Bimini Capital Management, Inc. (OTCQB:BMNM) Q2 2016 Results Earnings Conference Call August 10, 2016 10:00 AM ET
Robert Cauley - Chairman of the Board, Chief Executive Officer and Secretary
Good morning and welcome to the Second Quarter 2016 Earnings Conference Call for Bimini Capital Management. This call is being recorded today, August 10, 2016.
At this time, the company would like to remind the listeners that statements made during today’s conference call relating to matters that are not historical facts are forward-looking statements subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Listeners are cautioned that such forward-looking statements are based on information currently available on management’s good faith, belief with respect to future events and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in such forward-looking statements.
Important factors that could cause such differences are described in the company’s filings with the Securities and Exchange Commission, including the company’s most recent Annual Report on Form 10-K. The company assumes no obligation to update such forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking statements.
Now, I would like to turn the conference over to the company’s Chairman and Chief Executive Officer, Mr. Robert Cauley. Please go ahead, sir.
Thank you, operator, and good morning. Effective with 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 MortCo, our former mortgage company. This involved moving the MBS portfolio from Bimini to MortCo, among other things.
We initiated the process in late 2015 and continued to take these steps during the first two quarters of 2016. Going forward, the results of the MBS portfolio will continue to be presented in our financial statements as if the entire portfolio resided at Bimini, but this is simply because MortCo, as a 100% owned subsidiary, is consolidated. As of March 31, 2016, approximately 49% of the MBS portfolio was held by MortCo and the other 51% was still at Bimini. As of June 30, 2016, the allocation was 67% at MortCo and 33% at Bimini.
Please note as we report our results of operations on a consolidated basis, the balance of my remarks regarding the MBS portfolio will be based on the assumption there is only one portfolio, although I will continue to distinguish between the pass through and structured sub-portfolios.
Going to the second quarter of 2016, the portfolio grew slightly from $109.2 million at March 31, 2016 to $110.8 million at June 30, 2016 as the capital allocated to the portfolio increased from $9.9 million at March 31, 2016 to $11.3 million at June 30, 2016.
Net purchases were $4.7 million, all pass throughs, which exceeded $3.6 million of the various forms of runoff, pay downs and the associated premium lost due to pay down on pass throughs and return on investment on structured securities. Net mark to market gains for both sub-portfolios were $0.5 million. Note, premium lost due to pay downs is a component of the mark to market gain and losses from pass throughs. Inclusive of the premium lost due to pay downs on our pass through portfolio, the net gain would have been $0.2 million.
We will continue to transition the portfolios through sales at the Bimini level and purchases at the MortCo level funded by the proceeds. We currently have three repurchase agreement funding providers at the MortCo level versus two at March 31, 2016 and we’ll seek to add as the need arises. Since our intention is to ultimately have the entire MBS portfolio at MortCo, the Bimini and MortCo portfolios are run as if they are still one. There is no separation in strategy or positioning.
The portfolio generated a 7.7% return on invested capital for the period, not annualized. The returns for the two sub-portfolios were quite different with the market rally we experienced as they were designed to be, the MBS pass through portfolio generated a return on investment capital of 19.0%, benefiting from mark to market gains of $0.3 million. Conversely, the structured securities portfolio generated return of negative 10.6% as mark to market losses overwhelmed the interest income generated by the securities.
Repayments on the pass through portfolio declined from 11.8 CPR for the first quarter of 2016 to 7.8 CPR for the second quarter of 2016. The structured securities portfolio increased from 16.6 CPR during the first quarter to 20.4 CPR in the second quarter of 2016. Combined the portfolios slowed from 14.3 CPR in the first quarter of 2016 to 12.6 CPR in the second quarter.
Our portfolio remains 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. To date, the year 2016 has seen the market rally and expectations with respect to Fed policy actions have varied significantly from expecting 2 to 3 hikes in 2016 earlier in the year, at least according to the Fed, to expectations of potential cuts in rates shortly after the Brexit vote was announced in late June.
Such fear in the market has abated substantially in the third quarter. As we move further into the third quarter, the market has improved. The economic data, starting with the June non-farm payroll report on July 8, and again last Friday when the July report was issued, strengthened and the June report appears to have been an aberration.
The balance of the economic data since, at least pertaining to the consumer, has been strong and the economy appears to be well on its way to recovering from the slowdown in the first quarter. While GDP growth in the first quarter was less than 1% and growth in the second quarter appears to have been slightly over 1%, at least based on the advance received on late July, growth appears to be accelerating in the third quarter.
Secondly, the fall-out from the Brexit, as it was dubbed, appears to have been minimal. Since the event in late June, the European Central Bank has held a meeting and opted to maintain their current monetary policy as they wait to further assess the impact, if any, from the referendum.
