Attached files
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EX-32.1 - EXHIBIT 32.1 - Apollo Residential Mortgage, Inc. | a06302015exhibit321.htm |
EX-31.1 - EXHIBIT 31.1 - Apollo Residential Mortgage, Inc. | a06302015exhibit311.htm |
XML - IDEA: XBRL DOCUMENT - Apollo Residential Mortgage, Inc. | R9999.htm |
EX-31.2 - EXHIBIT 31.2 - Apollo Residential Mortgage, Inc. | a06302015exhibit312.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________
FORM 10-Q
_________________________________________
(Mark One)
þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended June 30, 2015
o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 001-35246
____________________________________________________
Apollo Residential Mortgage, Inc.
(Exact name of Registrant as specified in its charter)
____________________________________________________
Maryland | 45-0679215 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) |
Apollo Residential Mortgage, Inc.
c/o Apollo Global Management, LLC
9 West 57th Street, 43rd Floor
New York, New York 10019
(Address of Registrant’s principal executive offices)
(212) 515–3200
(Registrant’s telephone number, including area code)
____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer | o | Accelerated filer | þ | |||
Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date. As of August 10, 2015, there were 32,100,609 shares, par value $0.01, of the registrant’s common stock issued and outstanding.
TABLE OF CONTENTS
Page | |
2
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands—except share and per share data)
June 30, 2015 | December 31, 2014 | |||||||
(Unaudited) | ||||||||
Assets: | ||||||||
Cash and cash equivalents | $ | 113,350 | $ | 114,443 | ||||
Restricted cash | 77,116 | 69,006 | ||||||
Residential mortgage-backed securities, at fair value ($3,192,641 and $3,583,853 pledged as collateral, respectively) | 3,423,818 | 3,755,632 | ||||||
Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value | 178,904 | 104,438 | ||||||
Other investment securities, at fair value ($149,801 and $34,228 pledged as collateral, respectively) | 149,801 | 34,228 | ||||||
Other investments | 44,089 | 40,561 | ||||||
Mortgage loans, at fair value ($0 and $13,602 pledged as collateral, respectively) | — | 14,120 | ||||||
Investment related receivable ($131,407 and $168,705 pledged as collateral, respectively) | 136,128 | 191,455 | ||||||
Interest receivable | 10,389 | 10,455 | ||||||
Derivative instruments, at fair value | 17,617 | 11,642 | ||||||
Other assets | 1,370 | 2,073 | ||||||
Total Assets | $ | 4,152,582 | $ | 4,348,053 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Liabilities: | ||||||||
Borrowings under repurchase agreements | $ | 3,177,679 | $ | 3,402,327 | ||||
Non-recourse securitized debt, at fair value | 25,893 | 34,176 | ||||||
Investment related payable | 134,891 | 76,105 | ||||||
Obligation to return cash held as collateral | 11,366 | 2,546 | ||||||
Accrued interest payable | 8,551 | 13,026 | ||||||
Derivative instruments, at fair value | 8,736 | 8,949 | ||||||
Payable to related party | 4,600 | 4,968 | ||||||
Dividends and dividend equivalents payable | 19,192 | 18,305 | ||||||
Accounts payable, accrued expenses and other liabilities | 1,549 | 1,699 | ||||||
Total Liabilities | 3,392,457 | 3,562,101 | ||||||
Commitments and Contingencies (Note 14) | ||||||||
Stockholders’ Equity: | ||||||||
Preferred stock, $0.01 par value, 50,000,000 shares authorized, 6,900,000 shares issued and outstanding ($172,500 aggregate liquidation preference) | $ | 69 | $ | 69 | ||||
Common stock, $0.01 par value, 450,000,000 shares authorized, 32,100,609 and 32,088,045 shares issued and outstanding, respectively | 321 | 321 | ||||||
Additional paid-in capital | 794,045 | 793,274 | ||||||
Accumulated deficit | (34,310 | ) | (7,712 | ) | ||||
Total Stockholders’ Equity | 760,125 | 785,952 | ||||||
Total Liabilities and Stockholders’ Equity | $ | 4,152,582 | $ | 4,348,053 |
See notes to unaudited consolidated financial statements.
3
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(in thousands—except per share data)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Interest Income: | ||||||||||||||||
Residential mortgage-backed securities | $ | 35,818 | $ | 35,991 | $ | 71,432 | $ | 71,816 | ||||||||
Securitized mortgage loans | 3,623 | 1,927 | 5,790 | 4,173 | ||||||||||||
Other | 2,177 | 223 | 3,691 | 332 | ||||||||||||
Total Interest Income | 41,618 | 38,141 | 80,913 | 76,321 | ||||||||||||
Interest Expense: | ||||||||||||||||
Repurchase agreements | (7,901 | ) | (7,078 | ) | (15,366 | ) | (13,904 | ) | ||||||||
Securitized debt | (333 | ) | (432 | ) | (699 | ) | (874 | ) | ||||||||
Total Interest Expense | (8,234 | ) | (7,510 | ) | (16,065 | ) | (14,778 | ) | ||||||||
Net Interest Income | 33,384 | 30,631 | 64,848 | 61,543 | ||||||||||||
Other Income/(Loss), net: | ||||||||||||||||
Realized gain/(loss) on sale of residential mortgage-backed securities, net | (4,530 | ) | (7,072 | ) | 4,008 | (18,882 | ) | |||||||||
Realized gain on sale of other investment securities, net | 102 | — | 102 | — | ||||||||||||
Unrealized gain/(loss) on residential mortgage-backed securities, net | (41,354 | ) | 51,590 | (29,149 | ) | 102,237 | ||||||||||
Unrealized gain/(loss) on securitized debt | 1,001 | (364 | ) | 1,014 | (354 | ) | ||||||||||
Unrealized gain/(loss) on securitized mortgage loans, net | (1,896 | ) | 2,042 | 466 | 3,096 | |||||||||||
Unrealized gain/(loss) on other investment securities | (2,649 | ) | 54 | (2,678 | ) | 176 | ||||||||||
Realized and unrealized gain/(loss) on derivative instruments, net | 12,463 | (27,133 | ) | (14,058 | ) | (64,323 | ) | |||||||||
Other, net | (3 | ) | (49 | ) | 9 | (31 | ) | |||||||||
Other Income/(Loss), net | (36,866 | ) | 19,068 | (40,286 | ) | 21,919 | ||||||||||
Operating Expenses: | ||||||||||||||||
General and administrative (includes ($304), ($408), ($797) and ($867) of non-cash stock based compensation, respectively) | (3,655 | ) | (2,921 | ) | (7,505 | ) | (6,016 | ) | ||||||||
Management fee - related party | (2,895 | ) | (2,774 | ) | (5,682 | ) | (5,560 | ) | ||||||||
Total Operating Expenses | (6,550 | ) | (5,695 | ) | (13,187 | ) | (11,576 | ) | ||||||||
Net Income/(Loss) | $ | (10,032 | ) | $ | 44,004 | $ | 11,375 | $ | 71,886 | |||||||
Preferred Stock Dividends Declared | (3,450 | ) | (3,450 | ) | (6,900 | ) | (6,900 | ) | ||||||||
Net Income/(Loss) Allocable to Common Stock and Participating Securities | $ | (13,482 | ) | $ | 40,554 | $ | 4,475 | $ | 64,986 | |||||||
Earnings/(Loss) per Common Share - Basic | $ | (0.43 | ) | $ | 1.26 | $ | 0.13 | $ | 2.02 | |||||||
Earnings/(Loss) per Common Share - Diluted | $ | (0.43 | ) | $ | 1.25 | $ | 0.13 | $ | 2.01 | |||||||
Dividends Declared per Share of Common Stock | $ | 0.48 | $ | 0.42 | $ | 0.96 | $ | 0.82 |
See notes to unaudited consolidated financial statements.
