
Affairs.
One-week and two-month U.S. dollar LIBOR rates phased out on December 31,
2021, but other U.S. dollar tenors may continue
until June 30, 2023. We will monitor the emergence of SOFR carefully as it appears likely
to become the new benchmark for hedges
and a range of interest rate investments. At this time, however, no consensus exists as to what rate or rates may
become accepted
alternatives to LIBOR.
Effective January 1, 2021, Fannie Mae, in alignment with Freddie Mac, extended the timeframe for
its delinquent loan buyout
policy for Single-Family Uniform Mortgage-Backed Securities (UMBS)
and Mortgage-Backed Securities (MBS) from four consecutively
missed monthly payments to twenty-four consecutively missed monthly payments (i.e.,
24 months past due). This new timeframe
applied to outstanding single-family pools and newly issued single-family pools and was
first reflected when January 2021 factors were
released on the fourth business day in February 2021.
For Agency RMBS investors, when a delinquent loan is bought out of a pool of
mortgage loans, the removal of the loan from the
pool is the same as a total prepayment of the loan.
The respective GSEs anticipated, however, that delinquent loans will be
repurchased in most cases before the 24-month deadline under one of the following
exceptions listed below.
•
a loan that is paid in full, or where the related lien is released and/or the
note debt is satisfied or forgiven;
•
a loan repurchased by a seller/servicer under applicable selling and servicing
requirements;
•
a loan entering a permanent modification, which generally requires it to
be removed from the MBS. During any modification
trial period, the loan will remain in the MBS until the trial period ends;
•
a loan subject to a short sale or deed-in-lieu of foreclosure; or
•
a loan referred to foreclosure.
Because of these exceptions, the GSEs believe based on prevailing assumptions
and market conditions this change will have only
a marginal impact on prepayment speeds, in aggregate. Cohort level impacts
may vary. For example, more than half of loans referred
to foreclosure are historically referred within six months of delinquency. The degree to which speeds are affected depends on
delinquency levels, borrower response, and referral to foreclosure timelines.
The scope and nature of the actions the U.S. government or the Fed will
ultimately undertake are unknown and will continue to
evolve.
71
Effect on Us
Regulatory developments, movements in interest rates and prepayment rates
affect us in many ways, including the following:
Effects on our Assets
A change in or elimination of the guarantee structure of Agency RMBS may increase
our costs (if, for example, guarantee fees
increase) or require us to change our investment strategy altogether. For example, the elimination of the guarantee
structure of Agency
RMBS may cause us to change our investment strategy to focus on
non-Agency RMBS, which in turn would require us to significantly
increase our monitoring of the credit risks of our investments in addition to interest
rate and prepayment risks.
Lower long-term interest rates can affect the value of our Agency RMBS in a number of ways.
If prepayment rates are relatively
low (due, in part, to the refinancing problems described above), lower long-term interest
rates can increase the value of higher-coupon
Agency RMBS. This is because investors typically place a premium on assets
with yields that are higher than market yields. Although
lower long-term interest rates may increase asset values in our portfolio, we
may not be able to invest new funds in similarly-yielding
assets.
If prepayment levels increase, the value of our Agency RMBS affected by such prepayments may decline.
This is because a
principal prepayment accelerates the effective term of an Agency RMBS, which would shorten
the period during which an investor
would receive above-market returns (assuming the yield on the prepaid asset
is higher than market yields). Also, prepayment proceeds
may not be able to be reinvested in similar-yielding assets. Agency RMBS
backed by mortgages with high interest rates are more
susceptible to prepayment risk because holders of those mortgages
are most likely to refinance to a lower rate. IOs and IIOs, however,
may be the types of Agency RMBS most sensitive to increased prepayment
rates. Because the holder of an IO or IIO receives no
principal payments, the values of IOs and IIOs are entirely dependent
on the existence of a principal balance on the underlying
mortgages. If the principal balance is eliminated due to prepayment, IOs
and IIOs essentially become worthless. Although increased
prepayment rates can negatively affect the value of our IOs and IIOs, they have the opposite
effect on POs. Because POs act like zero-
coupon bonds, meaning they are purchased at a discount to their par value
and have an effective interest rate based on the discount
and the term of the underlying loan, an increase in prepayment rates would reduce
the effective term of our POs and accelerate the
yields earned on those assets, which would increase our net income.
Higher long-term rates can also affect the value of our Agency RMBS.
As long-term rates rise, rates available to borrowers also
rise.
This tends to cause prepayment activity to slow and extend the expected
average life of mortgage cash flows.
As the expected
average life of the mortgage cash flows increases, coupled with higher discount
rates, the value of Agency RMBS declines.
Some of
the instruments the Company uses to hedge our Agency RMBS assets,
such as interest rate futures, swaps and swaptions, are stable
average life instruments.
This means that to the extent we use such instruments to hedge
our Agency RMBS assets, our hedges may
not adequately protect us from price declines, and therefore may negatively impact our
book value.
It is for this reason we use interest
only securities in our portfolio. As interest rates rise, the expected average
life of these securities increases, causing generally positive
price movements as the number and size of the cash flows increase the
longer the underlying mortgages remain outstanding. This
makes interest only securities desirable hedge instruments for pass-through
Agency RMBS.
As described above, the Agency RMBS market began to experience severe dislocations
in mid-March 2020 as a result of the
economic, health and market turmoil brought about by COVID-19. On March 23, 2020,
the Fed announced that it would purchase
Agency RMBS and U.S. Treasuries in the amounts needed to support smooth market functioning, which
largely stabilized the Agency
RMBS market, but announced a tapering of these purchases in November 2021.
The Fed’s reduction of these purchases could
negatively impact our investment portfolio. Further, the moratoriums on foreclosures and evictions
described above will likely delay
potential defaults on loans that would otherwise be bought out of Agency MBS pools
as described above.
Depending on the ultimate
resolution of the foreclosure or evictions, when and if it occurs, these loans
may be removed from the pool into which they were
72
securitized. If this were to occur, it would have the effect of delaying a prepayment on the Company’s derivativesecurities until such time. As the
majority of the Company’s Agency RMBS assets were acquired at a premium to par, this will tend to increase the realized
yield on the
asset in question.
Because we base our investment decisions on risk management principles
rather than anticipated movements in interest rates, in
a volatile interest rate environment we may allocate more capital to structured Agency
RMBS with shorter durations. We believe these
securities have a lower sensitivity to changes in long-term interest rates than other
asset classes. We may attempt to mitigate our
exposure to changes in long-term interest rates by investing in IOs and
IIOs, which typically have different sensitivities to changes in
long-term interest rates than PT RMBS, particularly PT RMBS backed by fixed-rate
mortgages.
Effects on our borrowing costs
We leverage our PT RMBS portfolio and a portion of our structured Agency RMBS
with principal balances through the use of short-
term repurchase agreement transactions. The interest rates on our debt
are determined by the short term interest rate markets. 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
The country and economy currently appear to be on the verge of recovering from
the COVID-19 pandemic.
While the virus
continues to infect people and often results in hospitalizations and deaths,
the effect on economic activity has decreased materially.
Coupled with unprecedented monetary and fiscal policy, the most significant combination of the two since the Second World War, the
fading effect of the pandemic is clearly causing the economy to run at unsustainable
levels, resulting in very tight labor markets and the
highest levels of inflation in decades. The Fed has begun the rapid transformation
from accommodation to constraint and will likely
begin raising short-term rates at their meeting in March of 2022.
Currently the market anticipates the Fed will continue to raise rates
throughout the year and into 2023, possibly by as much as 200 basis points.
Further, they are rapidly winding down their asset
purchases and will likely stop asset purchases altogether – possibly by the
end of the year – as they begin the process of “normalizing”
the size of their balance sheet.
Market experts estimate the Fed may have to shrink the size of their balance
sheet by up to $4 trillion,
and over a much shorter time frame than the last time they did so over the
period from 2017 to 2019.
The effect of these developments
on the level of interest rates has been a material flattening of the U.S. Treasury curve, whereby
short and intermediate term rates rise
and more so relative to longer maturity U.S. Treasuries.
For the Company,
this means our funding costs are likely to rise materially over the course
of 2022 and possibly into 2023.
While
longer-term maturities have not risen as much as short and intermediate term rates,
they have risen and refinancing and purchase
activity in the residential housing market is likely to slow. If this occurs, it would slow premium amortization on the Company’s Agency
RMBS securities. The net effect of higher funding costs and slower premium amortization
will depend on the extent and timing of both,
but may reduce the Company’s net interest income, and perhaps meaningfully so, over this period.
To the
extent geo-political events unfold, such as the current crisis in
Ukraine, the Fed may have to alter their monetary policy
decisions over the course of 2022 and beyond.
However, given the level of inflation and strength of the economy at present, such
developments would likely have to be severe in order to meaningfully
impact the path of monetary policy over the near-term.
Critical Accounting Estimates
73
Our 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 policies involve
decisions and assessments which could
significantly affect reported assets, liabilities, revenues and expenses. Management has
identified its most critical accounting
estimates:
Mortgage-Backed Securities
Our investments in Agency RMBS are accounted for at fair value. We acquire our Agency
RMBS for the purpose of generating
long-term returns, and not for the short-term investment of idle capital.
As discussed in Note 12 to the financial statements, our Agency RMBS are valued using
Level 2 valuations, and such valuations
currently are determined by our manager based on independent pricing sources and/or
third party broker quotes, when available.
Because the price estimates may vary, our Manager must make certain judgments and assumptions about the appropriate
price to use
to calculate the fair values. Alternatively, our Manager could opt to have the value of all of our positions in Agency RMBS
determined
by either an independent third-party or do so internally.
In managing our portfolio, Bimini Advisors employs the following four-step process at
each valuation date to determine the fair
value of our Agency RMBS:
•
First, our Manager obtains fair values from subscription-based independent pricing
sources. These prices are used by both
our Manager as well as many of our repurchase agreement counterparty on
a daily basis to establish margin requirements for our
borrowings.
•
Second, our Manager requests non-binding quotes from one to four broker-dealers
for certain Agency RMBS in order to
validate the values obtained by the pricing service. Our Manager requests these
quotes from broker-dealers that actively trade and
make markets in the respective asset class for which the quote is requested.
•
Third, our Manager reviews the values obtained by the pricing source and the broker-dealers
for consistency across similar
assets.
•
Finally, if the data from the pricing services and broker-dealers is not homogenous or if the data obtained is inconsistent with
our Manager’s market observations, our Manager makes a judgment
to determine which price appears the most consistent with
observed prices from similar assets and selects that price. To the extent our Manager believes that none of the prices are consistent
with observed prices for similar assets, which is typically the case for only an
immaterial portion of our portfolio each quarter, our
Manager may use a third price that is consistent with observed prices for
identical or similar assets. In the case of assets that have
quoted prices such as Agency RMBS backed by fixed-rate mortgages, our Manager
generally uses the quoted or observed market
price. For assets such as Agency RMBS backed by ARMs or structured Agency
RMBS, our Manager may determine the price based
on the yield or spread that is identical to an observed transaction or a similar
asset for which a dealer mark or subscription-based price
has been obtained.
Management believes its pricing methodology to be consistent with the
definition of fair value described in Financial Accounting
Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements.
Derivative Financial Instruments
We use derivative instruments to manage interest rate risk, facilitate asset/liability strategies
and manage other exposures, and we
may continue to do so in the future. The principal instruments that we have
used to date are Fed Funds, T-Note and Eurodollar futures
contracts, interest rate swaps, interest rate swaptions and TBA securities,
but we may enter into other derivatives in the future.
74
We account 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.
We have elected not to treat any of our derivative financial instruments as hedges in
order to align the accounting treatment of its
derivative instruments with the treatment of our portfolio assets under the fair
value option election. All derivative instruments are
carried at fair value, and changes in fair value are recorded in earnings for
each period.
Our futures contracts are Level 1 valuations, as
they are exchange-traded instruments and quoted market prices are readily available.
Our interest rate swaps,
interest rate swaptions
and TBA securities are Level 2 valuations. The fair value of interest rate swaps
is determined using a discounted cash flow approach
using forward market interest rates and discount rates, which are observable
inputs. The fair value of interest rate swaptions is
determined using an option pricing model. The fair value of our TBA
securities are determined by the Company based on independent
pricing sources and/or third party broker quotes, similar to how
the fair value of our Agency RMBS is derived, as discussed above.
Income Recognition
Since we commenced operations, we have elected to account for all of our Agency
RMBS under the fair value option.
All of our Agency RMBS are either pass-through securities or structured Agency
RMBS, including CMOs, IOs, IIOs or POs. Income
on pass-through securities, POs and CMOs that contain principal balances is
based on the stated interest rate of the security. As a
result of accounting for our RMBS under the fair value option, premium or
discount present at the date of purchase is not amortized.
For IOs, IIOs and CMOs that do not contain principal balances, 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, current interest rates and current
asset prices. The new effective yield is calculated based
on the carrying value at the end of the previous reporting period, the new prepayment
estimates and the contractual terms of the
security. Changes in fair value of all of our Agency RMBS during the period are recorded in earnings and reported as unrealized
gains
(losses) on mortgage-backed securities in the accompanying statements of operations.
For IIO securities, effective yield and income
recognition calculations also take into account the index value applicable to
the security.
Capital Expenditures
At December 31, 2021,
we had no material commitments for capital expenditures.
Dividends
In addition to other requirements that must be satisfied to continue to qualify as a REIT, we must pay annual dividends to our
stockholders of at least 90% of our REIT taxable income, determined without regard
to the deductions 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
75
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
0.790
53,570
2021
0.780
97,601
2022 YTD
(1)
0.110
19,502
Totals
$
12.545
$
459,066
(1)
On January 13, 2022, the Company declared a dividend of $0.055 per
share to be paid on February 24, 2022. On February 16, 2022, the
Company declared a dividend of $0.055 per share to be paid on March 29,
2022. The dollar amount of the dividend declared in February 2022
is estimated based on the number of shares outstanding at February
25, 2022. The effects of these dividends are included in the table
above
but are not reflected in the Company’s financial statements as of December
31, 2021.
ITEM 7A.
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in market factors such as
interest rates, foreign currency exchange
rates, commodity prices and equity prices. The primary market risks that we
are exposed to are interest rate risk, prepayment risk,
spread risk, liquidity risk, extension risk and counterparty credit risk.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental
monetary and tax policies, domestic and international
economic and political considerations and other factors beyond our control.
Changes in the general level of interest rates can affect our net interest income, which is the
difference between the interest
income earned on interest-earning assets and the interest expense incurred in
connection with our interest-bearing liabilities, by
affecting the spread between our interest-earning assets and interest-bearing liabilities. Changes
in the level of interest rates can also
affect the rate of prepayments of our securities and the value of the RMBS that constitute our
investment portfolio, which affects our net
income, ability to realize gains from the sale of these assets and ability to borrow, and the amount that we can
borrow against, these
securities.
We may utilize a variety of financial instruments in order to limit the effects of changes in interest rates on
our operations. The
principal instruments that we use are futures contracts, interest rate swaps and
swaptions. These instruments are intended to serve as
an economic hedge against future interest rate increases on our repurchase agreement
borrowings.
Hedging techniques are partly
based on assumed levels of prepayments of our Agency RMBS.
If prepayments are slower or faster than assumed, the life of the
Agency RMBS will be longer or shorter, which would reduce the effectiveness of any hedging strategies we may use and
may cause
losses on such transactions.
Hedging strategies involving the use of derivative securities are highly
complex and may produce volatile
returns.
Hedging techniques are also limited by the rules relating to REIT
qualification.
In order to preserve our REIT status, we may
be forced to terminate a hedging transaction at a time when the transaction is
most needed.
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 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
76
underlying mortgage loans tends to shorten the resulting cash flows from
our investments substantially. Prepayments occur for various
reasons, including refinancing of underlying mortgages, loan payoffs in connection with home
sales, and borrowers paying more than
their scheduled loan payments, which accelerates the amortization of the loans.
The duration of our IO and IIO portfolios will vary greatly depending on the
structural features of the securities.
While prepayment
activity will always affect the cash flows associated with the securities, the interest only
nature of IOs may cause their durations to
become extremely negative when prepayments are high, and less negative when prepayments
are low.
Prepayments affect the
durations of IIOs similarly, but the floating rate nature of the coupon of IIOs (which is inversely related to the level of one
month LIBOR)
causes their price movements, and model duration, to be affected by changes in both prepayments
and one month LIBOR, both
current and anticipated levels.
As a result, the duration of IIO securities will also vary greatly.
Prepayments on the loans underlying our RMBS can alter the timing of the cash flows
from the underlying loans to us. As a result,
we gauge the interest rate sensitivity of our assets by measuring their effective duration.
While modified duration measures the price
sensitivity of a bond to movements in interest rates, effective duration captures both the
movement in interest rates and the fact that
cash flows to a mortgage related security are altered when interest rates
move. Accordingly, when the contract interest rate on a
mortgage loan is substantially above prevailing interest rates in the market,
the effective duration of securities collateralized by such
loans can be quite low because of expected prepayments.
We face the risk that the market value of our PT RMBS assets will increase or decrease
at different rates than that of our
structured RMBS or liabilities, including our hedging instruments. Accordingly, we assess our interest rate risk by estimating the
duration of our assets and the duration of our liabilities. We generally calculate duration
using various third party models.
However,
empirical results and various third party models may produce different duration numbers
for the same securities.
The following sensitivity analysis shows the estimated impact on the fair value of
our interest rate-sensitive investments and hedge
positions as of December 31, 2021 and December 31, 2020, assuming rates instantaneously
fall 200 bps, fall 100 bps, fall 50 bps, rise
50 bps, rise 100 bps and rise 200 bps, adjusted to reflect the impact of
