Yield Curve And Interest Rate Trends To Support Mortgage REITs' Financial Stability

Key Takeaways

• Steepening yield curve and lower funding costs improve net interest income and earnings through a positive net interest spread.
  
• Pro-growth policies and potential Fed rate cuts may enhance returns on equity and reduce cash interest expenses.
  
• Exposure to interest rate risks, declining book value, and regulatory uncertainties may challenge Orchid Island Capital's profitability and asset growth.

Catalysts

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

• The steepening of the yield curve and lower funding costs are leading to a positive net interest spread for Orchid Island Capital, suggesting an improvement in net interest income and overall earnings.
  
• The expectation of a stable or slowly falling interest rate environment is promoting positive carry and reduced volatility for their portfolio, potentially enhancing net margins and overall financial stability.
  
• With higher long-term interest rates, Orchid Island Capital’s up-in-coupon bias means slower prepayment speeds, which can lead to better carry and improved income from their mortgage-backed securities (MBS) portfolio.
  
• Even though banks are not currently major buyers of mortgages, there is potential for spread tightening if banks re-enter the market, which could improve future revenues and margins.
  
• A pro-growth agenda from the new administration, combined with anticipated Fed interest rate cuts, could lower cash interest expenses further and potentially enhance returns on equity (ROE) and earnings.

Orchid Island Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Orchid Island Capital's revenue will grow by 15.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 69.2% today to 58.6% in 3 years time.
• Analysts expect earnings to reach $49.7 million (and earnings per share of $0.48) by about March 2028, up from $37.7 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 29.2x on those 2028 earnings, up from 20.8x today. This future PE is greater than the current PE for the US Mortgage REITs industry at 12.2x.
• 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 10.25%, as per the Simply Wall St company report.

Orchid Island Capital Future Earnings Per Share Growth

Risks

• The decline in Orchid Island Capital's net income per share from $0.24 in Q3 to $0.07 in Q4 suggests potential ongoing challenges in maintaining profitability, which could further impact net margins.
  
• The decrease in book value from $8.40 at the end of Q3 to $8.09 at the end of 2024 reflects potential difficulties in maintaining or growing asset values, which could affect overall earnings.
  
• The company's reliance on interest spreads, which are sensitive to changes in rates, suggests exposure to interest rate risks that could adversely affect revenue if market conditions shift unfavorably.
  
• High prepayment speeds and the associated refinancing risks may lead to variability in cash flows and could compress future net interest margins, impacting projected earnings.
  
• The potential for regulatory changes or macroeconomic shifts, such as inflation fears and fiscal spending changes, could increase risk and unpredictability in financial performance, impacting future revenue and profitability.

Valuation

• The analysts have a consensus price target of $9.5 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 $84.8 million, earnings will come to $49.7 million, and it would be trading on a PE ratio of 29.2x, assuming you use a discount rate of 10.2%.
• Given the current share price of $8.39, the analyst price target of $9.5 is 11.7% higher.
• 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.