4
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
(in thousands—except share data)
Preferred Stock | Common Stock | Additional Paid- In Capital | Accumulated Deficit | Total | ||||||||||||||||||||||
Shares | Par | Shares | Par | |||||||||||||||||||||||
Balance at December 31, 2014 | 6,900,000 | $ | 69 | 32,088,045 | $ | 321 | $ | 793,274 | $ | (7,712 | ) | $ | 785,952 | |||||||||||||
Restricted stock grants | — | — | 9,332 | — | — | — | — | |||||||||||||||||||
Net settlement of vested restricted stock units in common stock | — | — | 3,232 | — | (26 | ) | — | (26 | ) | |||||||||||||||||
Equity based compensation expense | — | — | — | — | 797 | — | 797 | |||||||||||||||||||
Net income | — | — | — | — | — | 11,375 | 11,375 | |||||||||||||||||||
Dividends declared on preferred stock | — | — | — | — | — | (6,900 | ) | (6,900 | ) | |||||||||||||||||
Dividends declared on common stock, restricted stock and restricted stock units | — | — | — | — | — | (31,073 | ) | (31,073 | ) | |||||||||||||||||
Balance at June 30, 2015 | 6,900,000 | $ | 69 | 32,100,609 | $ | 321 | $ | 794,045 | $ | (34,310 | ) | $ | 760,125 |
See notes to unaudited consolidated financial statements.
5
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
Six Months Ended June 30, | ||||||||
2015 | 2014 | |||||||
Cash Flows from Operating Activities: | ||||||||
Net income | $ | 11,375 | $ | 71,886 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Premium amortization/(discount accretion), net | (16,916 | ) | (11,839 | ) | ||||
Amortization of deferred financing costs | 250 | 214 | ||||||
Equity based compensation expense | 797 | 867 | ||||||
Unrealized (gain)/loss on mortgage-backed securities, net | 29,149 | (102,237 | ) | |||||
Unrealized (gain) on securitized mortgage loans, net | (466 | ) | (3,096 | ) | ||||
Unrealized (gain)/loss on derivative instruments, net | (7,835 | ) | 33,185 | |||||
Unrealized (gain)/loss on securitized debt | (1,014 | ) | 354 | |||||
Unrealized (gain)/loss on other investment securities | 2,678 | (176 | ) | |||||
Realized (gain) on sales of mortgage-backed securities | (13,763 | ) | (3,392 | ) | ||||
Realized loss on sales of mortgage-backed securities | 9,755 | 22,274 | ||||||
Realized loss on derivative instruments | 12,009 | 21,268 | ||||||
Realized loss on real estate owned, net | 1,128 | 68 | ||||||
Realized (gain) on sale of other investment securities, net | (102 | ) | — | |||||
Depreciation on bond for title contracts | 179 | — | ||||||
Changes in operating assets and liabilities: | ||||||||
Decrease in accrued interest receivable, less purchased interest | 195 | 330 | ||||||
Decrease in other assets | 456 | 102 | ||||||
(Increase)/decrease in accrued interest payable | (4,475 | ) | 2,369 | |||||
Decrease in accounts payable and accrued expenses | (226 | ) | (1,261 | ) | ||||
Decrease in payable to related party | (440 | ) | (285 | ) | ||||
Decrease in other liabilities | 76 | — | ||||||
Net cash provided by operating activities | 22,810 | 30,631 | ||||||
Cash Flows from Investing Activities: | ||||||||
Purchases of mortgage-backed securities | (1,353,785 | ) | (732,928 | ) | ||||
Proceeds from sales of mortgage-backed securities | 1,581,047 | 647,859 | ||||||
Purchases of mortgage loans, simultaneously securitized | (67,357 | ) | — | |||||
Purchase of other investment securities | (142,383 | ) | (953 | ) | ||||
Proceeds from sales of other investment securities | 17,679 | — | ||||||
Warehouse line advances | (3,525 | ) | (13,462 | ) | ||||
Payments received on warehouse line | 11,687 | — | ||||||
Purchase of real estate subject to sale agreements | (8,711 | ) | — | |||||
Purchase of mortgage loans | (2,512 | ) | — | |||||
(Increase)/decrease in restricted cash related to investing activities | 805 | (9,193 | ) | |||||
Increase/(decrease) in cash collateral held related to investing activities | 8,820 | (27,228 | ) | |||||
Principal payments received on mortgage-backed securities | 209,146 | 137,282 | ||||||
Principal payments received on securitized mortgage loans | 5,512 | 3,913 | ||||||
Principal payments received on other investment securities | 7,565 | 802 | ||||||
Principal payments received on other investments | 191 | — | ||||||
Principal payments received on mortgage loans | 210 | — | ||||||
Payments made for termination of derivative instruments | (1,977 | ) | (6,424 | ) | ||||
Purchase of interest rate swaptions | (8,385 | ) | (11,537 | ) | ||||
Other, net | 14 | 31 | ||||||
Net cash provided/(used) by investing activities | 254,041 | (11,838 | ) |
(Continued on next page.)
6
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
(Continued.)
Six Months Ended June 30, | ||||||||
2015 | 2014 | |||||||
Cash Flows from Financing Activities: | ||||||||
Proceeds from repurchase agreement borrowings | 7,943,331 | 5,621,450 | ||||||
Repayments of repurchase agreement borrowings | (8,167,979 | ) | (5,663,519 | ) | ||||
Increase/(decrease) in restricted cash related to financing activities | (8,915 | ) | 31,559 | |||||
Principal payments on securitized debt | (7,269 | ) | (5,052 | ) | ||||
Payments made for deferred financing costs | — | (169 | ) | |||||
Dividends paid on preferred stock | (6,900 | ) | (6,900 | ) | ||||
Dividends paid on common stock and dividend equivalent rights | (30,186 | ) | (26,107 | ) | ||||
Payments related to delivery of common stock for settlement of restricted stock units | (26 | ) | — | |||||
Net cash used by financing activities | (277,944 | ) | (48,738 | ) | ||||
Net decrease in cash | (1,093 | ) | (29,945 | ) | ||||
Cash and cash equivalents at beginning of period | 114,443 | 127,959 | ||||||
Cash and cash equivalents at end of period | $ | 113,350 | $ | 98,014 |
Supplemental Disclosure of Operating Cash Flow Information: | ||||||||
Interest paid | $ | 19,936 | $ | 12,968 | ||||
Supplemental disclosure of non-cash financing/investing activities: | ||||||||
Residential mortgage-backed securities (purchased)/sold not settled, net | $ | (3,322 | ) | $ | (13,299 | ) | ||
Due from broker | $ | 4,559 | $ | 3,136 | ||||
Dividends and dividend equivalent rights declared, not yet paid | $ | 19,192 | $ | 17,124 | ||||
Deferred financing costs not yet paid | $ | — | $ | 14 |
See notes to unaudited consolidated financial statements.