convexity, which is the measure of the sensitivity of our hedge
positions and Agency RMBS’ effective duration to movements in interest rates.
We have a negatively convex asset profile and a linear
to slightly positively convex hedge portfolio (short positions).
It is not at all uncommon for us to have losses in both directions.
All changes in value in the table below are measured as percentage changes from
the investment portfolio value and net asset
value at the base interest rate scenario. The base interest rate scenario assumes
interest rates and prepayment projections as of
December 31, 2021 and 2020.
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 our
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 December 31, 2021
-200 Basis Points
(2.01)%
(17.00)%
-100 Basis Points
(0.33)%
(2.76)%
-50 Basis Points
0.19%
1.59%
+50 Basis Points
(0.48)%
(4.04)%
77
+100 Basis Points
(1.64)%
(13.91)%
+200 Basis Points
(4.79)%
(40.64)%
As of December 31, 2020
-200 Basis Points
2.43%
21.85%
-100 Basis Points
1.35%
12.08%
-50 Basis Points
0.69%
6.18%
+50 Basis Points
(0.90)%
(8.03)%
+100 Basis Points
(2.39)%
(21.42)%
+200 Basis Points
(4.95)%
(44.44)%
(1)
Interest rate sensitivity is derived from models that are dependent on
inputs and assumptions provided by third parties as well as by our
Manager, and assumes there are no changes
in mortgage spreads and assumes a static portfolio. Actual results could differ
materially from
these estimates.
(2)
Includes the effect of derivatives and other securities used for hedging
purposes.
(3)
Estimated dollar change in investment portfolio value expressed as a percent
of the total fair value of our investment portfolio as of such date.
(4)
Estimated dollar change in portfolio value expressed as a percent of stockholders' equity as
of such date.
In addition to changes in interest rates, other factors impact the fair value of our
interest rate-sensitive investments, such as the
shape of the yield curve, market expectations as to future interest rate changes
and other market conditions. Accordingly, in the event
of changes in actual interest rates, the change in the fair value of our assets would
likely differ from that shown above and such
difference might be material and adverse to our stockholders.
Prepayment Risk
Because residential borrowers have the option to prepay their mortgage loans at
par at any time, we face the risk that we will
experience a return of principal on our investments faster than anticipated. Various factors affect the rate at which mortgage
prepayments occur, including changes in the level of and directional trends in housing prices, interest rates, general economic
conditions, loan age and size, loan-to-value ratio, the location of the property and
social and demographic conditions. Additionally,
changes to GSE 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 December 31, 2021,
we had unrestricted cash and cash equivalents of $385.1 million and unpledged
securities of approximately $4.7 million (not including
78
unsettled securities purchases or securities pledged to us) available to
meet margin calls on our repurchase agreements and derivative
contracts, and for other corporate purposes. However, should the value of our Agency RMBS pledged as collateral
or the value of our
derivative instruments suddenly decrease, margin calls relating to our repurchase
and derivative agreements could increase, causing
an adverse change in our liquidity position. Further, there is no assurance that we will always be able to renew
(or roll) our repurchase
agreements. In addition, our counterparties have the option to increase our haircuts
(margin requirements) on the assets we pledge
against repurchase agreements, thereby reducing the amount that can be borrowed against
an asset even if they agree to renew or roll
the repurchase agreement. Significantly higher haircuts can reduce our
ability to leverage our portfolio or even force us to sell assets,
especially if correlated with asset price declines or faster prepayment rates on our
assets.
Extension Risk
The projected weighted average life and the duration (or interest rate
sensitivity) of our investments is based on our Manager's
assumptions regarding the rate at which the borrowers will prepay the underlying mortgage
loans. In general, we use futures contracts
and interest rate swaps and swaptions to help manage our funding cost
on our investments in the event that interest rates rise. These
hedging instruments allow us to reduce our funding exposure on the notional amount
of the instrument for a specified period of time.
However, if prepayment rates decrease in a rising interest rate environment, the average life or duration of
our fixed-rate assets or
the fixed-rate portion of the ARMs or other assets generally extends. This could have
a negative impact on our results from operations,
as our hedging instrument expirations are fixed and will, therefore, cover a
smaller percentage of our funding exposure on our
mortgage assets to the extent that their average lives increase due to slower prepayments.
This situation
may
also cause the market
value of our Agency RMBS and CMOs collateralized by fixed rate mortgages
or hybrid ARMs to decline by more than otherwise would
be the case, while most of our hedging instruments would not receive any incremental
offsetting gains. In extreme situations, we may
be forced to sell assets to maintain adequate liquidity, which could cause us to incur realized losses.
Counterparty Credit Risk
We are exposed to counterparty credit risk relating to potential losses that could be recognized
in the event that the counterparties
to our repurchase agreements and derivative contracts fail to perform their obligations
under such agreements. The amount of assets
we pledge as collateral in accordance with our agreements varies over time based
on the market value and notional amount of such
assets as well as the value of our derivative contracts. In the event of a default
by a counterparty, we may not receive payments
provided for under the terms of our agreements and may have difficulty obtaining our assets
pledged as collateral under such
agreements. Our credit risk related to certain derivative transactions is largely
mitigated through daily adjustments to collateral pledged
based on changes in market value, and we limit our counterparties to registered
central clearing exchanges and major financial
institutions with acceptable credit ratings, monitoring positions with individual counterparties
and adjusting collateral posted as required.
However, there is no guarantee our efforts to manage counterparty credit risk will be successful and we could suffer significant losses if
unsuccessful.
79
ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY
DATA
Index to
Financial
Statements
Page
Report of
Independent
Registered
Public Accounting
Firm (
BDO USA, LLP
;
West Palm Beach, FL
; PCAOB ID#
243
)
80
Balance Sheets
82
Statements
of Operations
83
Statements
of Stockholders’
Equity
84
Statements
of Cash Flows
85
Notes to
Financial
Statements
86
80
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
Orchid Island Capital, Inc.
Vero Beach, Florida
Opinion on the Financial Statements
We have audited the accompanying balance sheets of Orchid Island Capital, Inc. (the “Company”)
as of December 31, 2021 and
2020, the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2021, and the related notes (collectively referred to as the “financial
statements”). In our opinion, the financial
statements present fairly, in all material respects, the financial position of the Company at December 31, 2021 and 2020,
and the
results of its operations and its cash flows for each of the three years in the period
ended December 31, 2021
,
in conformity with
accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States)
(“PCAOB”), the Company's internal control over financial reporting as of December
31, 2021, based on criteria established in
Internal
Control – Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
and our report dated February 25, 2022 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management.
Our responsibility is to express an opinion on the
Company’s financial statements based on our audits. We are a public accounting firm registered with
the PCAOB and are required to
be independent with respect to the Company in accordance with the U.S. federal
securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards
require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement, whether due to error or
fraud.
Our audits included performing procedures to assess the risks of material misstatement
of the financial statements, whether due to
error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence
regarding the amounts and disclosures in the financial statements. Our audits
also included evaluating the accounting principles used
and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe
that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current
period audit of the financial statements that was
communicated or required to be communicated to the audit committee and that: (1)
relates to accounts or disclosures that are material
to the financial statements and (2) involved our especially challenging,
subjective, or complex judgments. The communication
of the critical audit matter does not alter in any way our opinion on the financial
statements, taken as a whole, and we are not, by
communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts
or disclosures
to which it relates.
Valuation of Investments in Mortgage-Backed Securities
As described in Notes
1
and
12
to the financial statements, the Company
accounts for its Level 2
mortgage-backed securities at fair
value, which
totaled
$6.5
billion at December 31, 2021.
The fair value of mortgage-backed securities is
based on independent pricing
sources and/or third-party broker
quotes, when available. Because the price estimates may vary, management must make certain
judgments and assumptions about the appropriate price to use to calculate the fair
values based on various techniques including
observing the most recent market for like or identical assets (including
security coupon rate, maturity, yield, prepayment speed), market
credit spreads, and model driven approaches.
81
We identified the valuation of mortgage-backed securities
as
a critical audit matter.
The principal considerations for our determination
are: (i)
the potential for bias in how management subjectively selects the price from
multiple pricing sources to determine the fair value
of the mortgage-backed securities and (ii)
the audit effort involved, including the use of
valuation
professionals with specialized skill and
knowledge.
The primary procedures we performed to address this critical audit matter included:
●
Testing the
design, implementation, and operating
effectiveness of
controls
relating to the valuation of mortgaged-backed
securities, including
controls over
management’s
process to select the price from multiple pricing sources.
●
Reviewing
the
range of values used for each investment position,
and
assessing
the price selected
for management bias
by comparing the price
to the high, low and average of the range of pricing sources.
●
Testing the reasonableness of fair values determined by management by comparing the fair value of certain securities to
recent transactions, if applicable.
●
Utilizing
personnel with specialized knowledge and skill in valuation to develop
an independent estimate of the fair value of
each investment position by considering the stated security coupon rate,
yield, maturity, and prepayment speeds, and
comparing to the fair value used by management.
/s/ BDO USA, LLP
Certified Public Accountants
We have served as the Company's auditor since 2011.
West Palm Beach, Florida
February 25, 2022
82
ORCHID ISLAND CAPITAL, INC.
BALANCE SHEETS
($ in thousands, except per share data)
December 31, 2021
December 31, 2020
ASSETS:
Mortgage-backed securities, at fair value (includes pledged assets
of $
6,506,372
$
6,511,095
$
3,726,895
and $
3,719,906
, respectively)
U.S. Treasury Notes, at fair value (includes pledged assets of
$29,740
and $
0
, respectively)
37,175
0
Cash and cash equivalents
385,143
220,143
Restricted cash
65,299
79,363
Accrued interest receivable
18,859
9,721
Derivative assets
50,786
20,999
Receivable for securities sold, pledged to counterparties
0
414
Other assets
320
516
Total Assets
$
7,068,677
$
4,058,051
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Repurchase agreements
$
6,244,106
$
3,595,586
Dividends payable
11,530
4,970
Derivative liabilities
7,589
33,227
Accrued interest payable
788
1,157
Due to affiliates
1,062
632
Other liabilities
35,505
7,188
Total Liabilities
6,300,580
3,642,760
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $
0.01
par value;
100,000,000
shares authorized; no shares issued
and outstanding as of December 31, 2021 and December 31, 2020
0
0
Common Stock, $
0.01
par value;
500,000,000
shares authorized,
176,993,049
shares issued and outstanding as of December 31, 2021 and
76,073,317
shares issued
and outstanding as of December 31, 2020
1,770
761
Additional paid-in capital
849,081
432,524
Accumulated deficit
(82,754)
(17,994)
Total Stockholders' Equity
768,097
415,291
Total Liabilities
and Stockholders' Equity
$
7,068,677
$
4,058,051
See Notes to Financial Statements
83
ORCHID ISLAND CAPITAL, INC.
STATEMENTS
OF OPERATIONS
For the Years Ended December 31, 2021,
2020 and 2019
($ in thousands, except per share data)
2021
2020
2019
Interest income
$
134,700
$
116,045
$
142,324
Interest expense
(7,090)
(25,056)
(83,666)
Net interest income
127,610
90,989
58,658
Realized losses on mortgage-backed securities
(5,542)
(24,986)
(10,877)
Unrealized (losses) gains on mortgage-backed securities and U.S. Treasury
Notes
(198,454)
25,761
38,045
Gains (losses) on derivative instruments
26,877
(79,092)
(51,176)
Net portfolio (loss) income
(49,509)
12,672
34,650
Expenses:
Management fees
8,156
5,281
5,528
Allocated overhead
1,632
1,514
1,380
Incentive compensation
1,132
38
115
Directors' fees and liability insurance
1,169
998
998
Audit, legal and other professional fees
1,112
1,045
1,105
Direct REIT operating expenses
1,475
1,057
997
Other administrative
575
611
262
Total expenses
15,251
10,544
10,385
Net (loss) income
$
(64,760)
$
2,128
$
24,265
Basic and diluted net (loss) income per share
$
(0.54)
$
0.03
$
0.43
Weighted Average Shares Outstanding
121,144,326
67,210,815
56,328,027
See Notes to Financial Statements
84
ORCHID ISLAND CAPITAL, INC.
STATEMENTS
OF STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2021,
2020 and 2019
(in thousands)
Additional
Retained
Common Stock
Paid-in
Earnings
Shares
Par Value
Capital
(Deficit)
Total
Balances, January 1, 2019
49,132
$
491
$
379,975
$
(44,387)
$
336,079
Net income
-
0
0
24,265
24,265
Cash dividends declared
-
0
(54,421)
0
(54,421)
Issuance of common stock pursuant to public offerings, net
14,377
145
92,169
0
92,314
Stock based awards and amortization
23
0
294
0
294
Shares repurchased and retired
(470)
(5)
(3,019)
0
(3,024)
Balances, December 31, 2019
63,062
631
414,998
(20,122)
395,507
Net income
-
0
0
2,128
2,128
Cash dividends declared
-
0
(53,570)
0
(53,570)
Issuance of common stock pursuant to public offerings, net
13,019
130
70,920
0
71,050
Stock based awards and amortization
12
0
244
0
244
Shares repurchased and retired
(20)
0
(68)
0
(68)
Balances, December 31, 2020
76,073
761
432,524
(17,994)
415,291
Net loss
-
0
0
(64,760)
(64,760)
Cash dividends declared
-
0
(97,601)
0
(97,601)
Issuance of common stock pursuant to public offerings, net
100,828
1,008
513,051
0
514,059
Stock based awards and amortization
92
1
1,107
0
1,108
Balances, December 31, 2021
176,993
$
1,770
$
849,081
$
(82,754)
$
768,097
See Notes to Financial Statements
85
ORCHID ISLAND CAPITAL, INC.
STATEMENTS
OF CASH FLOWS
For the Years Ended December 31, 2021,
2020 and 2019
($ in thousands)
2021
2020
2019
CASH FLOWS FROM OPERATING
ACTIVITIES:
Net (loss) income
$
(64,760)
$
2,128
$
24,265
Adjustments to reconcile net (loss) income to net cash provided by operating
activities:
Stock based compensation
772
244
294
Realized and unrealized losses (gains) on mortgage-backed securities
203,731
(775)
(27,168)
Unrealized losses on U.S. Treasury Notes
265
0
0
Realized and unrealized (gains) losses on derivative instruments
(35,350)
58,891
45,207
Changes in operating assets and liabilities:
Accrued interest receivable
(9,138)
2,683
837
Other assets
196
(446)
80
Accrued interest payable
(369)
(9,944)
4,656
Other liabilities
663
2,583
22
Due to affiliates
430
10
(32)
NET CASH PROVIDED BY OPERATING
ACTIVITIES
96,440
55,374
48,161
CASH FLOWS FROM INVESTING ACTIVITIES:
From mortgage-backed securities investments:
Purchases
(6,430,725)
(4,859,434)
(4,241,822)
Sales
2,851,708
4,200,536
3,321,206
Principal repayments
591,086
523,699
594,833
Purchases of U.S. Treasury Notes
(37,440)
0
0
Net proceeds from reverse repurchase agreements
0
30
0
Net Proceeds from (payments on) on derivative instruments
8,571
(64,171)
(29,023)
NET CASH USED IN INVESTING ACTIVITIES
(3,016,800)
(199,340)
(354,806)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from repurchase agreements
35,950,241
33,140,625
45,595,010
Principal payments on repurchase agreements
(33,301,721)
(32,993,145)
(45,171,956)
Cash dividends
(90,984)
(53,645)
(53,307)
Proceeds from issuance of common stock, net of issuance costs
514,059
71,050
92,314
Common stock repurchases, including shares withheld from employee stock awards
for payment of taxes
(299)
(68)
(3,024)
NET CASH PROVIDED BY FINANCING ACTIVITIES
3,071,296
164,817
459,037
NET INCREASE IN CASH, CASH EQUIVALENTS
AND RESTRICTED CASH
150,936
20,851
152,392
CASH, CASH EQUIVALENTS
AND RESTRICTED CASH, beginning of the period
299,506
278,655
126,263
CASH, CASH EQUIVALENTS
AND RESTRICTED CASH, end of the period
$
450,442
$
299,506
$
278,655
SUPPLEMENTAL DISCLOSURE OF
CASH FLOW INFORMATION:
Cash paid during the period for:
Interest
$
7,458
$
35,000
$
79,010
See Notes to Financial Statements
86
ORCHID ISLAND
CAPITAL, INC.
NOTES TO FINANCIAL
STATEMENTS
DECEMBER
31, 2021
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 $
125,000,000
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
15,123,178
shares under the August 2017 Equity Distribution Agreement for aggregate
gross proceeds of approximately $
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, Orchid entered into an underwriting agreement (the “2019 Underwriting
Agreement”) with Morgan Stanley & Co.
LLC, Citigroup Global Markets Inc. and 2018.J.P. Morgan Securities LLC, as representatives of the underwriters named therein, relating to
the offer and sale of 7,000,000 shares of the Company’s common stock at a price to the public of
$
6.55
per share. The underwriters
purchased the shares pursuant to the 2019 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 the
Company of approximately $
44.2
million after
deduction 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 $
200,000,000
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
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, after commissions and fees, prior to 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 could offer and sell, from time to time, up
to an aggregate amount of $
150,000,000
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
27,493,650
shares under the August 2020 Equity Distribution Agreement for aggregate
gross proceeds of approximately $
150.0
million, and net proceeds of approximately $
147.4
million, after commissions and fees, prior to
its termination in June 2021.
On January 20, 2021, Orchid entered into an underwriting agreement (the “January
2021 Underwriting Agreement”) with J.P.
Morgan Securities LLC (“J.P. Morgan”), relating to the offer and sale of
7,600,000
shares of the Company’s common stock. J.P.
Morgan purchased the shares of the Company’s common stock from the Company pursuant
to the January 2021 Underwriting
Agreement at $
5.20
per share. In addition, the Company granted J.P. Morgan a 30-day option to purchase up to an additional
1,140,000
shares of the Company’s common stock on the same terms and conditions, which
J.P.
Morgan exercised in full on January
21, 2021. The closing of the offering of
8,740,000
shares of the Company’s common stock occurred on January 25, 2021, with
87
proceeds to the Company of approximately $
45.2
million, after deduction of underwriting discounts and commissions and
other
estimated offering expenses.
On March 2, 2021, Orchid entered into an underwriting agreement (the “March 2021 Underwriting
Agreement”) with J.P. Morgan,
relating to the offer and sale of
8,000,000
shares of the Company’s common stock. J.P. Morgan purchased the shares of the
Company’s common stock from the Company pursuant to the March 2021 Underwriting
Agreement at $
5.45
per share. In addition, the
Company granted J.P. Morgan a 30-day option to purchase up to an additional
1,200,000
shares of the Company’s common stock on
the same terms and conditions, which J.P. Morgan exercised in full on March 3, 2021. The closing of the offering of
9,200,000
shares
of the Company’s common stock occurred on March 5, 2021, with proceeds to the Company
of approximately $
50.0
million, after
deduction of underwriting discounts and commissions and other estimated offering expenses.
On June 22, 2021, Orchid entered into an equity distribution agreement (the “June
2021 Equity Distribution Agreement”) with four
sales agents pursuant to which the Company could offer and sell, from time to time, up to
an aggregate amount of $
250,000,000
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
49,407,336
shares under the June 2021 Equity Distribution Agreement for aggregate
gross proceeds of approximately $
250.0
million, and net proceeds of approximately $
246.0
million, after commissions and fees,
prior to
its termination in October 2021.
On October 29, 2021, Orchid entered into an equity distribution agreement (the
“October 2021 Equity Distribution Agreement”) with
four sales agents pursuant to which the Company may offer and sell, from time to time, up
to an aggregate amount of $
250,000,000
of
shares of the Company’s common stock in transactions that are deemed to be “at the market”
offerings and privately negotiated
transactions.
Through December 31, 2021, the Company issued a total of
15,835,700
shares under the October 2021 Equity
Distribution Agreement for aggregate gross proceeds of approximately $
78.3
million, and net proceeds of approximately $
77.0
million,
after commissions and fees.
Basis of
Presentation
and Use of
Estimates
The accompanying
financial
statements
have been
prepared
in accordance
with accounting
principles
generally
accepted
in the
United States
(“GAAP”).
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 December
31, 2021.
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.
 
