Bimini Capital Management, Inc.

Robert Cauley - Chairman, CEO and Secretary George Haas - President, CFO, CIO and Treasurer

Thank you, operator. Good morning.

Developments that began to unfold during the first quarter and early second quarter of 2017 continued during the balance of the second quarter and early third quarter. Economic data, particularly inflation data, softened significantly.

The Trump administration appears to have lost most, if not all, of its momentum with respect to its legislative agenda. The administration's attempt to repeal and replace the Affordable Care Act thus far have failed and the administration will now likely face a political battle over the budget and debt ceiling early this fall.

The administration's momentum has been further sapped by the ongoing investigation to potential collusion with the Russian officials in the 2016 presidential election. The Federal Reserve, despite the fact that it raised rates by another 25 basis points in June and may announce a tapering of its asset purchases in September, has turned more dovish of late, particularly the chairwoman.

The equity markets were flushed with optimism as we entered 2017. With a pro-business administration taking the reign in Washington, risk assets generally rallied.

The stock market has continued to rally into the second and early third quarter, although not for the reasons anticipated. The economic data has been generally soft, inflation data has made a significant reversal and now all measures of consumer inflation are well below levels seen at the end of 2016.

Initially, the Fed and particularly the chairwoman, discounted the softness due to short term transitory causes such as cellular phone and prescription drug costs that were viewed as unsustainable. This rhetoric has reversed and recent comments from the Fed chair and other members of the FOMC suggest the Fed has become quite concerned with the level and direction of inflation measures.

The futures markets, the euro dollar, U.S. treasury and Fed funds have priced out most future rate hikes.

Current pricing applies, at most, one more full rate hike by the end of 2018. This is in sharp contrast to projections published by the Fed as recently as June 14 which called for one more rate hike this year, 3 next year and a terminal rate near 3%.

While the markets still expect the Fed to announce a tapering of its reinvestment of maturing U.S. treasury and MBS holdings likely after the conclusion of its September meeting, the market views any such actions as likely to suppress already low inflation.

During the second quarter, the spread between the 5-year and 30-year U.S. treasuries declined from approximately 110 basis points at beginning of the second quarter to less than 95 basis points at quarter-end.

The absence of any meaningful inflationary pressures are pervasive as both Europe and Asia are experiencing subdued inflation as well. As a result of these developments, the equity markets have rallied.

However, the factors that fueled the optimism at the end of 2016 never materialized and the market is faced with a vastly different reality. The prospect of robust growth, fiscal stimulus, renewed inflationary pressures and higher rates have been replaced with expectations for less Fed rate hiking, low inflation and lower long term rates.

During the second quarter of 2017, the yields on benchmark U.S. treasury securities were slightly higher on the curb out to 4 years, reflecting the 25 basis point hike in June.

Yields beyond the 4-year point of the curb declined modestly. The mortgage market had mixed results for the second quarter.

Current coupon 30-year mortgages traded at a slightly tighter spread to comparable duration U.S. treasuries at the end of the quarter, tightening approximately 2 basis points and tightening another 6 basis points at the end of the quarter.

Higher coupon mortgages underperformed comparable duration U.S. treasuries and lower coupon mortgages.

Prepayment speeds remain subdued despite the rally and longer maturities of the U.S. treasury curve.

We experienced mark-to-market losses on our funding hedges -- funding hedge positions as a result of this significant shift in expectations surrounding monetary policy going forward. With the widening in higher coupon fixed rate mortgages, our core holding, there was no offsetting price appreciation on the asset side.

Now, I will focus on developments at Bimini during the second quarter of 2017. To reiterate information that we have shared with you since early 2016, Bimini is no longer a REIT and our tax NOLs are essential to a 2-pronged strategy.

First, we will manage the portfolio and operations [indiscernible] on capital and collect management fees and overhead sharing payments through our subsidiary, Bimini Advisors. As Bimini Advisors is consolidated by Bimini for federal income tax purposes, we expect these operations will generate taxable income that could be used to absorb Bimini's net operating losses of approximately $19.1 million as of December 31, 2016.

Secondly, we will manage the portfolio at Royal Palm and hopefully generate sufficient taxable income to absorb up to $257 million of net operating losses as of December 31, 2016 at Royal Palm. As you all know, we also have retained interests or residuals at Royal Palm and these generate a modest cash flow stream over time.