7
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Unless the context requires otherwise, references to “we,” “us,” “our,” “AMTG” or “Company” refer to Apollo Residential Mortgage, Inc., as consolidated with its subsidiaries and variable interest entities (or, VIEs) in which we are the primary beneficiary. The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” refers to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the United States (or, U.S.) Government, such as Ginnie Mae; “Agency Inverse Floater” refers to securities that have a floating interest rate with coupons that reset periodically based on an index and which coupon varies inversely with changes in index, which index is typically the one month LIBOR; “Agency IO” and “Agency Inverse IO” refers to Agency interest-only and Agency inverse interest-only securities, respectively, which receive some or all of the interest payments, but no principal payments, made on a related series of Agency RMBS, based on a notional principal balance; “Agency RMBS” refer to RMBS issued or guaranteed by an Agency; “Alt-A” refers to residential mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to Agency underwriting guidelines and generally allow homeowners to qualify for a mortgage loan with reduced or alternate forms of documentation; “ARMs” refer to adjustable rate mortgages; “ARM RMBS” refer to RMBS collateralized by ARMs; “BFT Contracts” refer to bond for title contracts which are agreements to sell real estate; “CMOs” refer to collateralized mortgage obligation bonds; “December 2014 Pool” refers to the loan pool we purchased in December 2014; “Fannie Mae” refers to the Federal National Mortgage Association; “February 2013 Pool” refers to the loan pool we purchased in February 2013; “February 2013 Securitization” refers to the securitization that we transacted in February 2013 simultaneously with the purchase of the February 2013 Pool; “Freddie Mac” refers to the Federal Home Loan Mortgage Corporation; “Hybrids” refer to mortgage loans that have fixed interest rates for a period of time and, thereafter, generally adjust annually based on an increment over a specified interest rate index; “LIBOR” refers to the London Interbank Offered Rate; “Long TBA Contracts” refer to TBA Contracts for which we would be required to buy certain Agency RMBS on a forward basis; “March 2015 Pool” refers to the loan pool we purchased in March 2015; “March 2015 Securitization” refers to the securitization that we transacted in March 2015, combining the December 2014 Pool with the March 2015 Pool, for which we retained the security issued in the securitization; “non-Agency RMBS” refer to RMBS that are not issued or guaranteed by an Agency; “Option ARMs” refer to mortgages that provide the mortgagee payment options, which may initially include a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment or a 30-year fully amortizing payment; “REO” refers to real estate owned as a result of foreclosure on mortgage loans; “Risk Sharing Securities” refer to securities issued by Fannie Mae and/or Freddie Mac which are structured to be subject to the performance of referenced pools of residential mortgage loans and represent unsecured general obligations of the issuing Agency; “RMBS” refer to residential mortgage-backed securities; “SBC-MBS” refer to small balance commercial-mortgage-backed securities; “Seller Financing Program” refers to our initiative whereby we provide advances through a warehouse line to a third party to finance the acquisition and improvement of single family homes and, once the homes are improved, they are marketed for sale, with the seller providing financing to the buyer in the form of a mortgage loan or a BFT Contract; “Short TBA Contracts” refer to TBA Contracts for which we would be required to sell certain Agency RMBS on a forward basis; “Subprime” refers to mortgage loans that have been originated using underwriting standards that are less restrictive than those used to originate prime mortgage loans; “Swaps” refer to interest rate swap contracts where we agree to pay a fixed rate of interest and receive a variable rate of interest based on the notional amount of the interest rate swap contract; “Swaptions” refer to option contracts that allow us to enter into a Swap at the expiration of the option period; “TBA Contracts” refer to to-be-announced contracts to purchase or sell certain Agency RMBS on a forward basis and “VIE” refers to a variable interest entity.
Note 1– Organization
We were incorporated as a Maryland corporation on March 15, 2011 and commenced operations on July 27, 2011. We are externally managed and advised by ARM Manager, LLC (or, Manager), an indirect subsidiary of Apollo Global Management, LLC (together with its subsidiaries,“Apollo”).
We operate and have elected to qualify as a real estate investment trust (or, REIT) under the Internal Revenue Code of 1986, as amended (or, Internal Revenue Code), commencing with the taxable year ended December 31, 2011. We also operate our business in a manner that allows us not to register as an investment company as defined under the Investment Company Act of 1940 (or, 1940 Act).
We invest on a levered basis in residential mortgage and mortgage-related assets in the U.S. At June 30, 2015, our portfolio was comprised of: (i) Agency RMBS, (which include pass-through securities whose underlying collateral primarily includes 30 year fixed-rate mortgages), Agency IO, Agency Inverse IO and Agency Inverse Floater securities; (ii) non-Agency RMBS; (iii) securitized mortgage loans; (iv) other mortgage-related securities; (v) mortgage loans; and (vi) other real estate related investments associated with our Seller Financing Program. Over time, we may invest in a broader range of other residential mortgage and mortgage-related assets.
8
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 2 – Summary of Significant Accounting Policies
(a) | Basis of Presentation and Consolidation |
The interim unaudited consolidated financial statements include our accounts and those of our consolidated subsidiaries and a VIE in which we are the primary beneficiary. All intercompany amounts have been eliminated in consolidation. We currently operate as one business segment.
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (or, GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
In the opinion of management, all adjustments have been made (which include only normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014, which was filed with the Securities and Exchange Commission (or, the SEC) on February 19, 2015. Our results of operations for the quarterly period ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year or any other future period.
(b) | Cash and Cash Equivalents |
We consider all highly liquid short term investments with original maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. We deposit our cash with what we believe to be high credit quality institutions. From time to time, our cash may include amounts pledged to us by our counterparties as collateral for our derivative instruments. At June 30, 2015 and December 31, 2014, our cash and cash equivalents were primarily comprised of cash on deposit with our prime broker (which is domiciled in the U.S.); substantially all of which was in excess of applicable insurance limits and, we had $40,005 and $40,000 invested in a money market fund at June 30, 2015 and December 31, 2014, respectively. Included in cash and cash equivalents was cash pledged by our counterparties to us of $11,366 and $2,546 at June 30, 2015 and December 31, 2014, respectively.
(c) | Obligation to Return Cash Held as Collateral |
From time to time, we may hold cash pledged as collateral to us by certain of our derivative counterparties as a result of margin calls made by us. Cash pledged to us is unrestricted in use and, accordingly, is included as a component of cash on our consolidated balance sheets. In addition, a corresponding liability is reported as an obligation to return cash held as collateral.
(d) | Restricted Cash |
Restricted cash represents cash held by our counterparties as collateral against our repurchase agreement borrowings, Swaps or other derivative instruments. Restricted cash is not available for general corporate purposes, but may be applied against amounts due to counterparties under our repurchase agreement borrowings and Swaps, or returned to us when our collateral requirements are exceeded or at the maturity or termination of the derivative instrument or repurchase agreement.
(e) Investment Securities and Securitized Mortgage Loans
Our investment securities, which are comprised of RMBS and other investment securities, are designated as available for sale. Our RMBS portfolio is comprised of mortgage pass-through certificates, CMOs, including Agency IO and Agency Inverse IO representing interests in or obligations backed by pools of mortgage loans. Our securitized mortgage loans, which are designated as held for investment, are presented on our balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” These mortgage loans are comprised of pools of performing, re-performing and non-performing mortgage loans that we purchased at a discount to principal balance.
