Details of Third Quarter 2016 Results of Operations

Management of Orchid Island Capital, Inc.

Upon completion of its initial public offering, Orchid became externally managed and advised by Bimini and its MBS investment team pursuant to the terms of a management agreement. 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 income statement for the current period. For the three months ended September 30, 2016, Bimini's statement of operations included a fair value adjustment of $0.2 million and dividends of $0.6 million from its investment in Orchid common stock.  Also during the three months ended September 30, 2016, Bimini recorded $1.4 million in advisory services revenue for managing Orchid's portfolio consisting of $1.1 million of management fees and $0.3 million in overhead reimbursement.

Capital Allocation and Return on Invested Capital

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The tables below present the allocation of capital between the respective portfolios at September 30, 2016 and June 30, 2016, and the return on invested capital for each sub-portfolio for the three month period ended September 30, 2016.   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 2016, the Company received approximately $4.2 million in scheduled and unscheduled principal repayments and prepayments, which equated to a constant prepayment rate ("CPR") of approximately 13.6% for the third quarter of 2016. 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, 2016 and December 31, 2015:

 

Financing and Liquidity

As of September 30, 2016, the Company had outstanding repurchase obligations of approximately $126.0 million with a net weighted average borrowing rate of 0.74%.  These agreements were collateralized by MBS with a fair value, including accrued interest, of approximately $133.5 million.  At September 30, 2016, the Company's liquidity was approximately $6.2 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 listing of outstanding borrowings under repurchase obligations at September 30, 2016.

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, 2016, such instruments were comprised entirely of Eurodollar futures contracts. The tables below present information related to outstanding Eurodollar futures contracts at September 30, 2016.

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Management Commentary

Commenting on the third quarter, Robert E. Cauley, Chairman and Chief Executive Officer, said, "The economic trends in place over the course of the first and second quarters of 2016 reversed in the third quarter and into the fourth.  The broadest measure of economic growth in the United States, gross domestic product, or "GDP", appears to have rebounded back to around 2%, the level widely considered to be at or slightly above trend growth in the United States in the post Great Recession world. Interest rates, after falling precipitously early in the year and again after passage of the referendum in the United Kingdom known as "Brexit", have since stabilized and, earlier this month, moved back above levels seen just before the Brexit vote on June 23, 2016.  In fact, the yield on the 10 year US Treasury reached an all-time low yield shortly after the Brexit vote.  However, while the slow growth witnessed in the US over the first half of the year has ended, economic growth is by no means robust.  Many of the drags on growth, predominantly in the manufacturing and energy sectors, have stabilized but have not recovered meaningfully. The strongest sectors of the economy, the housing, consumer and labor markets, continue to perform relatively well and drive economic growth.  However, the net of all this activity appears to be modest growth accompanied by increasing, but not excessive, inflation.  Second quarter GDP growth was 1.4% and GDP growth for the third quarter was initially reported on October 28, 2016, at 2.9%. Inflation, especially the Federal Reserve's (the "Fed") preferred measure, personal consumption expenditures, was reported at 1.6% on the core level late last week.  Base line effects resulting from the sharp drop in oil prices in late 2014 and 2015 should cause this measure to continue to move towards 2%, the Fed's target level.

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"These conditions should allow the Fed to remove accommodation at a very gradual pace. To wit, the market now expects the Fed to raise rates before year end, probably at its December meeting. Public comments by various Fed governors and committee members have been consistent in supporting this expectation. Assuming incoming economic data remains supportive and financial conditions do not deteriorate, we expect the Fed to move rates higher by 25 bps at its December meeting. Nonetheless, it is equally likely, in the eyes of most market participants, that the Fed will not raise rates aggressively in 2017 and beyond. Public comments by the Fed officials described above are also consistent with this expectation. Accordingly, we expect the level of the U.S. Federal Funds ("Fed Funds") rate, and funding levels generally, only to move modestly higher over the next few years.

"With this backdrop in the economy and rates market, the mortgage market has performed well over the course of the third quarter of 2016. From a price perspective, the slight increase in rates over the course of the third quarter – the US treasury curve flattened modestly as two year yields increased by approximately 17.5 bps while the ten year treasury yields increased by approximately 12.5 bps – coupled with expectations that prepayment speeds would moderate, enabled 30 year fixed rate mortgages to tighten in spread to comparable duration treasuries. In fact, with rates up, prices of 30 year fixed rate 3% through 4.5% securities increased. The same is true of higher coupon 15 year, fixed rate securities, although to a lesser extent. From a prepayment perspective, speeds accelerated into the late summer post-Brexit and appear to have peaked in August, based on the report issued in early September.  However, speeds moderated only modestly in September – based on the report issued in early October.  Going forward the combination of higher rates – the MBA survey rate issued on October 20, 2016 was the highest since just before the Brexit vote – coupled with the seasonal slowdown in prepayments, should cause prepayment rates to decrease further. This in turn should be supportive of mortgage valuations. In addition, the Fed appears intent on continuing the reinvestment of pay-downs on its MBS holdings, and banks, particularly large banks, continue to add to their MBS holdings, both in securitized and whole-loan form.  Both of these trends are supportive of mortgage valuations as well.  A potential pitfall would be if the Fed, in an effort to steepen the curve, terminated, or significantly reduced, its reinvestment of pay-downs. Governor Eric Rosengren of the Boston Fed recently hinted at this possibility, although Fed leadership, Chair Yellen, Vice Chair Fischer and NY Fed governor Dudley, have not.