Because of these tax net operating losses, all revenues in excess of our cost from the advisory services, the MBS portfolio at Royal Palm, dividends received on our Orchid Island shares and the residuals are available to be deployed in the MBS portfolio at Royal Palm until these NOLs either expire or are consumed. This, in turn, allows us to grow the portfolio and potentially increase net revenues in the future.

Now to our operations for the quarter. Advisory services revenue benefited from growth at Orchid Island during the first and second quarters.

Revenue from the management of Orchid Island Capital grew from $1.67 million in the first quarter of 2017 to $1.79 million in the second quarter of 2017. The comparable figure for the second quarter of 2016 was $1.27 million.

Dividends from our holdings of Orchid shares increased modestly, with the additional shares added during the first quarter and totaled $0.6 million. Turning now to the RMBS portfolio at Royal Palm Capital.

The pass-through portfolio incurred a modest mark-to-market gain for the quarter. Inclusive of this mark-to-market gain, net losses on our associated hedges, the pass-through portfolio posted a 4.2% gain for the quarter, not annualized.

The structured portfolio, due to unrealized mark-to-market losses, suffered a 1.1% loss for the quarter, not annualized, as the IO sub-portfolio was impacted by a modest rally in rates. Combined, the RMBS portfolio generated a 2.6% return for the quarter, again, not annualized.

The MBS portfolio increased slightly over 13% during the quarter as we added $19.2 million of pass-through MBS had paid down to $2.3 million in return of investment of $0.3 million on the structured portfolio. Aggregate mark-to-market gains were $0.2 million.

Since quarter-end, the portfolio has grown by approximately $14 million as we continue to invest free cash flows into the portfolio, increasing the income potential of the portfolio, enhancing our ability to utilize our NOLs at Royal Palm Capital. With the additions to the pass-through portfolio, the capital allocation of the pass-through portfolio increased to 76.3% versus 70.1% at March 31,2017.

The allocation to the structured securities portfolio declined from 29.9% at March 31, 2017 to 23.7% at June 30, 2017. These swings in our capital allocation are not intended to represent a strategic shift in our strategy as the changes to the structured securities portfolio are only temporary.

The purchases and sales we make can be rather lumpy as we cede to own round, lot-sized positions, so the positions are rather large in proportion of the total capital in the portfolio. Further, structured securities are not very compelling at the moment and we do plan to add when we've seen more attractive offerings.

Prepayment speeds on our pass-through securities increased modestly from 4.8 CPR for the first quarter of 2017 to 5.9 CPR for the second quarter of 2017. The structured securities portfolio increased as well from 18.8 CPR during the first quarter to 20.4 CPR in the second quarter of 2017.

Combined, the portfolios increased from 8.8 CPR in the first quarter of 2017 to 9.9 CPR in the second quarter of 2017. Royal Palm's portfolio experienced similar speeds in July based on the report issued last Friday.

Finally, the portfolio remains positioned for higher rate scenarios with high coupon -- with a high coupon fixed rate concentration with various forms of call-protected securities. Operator, that concludes my prepared remarks.

We'll now open up the call to questions.

So one of my recurring themes that I'd like to ask about is your progress with growing the managed portfolio in Orchid. And what I'm clearly seeing is that you had some great success with expanding the Orchid portfolio in the last quarter, exhausting the prior ATM program and, rather optimistically, immediately opening another one.

So from my perception, that seems to suggest that things are going well there, but in your Orchid call, you did suggest that you're having some troubles finding assets to buy due to competition from other players in the space. I just -- just generally, I'm very interested in what your view is in terms of how -- what your strategic direction is there in terms of growing the Orchid portfolio?

How well it's going? Any constraints on that growth and what your sort of short, medium and longer term goals are?

Just an ongoing update on that because it's obviously your #1 revenue driver there.

Yes, certainly. Well, as we implied on the call, as we mentioned, the market is not very attractive because of the capital raising done by our peers.

And we really have not been active in adding at all and probably will not as long as the market stays the way it is. We don't know what the future holds in terms of future capital raising by our peers, but especially in the case of Annaly where they raised such a large sum of cash in a short period of time, put a lot of pressure on the market and just created a lot of unattractive securities to own.