At June 30, 2015, our other investment securities were comprised of investments in Risk Sharing Securities issued by Freddie Mac and Fannie Mae and SBC-MBS. Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property. In some instances, certain of the mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principals of the related business and/or borrowing entity. Our investments in Risk Sharing Securities and SBC-MBS are included in “Other investment securities, at fair value” on
9
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
our consolidated balance sheet. Interest income on our Risk Sharing Securities is included in “Interest Income - Other” and changes in the estimated fair value of such securities is included in “Unrealized gain/(loss) on other investment securities” on our consolidated statements of operations.
Balance Sheet Presentation
Purchases and sales of our investment securities are recorded on the trade date. Our RMBS and other investment securities pledged as collateral against borrowings under repurchase agreements are included in “Residential mortgage-backed securities, at fair value” and “Other investment securities, at fair value” on our consolidated balance sheet, respectively, with the fair value of securities pledged disclosed parenthetically. Amounts receivable/payable associated with sales/purchases of securities at the balance sheet date are reflected on our consolidated balance sheet as “Investment related receivable” and “Investment related payable,” respectively.
For purposes of determining the applicable accounting policy with respect to our investment securities, we review credit ratings available from each of the three major credit rating agencies (i.e. Moody’s Investors Services, Inc., Standard & Poor’s Ratings Services and Fitch, Inc.) for each investment security at the time of purchase and apply the lowest rating.
The aggregate fair value of the mortgage loans associated with our securitization transactions are presented on our consolidated balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” (See Notes 5 and 15.)
Impairments
Investment Securities: We have elected the fair value option of accounting for our investment securities and, as such, all changes in the market value of our investment securities are recorded through earnings, including other-than-temporary impairments (or, OTTI), if any. When the fair value of an investment security is less than its amortized cost at the balance sheet date, the security is considered impaired. We assess our impaired securities on at least a quarterly basis and designate such impairments as either “temporary” or “other-than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell an impaired security before its anticipated recovery, then we recognize an OTTI, which reduces the amortized cost basis of the impaired security. Following the recognition of an OTTI, a new cost basis is established for the security. Changes in the fair value of the security on which an OTTI charge was made will be reflected in unrealized gains/(losses) but will not result in a change to the amortized cost of the impaired security. Increases in interest income may be recognized on a security that an OTTI charge was taken, if the performance of such security subsequently improves. The determination as to whether an OTTI exists is subjective, given that such determination is based on information available at the time of assessment as well as our Manager’s estimate of the future performance and cash flow projections for the individual security. (See Notes 4 and 6.)
Securitized Mortgage Loans: We have elected the fair value option of accounting for our securitized mortgage loans and, as such, all changes in the estimated fair value of our securitized mortgage loans are recorded through earnings, including a provision for loan losses, if any. Our securitized mortgage loans had evidence of deterioration of credit quality at the time of acquisition. We analyze our securitized mortgage loan pool at least quarterly to assess the actual performance compared to the expected performance. If the revised cash flow estimates on our securitized mortgage loans provide a lower yield than the previous yield, we recognize a provision to loan losses (i.e., a reduction in the amortized cost of the securitized mortgage loans that is recorded in earnings) in an amount such that the yield will remain unchanged. If cash flow estimates on our securitized mortgage loans increase subsequent to recording a provision to loan losses, we will reverse previously recognized provision for loan losses before any increase to the yield is made. (See Note 5.)
(f) Designation and Fair Value Option Election
To date, we have elected the fair value option of accounting for all of our investment securities, at the time of purchase, and our securitized debt, when initially incurred. As a result of the fair value election on such assets/liabilities, we record the change in the estimated fair value of such assets and liabilities in earnings as unrealized gains/(losses). We generally intend to hold our investment securities to generate interest income; however, we have and may continue to sell certain of our investment securities as part of the overall management of our assets and liabilities and operating our business. Realized gains/(losses) on the sale of investment securities are recorded in earnings using the specific identification method.
Our securitized mortgage loans are considered held for investment purposes, as we expect that we will be required to continue to consolidate the VIEs in which such loans are held and generally do not have the authority to sell the mortgage loans held in such VIEs. Consistent with our investments in RMBS, we have elected the fair value option for our securitized mortgage loans and, as a result, we record changes in the estimated fair value of such assets in earnings as unrealized gains/(losses).
10
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
We believe that our election of the fair value option for our investment securities, securitized mortgage loans and securitized debt improves financial reporting, as such treatment is consistent with how we present the changes in the fair value of our Swaps, Swaptions and TBA Contracts, all of which are derivative instruments, through earnings.
(g) | Interest Income Recognition |
Investment Securities
Interest income on investment securities is accrued based on the outstanding principal balance and the current coupon interest rate on each security. In addition, premiums and discounts associated with Agency RMBS, non-Agency RMBS and other investment securities rated AA and higher by a nationally recognized statistical rating organization at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. In order to determine the effective yield, we estimate prepayments for each security. For those securities, if prepayment levels differ, or are expected to differ in the future from our previous assessment, we adjust the amount of premium amortization recognized in the period that such change is made, applying the retrospective method, resulting in a cumulative catch-up reflecting such change. To the extent that prepayment activity varies significantly from our previous prepayment estimates, we may experience volatility in our interest income. For Agency pass-through RMBS that we acquired subsequent to June 30, 2013, we do not estimate prepayments to determine premium amortization or discount accretion on such securities. Instead, the amount of premium amortization/discount accretion on Agency pass-through RMBS acquired subsequent to June 30, 2013 is based upon actual prepayment experience, which may vary significantly over time.
For Agency IO, Agency Inverse IO and Agency Inverse Floaters, income is accrued based on the amortized cost and the effective yield. Cash received on Agency IO and Agency Inverse IO is first applied to accrued interest and then to reduce the amortized cost. At each reporting date, the effective yield is adjusted prospectively based on the current cash flow projections, which reflect prepayment estimates and the contractual terms of the security.
Interest income on non-Agency RMBS and other investment securities rated below AA or not rated by a nationally recognized statistical rating organization is recognized based on the effective yield method of accounting. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on our observation of current information and events and include assumptions related to the future path of interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models and our judgment about interest rates, prepayment speeds, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and the payment priority structure of the security; therefore, actual maturities are generally shorter than the stated contractual maturities of the underlying mortgages. Based on the projected cash flows for our non-Agency RMBS, we generally expect that a portion of the purchase discount on such securities will not be recognized as interest income and is instead viewed as a credit discount. The credit discount mitigates our risk of loss on our non-Agency securities. The amount considered to be credit discount may change over time, based on the actual performance of the underlying mortgage collateral, actual and projected cash flows from such collateral, economic conditions and other factors. If the performance of a non-Agency RMBS with a credit discount is more favorable than forecasted, we may accrete more discount into interest income than expected at the time of purchase or when performance was last assessed. Conversely, if the performance of a non-Agency RMBS with a credit discount is less favorable than forecasted, the amount of discount accreted into income may be less than expected at the time of purchase or when performance was last assessed and/or impairment and write-downs of such securities to a new lower cost basis could result.