The Bank of England announced significant steps recently, involving both a reduction of rates as well as substantial increases in asset purchases by the central bank. The markets have reacted accordingly as equities, both here and in Europe, have returned to levels seen before the vote, and in some cases higher. Interest rates have moved off the extreme lows seen immediately after the vote but have yet to reach pre-Brexit levels, as is the case with the British Pound.
Mortgages have tightened, especially over the last week or so, although they still trade at slightly wider levels than those seen before the vote. Importantly for us, primary mortgage rates did not react meaningfully to the sharp rally in rates as originators appear to be unable or unwilling to lower rates available to borrowers as much as the move in benchmark rates would suggest.
Given the turn in economic data the front end of the curve, and funding levels, have stabilized and are in fact higher than before the UK referendum. This has likely kept originators from lowering primary rates as their margins would just be squeezed further if they lowered rates to borrowers.
The significance of these events to us is that we will continue to focus the portfolio of risk exposure towards premium securities with high prepayment sensitivity, especially with respect to the pass through portfolio. The extended period of time that borrowers have been exposed to lower rates coupled with the hesitance of lenders aggressively pursuing refinancing opportunities described above, provided us with adequate comfort to maintain this posture. We do not envision another acceleration in speeds from here and expect August speeds to be released in early September to be the high watermark for the year before tapering off into the fall and winter.
As we disclosed earlier in the year, during the fourth quarter of 2015, we added additional shares of Orchid Island Capital at the MortCo 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 portfolio operations described above.
For the second quarter of 2016 the dividends on the Orchid shares were $0.6 million and we recorded $0.1 million on mark to market loss on the Orchid shares. In the future, we may continue to add shares of Orchid or reduce our holdings based on the relative attractiveness of Orchid shares versus MBS investment opportunities.
The second aspect of our operations is the advisory services performed by Bimini Advisors, another subsidiary, which is the external manager of Orchid. The advisory services operations generated revenues of $1.3 million for the second 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.
And finally, we continue to retain interests or residuals as they are commonly called from the securitizations of our former mortgage company conducted in 2004 through 2006. Cash flows from these residuals are available [indiscernible] MBS portfolio at MortCo and totaled $0.8 million for the first six months of the year.
That concludes my prepared remarks. Operator, we can now open up the call for questions.
[Operator Instructions] And our first question comes from the line of [Davis Atlas]
Congratulations on restarting or launching new ATM program on Orchid. So my question relates to the – I’m struggling over the language a little bit. I don't know have a background in accounting, the tax losses that you're planning to utilize, I think the number is $60 million and I’m not saying this quite correctly, but can you walk us through how you arrived at that number and maybe give some color commentary on what your confidence level is regarding that? What critical steps you feel like you need to achieve to get to that number? Anything that help me understand where that number came from and how solid it feels to you?
First of all, there are tax losses available at both Bimini, the parent, and MortCo, the former mortgage company. Based on the cash flows that the company is generating above and beyond cash flows needed to cover its expenses, we can project out those cash flows into the future and since we have the NOLs there is no obligation to pay any tax and therefore any cash flows that are generated, any profit if you will can be redeployed into the portfolio.
And so for purposes of coming up with an assumption in this deferred tax asset as it's called you basically take your current growth assumptions, the size of the existing portfolio and project that out over time, you make some assumptions on the net interest income that you will be receiving on future investments based on any absence or any information the contrary we basically assume that what we earn today is a proxy for what we will earn in the future.
And so this kind of cycle of organic growth if you will whereby we have excess cash flows today, we put those into the portfolio, the portfolio grows, we generate even more net interest income in the future and then again redeploy that net interest spread into the portfolio. So this growth continues to accelerate over time. Again, it's based on the starting point is today or in this case at the end of 2015, the size of the portfolio and those projected cash flows.
And you project those out over the life of the NOLs and then based on that you come up with some number for how much of those NOLs you expect to realize or harvest and that gives you this deferred tax asset. And under GAAP accounting rules we have to revisit that assumption at least annually. We do even more so than that. And we may have to adjust those assumptions based on any number of ultimate outcomes.
Now, one of the things that’s a component of that is the fact that we receive management fees from Orchid. So to the extent that Orchid is growing or not growing or at what rate it might grow, it will affect the cash flows we receive from that aspect of our business and again those tend to be ploughed right back into the portfolio to fund growth. So that's another element that has to be updated periodically.
It is an assumption at the end of the day. It’s based on a lot of inputs and it requires frequent revisiting. It was our best guess at the date. It's obviously heavily scrutinized by our auditors. But at the same time, they recognize it's nothing more than an assumption. They only require that it's reasonable and that you update it frequently.
Predictions are difficult, especially about the future. So I hear everything you said, thank you very much. I'm curious then about the landmarks you expect to achieve in terms of the size of the portfolio. Can you share some of those numbers in terms of what assumptions went into that model in terms of what milestones you think you need to hit to hit those numbers?
