US Mortgage Spreads Will Normalize And Unlock Value

Key Takeaways

• Wide mortgage spreads and low volatility allow for asset acquisition and effective hedging, positioning Orchid Island Capital for margin and earnings growth.
  
• Strong housing demand and strategic portfolio management drive stable income, resilience, and improved returns amid evolving market conditions.
  
• Reliance on undiversified agency RMBS, leverage, and equity raises exposes Orchid Island Capital to outsized risk, margin compression, and persistent earnings and book value challenges.

Catalysts

A specialty finance company, invests in residential mortgage-backed securities (RMBS) in the United States.

• The confluence of historically wide mortgage spreads over swaps (circa 200 bps on production coupons) and low market volatility presents a rare opportunity for Orchid Island Capital to acquire high-carry, attractively priced assets and hedge effectively, positioning the company for margin expansion and sustained earnings growth as spreads eventually normalize.
  
• Robust, persistent demand for U.S. housing-driven by demographic shifts and constrained housing supply-is supporting stable prepayment speeds and elevated mortgage balances, underpinning Orchid's asset base and enabling steady, predictable income flow even in a challenging macro environment, which benefits both revenue and earnings stability.
  
• Anticipated gradual normalization and increased transparency in monetary policy, along with future potential Fed rate cuts and regulatory relief, are expected to draw banks back as major RMBS buyers, which should support tighter spreads and enhance asset valuations-translating into future book value gains and improved total returns.
  
• Management's ongoing optimization of portfolio mix (emphasizing higher coupon, specified pools) and advanced hedging strategies tailored to the current curve and volatility regime enhance Orchid's adaptability, enabling improved net interest margins and more resilient earnings across multiple rate scenarios.
  
• Ample funding access and capital discipline-including opportunistic share buybacks and accretive capital raises-provide Orchid with flexibility to scale into attractive market dislocations, supporting both book value per share and medium-term earnings growth prospects as market conditions eventually rebound.

Orchid Island Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Orchid Island Capital's revenue will grow by 154.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 26.4% today to 99.0% in 3 years time.
• Analysts expect earnings to reach $397.4 million (and earnings per share of $3.19) by about July 2028, up from $6.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 4.2x on those 2028 earnings, down from 144.0x today. This future PE is lower than the current PE for the US Mortgage REITs industry at 11.7x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.43%, as per the Simply Wall St company report.

Orchid Island Capital Future Earnings Per Share Growth

Risks

• Interest rate volatility and persistent higher long-term rates, as suggested by discussions about ongoing government deficits, elevated treasury issuance, and curve steepening, may continue to pressure the value of Orchid Island Capital's MBS portfolio, leading to additional book value erosion and increased earnings volatility.
  
• The company's repeated need for equity raises-even at a slight dilution to book value-signals challenges with internally generated capital and long-term earnings per share growth, risking chronic dilution for existing shareholders and undermining dividend sustainability.
  
• Orchid Island Capital's portfolio remains exclusively focused on agency RMBS, making it structurally less diversified than industry peers and potentially more vulnerable to sector-specific downturns or regulatory changes, limiting its ability to protect or grow revenue streams if market conditions worsen.
  
• Ongoing mark-to-market hedge losses, reliance on high leverage (over 7x), and exposure to swap and treasury basis spreads create net margin compression risks during periods of market stress or rapid changes in funding costs, directly threatening profitability and net margins.
  
• The muted participation of major bank buyers in the MBS market, as highlighted in management's remarks, prolongs cheap MBS valuations and constrains prospects for spread tightening, potentially capping long-term capital gains and limiting upside in Orchid's book value and share price.

Valuation

• The analysts have a consensus price target of $8.0 for Orchid Island Capital based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $401.3 million, earnings will come to $397.4 million, and it would be trading on a PE ratio of 4.2x, assuming you use a discount rate of 10.4%.
  
• Given the current share price of $7.28, the analyst price target of $8.0 is 9.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.