88
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)
December 31, 2021
December 31, 2020
2019
2018
Eurodollar futures contracts (short positions)Cash and cash equivalents
$
(8,337)385,143
$
(13,860)220,143
Restricted cash
65,299
79,363
Total cash, cash equivalents
and restricted cash
$
7,170
U.S. Treasury Note futures contracts (short position)
(4,707)
(5,175)
5,507
Fed Funds futures contracts (short positions)
0
177
0
Interest rate swaps
(66,212)
(26,582)
8,609
Receiver swaptions
-
-
105
Payer swaptions (long positions)
98
(1,379)
(1,607)
Payer swaptions (short positions)
(3,070)
0
0
TBA securities (short positions)
(6,719)
(6,264)
4,327
TBA securities (long positions)
9,950
1,907
200
U.S. Treasury securities (short positions)
(95)
0
0
Total450,442
$
(79,092)299,506
$
(51,176)
$
24,311
Credit Risk-Related Contingent Features
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 useCompany
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 derivativesthe counterparty.
The
Company limits
uninsured
balances
to only large,
well-known
banks
and exchange
clearing
members and
believes that
it is not
exposed to
any significant
credit risk
on cash and
cash equivalents
or restricted
cash balances.
Mortgage-Backed
Securities
and U.S.
Treasury Notes
The Company
invests primarily
in mortgage
pass-through
(“PT”) residential
mortgage
backed (“RMBS”)
and collateralized
mortgage
obligations
(“CMOs”)
certificates
issued by
Freddie Mac,
Fannie Mae
or Ginnie
Mae,
interest-only
(“IO”) securities
and inverse
interest-only
(“IIO”) securities
representing interest in or obligations backed by pools of RMBS. We refer to RMBS
and CMOs as PT RMBS.
We refer
to IO and IIO securities as structured RMBS. The Company also invests in U.S. Treasury Notes, primarily to
satisfy collateral
requirements of derivative counterparties. The Company has elected to account
for its investment in RMBS and U.S. Treasury Notes
under the fair value option. Electing the fair value option requires the Company
to record changes in fair value in the statement of
operations, which, in management’s view, more appropriately reflects the results of our operations for a particular reporting period
and
is consistent with the underlying economics and how the portfolio is managed.
The Company
records securities
transactions
on the trade
date. Security
purchases
that have
not settled
as of the
balance sheet
date
are included
in the portfolio
balance with
an offsetting
liability
recorded,
whereas securities
sold that
have not
settled as
of the balance
sheet date
are removed
from the
portfolio
balance with
an offsetting
receivable
recorded.
Fair value
is defined
as the price
that would
be received
to sell the
asset or
paid to transfer
the liability
in an orderly
transaction
between market
participants
at the measurement
date.
The fair
value measurement
assumes
that the
transaction
to sell the
asset or
transfer
the liability
either occurs
in the principal
market for
the asset
or liability, or
in the absence
of a principal
market, occurs
in the most
advantageous
market for
the asset
or liability. Estimated
fair values
for RMBS
are based
on independent
pricing sources
and/or third
party
broker quotes,
when available.
Estimated
fair values
for U.S.
Treasury Notes
are based
on quoted
prices for
identical
assets in
active
markets.
Income on
PT RMBS
securities
and U.S.
Treasury Notes
is based on
the stated
interest
rate of the
security. Premiums
or discounts
present at
the date
of purchase
are not amortized.
Premium lost
and discount
accretion
resulting
from monthly
principal
repayments
are
reflected
in unrealized
gains (losses)
on RMBS
in the statements
of operations.
For IO securities,
the income
is accrued
based on
the
carrying value
and the effective
yield. The
difference
between income
accrued and
the interest
received on
the security
is characterized
as
a return
of investment
and serves
to reduce
the asset’s
carrying
value. At
each reporting
date, the
effective yield
is adjusted
prospectively
for future
reporting
periods
based on
the new estimate
of prepayments
and the contractual
terms of
the security. For
IIO securities,
effective
yield and
income recognition
calculations
also take
into account
the index
value applicable
to the security.
Changes
in fair value
of RMBS
during each
reporting
period are
recorded
in earnings
and reported
as unrealized
gains or
losses on
mortgage-backed
securities
in the accompanying
statements
of operations.
89
Derivative Financial 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 TBA
securities
transactions,
but the Company
may enter
into other
derivative
and other
hedging instruments
in the future.
The Company
accounts for
TBA securities
as derivative
instruments.
Gains and
losses associated
with TBA
securities
transactions
are reported
in gain (loss)
on derivative
instruments
in the accompanying
statements
of operations.
Derivative
and other
hedging instruments
are carried
at fair value,
and changes
in fair value
are recorded
in earnings
for each
period.
The Company’s
derivative
financial
instruments
are not designated
as hedge
accounting
relationships,
but rather
are used as
economic
hedges of
its portfolio
assets and
liabilities.
Gains and
losses on
derivatives,
except those
that result
in cash receipts
or payments,
are
included in
operating
activities
on the statement
of cash flows.
Cash payments
and cash receipts
from settlements
of derivatives,
including
current period
net cash settlements
on interest
rate swaps,
is classified
as an investing
activity
on the statements
of cash flows.
Holding derivatives
 
