ORC, MAIN, and GBDC Q3 2023 Updates by Scott Kennedy

Introduction section by Colorado Wealth Management Fund.

Article section by Scott Kennedy.

There are three articles contained in this post. They are earnings updates for:

1. Orchid Island Capital (ORC)

2. Main Street Capital (MAIN)

3. Golub Capital (GBDC)

They will be presented in that order.

Each update is designed to serve as a stand-alone article, but I’m packing them all into one e-mail for simplicity. Consequently, if you decide to read all 3, you’ll notice some repetitive parts. If you’re only interested in one or two, you’ll be able to skip the other.

We may modify this layout in the future based on reader feedback. Specifically, sections about the process may be rolled into one article and linked. That will keep the information accessible while removing repetition for frequent readers.

Bringing More of Scott’s Work to Our Website

The REIT Forum is a service produced by Michael Vanloon (better known as Colorado Wealth Management Fund) and Scott Kennedy. After intense consideration, I decided to launch our service through Substack. Since then, we’ve seen great success. Substack enables us to give readers real-time alerts with entire articles delivered directly to their inboxes.

You’re probably used to seeing the “from” field saying: “ColoradoWealthManagementFund from The REIT Forum”.

In some of our future e-mails, it may say:

“Scott Kennedy from The REIT Forum”.

That will simply mean we’ve updated the backend of the website for Scott Kennedy to directly post his articles.

I want to make browsing our work as simple as possible for readers. This will be another step in that direction.

For the moment, I’ll be posting Scott’s work. The following articles are a direct copy and paste from Scott. While we get the back end set up, there is a delay in getting the articles posted. Rest assured that it should be solved soon.

Finding Our Positions

I posted a subscriber-exclusive article with links to our Google Sheets. You can always access our positions there. Scott’s positions are updated each week. CWMF’s positions are usually updated on the same day as the trade.

Sharing Article 1 for All

I’ll include the first article, the one covering ORC, before we swap over to the exclusive section.

Updating Book Value and Targets

Tonight or tomorrow, there will be another article for subscribers with updated price targets that include all the latest data as of Friday’s close. For agency mortgage REITs, book values have been moving significantly. Please be advised that the values are changing constantly, and targets are updated each week.

That update will have more recent data (estimates and targets) than the earnings update below.

The rest of this post is from Scott Kennedy.

Article #1: Scott Kennedy’s mREIT Earnings Series: Assessing Orchid Island Capital’s Performance For Q3 2023

• This 1st earnings assessment article reviews ORC’s BV and core earnings equivalent performance during Q3 2023. This article is mainly for subscribers who do not utilize chat.

• This article also discusses how ORC’s quarterly change in BV and core earnings equivalent “matched up” to expectations. Earnings remain a key driver to stock performance.

• ORC’s BV was a very minor-minor underperformance while its core earnings equivalent was a modest outperformance.

• No change in ORC’s percentage recommendation ranges or risk rating.  ORC is currently deemed appropriately valued (HOLD).

• As anticipated, ORC reported a massive decrease in Q3 2023 BV.  Even with a recent notable drop in stock price, ORC's valuation is still not attractive. Continue to be cautious.

Introduction:

Hi subscribers. For new members, my name is Scott Kennedy and currently I fully cover 20 mortgage real estate investment trust (mREIT) and 15 business development company (“BDC”) common stocks within this Marketplace Service regarding research/data, subscriber questions, weekly projected book values/net asset values (BV/NAV), and common stock recommendation ranges. Colorado (“CO”) Wealth Management handles the mREIT preferred stocks and he and his team handles all other applicable REIT sectors outside the mREIT sector. CO also provides some mREIT common stock and BDC articles from time-to-time which are more of an “overview/introduction” discussion; typically based either on my or our combined research/data. This also includes some macroeconomic trends and data. My name is always attached to all Marketplace Service articles I personally wrote so there is no confusion for subscribers.

This REIT Forum article is part of a series of articles over a span of 6-7 weeks which will analyze my previously projected BV/NAV and core earnings (or core earnings equivalent)/net investment income (“NII”) figures and compare these metrics to each mREIT’s and BDC’s actual reported results, respectively. For readers who are familiar with my public mREIT and/or BDC articles, these types of articles are beneficial to readers who desire to pursue a more active investing strategy and/or want more “real time” thoughts/analysis.

I hope my services/contributions ultimately help enhance a subscriber’s total investment returns or minimize their total investment losses within the mREIT and BDC sectors. At the very least, I hope subscribers will gain more insight into the mREIT and BDC sectors by reading my/our exclusive REIT Forum articles.

