Orchid Island Capital: Delicious 20% return with a secondary order of risk (NYSE:ORC)

Eonen

Orchid Island Capital, Inc. (NYSE: ORC) is a United States-based real estate investment trust (“REIT”) that invests in residential mortgage-backed securities (“RMBS”) on a leveraged basis. The company has been paying monthly dividends since the very beginning. Since 2014, this mREIT has generated a tempting return between 15 and 20 percent. The company complaints that the income generated to be distributed to its shareholders is mainly based on the difference between the return on its mortgage assets and the cost of its borrowings. It can certainly be an attractive investment option for investors seeking income, if that return is sustainable.

Orchid Island Capital Business Model

Orchid Island Capital Business objective is to provide attractive long-term risk-adjusted total returns through a combination of capital appreciation and the payment of regular monthly distributions. This mREIT operates primarily through Agency RMBS. Agency RMBS are issued and guaranteed by a federally chartered company or agency. The principal and interest payments of its RMBS are guaranteed by the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation or the Government National Mortgage Association, and are secured by single family residential mortgages.

ORC’s investment portfolio is widely divided in pass-through agency RMBS and structured agency RMBS. Pass-through Agency RMBS includes Mortgage Transfer Certificates and Secured Mortgage Bonds issued by Fannie Mae, Freddie Mac or Ginnie Mae. Structured Agency RMBS include mortgage-backed bonds, interest-only securities, inverse interest-only securities, and principal-only securities. These investments are financed by short-term borrowings structured as repurchase agreements.

Share split announced on August 17

Orchid Island Capital announced a 1:5 reverse stock split of its outstanding shares, which will become effective on August 30, 2022. All five issued and outstanding common shares held by an investor on that date will be converted into one share. The shares should begin trading on a adjusted according to distribution at the opening of the market on August 31, 2022. No fractional shares will be issued in this regard and shareholders who would otherwise have received fractional shares will receive cash in lieu of such fractional shares. The assess will be determined based on the closing price of ORC’s shares on the NYSE on August 30, 2022.

The number of shares in circulation will thus increase from 176 million to almost 37 million. Orchid Island Capital also reported monthly cash dividend $0.16 for the month of August 2022 which will be paid on a split-adjusted basis. The August dividend is equivalent to a dividend of $0.032 per common share on a pre-split basis. In this sense, the payment decreases from $0.045 per share. The Company believes book value per share as of August 16, 2022 at approximately $3.10 to $3.12 per share excluding the Reverse Stock Split, an increase of approximately 8% from that of June 30, 2022 of $2.87. However, the reverse stock split may not allow the book value to increase to that extent.

Inherent risk factors

Orchid Island Capital was incorporated in 2010 and is based in Vero Beach, Florida. It is externally managed and advised by Bimini Advisors, LLC, a wholly owned subsidiary of Bimini Capital Management, Inc. This mREIT owns only 22.3% institutional holdings, nearly 6% of which is owned by Vanguard Group Inc. The company also failed to achieve price growth despite such a high yield. Negative price growth and weak institutional investment are raising concerns about this stock.

Orchid Island Capital May change their investment strategy, investment guidelines and asset allocation without prior notice or shareholder consent, which may result in riskier investments. A change in investment strategy may increase interest rate risk and could be adversely affected by fluctuations in the real estate market. In addition, the charter provides that the board of directors may revoke or otherwise terminate the REIT qualification, without the approval of our shareholders. These changes could have a material adverse effect on ORC’s financial condition, results of operations, stock market price performance and ability to generate a high return for its shareholders.

Orchid Island Capital board members are subject to conflicts of interest arising from their relationship with Bimini. All of its managers are employees of Bimini. As a result, officers may have conflicts between their duties to ORC and their duties to Bimini. ORC 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 ORC has or may have an interest. Additionally, Orchid Island Capital may engage in transactions directly with Bimini or its affiliates, including the purchase and sale of all or a portion of a Portfolio Asset. This relationship surely creates concern for ORC investors.

Investment thesis

Orchid Island Capital has so far successfully invested in residential mortgage-backed securities (“RMBS”) on a leveraged basis. The business has generated extremely high returns over the past eight years. However, this mREIT has low institutional investments and failed to achieve price growth despite such a high yield. A likely reason behind such weak institutional interest may be the uncertainties surrounding management and the power vested in the board of directors.

ORC has the ability to change its investment strategy, investment guidelines and asset allocation without notice or without obtaining the consent of its shareholders. The company also faces a conflict of interest in its relationship with Bimini. The stock split also indicates a lack of trust on the part of Orchid Island Capital’s board members. The reverse stock split may be detrimental to the book value of this mREIT. The company has already announced a reduction in the dollar value of its payment. So, although the stock is very lucrative due to its extremely high yield, the kind of risk it carries might make investors a bit skeptical about hoarding this stock.

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