"A second consideration for mortgage valuations is pay-up premiums on call-protected securities.  We have a significant allocation of its portfolio to these securities. In spite of the increase in rates during the third quarter, and continuing into the fourth quarter, such pay-up premiums remain elevated, consistent with prepayment speeds. Going forward, if prepayment speeds moderate further, call protected security pay-up premiums could diminish. The Company will have to weigh the potential risks of continued pay-up premium erosion versus the need for prepayment protection as speeds have moderated only modestly so far.

"As we have discussed previously, beginning with the tax year 2015 Bimini is no longer a REIT for Federal income tax purposes.  Earlier this year we announced that we would take steps to take advantage of net operating losses available at both Bimini and our former mortgage company.  Incidentally, we recently changed the name of our former mortgage company from MortCo TRS, LLC to Royal Palm Capital, LLC ("Royal Palm"). The steps contemplated involved moving the MBS portfolio from Bimini to Royal Palm, among other things.  We took the initial steps in late 2015 and continued to do so during the first two quarters of 2016.  The process was completed during the third quarter of 2016, and now, the entire MBS portfolio resides at Royal Palm.  Going forward, the results of the MBS portfolio will continue to be presented as if the portfolio resides at Bimini, but this is simply because Royal Palm, as a 100% owned subsidiary, is consolidated. The second aspect of our operations is the advisory services performed by Bimini Advisors, another Bimini subsidiary, which is the external manager of Orchid.  Going forward discussions of the results of operations will be divided into these two areas.

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"Over the course of the third quarter of 2016 we increased the capital allocated to our MBS portfolio from $11.3 million to $13.5 million.  The portfolio continues to be biased towards higher coupon, fixed rate securities with various forms of prepayment protection, interest only and inverse interest only securities, and funding hedges positioned primarily on the belly of the curve. As the portfolio grew during the quarter, all of the capital was allocated to the PT MBS portfolio initially.  This caused the capital allocation to move heavily in favor of PT MBS, from 73.7% at June 30, 2016 to 80.4% at September 30, 2016. We have added to our IIO position since quarter end and will continue to migrate the allocation of capital into more balance going forward.  The net effect of economic and market developments in the period ended September 30, 2016 described above resulted in a small negative mark to market adjustment on our combined MBS portfolio and associated hedges, of approximately $0.02 million, and the portfolio generated a 7.9% return on invested capital for the period – not annualized.  The returns for the two sub-portfolios were both positive with the modest market sell-off we experienced.  The MBS pass-through portfolio generated a return on invested capital of 10.3%, inclusive of modest mark to market gains of approximately $0.04 million. Conversely, the structured securities portfolio generated a return of 1.3%, as small mark to market gains enhanced net positive, albeit modest, interest income generated by the securities of $0.02 million.  Prepayments on the pass-through portfolio increased from 7.8 CPR for the second quarter of 2016 to 9.4 CPR for the third quarter of 2016.  The structured securities portfolio decreased slightly from 20.4 CPR during the second quarter to 19.7 CPR in the third quarter of 2016.  Combined the portfolio speed increased from 12.6 CPR in the second quarter of 2016 to 13.6 CPR in the third quarter.

"Bimini has owned shares of Orchid since Orchid's inception.  During the fourth quarter of 2015 we added additional shares of Orchid at the Royal Palm level. We own these shares as proxies for exposure to the MBS portfolio although the dividends received on all of our Orchid shares are not a component of the total return of our MBS operations described above.  For the third quarter of 2016, the dividends on the Orchid shares were $0.6 million and we recorded $0.2 million on mark to market gains on the Orchid shares.

"The advisory services operations generated revenues of $1.4 million for the third quarter of 2016.  Such revenues are a function of the size of the capital base of Orchid, as adjusted, and the prorated allocation of certain Bimini overhead expenses, in both cases in accordance with the terms of the management agreement between the parties.

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Summarized Financial Statements

The following is a summarized presentation of the unaudited consolidated balance sheets as of September 30, 2016, and December 31, 2015, and the unaudited consolidated statements of operations for the nine and three months ended September 30, 2016 and 2015. Amounts presented are subject to change.

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