Orchid Island Capital (NYSE:ORC) provided its latest portfolio update and declared its dividend for June 2016. The results were a bit surprising to me as an analyst because ORC is sustaining its dividend at a fairly exceptional level of about 15.26% of Q1 book value. I don't see any way for a mortgage REIT to earn that level of return on a reliable basis, but ORC felt confident enough to maintain the dividend for now. Its portfolio positioning has been fairly reasonable for the quarter, but the high level of prepayments still gives me a great deal of concern.
The following chart demonstrates the major portfolio statistics as of the end of May. If Annaly Capital Management (NYSE:NLY) were providing this kind of portfolio update, I believe it would immediately be incorporated into share prices.
The prepayments on both the pass through and structured RMBS portfolios remain elevated and in line with levels that could be expected for spring when long-term rates remain low. The seasonal impact combined with low rates can hammer portfolios, but ORC is still maintaining. It remains to be seen whether it sees this as a long-term viable strategy or not. Remember that CYS Investments (NYSE:CYS) just cut its dividend from $.26 to $.25. Prior to the cut, it was yielding 10.99% off trailing book value. Capstead Mortgage Corporation (NYSE:CMO) cut its dividend from $.26 to $.23 to deal with the impact of prepayments. Capstead was only yielding 9.24% off trailing book value. Keep in mind, both of these other mortgage REITs also have lower operating costs as a percentage of shareholders' equity.
Book Value Should be Decent
By my calculations, it looks like ORC should still be performing decently on book value as well. Granted, the second quarter so far has been an easier quarter on book values. My concerns about ORC linger because it trades at a materially smaller discount to book value than other mortgage REITs and level of net interest income necessary off book value to cover the dividend and all operating costs is exceptionally high.
The combination of respectable book value performance and sustaining the dividend should allow ORC to remain at a premium to peers, at least until the next dividend announcement. I remain concerned over the longer term that outperforming peers to the extent of covering a 15% yield on book value when others with lower costs are not covering 9% to 11% seems very optimistic.
So far, this remains a clear positive for Orchid Island Capital, but I believe the yield off book value remains unsustainable unless there is a very material change in the interest rate environment. Outside of a major change in the interest rate environment, I will regularly be concerned about ORC when it is about to declare its next dividend. If prepayments rise in June, it will become a larger concern.
In the present time, if ORC gets its share price above book value, I would expect it to issue shares as quickly as possible. Doing so would be positive for long-term shareholders because it would drive down its operating expenses as a percentage of equity.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PREFERRED SHARES OF CMO OR CYS over the next 72 hours.
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