Securitized Mortgage Loans and Mortgage Loans
Application of the interest method of accounting for our pools of securitized mortgage loans and mortgage loans requires the use of estimates to calculate a projected yield. We calculate the yield based on the projected cash flows for each pool of mortgage loans. To the extent the actual performance of a loan pool is better than last expected, the yield is adjusted upward prospectively to reflect the revised estimate of cash flows over the remaining life of such mortgage pool. However, if the revised cash flow estimates on a loan pool provides a lower yield than the original or the last calculated yield, we recognize an OTTI (i.e., a reduction in the amortized cost of the loan pool that is recorded in earnings) such that the yield will remain unchanged. Decreasing yields arising solely from a change in the contractual interest rate on variable rate loans are not treated as an OTTI. If future cash collections are materially different in amount or timing than projected cash collections, earnings could be affected, either positively or negatively.
11
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
On at least a quarterly basis, our Manager reviews and, if appropriate, makes adjustments to cash flow projections based on input and analysis received from external sources, internal models and our Manager’s judgment about interest rates, prepayment speeds, home prices, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such loans and/or the recognition of an OTTI.
Warehouse Line Receivable
We accrue interest income on our warehouse line receivable, which is included as a component of our “Interest income-other” and “Other investments,” on our consolidated financial statements, based on the contractual terms governing the warehouse line receivable agreement. We assess the collectability of the warehouse receivable and associated income on at least a quarterly basis.
(h) | Investment Consolidation and Transfers of Financial Assets |
We evaluate the underlying entity that issues securities we acquire or to which we make a loan to determine the appropriate accounting methods.
In VIEs, an entity is subject to consolidation if the equity investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities or are not exposed to the entity’s losses or entitled to its residual returns. VIEs that meet certain scope characteristics are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This determination can sometimes involve complex and subjective analyses. We are required on an ongoing basis to assess whether we are the primary beneficiary of a VIE.
With respect to our securitizations, we consolidate the VIEs/securitization trusts that were created to facilitate the transactions and to which the underlying assets in connection with the securitizations were transferred. In determining the accounting treatment to be applied to securitization transactions, we evaluate whether the entity used to facilitate the transactions was a VIE and, if so, whether it should be consolidated. Based on our evaluations, we have concluded since inception of our securitizations that the VIEs should be consolidated. If we determine in the future that consolidation is not required for a securitization, we would have to assess whether the transfer of the underlying assets qualify as a sale or should be accounted for as secured financings under GAAP.
We may periodically enter into transactions in which we sell assets. Upon a transfer of financial assets, we may sometimes retain or acquire senior or subordinated interests in the related assets. In connection with such transactions, a determination must be made as to whether we, as the transferor, have surrendered control over transferred financial assets. That determination must consider our continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. The financial components approach under applicable GAAP limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. It defines the term “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale.
From time to time, we may securitize mortgage loans we hold if such securitization allows us access to better financing terms. Depending upon the structure of the securitization transaction these transactions will be accounted for as either a “sale” and the loans will be removed from the consolidated balance sheet or, as a “financing” with the loans remaining on our consolidated balance sheet. Significant judgment may be exercised by us in determining whether a transaction should be recorded as a “sale” or a “financing.”
(i) | Deferred Financing Costs |
Costs incurred in connection with securing our financings are capitalized and amortized using the effective interest rate method over the respective financing term with such amortization reflected on our consolidated statements of operations as a component of interest expense. Our deferred financing costs may include legal, accounting and other related fees. These deferred charges are included on our consolidated balance sheet as a component of “Other assets.” The amortization of deferred charges associated with our securitized debt is adjusted to reflect actual repayments of the securitized debt.
12
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(j) | Earnings Per Share |
Earnings per share (or, EPS) is computed using the two-class method of accounting, which includes the weighted-average number of shares of common stock outstanding during the period and other securities that participate in dividends, such as our unvested restricted stock and restricted stock units (or, RSUs), to arrive at total common equivalent shares. In applying the two-class method, earnings are allocated to both shares of common stock and securities that participate in dividends based on their respective weighted-average shares outstanding for the period. During periods of net loss, losses are allocated only to the extent that the participating securities are required to absorb such losses. (See Note 18.)
(k) | Derivative Instruments |
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments, currently comprised of Swaps, Swaptions and, from time to time, TBA Contracts as part of our interest rate risk management. We view our derivative instruments as economic hedges, which we believe mitigate interest rate risk associated with our borrowings under repurchase agreements and/or the fair value of our RMBS portfolio. We do not enter into derivative instruments for speculative purposes.
All derivatives are reported as either assets or liabilities on the balance sheet at estimated fair value. We have not elected hedge accounting for our derivative instruments and, as a result, changes in the fair value for our derivatives are recorded in earnings. The fair value adjustments, along with the related interest income or interest expense, are recognized in the consolidated statements of operations in the line item “Realized and unrealized gain/(loss) on derivative instruments, net.”
To-Be-Announced Securities
TBA Contracts are forward contracts for the purchase or sale of Agency RMBS by a specified issuer and for a specified face amount, coupon and stated term, at a predetermined price on the date stated in the contract. The particular Agency RMBS as identified by a Committee on Uniform Securities Identification Procedures number (known as a CUSIP) delivered into the contract upon the settlement date are not known at the time of the transaction. We recognize in earnings unrealized gains and losses associated with TBA Contracts that are not subject to the regular-way exception, which applies: (i) when there is no other way to purchase or sell that security; (ii) if delivery of that security and settlement will occur within the shortest period possible for that type of security and (iii) if it is probable at inception and throughout the term of the individual contract that physical delivery of the security will occur. Changes in the value of our TBA Contracts and realized gains or losses on settlement are recognized in our consolidated statements of operations in the line item “Realized and unrealized gain/(loss) on derivative instruments, net.”
(l) | Repurchase Agreements |
Investment securities financed under repurchase agreements are treated as collateralized borrowings, unless they meet sale treatment or are deemed to be linked transactions. As of June 30, 2015, none of our repurchase agreements had been accounted for as linked transactions. As of June 30, 2015, all securities financed through a repurchase agreement have remained on our consolidated balance sheet as an asset (with the fair value of the securities pledged as collateral disclosed parenthetically) and cash received from the lender was recorded on our consolidated balance sheet as a liability. However, securities associated with the February 2013 Securitization are eliminated in consolidation with the VIE. Interest paid and accrued in connection with our repurchase agreements is recorded as interest expense.
(m) | Stock-based Payments |
We account for stock-based awards granted to our independent directors, to our Manager and to employees of our Manager and its affiliates using the fair value based methodology prescribed by GAAP. Expense related to restricted common stock issued to our independent directors is based on the fair value of our common stock on the grant date, and amortized into expense over the award vesting period on a straight-line basis. Expense related to RSUs issued to our Manager and to employees of our Manager and its affiliates are based on the estimated fair value of such award at the grant date and are remeasured quarterly for unvested awards. We measure the fair value of our RSUs using the price of our common stock and other measurement assumptions, including implied volatility and discount rates. We use the graded vesting attribution method of accounting to amortize expense related to RSUs granted to our Manager and its affiliates.
(n) | Income Taxes (Amounts in this Note 2(n) are not presented in thousands.) |
We elected to be taxed as a REIT for U.S. Federal income tax purposes, commencing with our taxable year ended December 31, 2011. Pursuant to the Internal Revenue Code, a REIT that distributes at least 90% of its net taxable income,
13
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
excluding net capital gains, as a dividend to its stockholders each year and which meets certain other conditions, will not be taxed on the portion of its taxable income that is distributed to its stockholders. We expect to meet the conditions required to enable us to continue to operate as a REIT and to distribute all of our taxable income, including net capital gains for the periods presented and therefore we have not recorded any provisions for income taxes on our consolidated statements of operations through June 30, 2015.