1) ORC’s BV and Core Earnings Equivalent Q3 2023 Performance (Projected Versus Actual Results):

On 10/11/2023, Orchid Island Capital Inc. (ORC) reported the company’s preliminary earnings results for the third quarter of 2023. Table 1 below provides ORC’s BV and earnings summary.

Table 1 – ORC Q3 2023 BV and Earnings Summary

Source: Taken Directly from the REIT Forum’s © Analytical Spreadsheets/Data

Regarding core earnings, unfortunately ORC does not provide this metric. However, a good “substitute” to this metric is ORC’s net spread income less operational expenses (which management continues to disclose/highlight). Within the chat feature of this Marketplace Service, I provided the following commentary in regards to ORC’s preliminary results for the third quarter of 2023:

“Hi subscribers, after the market close today, ORC provided the company’s monthly update. ORC declared a dividend of $0.120 per share for October 2023 (paid in November 2023; a ($0.04) per share decrease when compared to the prior month) and disclosed preliminary Q3 2023 results (as is typical). ORC reported an estimated BV as of 9/30/2023 of $8.92 per share (20.1% decrease) versus my prior projection of $9.10 per share (18.5% decrease). I consider this a very minor - minor (greater than a 1.0% but less than a 2.5%) underperformance and was well within my $8.60 - $9.60 per share range.

I would just point out the extreme volatility, especially for the agency mREIT model, during the third quarter of 2023. BVs notably decreased during September 2023 (some peers in excess of 12%). In my personal opinion, any quarterly BV variance at or within 4% this particular quarter should really be considered an accurate estimate (larger “cone” per se). So, only a (1.6%) quarterly BV variance should be considered very accurate. In addition, as a reminder, the current subscriber spreadsheets are based on CURRENT BVs. For example, currently each company’s BV estimate as of 10/6/2023 (soon to be as of 10/13/2023). In this chat note, I am comparing 9/30/2023 BV projections versus actual results. Something to mention for newer subscribers.

Simply put, ORC’s BV performance during third quarter of 2023 was largely as anticipated. Still, let us discuss some of the more notable events during the quarter. First, management was very aggressive issuing common equity. This was previously correctly anticipated (as noted throughout the quarter). ORC issued 8.4 million shares of common stock during the quarter. When calculated, this was nearly a 20% increase in the number of outstanding shares of common stock in just 1 quarter. This, in turn, led to an expansion of ORC’s agency residential mortgage-backed securities (“MBS”) sub-portfolio during the quarter (especially from a par value perspective). This was correctly anticipated on my end. Other sub-sector peers likely pursued a similar strategy as overall agency MBS pricing remained attractive during the third quarter of 2023. If anything, when compared to my expectations, ORC added a slightly larger amount of agency MBS during September 2023 which led to a fractionally higher amount of quarterly MBS valuation declines. This likely attributed to some of ORC’s (1.6%) quarterly BV underperformance when compared to my projection (again, a very small - small variance in this very volatile quarter).

Second, as ORC added to the company’s agency MBS portfolio during September 2023, I was a bit disappointed the company basically refrained from adding to its derivatives sub-portfolio in “lock step” (similar timing). A larger derivatives sub-portfolio would have directly resulted in some additional valuation gains during September 2023. As such, this also likely led to some of ORC’s (1.6%) quarterly BV underperformance when compared to my projection. Of course, until ORC “officially” reports earnings, I cannot provide an exact reconciliation/underperformance per share figure but this explanation should suffice for now.

Moving on, ORC’s net spread income less operational expenses of ($0.28) per share for the third quarter of 2023 was a modest outperformance versus my projection of ($0.35) per share. ORC’s net spread income less operational expenses was ($0.34) per share for the second quarter of 2023. As such, I projected a net spread income less operational expenses decrease of ($0.01) per share. In actuality, ORC reported a net spread income less operational expenses increase of $0.06 per share. The institutional analysts’ consensus average was net spread income less operational expenses of ($0.231) per share. So, we basically split the difference.

ORC’s modest quarterly core earnings equivalent improvement/outperformance was mainly due to the following: 1) a minor - modest increase in ORC’s MBS/investment sub-portfolio size by the end of the quarter (even larger increase in September 2023 when compared to my projection; minor positive factor); 2) a modest increase in weighted average yield by the end of the quarter (even larger increase in September 2023 when compared to my projection; minor positive factor); 3) a larger weighted average outstanding shares of common stock figure (as anticipated; neutral factor); and 4) a minor – modest increase in borrowing costs (as anticipated; neutral factor). In addition, ORC’s quarterly conditional/constant prepayment rate (“CPR”) fluctuation was basically as anticipated (no surprise in that metric).

