Details of Third Quarter 2017 Results of Operations

The Company reported net income of $1.5 million for the three month period ended September 30, 2017.   The results for the quarter included net interest income of $0.7 million, net gains on mortgage backed securities and derivative instruments of $0.1 million, gains on retained interests of $0.1 million, advisory services revenue of $1.9 million, dividends on Orchid Island Capital, Inc. ("Orchid") common stock of $0.6 million, fair value adjustments on Orchid common stock of $0.5 million and operating expenses of $1.5 million.

Management of Orchid Island Capital, Inc.

Orchid is managed and advised by Bimini.  As Manager, Bimini is responsible for administering Orchid's business activities and day-to-day operations.  Pursuant to the terms of the management agreement, Bimini Advisors provides Orchid with its management team, including its officers, along with appropriate support personnel.

Bimini also maintains a common stock investment in Orchid which is accounted for under the fair value option, with changes in fair value recorded in the statement of operations for the current period.  For the three months ended September 30, 2017, Bimini's statement of operations included a fair value adjustment of $0.5 million and dividends of $0.6 million from its investment in Orchid common stock.  Also during the three months ended September 30, 2017, Bimini recorded $1.9 million in advisory services revenue for managing Orchid's portfolio consisting of $1.5 million of management fees and $0.4 million in overhead reimbursement.

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Capital Allocation and Return on Invested Capital

The tables below present the allocation of capital between the respective portfolios at September 30, 2017 and June 30, 2017, and the return on invested capital for each sub-portfolio for the three month period ended September 30, 2017.   Capital allocation is defined as the sum of the market value of securities held, less associated repurchase agreement borrowings, plus cash and cash equivalents and restricted cash associated with repurchase agreements. Capital allocated to non-portfolio assets is not included in the calculation.

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Prepayments

For the third quarter of 2017, the Company received approximately $2.7 million in scheduled and unscheduled principal repayments and prepayments, which equated to a constant prepayment rate ("CPR") of approximately 8.3% for the third quarter of 2017.  Prepayment rates on the two MBS sub-portfolios were as follows (in CPR):

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Portfolio

The following tables summarize the MBS portfolio as of September 30, 2017 and December 31, 2016:

 

($ in thousands)
					Weighted
			Percentage		Average
			of	Weighted	Maturity
		Fair	Entire	Average	in	Longest
Asset Category		Value	Portfolio	Coupon	Months	Maturity
September 30, 2017
Fixed Rate MBS	$	195,151	98.6%	4.23%	326	1-Sep-47
Total PT MBS		195,151	98.6%	4.23%	326	1-Sep-47
Interest-Only Securities		1,643	0.8%	3.44%	232	25-Dec-39
Inverse Interest-Only Securities		1,196	0.6%	5.32%	281	25-Apr-41
Total Structured MBS		2,839	1.4%	4.23%	253	25-Apr-41
Total MBS	$	197,990	100.0%	4.23%	325	1-Sep-47
December 31, 2016
Fixed Rate MBS	$	124,299	95.4%	4.24%	347	1-Oct-46
Total PT MBS		124,299	95.4%	4.24%	347	1-Oct-46
Interest-Only Securities		2,654	2.0%	3.48%	245	25-Dec-39
Inverse Interest-Only Securities		3,349	2.6%	5.52%	325	25-Dec-46
Total Structured MBS		6,003	4.6%	4.62%	290	25-Dec-46
Total MBS	$	130,302	100.0%	4.26%	344	25-Dec-46

 

 

 

 

Financing and Liquidity

As of September 30, 2017, the Company had outstanding repurchase obligations of approximately $187.4 million with a net weighted average borrowing rate of 1.35%.  These agreements were collateralized by MBS with a fair value, including accrued interest, of approximately $198.2 million.  At September 30, 2017, the Company's liquidity was approximately $5.7 million, consisting of unpledged MBS and cash and cash equivalents.

We may pledge more of our structured MBS as part of a repurchase agreement funding, but retain cash in lieu of acquiring additional assets.  In this way, we can, at a modest cost, retain higher levels of cash on hand and decrease the likelihood we will have to sell assets in a distressed market in order to raise cash.  Below is a list of outstanding borrowings under repurchase obligations at September 30, 2017.

Hedging

In connection with its interest rate risk management strategy, the Company economically hedges a portion of the cost of its repurchase agreement funding and also its junior subordinated notes by entering into derivative financial instrument contracts.  The Company has not elected hedging treatment under U.S. generally accepted accounting principles ("GAAP") in order to align the accounting treatment of its derivative instruments with the treatment of its portfolio assets under the fair value option election. As such, all gains or losses on these instruments are reflected in earnings for all periods presented.  As of September 30, 2017, such instruments were comprised entirely of Eurodollar futures contracts.