As of December 31, 2014, we had estimated net capital loss carryforward amounts of $84.0 million which may be carried forward and applied against future net capital gains. Our capital loss carryforward amounts will reduce the amount of future capital gains, if any, that we would otherwise expect to distribute, since capital gains would first be reduced by the capital loss carryforward. In addition, as of December 31, 2014, we had estimated net deferred tax gains from terminated Swaps of $18.3 million and net deferred tax losses from terminated Swaptions of $14.9 million. These deferred gains/losses are expected to be amortized into future ordinary taxable income over the remaining terms of the underlying Swaps.
We have elected to treat a wholly owned subsidiary as a taxable REIT subsidiary (or, TRS). A TRS may participate in activities that would otherwise not be allowed to be carried on in a REIT. A TRS is subject to U.S. Federal, state and local income tax at regular corporate tax rates.
As of December 31, 2014, our TRS entities, which are not consolidated with the Company for income tax purposes, have an estimated net operating loss carryforward of $1.3 million and a capital loss carryforward of $0.1 million. Given the limited operating history of our TRS entities, there can be no assurance that such entities will generate taxable income in the future. As a result, the deferred tax asset of approximately $0.6 million and $0.06 million, associated with our net operating loss carryforward and capital loss carryforward, respectively, have been offset by a valuation allowance, such that we had no net deferred tax asset or liability at December 31, 2014, and had not recorded any tax benefits through June 30, 2015.
Under GAAP, a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Based upon review of our federal, state and local income tax returns and tax filing positions, we determined that no unrecognized tax benefits for uncertain tax positions were required to be recorded. In addition, we do not believe that we have any tax positions for which it is reasonably possible that we will be required to record significant amounts of unrecognized tax benefits within the next twelve months.
Our capital loss carryforward amounts expire in 2018 and 2019. Our major tax jurisdictions are U.S. Federal, New York State and New York City. The statute of limitations is open for all jurisdictions for tax years beginning 2011.
(o) Variable Interest Entities
We consolidate a VIE when we have both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. We are required to reconsider our evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE. (See Note 2(h).)
Prior to the completion of our initial securitization transaction in February 2013, we had not transferred assets to VIEs or Qualifying Special Purpose Entities (or, QSPEs) and other than acquiring RMBS issued by such entities, had no other involvement with VIEs or QSPEs. (See Note 15.)
14
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(p) | Recent Accounting Pronouncements |
Accounting Standards Adopted
In January 2014, the Financial Accounting Standards Board (or, FASB) issued guidance in order to help determine when a creditor should derecognize a loan receivable and recognize the real estate property by clarifying when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. The guidance is effective for public business entities for fiscal years beginning after December 15, 2014. The adoption of this guidance did not have a material impact our consolidated financial statements.
In April 2014, the FASB issued guidance to improve the definition of discontinued operations and to enhance convergence between the FASB’s and International Accounting Standard Board’s reporting requirements for discontinued operations. The new definition of discontinued operations limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity’s operations and financial results. The new guidance affects entities that have either of the following: (1) a component of an entity that either is disposed of or meets the criteria under current guidance to be classified as held-for-sale or (2) a business or nonprofit activity that, on acquisition, meets the criteria under current guidance to be classified as held-for-sale. The guidance is effective for all disposals (or classifications as held-for-sale) of components of an entity and all businesses or nonprofit activities that, on acquisition, are classified as held-for-sale that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held-for-sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of this guidance did not impact our consolidated financial statements.
In June 2014, the FASB issued guidance that requires repurchase-to-maturity transactions to be accounted for as secured borrowings rather than as sales with a forward repurchase commitment. The new guidance eliminated existing guidance on repurchase financings and requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. If derecognition criteria are met, the initial transfer will generally be accounted for as a sale and the repurchase agreement will generally be accounted for as a secured borrowing. Under prior guidance, there was a rebuttable presumption that the two parts of the repurchase financing are linked, meaning that the transactions should be combined and accounted for as a forward agreement to sell (purchase) a financial asset. The new guidance requires new disclosures for repurchase agreements, securities lending transactions and repurchase-to-maturity transactions that are accounted for as secured borrowings. These disclosures include information about the types of assets pledged and the relationship between those assets and the related obligation to return the proceeds. The new standard also requires new disclosures for transfers of financial assets that are accounted for as sales that involve an agreement with the transferee entered into in contemplation of the initial transfer that result in the transferor retaining substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. The disclosures include information about the nature of the transactions, the transferor’s continuing exposure to the financial assets it derecognized and the components of the transactions presented in the financial statements. The guidance is effective for the first interim or annual period beginning after December 15, 2014, except for the disclosures related to transactions accounted for as secured borrowings, which are effective for periods beginning on or after March 15, 2015; earlier application of this guidance was not permitted. The adoption of this guidance did not have a material impact on our consolidated financial statements, but resulted in additional disclosures with respect to our repurchase borrowings, as presented in Note 9.
In August 2014, the FASB issued guidance to eliminate diversity in practice in the accounting for measurement differences in both the initial consolidation and subsequent measurement of the financial assets and the financial liabilities of a collateralized financing entity. A reporting entity that consolidates a collateralized financing entity within the scope of the new guidance may elect to measure the financial assets and the financial liabilities of that collateralized financing entity using either the measurement alternative included in the new guidance or the existing guidance on fair value measurement. When the measurement alternative is not elected for a consolidated collateralized financing entity within the scope of the new guidance, the new guidance clarifies that (1) the fair value of the financial assets and the fair value of the financial liabilities of the consolidated collateralized financing entity should be measured using the requirements of the existing guidance on fair value measurement and (2) any differences in the fair value of the financial assets and the fair value of the financial liabilities of that consolidated collateralized financing entity should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income (loss). When a reporting entity elects the measurement alternative included in the new guidance for a collateralized financing entity, the reporting entity should measure both the financial assets and the financial liabilities of that collateralized financing entity in its consolidated financial statements using the more observable of the fair value of the financial assets and the fair value of the financial liabilities. The guidance applies to a reporting entity that is required to consolidate a collateralized financing entity under the existing variable interest entity guidance when (1) the reporting entity measures all of the financial assets and the financial liabilities of that consolidated collateralized financing
15
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
entity at fair value in the consolidated financial statements based on other guidance and (2) the changes in the fair values of those financial assets and financial liabilities are reflected in earnings. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2015. Early adoption of this guidance is permitted as of the beginning of an annual period. Our early adoption of this guidance during the period ended March 31, 2015 did not have a material impact our consolidated financial statements. (See Note 3(b).)
In February 2015, the FASB issued guidance affecting reporting entities that are required to evaluate whether they should consolidate certain legal entities, particularly those that have fee arrangements and related party relationships. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2015. Early adoption is permitted as of the beginning of an annual period. The amendments found in this accounting update do not affect the criteria within the Company’s VIE analysis related to its securitization trusts, which are currently consolidated. As such, our adoption of this guidance during the period ended March 31, 2015 did not have an impact on our consolidated financial statements.