creates exposure
 
to credit
 
risk relatingrelated
 
to the potential
 
losses thatfor failure
 
could beon the part
of counterparties
and exchanges
to
recognized inhonor their
commitments.
In the event
 
that the counterparties toof default
 
these instruments fail toby a counterparty,
 
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, weCompany
 
may be required to pledge assets
as collateral for our derivatives, whosehave
 
amounts vary over time based ondifficulty recovering
 
the market value, notional amount andits collateral
 
remaining term of theand may not
derivative contract. In
the event of
a default by
a counterparty, we may
not receive payments
 
provided
for under
 
the terms
of the agreement.
The Company’s
derivative
agreements
require it
to post or
receive
collateral
to mitigate
such risk.
In addition,
the Company
uses only
registered
central clearing
exchanges
and well-established
commercial
banks as counterparties,
monitors
positions
with individual
counterparties
and adjusts
posted collateral
as required.
Financial
Instruments
The fair
value of financial
instruments
for which
it is practicable
to estimate
that value
is disclosed,
either in
the body
of the financial
statements
or in the
accompanying
notes. RMBS,
Eurodollar,
Fed Funds
and T-Note futures
contracts,
interest
rate swaps,
interest
rate
swaptions
and TBA
securities
are accounted
for at fair
value in the
balance sheets.
The methods
and assumptions
used to
estimate fair
value for
these instruments
are presented
in Note 12
of the financial
statements.
The estimated
fair value
of cash and
cash equivalents,
restricted
cash, accrued
interest
receivable,
receivable
for securities
sold,
other assets,
due to affiliates,
repurchase
agreements,
payable for
unsettled
securities
purchased,
accrued interest
payable and
other
liabilities
generally
approximates
their carrying
values as
of December
31, 2021
and December
31, 2020
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.
90
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.
Stock-Based
Compensation
The Company
may grant
equity-based
compensation
to non-employee
members of
its board
of directors
and to the
executive
officers
and employees
of the Manager.
Stock-based
awards issued
include Performance
Units, Deferred
Stock Units
and immediately
vested
common stock
awards. Compensation
expense is
measured
and recognized
for all stock-based
payment awards
made to employees
and
non-employee
directors
based on
the fair
value of our
common stock
on the date
of grant.
Compensation
expense is
recognized
over each
award’s respective
service period
using the
graded vesting
attribution
method. We
do not estimate
forfeiture
rates; rather,
we adjust
for
forfeitures
in the periods
in which
they occur.
Income Taxes
Orchid elected and is organized and operated so as to qualify to be taxed as a REIT
under the Code.
REITs are generally not
subject to federal income tax on their REIT taxable income provided that they distribute
to their stockholders all of their REIT taxable
income on an annual basis.
A REIT must distribute at least 90% of its REIT taxable income,
determined without regard to the
deductions for dividends paid and excluding net capital gain, and meet other requirements
of the Code to retain its tax status.
Orchid assesses the likelihood, based on their technical merit, that uncertain tax positions
will be sustained upon examination
based on the facts, circumstances and information available at the end of each period.
All of Orchid’s tax positions are categorized as
highly certain.
There is no accrual for any tax, interest or penalties related to Orchid’s tax position
assessment.
The measurement of
uncertain tax positions is adjusted when new information is available,
or when an event occurs that requires a change.
Recent Accounting
Pronouncements
In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate
Reform on Financial Reporting.”
ASU 2020-04 provides optional expedients and exceptions to GAAP requirements
for modifications
on debt instruments, leases, derivatives, and other contracts, related to the expected
market transition from the London Interbank
Offered Rate (“LIBOR”), and certain other floating rate benchmark indices, or collectively, IBORs, to alternative reference rates. ASU
2020-04 generally considers contract modifications related to reference rate reform to
be an event that does not require contract
remeasurement at the modification date nor a reassessment of a previous accounting
determination. The guidance in ASU 2020-04 is
optional and may be elected over time, through December 31, 2022, as reference
rate reform activities occur. The Company does not
believe the adoption of this ASU will have a material impact on its financial statements.
In January 2021, the FASB issued ASU 2021-01 “Reference Rate Reform (Topic 848).
ASU 2021-01 expands the scope of ASC
848 to include all affected derivatives and give market participants the ability to apply
certain aspects of the contract modification and
91
hedge accounting expedients to derivative contracts affected by the discounting transition. In
addition, ASU 2021-01 adds
implementation guidance to permit a company to apply certain optional expedients
to modifications of interest rate indexes used for
margining, discounting or contract price alignment of certain derivatives as a result
of reference rate reform initiatives and
extends
optional expedients to account for a derivative contract modified as a continuation
of the existing contract and to continue hedge
accounting when certain critical terms of a hedging relationship change to modifications
made as part of the discounting transition. The
guidance in ASU 2021-01 is effective immediately and available generally through December
31, 2022, as reference rate reform
activities occur. The Company does not believe the adoption of this ASU will have a material impact on its financial statements.
NOTE 2.
MORTGAGE-BACKED SECURITIES AND U.S. TREASURY NOTES
The following
table presents
the Company’s
RMBS portfolio
as of December
31, 2021
and December
31, 2020:
(in thousands)
December 31, 2021
December 31, 2020
Pass-Through RMBS Certificates:
Fixed-rate Mortgages
$
6,298,189
$
3,560,746
Fixed-rate CMOs
0
137,453
Total Pass-Through
Certificates
6,298,189
3,698,199
Structured RMBS Certificates:
Interest-Only Securities
210,382
28,696
Inverse Interest-Only Securities
2,524
0
Total Structured
RMBS Certificates
212,906
28,696
Total
$
6,511,095
$
3,726,895
As of December
31, 2021,
the Company
held U.S.
Treasury Notes
with a fair
value of approximately
$37.2 million,
primarily
to satisfy
collateral
requirements
of one of
its derivative
counterparties.
The Company
did not hold
any U.S.
Treasury Notes
as of December
31,
2020.
The following
table is a
summary of
 
our derivative
agreements, and maynet gain
 
have difficulty obtaining(loss) from
 
our assets pledgedthe sale of
mortgage-backed
securities
for the years
ended December
31,
2021, 2020
and 2019.
(in thousands)
2021
2020
2019
Total
Total
Total
Carrying value of RMBS sold
$
2,857,250
$
4,225,522
$
3,332,083
Proceeds from sales of RMBS
2,851,708
4,200,536
3,321,206
Net (loss) gain on sales of RMBS
$
(5,542)
$
(24,986)
$
(10,877)
Gross gain on sales of RMBS
$
7,930
$
8,678
$
2,177
Gross loss on sales of RMBS
(13,472)
(33,664)
(13,054)
Net gain (loss) on sales of RMBS
$
(5,542)
$
(24,986)
$
(10,877)
NOTE 3.
REPURCHASE AGREEMENTS
The Company
pledges certain
of its RMBS
 
as collateral
under repurchase
agreements
with financial
institutions.
Interest
rates are
generally
fixed based
on prevailing
rates corresponding
to the terms
of the borrowings,
and interest
is generally
paid at the
termination
of a
borrowing.
If the fair
value of the
pledged securities
declines,
lenders
will typically
require the
Company to
post additional
collateral
or pay
down borrowings
to re-establish
agreed upon
collateral
requirements,
referred
to as "margin
calls." Similarly,
if the fair
value of
the pledged
securities
increases,
lenders
may release
collateral
back to the
Company. As of
December
31, 2021,
the Company
had met all
margin call
requirements.
92
As of December
31, 2021
and 2020,
the Company’s
repurchase
agreements
had remaining
maturities
as summarized
below:
($ in thousands)
OVERNIGHT
BETWEEN 2
BETWEEN 31
GREATER
(1 DAY OR
AND
AND
THAN
LESS)
30 DAYS
90 DAYS
90 DAYS
TOTAL
December 31, 2021
Fair market value of securities pledged, including
accrued interest receivable
$
0
$
4,624,396
$
1,848,080
$
52,699
$
6,525,175
Repurchase agreement liabilities associated with
these securities
$
0
$
4,403,182
$
1,789,327
$
51,597
$
6,244,106
Net weighted average borrowing rate
-
0.15%
0.13%
0.15%
0.15%
December 31, 2020
Fair market value of securities pledged, including
accrued interest receivable
$
0
$
2,112,969
$
1,560,798
$
55,776
$
3,729,543
Repurchase agreement liabilities associated with
these securities
$
0
$
2,047,897
$
1,494,500
$
53,189
$
3,595,586
Net weighted average borrowing rate
0
0.23%
0.22%
0.30%
0.23%
In addition,
cash pledged
to counterparties
as collateral
for repurchase
agreements
was approximately
$
57.3
million and
$
58.8
million
as of December
31, 2021
and 2020,
respectively.
If, during
the term
of a repurchase
agreement,
a lender
files for
 
our derivatives. Thebankruptcy, 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 December
31, 2021,
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
 
equivalents pledged
(if any),
including
accrued
interest
on such securities)
with all
counterparties
of approximately
$
as collateral for our derivative instruments are included in restricted cash on338.3
million.
The Company
did not
have an amount
at risk with
any individual
counterparty
that was
greater than
10% of the
Company’s equity
at December
31, 2021
and 2020
.
93
NOTE 4. DERIVATIVE AND OTHER HEDGING INSTRUMENTS
The table
below summarizes
fair value
information
about our
 
balance sheets.derivative
and other
hedging instruments
assets and
liabilities
as of
December
31, 2021
and 2020.
(in thousands)
Derivative and Other Hedging Instruments
Balance Sheet Location
December 31, 2021
December 31, 2020
Assets
Interest rate swaps
Derivative assets, at fair value
$
29,293
$
7
Payer swaptions (long positions)
Derivative assets, at fair value
21,493
17,433
TBA securities
Derivative assets, at fair value
0
3,559
Total derivative
assets, at fair value
$
50,786
$
20,999
Liabilities
Interest rate swaps
Derivative liabilities, at fair value
$
2,862
$
24,711
Payer swaptions (short positions)
Derivative liabilities, at fair value
4,423
7,730
TBA securities
Derivative liabilities, at fair value
304
786
Total derivative
liabilities, at fair value
$
7,589
$
33,227
Margin Balances Posted to (from) Counterparties
Futures contracts
Restricted cash
$
8,035
$
489
TBA securities
Restricted cash
0
284
TBA securities
Other liabilities
(856)
(2,520)
Interest rate swaption contracts
Other liabilities
(6,350)
(3,563)
Interest rate swap contracts
Restricted cash
0
19,761
Total margin
balances on derivative contracts
$
829
$
14,451
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 December
31,
2021 and
2020.
($ in thousands)
December 31, 2021
Average
Weighted
Weighted
Contract
Average
Average
Notional
Entry
Effective
Open
Expiration Year
Amount
Rate
Rate
Equity
(1)
U.S. Treasury Note Futures Contracts
(Short Positions)
(2)
March 2022 5-year T-Note futures
(Mar 2022 - Mar 2027 Hedge Period)
$
369,000
1.56%
1.62%
$
1,013
March 2022 10-year Ultra futures
(Mar 2022 - Mar 2032 Hedge Period)
$
220,000
1.22%
1.09%
$
(3,861)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
18
 