And so as long as that persists, we probably will not be active because, I mean, we, as you know, need to grow the Orchid portfolio, but you have to do so rationally. We're not just going to grow for the sake of growing and so it has to make sense on the asset side as well.

And Hunter wants to add into that.

No. I think that sums it up.

The two primary drivers of the decision-making, at least from Bob and I's perspective and then we present that to the Orchid's board and let them decide whether it's a good time to grow or not, is to have a favorable price-to-book ratio, preferably as large a premium as possible and also assets to buy. So right now, that calculus doesn't really lend itself to aggressive growth.

It did in the second quarter as 4.5% which is primary security, fixed rate 4.5%. So the lion's share of what Orchid owns cheapened significantly.

We were able to sort of add to them as they were -- add to that position as they were faltering in price with respect to hedges. So -- but right now, that's kind of shifted and payouts are very high and the investing environment is less compelling.

But it bounces around all the time. I'm sure by the time we talk next quarter that may be radically different.

So we'll just wait and take sort of a more long term view on the growth trajectory of Orchid.

And just one other thing I would add. With everybody anticipating the Fed's announcement next month and they're going to start to taper their reinvestment of paying -- pay-downs on their mortgage portfolio, it's kind of widely believed that mortgages will widen and they may very well.

But right now, if you look at the market, volatility is quite low. Volatility is very important for the mortgage market.

When it gets low, mortgages tend to look attractive. And if you look across various risk markets, spreads are pretty tight and so nothing is very compelling there.

And as a result, when you have a lot of multi-sector asset managers view the mortgage market as attractive, in addition to Annaly putting money to work, it just makes the mortgage market a little tight. So in terms of what that means for the fall and the widening that we expect with the Fed tapering, it really all depends on what goes on in other markets and with volatility.

If volatility stays low and credit spreads continue to tighten across the various credit markets, I don't know that you're going to see a lot of widening in mortgages because they just look attractive on a relative return basis. So we'll see what the future holds.

Okay. I get it.

So you react to the market as the events as they present. The second question.

And I know you answered -- you addressed this to some extent on the Orchid call, but I think it's -- unfortunately, it's kind of the elephant in the room. It has to be talked about which is our ongoing concern about the loss in book value in the Orchid side.

And it challenges -- from myself as an investor and looking at the situation and see that's not been a one quarter or one month phenomena, it's been pretty steady state. That might be my characterization.

You probably wouldn't agree with that. But do you want to comment on that in terms of what the challenges had been in the past and where we're going in the future?

I don't know, you can't know the future, but it is my #1 concern as an investor.

Yes. And it's ours as well.

You're right. It's been 3 quarters since the third quarter of 2016 when the book value was $11.21, I believe and declined for 3 quarters in a row.

In the case of the fourth quarter of last year, it was -- we kind of got whipsawed in July of 2016. The yield on the 10-year treasury reached its all-time low.

And then, the markets and ourselves were surprised by the outcome of the election, not just the fact that Trump won, but the Republicans gained and retained control of both houses. And the markets rallied and the equity markets rallied, the risk markets rallied and treasury sold off.

And so we got caught by that. And since then, we did reposition the portfolio more defensively and the market has since rallied and continues to rally.

It seems like the market doesn't want to price in any hiking for the Fed. And the fact that inflation has turned soft in the last 3 or 4 months hasn't helped.

So that's what drove the decline in the book value. I mean, if you're familiar with Orchid, you know we've had a very defensive position for some time now.

Position for higher rates, we tend to -- the risk that we take has to be in the form of prepayment risk. So we own securities that are very susceptible to prepayment, so higher coupon mortgages and IO's and inverse IO's.

The markets rallied and if it continues to, then we will have to reconsider our positioning and change to the extent we have to. So we're certainly aware of that and we'll see what the future holds, but we really can't continue to position that way indefinitely, given the fact that the market has not cooperated.

We still view the -- as we described in detail on the Orchid call, we still view the economy is quite strong and we think that the Fed, absent a complete collapse of inflation, still wants to normalize rates. And that -- given our positioning, that would do well, but we'll have to wait and see what plays out.

Thank you, operator and thank you for your time. To the extent you come up with call -- questions in the future or you didn't get a chance to listen to the call live, please call us at the office.

We will be glad to discuss anything. The number here is 772-231-1400.

Otherwise, we'll talk to you next time. Thank you.