That said, I would point out ORC’s net spread less operational expenses metric, a figure that management has continued to highlight and refer to as the company’s core earnings equivalent/earnings available for distribution (“EAD”) metric, excludes one recently growing factor/reconciliation. This specific metric excludes ORC’s current period hedging income. This is something I have extensively discussed in prior earnings chat notes so I will not reiterate here again (one can simply look back). As such, I would strongly recommend management provide an updated core earnings equivalent/EAD metric whereas ORC’s current period hedging income (expense) is INCLUDED in this specifically-referenced metric. This would equate to a more similar core earnings equivalent/EAD metric when compared to sub-sector peers. This would merely cause less confusion for market participants moving forward regarding dividend metrics; especially in light of the recent extremely quick increase in LIBOR/SOFR/PRIME. For subscribers, merely consider this notion when factoring in the viability of ORC’s business model (again, let us try and keep misnomers to a minimum). Since ORC did not disclose the company’s current period hedging income figure in the company’s monthly update, I cannot disclose this metric/figure at this time.

ORC also announced a ($0.04) per share monthly dividend decrease for October 2023 when compared to September 2023 ($0.12 per share versus a previous dividend of $0.16 per share). Simply put, this was correctly anticipated. Technically speaking, this (25%) reduction was at the low end of our previously-projected monthly dividend range of $0.12 - $0.16 per share. As most recently discussed in PART 2 of our mREIT sector comparison article, along with warning subscribers in prior ORC earnings chat notes, the company’s dividend was at a VERY HIGH risk for an eventual dividend reduction in late 2023 – early 2024. ORC’s Board of Directors simply made the prudent decision to, once again, reduce the monthly dividend to a more sustainable level beginning in October 2023 (needed to be done).

So, all-in-all, a very minor – minor underperformance on ORC’s quarterly BV (variance of only 1.6%; considering the quarterly decrease was (20.1%)) and a modest outperformance on the company’s core earnings equivalent metric (variance of $0.06 per share). These 2 metrics basically “offset” against one another when compared to overall quarterly performance when compared to my expectations.

While ORC’s 9/30/2023 BV basically matched my expectations, I still believe the notable net decrease in the company’s BV during 2022 - 2023, along with the notable core earnings equivalent decrease during 2022 – second quarter of 2023, only solidifies why I/we have this particular agency mREIT valued at a discount (relative to estimated CURRENT BV) versus the better-performing agency mREIT sub-sector peers. This includes peers who have performed modestly - notably better regarding 2022 - 2023 BV mitigation (less severe losses; for instance DX) and/or been able to perform notably better regarding generating core earnings/EAD (even when including ORC’s current period hedging income; for instance AGNC).

When taking ORC’s recent and projected performance into consideration, along with macroeconomic trends/events (mainly Fed monetary policy, the general projected movement of rates/yields, and projected economic performance over the foreseeable future), no change to my/our ORC percentage recommendation ranges (relative to CURRENT BV) or risk rating (remains at a 4.5).

At a closing price as of 10/11/2023 of $7.96 per share, ORC is deemed to be APPROPRIATELY VALUED/a HOLD recommendation (price target of $8.00 per share). However, as this price target indicates, ORC is very close to being OVERVALUED/a SELL recommendation. As such, I/we currently deem ORC is not attractively valued. Therefore, subscribers should not currently initiate or add to one’s existing position. In my opinion, a continued modest - notable pullback would first need to occur…”

Conclusions Drawn + BUY, SELL, or HOLD Recommendation:

Readers have continued to request that I provide these types of “earnings assessment” articles showing how my previously disclosed quarterly projections “stacked-up” to each covered mREIT’s/BDC’s results. I believe the analysis above accomplishes this request for the REIT Forum subscribers.

In summary, here is how ORC performed when compared to my expectations regarding the third quarter of 2023 (includes any risk rating and BUY, SELL, or HOLD recommendation range changes; as well as current recommendation):

1) ORC

BV: Very Minor-Minor Underperformance (Well Within Range)

Core Earnings Equivalent (Net Spread Income Less Operational Expenses): Modest Outperformance (Slightly OUTSIDE Range)

Percentage Recommendation Range (Relative to CURRENT BV): No Change (Reasoning Provided Above)

Risk Rating: No Change

Table 2 – ORC Notecard (As of 10/11/2023)

(Source: Taken Directly from the REIT Forum’s © Subscriber-Accessible Spreadsheets. Earnings Projection is Taken Directly from Either the Prior Quarter’s Actual Reported Figure or the Institutional Analysts’ Consensus Average and Annualized. At the End of Each Current Quarter, I Provide My Own Finalized Core Earnings/Core Earnings Equivalent or NII/Adjusted NII Metric Which Will Differ from the Estimate Provided Above.)