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 December
31, 2020 and
2019.
94
($ in thousands)
December 31, 2020
December 31, 2019Average
RepurchaseWeighted
DerivativeWeighted
RepurchaseContract
DerivativeAverage
Assets Pledged to CounterpartiesAverage
AgreementsNotional
AgreementsEntry
TotalEffective
AgreementsOpen
AgreementsExpiration Year
TotalAmount
PT RMBS - fair valueRate
Rate
Equity
(1)
Eurodollar Futures Contracts (Short Positions)
2021
$
3,692,81150,000
1.03%
0.18%
$
0(424)
U.S. Treasury Note Futures Contracts
(Short Position)
(2)
March 2021 5 year T-Note futures
(Mar 2021 - Mar 2026 Hedge Period)
$
3,692,81169,000
0.72%
0.67%
$
3,500,394
$
0
$
3,500,394
Structured RMBS - fair value
27,095
0
27,095
83,960
0
83,960
Accrued interest on pledged securities
9,636
0
9,636
12,367
0
12,367
Restricted cash
58,829
20,534
79,363
65,851
19,034
84,885
Total
$
3,788,371
$
20,534
$
3,808,905
$
3,662,572
$
19,034
$
3,681,606(186)
(1)
Assets PledgedOpen equity represents the cumulative gains (losses) recorded on open
 
futures positions from Counterpartiesinception.
(2)
5-Year T-Note
 
futures contracts were valued at a price of $
120.98
at December 31, 2021 and $
126.16
at December 31, 2020.
The contract
values of the short positions were $
446.4
million and $
87.1
million at December 31, 2021 and December 31, 2020, respectively.
10-Year Ultra
futures contracts were valued at price of $
146.44
at December 31, 2021. The contract value of the short position was $
322.2
million at
December 31, 2021.
Under our
interest
rate swap
agreements,
we typically
pay a fixed
rate and
receive a
floating rate
based on 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 December
31, 2021 and
2020.
($ in thousands)
Average
Net
Fixed
Average
Estimated
Average
Notional
Pay
Receive
Fair
Maturity
Amount
Rate
Rate
Value
(Years)
December 31, 2021
Expiration > 3 to ≤ 5 years
$
955,000
0.64%
0.16%
$
21,788
4.0
Expiration > 5 years
$
400,000
1.16%
0.21%
$
4,643
7.3
$
1,355,000
0.79%
0.18%
$
26,431
5.0
December 31, 2020
Expiration > 1 to ≤ 3 years
$
620,000
1.29%
0.22%
$
(23,760)
3.6
Expiration > 3 to ≤ 5 years
200,000
0.67%
0.23%
(944)
6.4
$
820,000
1.14%
0.23%
$
(24,704)
4.3
The table
 
below summarizes
our assets
pledged to
us from counterparties
under our
repurchase
agreements
and derivative
agreements
as of December
31, 2020 and
2019.
(in thousands)
December 31, 2020
December 31, 2019
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Orchid
Agreements
Agreements
Total
Agreements
Agreements
Total
Cash
$
120
$
6,083
$
6,203
$
1,418
$
0
$
1,418
U.S. Treasury securities - fair value
253
0
253
0
0
0
Total
$
373
$
6,083
$
6,456
$
1,418
$
0
$
1,418
PT 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.
Cash received
as margin is
recognized
in 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
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
subjectrelated to
 
such arrangementsthe Company’s
 
as if the Companyinterest
 
had
presentedrate swaption
 
them on apositions
 
net basis as
ofat December
 
31, 2020 and2021
 
2019.and 2020.
($ in thousands)
Option
Underlying Swap
Weighted
Average
Weighted
Average
Average
Adjustable
Average
Fair
Months to
Notional
Fixed
Rate
Term
Expiration
Cost
Value
Expiration
Amount
Rate
(LIBOR)
(Years)
December 31, 2021
Payer Swaptions (long positions)
≤ 1 year
$
4,000
$
1,575
3.2
400,000
1.66%
3 Month
5.0
> 1 year ≤ 2 years
32,690
19,918
18.4
1,258,500
2.46%
3 Month
14.1
$
36,690
$
21,493
14.7
$
1,658,500
2.27%
3 Month
11.9
Payer Swaptions (short positions)
≤ 1 year
$
(16,185)
$
(4,423)
5.3
$
(1,331,500)
2.29%
3 Month
11.4
December 31, 2020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
19
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
December 31, 2020
Interest rate swaps
$
7
$
0
$
7
$
0
$
0
$
7
Interest rate swaptions
17,433
0
17,433
0
(3,563)
13,870
TBA securities
3,559
0
3,559
0
(2,520)
1,039
$
20,999
$
0
$
20,999
$
0
$
(6,083)
$
14,916
(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
Collateral
Amount
December 31, 2020
Repurchase Agreements
$
3,595,586
$
0
$
3,595,586
$
(3,536,757)
$
(58,829)
$
0
Interest rate swaps
24,711
0
24,711
0
(19,761)
4,950
Interest rate swaptions
7,730
0
7,730
0
0
0
TBA securities
786
0
786
0
(284)
502
$
3,628,813
$
0
$
3,628,813
$
(3,536,757)
$
(78,874)
$
5,452
December 31, 2019
Repurchase Agreements
$
3,448,106
$
0
$
3,448,106
$
(3,382,255)
$
(65,851)
$
0
Interest rate swaps
20,146
0
20,146
0
(17,450)
2,696
TBA securities
512
0
512
0
(246)
266
$
3,468,764
$
0
$
3,468,764
$
(3,382,255)
$
(83,547)
$
2,962
The amounts
disclosed for
collateral
received by
or posted
to the same
counterparty
up to and
not exceeding
the net amount
of the
asset or liability
presented
in the balance
sheets. The
fair value
of the actual
collateral
received by
or posted
to the same
counterparty
typically exceeds
the amounts
presented.
See Note
5 for a discussion
of collateral
posted or
received against
or for repurchase
obligations
and derivative
and other
hedging instruments.
NOTE 7.
CAPITAL STOCK
Common Stock
Issuances
During 2020
and 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
$
6.23
3,170,727
$
19,447
At the Market Offering Program
(3)
Third Quarter
5.15
3,073,326
15,566
 
 
 
 
 
20
95
At the Market Offering ProgramPayer Swaptions (long positions)
(3)
Fourth Quarter
5.41
6,775,187
36,037
13,019,240≤ 1 year
$
71,050
2019
At the Market Offering Program
(3)
First Quarter3,450
$
6.845
1,267,8942.5
500,000
0.95%
3 Month
4.0
> 1 year ≤ 2 years
13,410
17,428
17.4
675,000
1.49%
3 Month
12.8
$
8,503
At the Market Offering Program
(3)
Second Quarter
6.70
4,337,931
28,495
At the Market Offering Program
(3)
Third Quarter
6.37
1,771,301
11,098
Follow-on Offering
(3)
Third Quarter
6.35
7,000,000
44,218
14,377,12616,860
$
92,31417,433
11.0
$
1,175,000
1.26%
3 Month
9.0
Payer Swaptions (short positions)
≤ 1 year
$
(4,660)
$
(7,730)
5.4
$
(507,700)
1.49%
3 Month
12.8
The following table summarizes our contracts to purchase and sell TBA
 
(1)securities as of December 31, 2021 and 2020.
Weighted average price received per share is before deducting($ in thousands)
Notional
the underwriters’ discount, if applicable, and other offering costs.
Net
Amount
Cost
Market
Carrying
Long (Short)
(1)
Basis
(2)
Net proceeds are net of the underwriters’ discount, if applicable, and
other offering costs.Value
(3)
Value
As of (4)
December 31, 2021
30-Year TBA securities:
3.0%
$
(575,000)
$
(595,630)
$
(595,934)
$
(304)
Total
$
(575,000)
$
(595,630)
$
(595,934)
$
(304)
December 31, 2020 the Company had 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.30-Year TBA securities:
2.0%
$
465,000
$
479,531
$
483,090
$
3,559
3.0%
(328,000)
(342,896)
(343,682)
(786)
Total
$
137,000
$
136,635
$
139,408
$
2,773
(1)
Stock Repurchase Program
On July 29, 2015,Notional amount represents the Company’s Board of Directors authorized the repurchase of up to
2,000,000
sharespar value (or principal balance) of the Company’s
common stock. On February 8, 2018, the Board of Directors approved an increaseunderlying
 
inAgency RMBS.
(2)
Cost basis represents the stock repurchase programforward price to be paid (received) for up to an
additional
4,522,822
the underlying
 
sharesAgency RMBS.
(3)
Market value represents the current market value of the Company's common stock. Coupled with the
783,757
TBA securit
 
shares remaining from the original 2,0000,000
share authorization, the increased authorization brought the total authorization to
5,306,579
shares, representing 10%ies (or of the thenunderlying Agency RMBS) as of period-end.
outstanding share count. As part(4)
Net carrying value represents the difference between the market
value and the cost basis of the stock repurchase program, shares may be purchased
in open market transactions, block
purchases, through privately negotiated transactions, or pursuant to any trading
plan that may be adopted in accordance with Rule
10b5-1 of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”).
Open market repurchases will be made in
accordance with Exchange Act Rule 10b-18, which sets certain restrictions on
the method, timing, price and volume of open market
stock repurchases. The timing, manner, price and amount of any repurchases will be determined by the Company in
its discretion and
will be subject to economic and market conditions, stock price, applicable legal requirements
and other factors.
The authorization does
not obligate the Company to acquire any particular amount of common stock
and the program may be suspended or discontinued at
the Company’s discretion without prior notice.
From the inception of the stock repurchase program through December 31, 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 year ended December 31, 2020, the Company repurchased a
total of
19,891
shares at an aggregate cost of
approximately $
0.1
million, including commissions and fees, for a weighted average price of
$
3.42
per share. During the year ended
December 31, 2019, the Company repurchased a total of
469,975
shares at an aggregate cost of approximately $
3.0
million, including
commissions and fees, for a weighted average price of $
6.43
per share. During the year ended December 31, 2018, the Company
repurchased a total of
3,979,402
shares at an aggregate cost of approximately $
26.4
million, including commissions and fees, for a
weighted average price of $
6.64
per share. The remaining authorization under the repurchase programTBA securities as of Decemberperiod-end and
 