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Management Commentary

Commenting on the third quarter, Robert E. Cauley, Chairman and Chief Executive Officer, said, "As we entered the first quarter of 2017, risk assets were performing very well as the Trump Administration took office and appeared to be very pro-business.  The markets looked forward to a roll back of recently expanding regulations across many industries, a new and hopefully improved health care act, tax reform and possibly much needed infrastructure spending to refurbish the nation's aging roads, highways, bridges and airports.  While the Trump Administration made bold promises, very little has been delivered.  Market optimism was quickly replaced with pessimism.  Political infighting among the Trump Administration and congressional Republicans has generally been the cause, as has turmoil within the White House itself.   Geopolitical events surfaced in early April, specifically on the Korean peninsula.  These events kept the market on edge and induced sporadic flight to quality rallies as headlines hit the market from time to time. Incoming inflation data since March was below expectations.  In the case of the core Consumer Price Index ("CPI") measure, the year over year figure moved from 2.3% in January 2017 to 1.7% by May and has stayed there through September.  The yield on the 10-year US Treasury rate hit its year to date low on September 7, 2017, closing at 2.04%, and nearly broke below the psychologically important 2% level intra-day. However, there was a perceptible change in market sentiment in early September, and the market reversed course into the end of the third quarter and early fourth quarter.  The Trump Administration managed to strike a deal with Congress – predominantly Democratic members ironically – to avoid a government shut-down by raising the debt ceiling and passing a continuing resolution to fund the government into December.

"In spite of the low inflation readings described above, the Federal Reserve (the "Fed") remains convinced these readings are being driven by temporary or transitory phenomenon, and that inflation will reverse and head back towards their two percent target over the medium term.  At the conclusion of their meeting on September 20th, the Fed was quite clear they expect to hike their target rate again at the December meeting barring surprise outcomes to the downside.  The market accepts this outcome as highly likely – as reflected in Fed Funds futures pricing.  However, using the same measure, the market does not expect the Fed to raise rates in 2018 and beyond to the extent the Fed expects.  As a result, the combination of benign inflation readings coupled with hawkish Fed expectations has caused the yield curve to flatten significantly during the third quarter – through the lows seen in late June - to multi-year lows.  A second order effect of these developments has occurred in the equity and risk markets as they continue to perform exceedingly well.  The major equity indices in the US have made record new highs almost daily of late.

"The RMBS market performed well in the third quarter due to low volatility, tight trading spreads across most competing asset classes and demand from asset managers and REITs. Current coupon, 30-year fixed rate mortgage backed securities are trading at their tightest spread to comparable duration U.S. Treasuries since early 2014.   As long as these conditions persist, we believe that the market is not likely to suffer a material widening of spreads to comparable duration U.S. Treasuries, even as the Fed has started to trim their asset purchases.  The risk to this outcome appears to be inflation exceeding market expectations, which should allow the Fed to carry out their stated intentions to raise rates three times in 2018 and more so in the years after. This would also put upward pressure on volatility and longer-term rates, both expected to negatively impact MBS performance.

"The impact of these developments on our portfolio and results were not material in the third quarter.  While higher coupon, fixed rate mortgage backed securities – our core holding – did not perform as well as lower coupon, fixed rate mortgages, market demand for the various forms of call protection was robust, and pay-up premiums increased during the quarter.  As a result, mark to market gains (losses) were approximately $0.5 million net, and $0.7 million excluding the effects of prepayments on the pass-through portfolio.  The flattening of the U.S. Treasury curve had a negligible negative impact of $0.02 million on our Euro dollar hedges. The flattening of the curve, and higher funding levels, put slight downward pressure on our net interest spread as well.  Going forward, we expect the slope of the U.S. Treasury curve and our net interest spread to be driven by inflation readings – either consistent with Fed expectations, a negative outcome, or a continuation of what we have seen for the last seven months.  The impact on longer term rates of the tapering of asset purchases by the Fed, if any, will also be critical.

"Outside of market developments, advisory services revenue continued to benefit from growth at Orchid Island. Advisory services revenue enabled us to grow our portfolio operations as mentioned above. The Company's retained interests continue to cash flow and add to funds available for deployment in the portfolio, although such cash flows have moderated somewhat in the past two quarters."

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Summarized Financial Statements

The following is a summarized presentation of the unaudited consolidated balance sheets as of September 30, 2017, and December 31, 2016, and the unaudited consolidated statements of operations for the nine and three months ended September 30, 2017 and 2016.  Amounts presented are subject to change.

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