Accounting Standards Issued but Not Yet Adopted
In May 2014, the FASB issued guidance to establish a comprehensive and converged standard on revenue recognition to enable financial statement users to better understand and consistently analyze an entity’s revenue across industries, transactions, and geographies. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance also specifies the accounting for certain costs to obtain or fulfill a contract with a customer. The new guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. Qualitative and quantitative information is required to be disclosed about: (1) contracts with customers, (2) significant judgments and changes in judgments, and (3) assets recognized from costs to obtain or fulfill a contract. The new guidance will apply to all entities. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2016; early application is not permitted. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In August 2014, the FASB issued guidance regarding management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related financial statement note disclosures. The new guidance requires that management evaluate each annual and interim reporting period whether conditions exist that give rise to substantial doubt about the entity’s ability to continue as a going concern within one year from the financial statement issuance date, and if so, provide related disclosures. Disclosures are only required if conditions give rise to substantial doubt, whether or not the substantial doubt is alleviated by management’s plans. No disclosures are required specific to going concern uncertainties if an assessment of the conditions does not give rise to substantial doubt. Substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable that a company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. If substantial doubt is alleviated as a result of the consideration of management’s plans, a company should disclose information that enables users of financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the financial statement notes): (1) principal conditions that initially give rise to substantial doubt, (2) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (3) management’s plans that alleviated substantial doubt. If substantial doubt is not alleviated after considering management’s plans, disclosures should enable investors to understand the underlying conditions, and include the following: (1) a statement indicating that there is substantial doubt about the company’s ability to continue as a going concern within one year after the issuance date, (2) the principal conditions that give rise to substantial doubt, (3) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (4) management’s plans that are intended to mitigate the adverse conditions. The new guidance applies to all companies. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2016, with early adoption permitted. Based on our current financial condition, we do not expect this guidance will have a material impact on our consolidated financial statements.
In November 2014, the FASB issued guidance to clarify how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the new guidance clarifies that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Further, the new guidance clarifies that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial
16
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
instrument. The new guidance applies to all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form of a share. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2015, with early adoption permitted. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In April 2015, the FASB issued guidance on the presentation of debt issuance costs. This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This guidance is effective for fiscal years and interim periods beginning after December 15, 2015, and requires retrospective application. We expect to adopt this guidance when effective, and do not expect this guidance to have a significant impact on our financial statements, although it will change the financial statement classification of our deferred financing costs. As of June 30, 2015, we had $576 of net deferred financing costs which are included as a component of “Other assets” on our consolidated balance sheet. Under the new guidance, these net deferred financing costs would reduce the carrying value of the associated borrowings/debt.
In June 2015, the FASB issued guidance providing for technical corrections and improvements to existing accounting standards. The amendments in this update represent changes to clarify, correct unintended application of guidance, or make minor improvements to existing accounting standards that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this guidance. The amendments that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this accounting guidance. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted
(q) Reclassifications
Certain prior period amounts have been reclassified to conform to the current presentation.
Note 3 – Fair Value of Financial Instruments
(a) General
We disclose the estimated fair value of our financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). We are required to provide enhanced disclosures regarding instruments in the Level III category, including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP provides a framework for measuring estimated fair value and for providing financial statement disclosure requirements for fair value measurements. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level I - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level II - Fair values are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These inputs may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.
Level III - Fair values are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.
The level in the fair value hierarchy, within which a fair measurement falls in its entirety, is based on the lowest level input that is significant to the fair value measurement. When available, we use quoted market prices to determine the estimated fair value of an asset or liability.
Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices received for such assets could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold are also subject to significant judgment, particularly in times of market illiquidity.
We have controls over our valuation processes that are intended to ensure that the valuations for our financial instruments are fairly presented in accordance with GAAP on a consistent basis. Our Manager and our chief executive officer oversee our
17
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
valuation process, which is carried out by our Manager and Apollo’s pricing group. Our audit committee has final oversight for the valuation process for all of our financial instruments and, on a quarterly basis, reviews and provides final approval for such process.
Any changes to our valuation methodology will be reviewed by our Manager and audit committee to ensure the changes are appropriate. We may refine our valuation methodologies as markets and products develop. The methods used by us may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and are believed to result in valuations consistent with other market participants, the use of different methodologies, or assumptions, to determine the estimated fair value of certain financial instruments could result in a different estimate of estimated fair value at the reporting date. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.
The following describes the valuation methodologies used for our financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
(b) Agency RMBS, non-Agency RMBS, TBA Contracts, Securitized Mortgage Loans, Non-Recourse Securitized Debt and Other Investment Securities
To determine the fair value of our Agency RMBS, non-Agency RMBS, TBA Contracts, other investment securities, securitized mortgage loans and non-recourse securitized debt, we obtain third party broker quotes which, while non-binding, are indicative of fair value. To validate the reasonableness of the broker quotes, we obtain and compare the broker quotes to valuations received from a third party pricing service and review the range of quotes received for outliers, compare quotes to recent market activity observed for similar securities and review significant changes in quarterly price levels. We generally do not adjust the prices we obtain from brokers; however, adjustments to valuations may be made as deemed appropriate to capture observable market information at the valuation date. Further, broker quotes are used provided that there is not an ongoing material event that affects the issuer of the securities being valued or the market thereof. If there is such an ongoing event, we will determine the estimated fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates and prepayment rates and, with respect to non-Agency RMBS, default rates and loss severities. Valuation techniques for RMBS may be based on models that consider the estimated cash flows of each debt tranche of the issuer, establish a benchmark yield, and develop an estimated tranche-specific spread to the benchmark yield based on the unique attributes of the tranche including, but not limited to, assumptions related to prepayment speed, the frequency and severity of defaults and attributes of the collateral underlying such securities. To the extent the inputs are observable and timely, the values would be categorized in Level II of the fair value hierarchy; otherwise they would be categorized as Level III. There were no events that resulted in us using internal models to value our Agency and non-Agency RMBS or other investment securities in our consolidated financial statements for the periods presented. Given the high level of liquidity and price transparency for our Agency RMBS, Risk Sharing Securities and TBA Contracts prices obtained from brokers and pricing services are readily verifiable to observable market transactions; as such, we categorize Agency RMBS, TBA Contracts and Risk Sharing Securities as Level II valuations. While market liquidity exists for non-Agency RMBS, securities underlying our securitized mortgage loans, securitized debt and SBC-MBS, periods of less liquidity or even illiquidity may also occur periodically for certain of these assets. As a result of this market dynamic and that observable market transactions may or may not exist from time to time, such instruments are categorized as Level III.
(c) Swaps and Swaptions
We determine the estimated fair value of our Swaps and Swaptions based on market valuations obtained from a third party with expertise in valuing such instruments. With respect to Swap valuations, the expected future cash flows are determined for the fixed and floating rate leg of the Swap. To arrive at the expected cash flows for the fixed leg of a Swap, the coupon rate stated in the Swap agreement is used and to arrive at the expected cash flows for the floating leg, the forward rates derived from raw yield curve data are used. Finally, both the fixed and floating legs’ cash flows are discounted using the calculated discount factors and the fixed and floating leg valuations are netted to arrive at a single valuation for the Swap at the valuation date. Swaptions require the same market inputs as Swaps with the addition of implied Swaption volatilities quoted by the market. The valuation inputs for Swaps and Swaptions are observable and, as such, their valuations are categorized as Level II in the fair value hierarchy.