31, 2020 is reported
837,311
in derivative assets (liabilities),
 
shares.
at fair value in our balance sheets.
Cash Dividends
Gain (Loss) From Derivative and Other Hedging Instruments, Net
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
$
1.395
$
4,662
2014
2.160
22,643
2015
1.920
38,748
2016
1.680
41,388
2017
1.680
70,717
21
2018
1.070
55,814
2019
0.960
54,421
2020
0.790
53,570
2021 - YTD
(1)
0.130
11,079
Totals
$
11.785
$
353,042
(1)
On January 14, 2021, the Company declared a dividend of $0.065 per
share to be paid on February 24, 2021. On February 10, 2021, the
Company declared a dividend of $0.065 per share to be paid on March
29, 2021. The dollar amount of the dividend declared in February 2021
is estimated based on the number of shares outstanding at February
26, 2021. The effect of these dividends are included in the table above,
but are not reflected in the Company’s financial statements as of December
31, 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 Boardderivative and other hedging instruments on the statements of Directors except that operations for
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
shares of the Company’s common stock that may be issued under the Incentive Plan.
Stock Awards
The Company may in the future issue immediately vested common stock under
the Incentive Plan to certain executive officers and
employees of its Manager. Although no such awards were granted in fiscal years 2020 or 2019, such awards
have previously been
issued.
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,
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
years ended December 31, 2020 and
2019.
($ in thousands, except per share data)
2020
2019
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Unvested, beginning of period
19,021
$
7.78
43,672
$
8.34
22
Forfeited
(1,607)
7.45
0
0
Vested and issued
(12,860)
7.93
(24,651)
8.78
Unvested, end of period
4,554
$
7.45
19,021
$
7.78
Compensation expense during period
$
38
$
115
Unrecognized compensation expense, end of period
$
4
$
42
Intrinsic value, end of period
$
24
$
111
Weighted-average remaining vesting term (in years)
0.4
0.8
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 distributions will be made in the form of 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 years
ended December 31,2021, 2020 and 2019.
($ in thousands, except per share data)
2020
2019
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Outstanding, beginning of period
43,570
$
6.56
12,434
$
7.37
Granted and vested
47,376
4.41
31,136
6.23
Outstanding, end of period
90,946
$
5.44
43,570
$
6.56
Compensation expense during period
$
180
$
180
Intrinsic value, end of period
$
473
$
255
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 December 31, 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
23
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.
REIT taxable
income (loss)
is computed
in accordance
with the Code,
which is different
than the Company’s
financial statement
net
income (loss)
computed in
accordance
with GAAP. 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 hedges for
tax
purposes.
As of December
31, 2020,
we had distributed
all of our
estimated
REIT taxable
income through
fiscal year
2020. Accordingly,
no
income tax
provision was
recorded
for 2020,
2019 and 2018.
NOTE 11.
EARNINGS PER SHARE (EPS)
The Company
had dividend
eligible Performance
Units and
Deferred Stock
Units that
were outstanding
during the
years ended
December 31,
2020, 2019
and 2018.
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 years
ended December
31, 2020,
2019 and 2018.
(in thousands, except per-share information)
2020
2019
2018
Basic and diluted EPS per common share:
Numerator for basic and diluted EPS per share of common stock:
Net income (loss) - Basic and diluted
$
2,128
$
24,265
$
(44,387)
Weighted average shares of common stock:
Shares of common stock outstanding at the balance sheet date
76,073
63,062
49,132
Unvested dividend eligible share based compensation
outstanding at the balance sheet date
96
63
0
Effect of weighting
(8,958)
(6,797)
3,066
Weighted average shares-basic and diluted
67,211
56,328
52,198
Net income (loss) per common share:
Basic and diluted
$
0.03
$
0.43
$
(0.85)
Anti-dilutive incentive shares not included in calculation.
0
0
56
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
24
●
Level 3 valuations,
where the
valuation
is generated
from model-based
techniques
that use significant
assumptions
not
observable
in the market,
but observable
based on Company-specific
data. These
unobservable
assumptions
reflect the
Company’s own
estimates for
assumptions
that market
participants
would use
in pricing
the asset or
liability. Valuation
techniques
typically
include option
pricing models,
discounted
cash flow
models and
similar techniques,
but may also
include the
use of market
prices of assets
or liabilities
that are not
directly comparable
to the subject
asset or liability.
The Company's
RMBS and
TBA securities
are Level
2 valuations,
and such valuations
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 (including
security coupon,
maturity, yield,
and prepayment
speeds),
spread pricing
techniques
to determine
market credit
spreads (option
adjusted spread,
zero volatility
spread, spread
to the U.S.
Treasury
curve or spread
to a benchmark
such as a TBA),
and model driven
approaches
(the discounted
cash flow
method, Black
Scholes and
SABR models
which rely
upon observable
market rates
such as the
term structure
of interest
rates and volatility).
The appropriate
spread
pricing method
used is based
on market
convention.
The pricing
source determines
the spread
of recently
observed trade
activity or
observable
markets for
assets similar
to those being
priced. The
spread is then
adjusted based
on variances
in certain
characteristics
between the
market observation
and the asset
being priced.
Those characteristics
include: type
of asset, the
expected life
of the asset,
the
stability and
predictability
of the expected
future cash
flows of the
asset, whether
the coupon
of the asset
is fixed or
adjustable,
the
guarantor
of the security
if applicable,
the coupon,
the maturity, the
issuer, size of
the underlying
loans, year
in which the
underlying
loans
were originated,
loan to value
ratio, state
in which the
underlying
loans reside,
credit score
of the underlying
borrowers
and other
variables
if appropriate.
The fair value
of the security
is determined
by using the
adjusted spread.
The Company’s
futures contracts
are Level
1 valuations,
as they are
exchange-traded
instruments
and quoted
market prices
are
readily available.
Futures contracts
are settled
daily. The Company’s
interest rate
swaps and
interest rate
swaptions
are Level 2
valuations.
The fair value
of interest
rate swaps
is determined
using a discounted
cash flow
approach
using forward
market interest
rates
and discount
rates, which
are observable
inputs. The
fair value
of interest
rate swaptions
is determined
using an option
pricing model.
RMBS (based
on the fair
value option),
derivatives
and TBA securities
were recorded
at fair value
on a recurring
basis during
the
years ended
December 31,
2020, 2019
and 2018.
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
December 31,
2020 and
2019.
Derivative
contracts are
reported as
a net position
by contract
type, and
not based
on master
netting arrangements.
(in thousands)
Quoted Prices2021
in Active
Significant
Markets for
Other
Significant
Identical
Observable
Unobservable
Assets
Inputs
Inputs
(Level 1)
(Level 2)
(Level 3)
December 31, 2020
Mortgage-backed securities2019
Eurodollar futures contracts (short positions)
$
0(10)
$
3,726,895(8,337)
$
(13,860)
U.S. Treasury Note futures contracts (short position)
(846)
(4,707)
(5,175)
Fed Funds futures contracts (short positions)
0
0
177
Interest rate swaps
23,613
(66,212)
(26,582)
Payer swaptions (long positions)
(2,580)
98
(1,379)
Payer swaptions (short positions)
9,062
(3,070)
0
Interest rate swapsfloors
2,765
0
(24,704)
0
Interest rate swaptions
0
9,703
0
TBA securities (short positions)
3,432
(6,719)
(6,264)
TBA securities (long positions)
(8,559)
9,950
1,907
U.S. Treasury securities (short positions)
0
2,773(95)
0
December 31, 2019
Mortgage-backed securitiesTotal
$
026,877
$
3,590,921(79,092)
$
0
(51,176)
Credit Risk-Related Contingent Features
The
 
use
 
of
 
derivatives
 
and
 
other
 
hedging
 
instruments
 
creates
 
exposure
 
25
Interest rate swaps
0
(20,146)
0
TBA securities
0
(512)
0
During the years ended December 31, 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 the “Manager” pursuant to
 
the terms of a management agreement. The
management agreement has been renewed through
February 20, 2022
credit
 
and provides for automatic
one-year
risk
 
extension options
thereafter and is subject to certain termination rights.relating
 
Under the terms of the management agreement, the Manager is responsible for
administering the business activities and day-to-day operations of the Company.to
 
The Manager receives a monthly management fee in
the amount of:
potential
 
●
losses
 
that
One-twelfth of 1.5% of the first $250 million of the Company’s month-end equity, as defined
could
be
recognized in the management agreement,
●
event
 
One-twelfth of 1.25% ofthat the Company’s month-end equity that is greater than $250 millioncounterparties to these
 
and less than or equalinstruments fail to $500
million, and
●
perform their
 
One-twelfth of 1.00% ofobligations under the Company’s month-end equity that is greater than $500contracts. We
 
million.attempt to
minimize this risk
 
The Company is obligated to reimburse the Manager for any direct expenses incurredby limiting
 
on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management agreement.our counterparties
 
Should the Company terminate the
management agreement without cause, it will pay the Manager a terminationfor instruments which
 
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 ofare not centrally
 
the agreement.
cleared on a
 
Totalregistered exchange
 
expenses recorded for the management fee and costs incurred were approximately
$
6.8
million, $
6.9
million and $
7.8
million for the years ended December 31, 2020, 2019 and 2018, respectively.
Other Relationships with Bimini
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, 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 December
31, 2020, Bimini
owned
2,595,357
shares, or
3.4
%, of the Company’s common stock.
NOTE 14.
QUARTERLY RESULTS
(UNAUDITED)
The following
is a presentation
of the quarterly
results of
operations for
the years ended
December 31,
2020 and 2019.
(in thousands, except per share information)
Quarter Ended
March 31, 2020
June 30, 2020
September 30, 2020
December 31, 2020
Interest income
$
35,671
$
27,258
$
27,223
$
25,893
Interest expense
(16,523)
(4,479)
(2,043)
(2,011)
Net interest income
19,148
22,779
25,180
23,882
Losses (gains)
(108,206)
28,749
5,745
(4,605)
Net portfolio income (loss)
(89,058)
51,528
30,925
19,277
to major financial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
96
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 December
31, 2021
and 2020.
(in thousands)
December 31, 2021
December 31, 2020
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Counterparties
Agreements
Agreements
Total
Agreements
Agreements
Total
PT RMBS - fair value
$
6,294,102
$
0
$
6,294,102
$
3,692,811
$
0
$
3,692,811
Structured RMBS - fair value
212,270
0
212,270
27,095
0
27,095
U.S. Treasury Notes
0
29,740
29,740
-
-
-
Accrued interest on pledged securities
18,804
13
18,817
9,636
0
9,636
Restricted cash
57,264
8,035
65,299
58,829
20,534
79,363
Total
$
6,582,440
$
37,788
$
6,620,228
$
3,788,371
$
20,534
$
3,808,905
Assets Pledged
from Counterparties
The table
below summarizes
assets pledged
to us from
counterparties
under our
repurchase
agreements
and derivative
agreements
as of December
31, 2021
and 2020.
(in thousands)
December 31, 2021
December 31, 2020
Repurchase
Derivative
Repurchase
Derivative
Assets Pledged to Orchid
Agreements
Agreements
Total
Agreements
Agreements
Total
Cash
$
4,339
$
7,206
$
11,545
$
120
$
6,083
$
6,203
U.S. Treasury securities - fair value
0
0
0
253
0
253
Total
$
4,339
$
7,206
$
11,545
$
373
$
6,083
$
6,456
PT 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.
Cash received
as margin
is recognized
in 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
are subject
to underlying
agreements
with master
netting or
 
 
 
 
 
 
 
 
 
 
 
 
26
Expenses:
Management fees and overhead expenses
1,724
1,616
1,629
1,826
Other expenses
417
1,140
1,220
972
Total expenses
2,141
2,756
2,849
2,798
Net income (loss)
$
(91,199)
$
48,772
$
28,076
$
16,479
Basic net (loss) income per share
$
(1.41)
$
0.74
$
0.42
$
0.23
Diluted net (loss) income per share
$
(1.41)
$
0.73
$
0.42
$
0.23
Weighted Average Shares Outstanding
64,590
66,310
67,302
70,497
Dividends declared per share
$
0.240
$
0.165
$
0.190
$
0.195
Quarter Ended
March 31, 2019
June 30, 2019
September 30, 2019
December 31, 2019
Interest income
$
32,433
$
36,455
$
35,907
$
37,529
Interest expense
(18,892)
(22,431)
(22,321)
(20,022)
Net interest income
13,541
14,024
13,586
17,507
Losses
(748)
(7,670)
(19,431)
3,841
Net portfolio income (loss)
12,793
6,354
(5,845)
21,348
Expenses:
Management fees and overhead expenses
1,608
1,653
1,791
1,856
Other expenses
588
1,168
841
880
Total expenses
2,196
2,821
2,632
2,736
Net income (loss)
$
10,597
$
3,533
$
(8,477)
$
18,612
Basic and diluted net income (loss) per share
$
0.22
$
0.07
$
(0.14)
$
0.29
Weighted Average Shares Outstanding
48,905
52,601
60,419
63,124
Dividends declared per share
$
0.24
$
0.24
$
0.24
$
0.24
Earnings per share (EPS) in each quarter is computed using the weighted-average number of shares outstanding
during that quarter while EPS for the full year is computed using the weighted-average number of shares outstanding during
the year.
The sum of the four quarters’ EPS may not equal the full year EPS.
 
 
NOTE 15. SUBSEQUENT EVENTS
 
January 2021 Stock Offering
 
On January 20, 2021, Orchid entered into an underwriting agreement (the “2021
 
Underwriting Agreement”) with J.P. Morgan
Securities LLC (the “Underwriter”), relating
97
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 offer
transactions.
The Company
reports
its assets
and sale ofliabilities
subject to
7,600,000
these arrangements
on a gross
basis.
The following
 
sharestable presents
information
regarding
those assets
and liabilities
subject to
such arrangements
as if the
Company had
presented
them on a
net basis
as of the Company’s common stock. The UnderwriterDecember
purchased the shares of the Company’s common stock from the Company pursuant to the31, 2021
 
Underwriting Agreement at $
5.20
per
share. In addition, the Company granted the Underwriter a 30-day option to
purchase up to an additional
1,140,000
shares of the
Company’s common stock on the same terms and conditions, which the Underwriter exercised
in full on January 21, 2021. The closing
of the offering of
8,740,000
shares of the Company’s common stock occurred on January 25, 2021, with net proceeds
to the Company
of approximately $
45.3
million after deduction of estimated offering expenses payable by the Company.
2020.
(in thousands)
27Offsetting 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
December 31, 2021
Interest rate swaps
$
29,293
$
0
$
29,293
$
0
$
0
$
29,293
Interest rate swaptions
21,493
0
21,493
0
(6,350)
15,143
$
50,786
$
0
$
50,786
$
0
$
(6,350)
$
44,436
December 31, 2020
Interest rate swaps
$
7
$
0
$
7
$
0
$
0
$
7
Interest rate swaptions
17,433
0
17,433
0
(3,563)
13,870
TBA securities
3,559
0
3,559
0
(2,520)
1,039
$
20,999
$
0
$
20,999
$
0
$
(6,083)
$
14,916
COVID-19 and CARES Act Update
(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
Collateral
Amount
December 31, 2021
Repurchase Agreements
$
6,244,106
$
0
$
6,244,106
$
(6,186,842)
$
(57,264)
$
0
Interest rate swaps
2,862
0
2,862
(2,862)
0
0
Interest rate swaptions
4,423
0
4,423
0
0
4,423
TBA securities
304
0
304
0
0
304
$
6,251,695
$
0
$
6,251,695
$
(6,189,704)
$
(57,264)
$
4,727
December 31, 2020
Repurchase Agreements
$
3,595,586
$
0
$
3,595,586
$
(3,536,757)
$
(58,829)
$
0
Interest rate swaps
24,711
0
24,711
0
(19,761)
4,950
Interest rate swaptions
7,730
0
7,730
0
0
7,730
TBA securities
786
0
786
0
(284)
502
$
3,628,813
$
0
$
3,628,813
$
(3,536,757)
$
(78,874)
$
13,182
The amounts
 