I don't have the projections in front of me. The existing portfolio was about $100 million when we started and as I said we started in a position where we were making more money. We have enough cash flow to cover our expenses with a margin so that we could continue to grow. Over time, by the time I think the NOLs, the last NOLs expire in the early 2030 at the Bimini level, the portfolio, I don’t remember the exact numbers, it does not get that large.
I’m going to say it’s in the hundreds of millions over the next almost 20 years. But again, a lot of assumptions went into that and I can kind of go over those – I mentioned one is the growth of the Orchid Island, the company Orchid Island and what that means for our management fees.
The net interest spread that we receive on the portfolio and for how much income we have to redeploy back into the portfolio, funding levels, yields on assets available to us, prepayment speeds on the portfolios we won, there's a number of assumptions. Again, the projection was where we were today going forward. So there's no hard fast numbers that we have to hit. It’s a combination of the output of all these assumptions really that drives that number.
If the management fee revenues grew more quickly than the portfolio, for example, or if the investment environment for the MBS portfolio wasn't as attractive, but have some growth in the size of the Orchid and thus the management fee revenues, then those levers so to speak would shift a little bit. I think the general assumption is there's going to be a modest amount of growth in both over the – both the size of the portfolio and the management fee revenues and those two things are connected.
So obviously the more attractive investing environment, the more likely Orchid is to be successful in its growth endeavors. And so those things can either compound on one another or if the market is really unattractive, the opposite can occur. So we can, in a period which really we’ve sort of been in for the last year where growth is not on the table because REIT stocks are trading at a large discount to book and the investing environment was tight. I think we've sort of turned the corner on that and have some opportunities for growth here both in the Bimini portfolio as well as the management fee revenues, but the market can change on a dime for sure.
Since I maybe the only caller, can I have one more quick question. Is this kind of a dumb question and I'm fully aware that it's a dumb, naive question. But can you explain in the simplest terms what kind of market environment is favorable versus unfavorable to your business? I read your quarterly reports and honestly I have difficulty to getting a takeaway in terms of what's good or bad to you economically. I don't understand the depth of your business, you explain this like you’re talking to a child.
Well, very simply what we do is not different from a bank. A bank makes loans and borrows money to fund those loans. We fund ourselves generally in the repo market and we invest in mortgage backed securities. So the greater the spread between the yield on our assets and the funding levels, the more profitable we are. In our press releases and so forth we talk a lot about the economy and how things are evolving and what the Fed's going to do and the reason that matters is because as we are on mortgage backed securities, the borrower has the controls when they refinance their mortgage.
So we don't control when we're going to get our money back at par. So to the extent we buy a security at a premium, in other words bond face value and that borrower refinances that hurts us because we lose whatever premium we paid about par. The way we position the portfolio is we tend to take a lot of exposure to refinancing activity, which means that when borrowers are refinancing a lot that's going to hurt us and when they're not that's going to be beneficial to us.
So really what that means in terms of what kind of markets are good for us, we like rates trending higher. We like signs that the economy is strengthening and maybe the Fed's going to be raising rates because that's going to tend to suppress refinancing activity. Our portfolio really reacts negatively to rallies, in other words when the yields are falling, we tend to do poorly. When yields are going higher, we tend to do well. So we're kind of positioned for a stronger economy, a recovery in the economy and/or prepayment activity declining. That's what really tends to drive our earnings.
That's specific to this particular rate environment as well, I mean since the financial crisis we've seen that the borrowers underlying the pools of mortgages we own are much less responsive to refinancing incentive than they were in years past say in the early 2000s or even IVs. And that’s a byproduct of a lot of different factors, but we feel comfortable in this environment, skewing our portfolio towards these higher premium securities which will do better if longer rates trend up.
The other element I guess to be incredibly simple is we'd love nothing more than for our funding rates to stay as low as they possibly can be forever, but we try to skew the balance of risks through our hedging in our premium portfolio to help offset the risk if rates do increase particularly on the long end of the curve, overwhelm so to speak the duration of our underlying portfolio. So the negatives that would occur are offset by both the income generating potential, the increased income generating potential of the portfolio as well as explicit gains in our funding hedges.
Thank you very much. That was excellent. That was perfect. Now, I get it.
All right. If you have more questions, feel free to call because we’re here every day and we love taking calls from investors, so don't hesitate.
[Operator Instructions] And I'm not showing any further questions at this time. I’d now like to turn the call back over to Mr. Robert Cauley for any closing remarks.
Thank you, operator, and everybody thank you for your time. To the extent you’re unable to listen to the call live and you hear the webcast and a question comes up, please don't hesitate to call us. We're here every day all day and the number 772-231-1400. We’re glad to answer any and all questions. Otherwise, we look forward to speaking with you next quarter. Thank you.
Ladies and gentlemen thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a great day.
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