Important Note: As always, please check the Google shared spreadsheets when it comes to intra-week recommendations as stock prices fluctuate.

Along with the data presented within this article, these recommendations consider the following mREIT catalysts/factors: 1) projected future MBS/investment price movements; 2) projected future derivative valuations; and 3) projected near-term (up to 1-year) dividend per share rates. These recommendations also consider the 8 Federal (“Fed”) Funds Rate increases by the FOMC during December 2016-2018 (a more hawkish tone/rhetoric when compared to 2014-2016), the three Fed Funds Rate decreases during 2019 due to the more dovish tone/rhetoric regarding overall monetary policy as a result of recent macroeconomic trends/events, and the very quick “plunge” in the Fed Funds Rate to near 0% in March 2020. This also considers the previous wind-down/decrease of the Fed Reserve’s balance sheet through gradual runoff/partial non-reinvestment (which began in October 2017 which increased spread/basis risk) and the prior “easing” of this wind-down that started in May 2019 regarding U.S. Treasuries and August 2019 regarding agency MBS (which partially reduced spread/basis risk when volatility remained subdued). This also considers the early Spring 2020 announcement of the start of another round of quantitative easing (“QE”) that includes the Fed specifically purchasing agency MBS (and “rolling over” all principal and interest payments into new agency MBS) which bolstered prices while keeping long-term/mortgage interest rates near historical lows (which lowered spread/basis risk for quite some time when volatility remained subdued). This also includes the recent “taper” of the Fed’s most recent QE program regarding its monthly purchases of $80 billion of U.S. Treasury securities and $40 billion of agency MBS. This taper began in November 2021 and market speculation around this future event caused a rise in spread/basis risk and during the summer of 2021 (as correctly previously anticipated) and the second half of the fourth quarter of 2021-October 2022. This includes the FOMC’s previously accelerated taper and the continued very quick rise in the Fed Funds Rate which began in March 2022. I/We continue to believe agency mREIT net interest margins will continue to narrow/become more severe during the remainder of 2023, begin to flatten out during early 2024, and gradually improve by the end of 2024.

Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader’s current investing strategy. The factual information provided within this article is intended to help assist readers when it comes to investing strategies/decisions.

Understanding My Valuation Methodology Regarding mREIT Common and BDC Stocks:

The basic "premise" around my recommendations in the mREIT common and BDC sectors is value. Regarding operational performance over the long-term, there are above average, average, and below average mREIT and BDC stocks. That said, better-performing mREIT and BDC peers can be expensive to own, as well as being cheap. Just because a well-performing stock outperforms the company’s sector peers over the long-term, this does not mean this stock should be owned at any price. As with any stock, there is a price range where the valuation is cheap, a price where the valuation is expensive, and a price where the valuation is appropriate. The same holds true with all mREIT common and BDC peers. As such, regarding my investing methodology, each mREIT common and BDC peer has their own unique BUY, SELL, or HOLD recommendation range (relative to estimated CURRENT BV/NAV). The better-performing mREITs and BDCs typically have a recommendation range at a premium to BV/NAV (varying percentages based on overall outperformance) and vice versa with the average/underperforming mREITs and BDCs (typically at a discount to estimated CURRENT BV/NAV).

Each company’s recommendation range is "pegged" to estimated CURRENT BV/NAV because this way subscribers/readers can track when each mREIT and BDC peer moves within the assigned recommendation ranges (daily if desired). That said, the underlying reasoning why I/we place each mREIT and BDC recommendation range at a different premium or (discount) to estimated CURRENT BV/NAV is based on roughly 15-20 catalysts which include both macroeconomic catalysts/factors and company-specific catalysts/factors (both positive and negative). This investing strategy is not for all market participants. For instance, not likely a “good fit” for extremely passive investors. For example, investors holding a position in a particular stock, no matter the price, for say a period of 5+ years. However, as shown throughout my articles written here at Seeking Alpha since 2013, in the vast majority of instances I have been able to enhance my personal total returns and/or minimize my personal total losses from specifically implementing this particular investing valuation methodology. I hope this provides some added clarity/understanding for new subscribers/readers regarding my valuation methodology utilized in the mREIT common and BDC sectors. Please disregard any minor “cosmetic” typos if/when applicable.

Scott’s Disclosure: I/we have a beneficial long position in the shares of GPMT, MITT-B, MITT-C, RC, RCB, RITM, RITM-D either through stock ownership, options, or other derivatives.

CWMF’s Disclosure: See all my positions from our subscriber Google Sheets (linked before the articles began).

Article #2: Scott Kennedy’s BDC Earnings Series: Assessing Main Street Capital’s Performance For Q3 2023