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. On January 29, 2021, the CDC issued guidance extending
eviction moratoriums for covered persons through
March 31, 2021. In addition, on February 9, 2021, the FHFA announced that the foreclosure moratorium begun under the
CARES Act
for loans backed by Fannie Mae and Freddie Mac and the eviction moratoriumdisclosed
 
for real estate ownedcollateral
received by Fannie Mae
or posted
to the same
counterparty
up to and Freddie Mac
not exceeding
the net amount
of the
were extended until March 31, 2021. On February 16, 2021,asset or
liability
presented
in the U.S. Housingbalance
sheets. The
fair value
of the actual
collateral
received
by or posted
to the same
counterparty
typically
exceeds the
amounts
presented.
See Note
5 for a discussion
of collateral
posted or
received
against or
for repurchase
obligations
and derivative
 
and Urban Development Department announced the
extension of the FHA eviction and foreclosure moratorium to June 30, 2021. The moratoriumsother
 
on foreclosures and evictions will likely
delay potential defaults on loans that would otherwise be bought out of Agency MBS pools.hedging
 
Depending on the ultimate resolution of the
foreclosure or evictions, when and if it occurs, these loans may be removed from
the pool into which they were securitized. If this were
to occur, it would have the effect of delaying a prepayment on the Company’s securities until such time. As the majority of the
Company’s Agency RMBS assets were acquired at a premium to par, this will tend to increase the realized yield on the asset in
question.instruments.
NOTE 7.
CAPITAL STOCK
Common Stock
Issuances
 
 
 
 
28
 
98
During 2021
and 2020,
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)
2021
At the Market Offering Program
(3)
First Quarter
$
5.10
308,048
$
1,572
Follow-on Offerings
First Quarter
5.31
17,940,000
95,336
At the Market Offering Program
(3)
Second Quarter
5.40
23,087,089
124,746
At the Market Offering Program
(3)
Third Quarter
4.94
35,818,338
177,007
At the Market Offering Program
(3)
Fourth Quarter
4.87
23,674,698
115,398
100,828,173
$
514,059
2020
At the Market Offering Program
(3)
First Quarter
$
6.23
3,170,727
$
19,447
At the Market Offering Program
(3)
Second Quarter
0
0
0
At the Market Offering Program
(3)
Third Quarter
5.15
3,073,326
15,566
At the Market Offering Program
(3)
Fourth Quarter
5.41
6,775,187
36,037
13,019,240
$
71,050
(1)
Weighted average price received per share is after deducting the underwriters’
discount, if applicable, and other offering costs.
(2)
Net proceeds are net of the underwriters’ discount, if applicable, and other
offering costs.
(3)
As of December 31, 2021, the Company had entered into ten equity distribution agreements,
nine of which have either been terminated
because all shares were sold or were replaced with a subsequent agreement.
Stock Repurchase Program
On July 29, 2015, the Company’s Board of Directors authorized the repurchase of up to
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. Coupled with the
783,757
shares remaining from the original 2,0000,000
share authorization, the increased authorization brought the total authorization
to
5,306,579
shares, representing 10% of the then
outstanding share count. On December 9, 2021, the Board of Directors approved an
increase in the number of shares of the
Company’s common stock available in the stock repurchase program for up to an additional
16,861,994
shares, bringing the remaining
authorization under the stock repurchase program to
17,699,305
shares, representing approximately 10% of the Company’s then
outstanding shares of common stock. As part of the stock repurchase program,
shares may be purchased in open market transactions,
block purchases, through privately negotiated transactions, or pursuant to any trading
plan that may be adopted in accordance with
Rule 10b5-1 of the Securities Exchange Act of 1934, as amended (the
“Exchange Act”).
Open market repurchases will be made in
accordance with Exchange Act Rule 10b-18, which sets certain restrictions
on the method, timing, price and volume of open market
stock repurchases. The timing, manner, price and amount of any repurchases will be determined by the Company
in its discretion and
will be subject to economic and market conditions, stock price, applicable legal requirements
and other factors.
The authorization does
not obligate the Company to acquire any particular amount of common stock
and the program may be suspended or discontinued at
the Company’s discretion without prior notice.
From the inception of the stock repurchase program through December 31, 2021, 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. The Company did not repurchase any of its common stock during the
year ended December 31, 2021. During the year ended
December 31, 2020, the Company repurchased a total of
19,891
shares at an aggregate cost of approximately $
0.1
million, including
commissions and fees, for a weighted average price of $
3.42
per share. During the year ended December 31, 2019, the Company
99
repurchased a total of
469,975
shares at an aggregate cost of approximately $
3.0
million, including commissions and fees, for a
weighted average price of $
6.43
per share. The remaining authorization under the stock repurchase program
as of December 31, 2021
is
17,699,305
shares.
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
$
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
0.790
53,570
2021
0.780
97,601
2022 - YTD
(1)
0.110
19,502
Totals
$
12.545
$
459,066
(1)
On January 13, 2022, the Company declared a dividend of $0.055 per
share to be paid on February 24, 2022. On February 16, 2022, the
Company declared a dividend of $0.055 per share to be paid on March 29,
2022. The dollar amount of the dividend declared in February 2022
is estimated based on the number of shares outstanding at February
25, 2022. The effect of these dividends are included in the table above,
but are not reflected in the Company’s financial statements as of December
31, 2021.
NOTE 8.
STOCK INCENTIVE PLAN
In 2021, the Company’s Board of Directors adopted, and the stockholders approved, the
Orchid Island Capital, Inc. 2021 Equity
Incentive Plan (the “2021 Incentive Plan”) to replace the Orchid Island Capital,
Inc. 2012 Equity Incentive Plan (the “2012 Incentive
Plan” and together with the 2021 Incentive Plan, the “Incentive Plans”). The 2021 Incentive
Plan provides for the award of stock
options, stock appreciation rights, stock award, performance units, other equity-based
awards (and dividend equivalents with respect to
awards of performance units and other equity-based awards) and incentive
awards.
The 2021 Incentive Plan is administered by the
Compensation Committee of the Company’s Board of Directors except that the Company’s full Board
of Directors will administer
awards made to directors who are not employees of the Company or its affiliates. The
2021 Incentive Plan provides for awards of up to
an aggregate of
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
7,366,623
shares of the Company’s common stock that may be issued under the 2021 Incentive Plan.
The 2021 Incentive Plan replaces the 2012 Incentive Plan, and no further
grants will be made under the 2012 Incentive Plan.
However, any outstanding awards under the 2012 Incentive Plan will continue in accordance with the terms of the
2012 Incentive Plan
and any award agreement executed in connection with such outstanding awards.
Performance Units
The Company has issued, and may in the future issue additional performance units
under the Incentive Plan to certain executive
officers and employees of its Manager.
“Performance Units” vest after the end of a defined performance period,
based on satisfaction
of the performance conditions set forth in the performance unit agreement.
When earned, each Performance Unit will be settled by the
issuance of one share of the Company’s common stock, at which time the Performance
Unit will be cancelled.
The Performance Units
contain dividend equivalent rights, which entitle the Participants to receive distributions
declared by the Company on common stock,
100
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,
included in incentive compensation on the statements of operations, is recognized
over the remaining vesting period once it becomes
probable that the performance conditions will be achieved.
The following table presents information related to Performance Units outstanding during
the years ended December 31, 2021 and
2020.
($ in thousands, except per share data)
2021
2020
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Unvested, beginning of period
4,554
$
7.45
19,021
$
7.78
Granted
137,897
5.88
0
0
Forfeited
(4,674)
5.88
(1,607)
7.45
Vested and issued
(4,554)
7.45
(12,860)
7.93
Unvested, end of period
133,223
$
5.88
4,554
$
7.45
Compensation expense during period
$
321
$
38
Unrecognized compensation expense, end of period
$
467
$
4
Intrinsic value, end of period
$
599
$
24
Weighted-average remaining vesting term (in years)
1.4
0.8
The number of shares of common stock issuable upon the vesting of the remaining
outstanding Performance Units was reduced in
2020 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%.
Stock Awards
The Company has issued, and may in the future issue additional, immediately vested
common stock under the Incentive Plans to
certain executive officers and employees of its Manager. Compensation expense for the stock awards is based on the fair
value of the
Company’s common stock on the grant date and is included in incentive compensation
in the statements of operations. The following
table presents information related to fully vested common stock issued during
the years ended December 31, 2021 and 2020. All of the
fully vested shares of common stock issued during the year ended December 31,
2021, and the related compensation expense, were
granted with respect to service performed during the previous fiscal year.
($ in thousands, except per share data)
2021
2020
Fully vested shares granted
137,897
0
Weighted average grant date price per share
$
5.88
$
0
Compensation expense related to fully vested shares of common stock awards
(1)
$
811
$
0
(1)
The awards issued during the year ended December 31, 2021 were granted
with respect to service performed in 2020. Approximately $600,000
of compensation expense related to the 2021 awards was accrued and recognized
in 2020.
Deferred Stock Units
101
Non-employee directors receive a portion of their compensation in the
form of deferred stock unit awards (“DSUs”) pursuant to the
Incentive Plans.
Each DSU represents a right to receive one share of the Company’s
common stock. The DSUs are immediately
vested and are settled at a future date based on the election of the individual participant.
Compensation expense for the DSUs is
included in directors’ fees and liability insurance in the statements of operations. The DSUs
contain dividend equivalent rights, which
entitle the participant to receive distributions declared by the Company on common
stock.
These distributions will be made in the form
of cash or additional DSUs at the participant’s election. The DSUs do not include the right
to vote the underlying shares of common
stock.
The following table presents information related to the DSUs outstanding during
the years ended December 31, 2021 and 2020.
($ in thousands, except per share data)
2021
2020
Weighted
Weighted
Average
Average
Grant Date
Grant Date
Shares
Fair Value
Shares
Fair Value
Outstanding, beginning of period
90,946
$
5.44
43,570
$
6.56
Granted and vested
52,030
5.29
47,376
4.41
Outstanding, end of period
142,976
$
5.38
90,946
$
5.44
Compensation expense during period
$
240
$
180
Intrinsic value, end of period
$
643
$
473
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 December 31, 2021.
NOTE 10.
INCOME TAXES
The Company
will generally
not be subject
to U.S. federal
income tax
on its REIT
taxable income
to the extent
that it distributes
its
REIT taxable
income to
its stockholders
and satisfies
the ongoing
REIT requirements,
including
meeting certain
asset, income
and stock
ownership
tests.
A REIT must
generally
distribute
at least 90%
of its REIT
taxable income,
determined
without regard
to the deductions
for
dividends
paid and
excluding
net capital
gain,
to its stockholders,
annually to
maintain REIT
status.
An amount
equal to
the sum of
85% of
its REIT
ordinary
income and
95% of its
REIT capital
gain net
income, plus
certain undistributed
income from
prior taxable
years, must
be
distributed
within the
taxable year
in order
to avoid the
imposition
of an excise
tax.
The remaining
balance may
be distributed
up to the
end of the
following
taxable year,
provided
the REIT
elects to treat
such amount
as a prior
year distribution
and meets
certain other
requirements.
REIT taxable
income (loss)
is computed
in accordance
with the
Code, which
is different
than the Company’s
financial
statement
net
income (loss)
computed in
accordance
with GAAP. 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
hedges for
tax
purposes.
As of December
31, 2021,
we had distributed
all of our
estimated
REIT taxable
income through
fiscal year
2021. Accordingly,
no
income tax
provision
was recorded
for 2021,
2020 and
2019.
NOTE 11.
EARNINGS PER SHARE (EPS)
102
The Company
had dividend
eligible
Performance
Units and
Deferred
Stock Units
that were
outstanding
during the
years ended
December
31, 2021,
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 years
ended December
31, 2021,
2020 and
2019.
(in thousands, except per-share information)
2021
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
$
(64,760)
$
2,128
$
24,265
Weighted average shares of common stock:
Shares of common stock outstanding at the balance sheet date
176,993
76,073
63,062
Unvested dividend eligible share based compensation
outstanding at the balance sheet date
0
96
63
Effect of weighting
(55,849)
(8,958)
(6,797)
Weighted average shares-basic and diluted
121,144
67,211
56,328
Net (loss) income per common share:
Basic and diluted
$
(0.54)
$
0.03
$
0.43
Anti-dilutive incentive shares not included in calculation.
281
0
0
NOTE 12.
FAIR VALUE
The framework
for using
fair value
to measure
assets and
liabilities
defines fair
value as the
price that
would be
received to
sell an
asset or
paid to transfer
a liability
(an exit
price). A
fair value
measure should
reflect the
assumptions
that market
participants
would use
in
pricing the
asset or
liability, including
the assumptions
about the
risk inherent
in a particular
valuation
technique,
the effect
of a restriction
on the sale
or use of
an asset and
the risk of
non-performance.
Required
disclosures
include stratification
of balance
sheet amounts
measured
at fair value
based on
inputs the
Company uses
to derive
fair value
measurements.
These stratifications
are:
●
Level 1 valuations,
where the
valuation
is based on
quoted market
prices for
identical
assets or
liabilities
traded in
active markets
(which include
exchanges
and over-the-counter
markets with
sufficient
volume),
●
Level 2 valuations,
where the
valuation
is based on
quoted market
prices for
similar instruments
traded in
active markets,
quoted
prices for
identical
or similar
instruments
in markets
that are
not active
and model-based
valuation
techniques
for which
all
significant
assumptions
are
observable
in the market,
and
●
Level 3 valuations,
where the
valuation
is generated
from model-based
techniques
that use
significant
assumptions
not
observable
in the market,
but observable
based on
Company-specific
data. These
unobservable
assumptions
reflect the
Company’s own
estimates
for assumptions
that market
participants
would use
in pricing
the asset
or liability. Valuation
techniques
typically
include option
pricing models,
discounted
cash flow
models and
similar techniques,
but may also
include
the
use of market
prices of
assets or
liabilities
that are
not directly
comparable
to the subject
asset or
liability.
The Company's
RMBS and
TBA securities
are Level
2 valuations,
and such valuations
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 (including
security
coupon,
maturity, yield,
and prepayment
speeds),
spread pricing
techniques
to determine
market credit
spreads (option
adjusted spread,
zero volatility
spread, spread
to the U.S.
Treasury
curve or
spread to
a benchmark
such as a
TBA), and
model driven
approaches
(the discounted
cash flow
method, Black
Scholes and
103
SABR models
which rely
upon observable
market rates
such as the
term structure
of interest
rates and
volatility).
The appropriate
spread
pricing method
used is based
on market
convention.
The pricing
source determines
the spread
of recently
observed trade
activity
or
observable
markets for
assets similar
to those
being priced.
The spread
is then adjusted
based on
variances
in certain
characteristics
between the
market observation
and the asset
being priced.
Those characteristics
include:
type of
asset, the
expected life
of the asset,
the
stability
and predictability
of the expected
future cash
flows of
the asset,
whether
the coupon
of the asset
is fixed or
adjustable,
the
guarantor
of the security
if applicable,
the coupon,
the maturity,
the issuer, size
of the underlying
loans, year
in which
the underlying
loans
were originated,
loan to value
ratio, state
in which
the underlying
loans reside,
credit score
of the underlying
borrowers
and other
variables
if appropriate.
The fair
value of the
security is
determined
by using
the adjusted
spread.
The Company’s
U.S. Treasury
Notes are
based on
quoted prices
for identical
instruments
in active
markets and
are classified
as
Level 1 assets.
The Company’s
futures contracts
are Level
1 valuations,
as they are
exchange-traded
instruments
and quoted
market prices
are
readily available.
Futures contracts
are settled
daily. The Company’s
interest
rate swaps
and interest
rate swaptions
are Level
2
valuations.
The fair
value of interest
rate swaps
is determined
using a discounted
cash flow
approach
using forward
market interest
rates
and discount
rates, which
are observable
inputs. The
fair value
of interest
rate swaptions
is determined
using an option
pricing model.
RMBS (based
on the fair
value option),
derivatives
and TBA
securities
were recorded
at fair value
on a recurring
basis during
the
years ended
December
31, 2021,
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
December
31, 2021
and
2020.
Derivative
contracts
are reported
as a net
position by
contract
type, and
not based
on master
netting arrangements.
(in thousands)
Quoted Prices
in Active
Significant
Markets for
Other
Significant
Identical
Observable
Unobservable
Assets
Inputs
Inputs
(Level 1)
(Level 2)
(Level 3)
December 31, 2021
Mortgage-backed securities
$
0
$
6,511,095
$
0
U.S. Treasury Notes
37,175
0
0
Interest rate swaps
0
26,431
0
Interest rate swaptions
0
17,070
0
TBA securities
0
(304)
0
December 31, 2020
Mortgage-backed securities
$
0
$
3,726,895
$
0
Interest rate swaps
0
(24,704)
0
Interest rate swaptions
0
9,703
0
TBA securities
0
2,773
0
During the years ended December 31, 2021 and 2020, there were no transfers of financial
assets or liabilities between levels 1, 2
or 3.
NOTE 13. RELATED PARTY TRANSACTIONS
104
Management Agreement
The Company is externally managed and advised by the “Manager” pursuant to
the terms of a management agreement. The
management agreement has been renewed through
February 20, 2023
and provides for automatic
one-year
extension options
thereafter and is subject to certain termination rights.
Under the terms of the management agreement, the Manager is responsible
for
administering the business activities and day-to-day operations of the
Company.
The Manager receives a monthly management fee in
the amount of:
●
One-twelfth of 1.5% of the first $250 million of the Company’s month-end equity, as defined in the management agreement,
●
One-twelfth of 1.25% of the Company’s month-end equity that is greater than $250
million and less than or equal to $500
million, and
●
One-twelfth of 1.00% of the Company’s month-end equity that is greater than $500
million.
The Company is obligated to reimburse the Manager for any direct expenses
incurred on its behalf and to pay the Manager the
Company’s pro rata portion of certain overhead costs set forth in the management agreement.
Should the Company terminate the
management agreement without cause, it will pay the Manager a termination
fee equal to three times the average annual management
fee, as defined in the management agreement, before or on the last day of the term of
the agreement.
Total
expenses recorded for the management fee and allocated overhead incurred
were approximately $
9.8
million, $
6.8
million
and $
6.9
million for the years ended December 31, 2021, 2020 and 2019, respectively.
Other Relationships with Bimini
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, 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 December
31, 2021, Bimini
owned
2,595,357
shares, or
1.5
%, of the Company’s common stock.
105
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
We had no disagreements with our Independent Registered Public Accounting Firm on any matter of accounting
principles or practices or financial statement disclosure.
ITEM 9A. 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.
Management’s Report of Internal Control over Financial Reporting
Management of the Company is responsible for establishing and maintaining
adequate internal control over financial reporting.
Internal control over financial reporting is defined in Rules 13a-15(f) under
the Exchange Act as a process designed by, or under the
supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board
of directors,
management and other personnel to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally
accepted accounting principles and includes those policies and
procedures that:
●
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect
the transactions and
dispositions of the assets of the Company;
●
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements
in accordance with generally accepted accounting principles, and that receipts
and expenditures of the Company are
being made only in accordance with authorizations of management and directors
of the Company; and
●
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of
the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may
not prevent or detect misstatements.
As a result,
even systems determined to be effective can provide only reasonable assurance regarding
the preparation and presentation of
financial statements.
Moreover, projections of any evaluation of effectiveness to future periods are subject to the risks that controls
may become inadequate because of changes in conditions or that the degree
of compliance with the policies or procedures may
deteriorate.
106
The Company’s management assessed the effectiveness of the Company’s internal control over financial
reporting as of
December 31, 2021.
In making this assessment, the Company’s management used criteria
set forth in
Internal Control—Integrated
Framework (2013)
issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Based on management’s assessment, the Company’s management believes that, as of December 31, 2021, the
Company’s
internal control over financial reporting was effective based on those criteria. The Company’s independent registered
public accounting
firm, BDO USA, LLP,
has issued an attestation report on the Company’s internal control over
financial reporting, which is included
herein.
107
Report of Independent Registered Public
Accounting Firm
Stockholders and Board of Directors
Orchid Island Capital, Inc.
Vero Beach, Florida
Opinion on Internal Control over Financial
Reporting
We
have
audited Orchid
Island
Capital, Inc.’s
(the “Company’s”)
internal control
over
financial
reporting
as
of
December 31, 2021, based on criteria established in
Internal Control – Integrated Framework (2013)
issued by the
Committee
of
Sponsoring Organizations
of
the
Treadway
Commission (the
“COSO
criteria”).
In
our opinion,
the
Company maintained, in
all material respects,
effective internal control over
financial reporting as
of December
31, 2021 based on the COSO criteria
.
We also have audited,
in accordance
with the standards
of the Public
Company Accounting
Oversight Board (United
States) (“PCAOB”), the balance sheets of the Company
as of December 31, 2021 and 2020, the related statements
of operations, stockholders’ equity,
and cash flows for each of the three years
in the period ended December 31,
2021, and the related notes and our report
dated February 25, 2022, expressed an
unqualified opinion thereon.
Basis for Opinion
The Company’s
management is responsible for maintaining effective
internal control over financial reporting and
for its assessment
of the effectiveness
of internal control over
financial reporting, included in
the accompanying
“Item 9A, Management’s
Report on
Internal Control over Financial
Reporting”. Our responsibility
is to express an
opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting
firm registered with
the PCAOB
and are
required to be
independent with respect
to the
Company in
accordance
with U.S.
federal
securities laws
and the
applicable
rules and
regulations
of the
Securities
and Exchange
Commission
and the PCAOB.
We conducted our
audit of
internal control
over financial
reporting in
accordance with
the standards
of the PCAOB.
Those standards
require that
we plan
and perform
the audit
to obtain
reasonable assurance
about whether
effective
internal control over financial
reporting was maintained in
all material respects. Our
audit included obtaining an
understanding of internal control over financial
reporting, assessing the risk that
a material weakness exists, and
testing and evaluating
the design and
operating effectiveness of
internal control based
on the assessed
risk. Our
audit also included
performing such
other procedures
as we considered
necessary in the
circumstances. We believe
that our audit provides a reasonable basis
for our opinion.
Definition and Limitations of Internal
Control over Financial Reporting
A
company’s
internal
control
over
financial
reporting
is
a
process
designed
to
provide
reasonable
assurance
regarding the reliability of financial
reporting and the preparation of financial
statements for external purposes in
accordance with
generally accepted accounting
principles. A
company’s
internal control over
financial reporting
includes those policies
and procedures that
(1) pertain to
the maintenance of
records that, in
reasonable detail,
accurately and fairly reflect
the transactions and
dispositions of the assets
of the company; (2)
provide reasonable
assurance that transactions are
recorded as necessary
to permit preparation of
financial statements in accordance
with generally accepted
accounting principles, and
that receipts and expenditures
of the company are
being made
only in accordance with authorizations of
management and directors of the company;
and (3) provide reasonable
assurance
regarding
prevention
or
timely
detection
of
unauthorized
acquisition,
use,
or
disposition
of
the
company’s assets that could have a material effect on the financial
statements.
Because
of
its
inherent
limitations,
internal
control
over
financial
reporting
may
not
prevent
or
detect
misstatements. Also, projections of
any evaluation of
effectiveness to future periods
are subject to
the risk that
controls
may
become
inadequate because
of
changes
in
conditions, or
that
the
degree
of
compliance with
the
policies or procedures may deteriorate.
108
/s/ BDO USA, LLP
Certified Public Accountants
West Palm Beach, Florida
February 25, 2022
109
ITEM 9B.
OTHER INFORMATION
None.
ITEM 9C.
DISCLOSURE
REGARDING
FOREIGN
JURISDICTIONS
THAT PREVENT INSPECTIONS
Not applicable.
110
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item 10 and not otherwise set forth below is incorporated herein by reference to the
Company's definitive Proxy Statement relating to the Company’s 2022 Annual Meeting of Stockholders (the “Proxy
Statement”), which the Company expects to file with the SEC, pursuant to Regulation 14A, not later than 120 days after
December 31, 2021.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is incorporated herein by reference to the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information required by this Item 12 is incorporated herein by reference to the Proxy Statement and to Part II, Item
5 of this Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item 13 is incorporated herein by reference to the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT
FEES AND SERVICES
The information required by this Item 14 is incorporated herein by reference to the Proxy Statement.
111
ITEM 15. EXHIBITS, FINANCIAL STATEMENT
SCHEDULES
a.
Financial Statements. The financial statements of the Company,
together with the report of Independent Registered Public
Accounting Firm thereon, are set forth in Part II-Item
8 of this Form 10-K
and are incorporated herein by reference.
 
The following
 
information is
 
is filed
as part of
 
of this Form
10-K:
Page
Report of
Independent
 
Registered Public
 
Public Accounting
Firm
280
Balance Sheets
482
Statements of
 
of Operations
583
Statements of
 
of Stockholders’
 
Equity
684
Statements of
 
of Cash Flows
785
Notes to
Financial
 
Statements
8
86
b.
Financial Statement Schedules.
 
Not applicable.
c.
Exhibits.
Exhibit No.
Description
29
10.610.8
10.710.9
10.810.10
10.910.11
10.1010.12
10.1110.13
10.1210.14
10.1310.15
10.1410.16
10.1510.17
10.18
10.19
10.20
30
Exhibit 101.PRE
XBRL
Taxonomy Extension
Presentation Linkbase Document ****
Exhibit 104
Cover Page Interactive Data File (embedded within the
Inline XBRL document)
*
Filed herewith.
* Represents*
 
a managementFurnished herewith.
***
Submitted electronically herewith.
†
Management contract or compensatory plan or arrangement.
** Filedplan.
 
herewith.
*** Furnished
herewith.ITEM 16. FORM 10-K SUMMARY
**** Submitted
electronically herewith.
The Company has elected not to provide summary information.
 
 
 
31
 
114
Signatures
Pursuant to the requirements of
 
of Section 13 or 15(d)
of the Securities Exchange
Act of 1934, as amended,
 
the Securities Exchange Act ofregistrant has duly
 
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:
 
March 12, 2021February 25, 2022
By:
/s/ Robert E. Cauley
Robert E. Cauley
Chief Executive Officer, President and Chairman of the Board
Date:
 
March 12, 2021February 25, 2022
By:
/s/ George H. Haas, IV
George H. Haas,
 
IV
Secretary, Chief Financial Officer, Chief Investment Officer and
Director (Principal Financial and Accounting Officer)
Pursuant to
the requirements
of the
Securities Exchange Act
of 1934,
this report
has been
signed below
by the
following persons
on
behalf of the Company and in the capacities and on the dates indicated.
/s/ Robert E. Cauley
Chairman of the Board, Director, Chief
February 25, 2022
Robert E. Cauley
Executive Officer, and President
(Principal Executive Officer)
/s/ George H. Haas, IV
Chief Financial Officer, Chief
February 25, 2022
George H. Haas, IV
Investment Officer, and Director
(Principal Financial and Accounting Officer)
/s/ W Coleman Bitting
Independent Director
February 25, 2022
W Coleman Bitting
/s/ Frank P.
Filipps
Independent Director
February 25, 2022
Frank P.
Filipps
/s/ Paula Morabito
Independent Director
February 25, 2022
Paula Morabito
/s/ Ava L. Parker
Independent Director
February 25, 2022
Ava L. Parker