18
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(d) Fair Value Hierarchy
The following tables present our financial instruments carried at estimated fair value as of June 30, 2015 and December 31, 2014 based upon our consolidated balance sheet by the valuation hierarchy:
Estimated Fair Value at June 30, 2015 | ||||||||||||||||
Level I | Level II | Level III | Total | |||||||||||||
Assets: | ||||||||||||||||
RMBS | $ | — | $ | 2,045,553 | $ | 1,378,265 | $ | 3,423,818 | ||||||||
Securitized mortgage loans (transferred to consolidated variable interest entities) | — | — | 178,904 | 178,904 | ||||||||||||
Other investment securities | — | 90,912 | 58,889 | 149,801 | ||||||||||||
Swaps/Swaptions | — | 17,617 | — | 17,617 | ||||||||||||
Total | $ | — | $ | 2,154,082 | $ | 1,616,058 | $ | 3,770,140 | ||||||||
Liabilities: | ||||||||||||||||
Swaps | $ | — | $ | 8,641 | $ | — | 8,641 | |||||||||
Non-recourse securitized debt | — | — | 25,893 | 25,893 | ||||||||||||
Short TBA Contracts | — | 95 | — | 95 | ||||||||||||
Total | $ | — | $ | 8,736 | $ | 25,893 | $ | 34,629 |
Estimated Fair Value at December 31, 2014 | ||||||||||||||||
Level I | Level II | Level III | Total | |||||||||||||
Assets: | ||||||||||||||||
RMBS | $ | — | $ | 2,287,523 | $ | 1,468,109 | $ | 3,755,632 | ||||||||
Securitized mortgage loans (transferred to consolidated variable interest entity) | — | — | 104,438 | 104,438 | ||||||||||||
Other investment securities | — | 10,395 | 23,833 | 34,228 | ||||||||||||
Mortgage Loans | — | — | 14,120 | 14,120 | ||||||||||||
Long TBA Contracts | — | 544 | — | 544 | ||||||||||||
Swaps/Swaptions | — | 11,098 | — | 11,098 | ||||||||||||
Total | $ | — | $ | 2,309,560 | $ | 1,610,500 | $ | 3,920,060 | ||||||||
Liabilities: | ||||||||||||||||
Swaps | — | 8,949 | — | 8,949 | ||||||||||||
Non-recourse securitized debt | — | — | 34,176 | 34,176 | ||||||||||||
Total | $ | — | $ | 8,949 | $ | 34,176 | $ | 43,125 |
(e) Level III Fair Value Measurement Disclosures
Our non-Agency RMBS, other investment securities, securitized mortgage loans and securitized debt are measured at fair value and are considered to be Level III measurements of fair value.
19
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
The following table presents a summary of changes in the fair value of our non-Agency RMBS for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Beginning balance | $ | 1,374,966 | $ | 1,298,541 | $ | 1,468,109 | $ | 1,212,789 | ||||||||
Purchases | 96,312 | 134,285 | 183,838 | 231,877 | ||||||||||||
Sales | (29,056 | ) | (4,742 | ) | (172,931 | ) | (11,309 | ) | ||||||||
Principal repayments | (66,129 | ) | (34,871 | ) | (119,384 | ) | (62,990 | ) | ||||||||
Total net gains/(losses) included in net income: | ||||||||||||||||
Realized gains/(losses), net | (254 | ) | 298 | 3,823 | 2,434 | |||||||||||
Unrealized gains/(losses), net (1) | (11,722 | ) | 4,815 | (12,629 | ) | 11,285 | ||||||||||
Discount accretion | 14,148 | 14,868 | 27,439 | 29,108 | ||||||||||||
Ending balance | $ | 1,378,265 | $ | 1,413,194 | $ | 1,378,265 | $ | 1,413,194 |
(1) | Includes unrealized losses of $88 and $1,462 that have been classified as OTTI for the three months ended June 30, 2015 and June 30, 2014, respectively, and unrealized losses of $1,879 and $2,633 that were classified as OTTI for the six months ended June 30, 2015 and June 30, 2014, respectively. |
The following table presents a summary of the changes in the fair value of our securitized mortgage loan pools associated with our securitizations for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Beginning balance | $ | 183,328 | $ | 110,307 | $ | 104,438 | $ | 110,984 | ||||||||
Transferred from mortgage loans | — | — | 81,093 | — | ||||||||||||
Mortgage loans securitized | — | — | — | — | ||||||||||||
Principal repayments | (1,816 | ) | (2,414 | ) | (5,512 | ) | (3,913 | ) | ||||||||
Discount accretion and other adjustments | (126 | ) | (223 | ) | (756 | ) | (264 | ) | ||||||||
Unrealized gain/(loss) during the period, net (1) | (1,866 | ) | 2,042 | 702 | 3,096 | |||||||||||
Loans transferred to REO | (616 | ) | — | (1,061 | ) | (191 | ) | |||||||||
Ending balance | $ | 178,904 | $ | 109,712 | $ | 178,904 | $ | 109,712 |
(1) | Amount is net of a provision for loan losses of $0 and $782 for the three months ended June 30, 2015 and June 30, 2014, respectively, and $0 and $2,967 for the six months ended June 30, 2015 and June 30, 2014, respectively. |
The following table presents a summary of the changes in fair value of our Level III other investment securities for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Beginning balance | $ | 39,916 | $ | 11,515 | $ | 23,833 | $ | 11,515 | ||||||||
Transferred out of Level III fair values (1) | — | (11,515 | ) | — | (11,515 | ) | ||||||||||
Purchases | 22,086 | — | 39,601 | — | ||||||||||||
Principal repayments | (3,046 | ) | — | (4,552 | ) | — | ||||||||||
Discount accretion | 525 | — | 816 | — | ||||||||||||
Unrealized loss | (591 | ) | — | (808 | ) | — | ||||||||||
Ending balance | $ | 58,890 | $ | — | $ | 58,890 | $ | — |
(1) | During the three and six months ended June 30, 2015, we did not transfer any investments into or out of the Level III category of the fair value hierarchy. During the six months ended June 30, 2014, we transferred an investment in Risk Sharing Securities from Level III to Level II, all which occurred during the three months ended March 31, 2014. The Risk Sharing Securities were transferred to Level II measurements of fair value based on the availability of significant observable market inputs which are used to price these securities. Transfers between levels are deemed to take place on the first day of the reporting period in which the transfer occurred. |
20
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
The following table presents a summary of the changes in fair value of our securitized debt for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Beginning balance | $ | 30,306 | $ | 41,226 | $ | 34,176 | $ | 43,354 | ||||||||
Principal paid | (3,412 | ) | (2,934 | ) | (7,270 | ) | (5,052 | ) | ||||||||
Unrealized gain/(loss) | (1,001 | ) | 364 | (1,013 | ) | 354 | ||||||||||
Ending balance | $ | 25,893 | $ | 38,656 | $ | 25,893 | $ | 38,656 |
(f) Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on our consolidated balance sheet, at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||||||||||
Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | |||||||||||||
Financial assets: | ||||||||||||||||
Investment related receivable (1) | $ | 136,128 | $ | 136,128 | $ | 191,455 | $ | 191,455 | ||||||||
Warehouse line receivable (1) (2) | $ | 20,464 | $ | 20,464 | $ | 28,639 | $ | 28,639 | ||||||||
Mortgage loans (2) | $ | 5,665 | $ | 5,665 | $ | 2,306 | $ | 2,306 | ||||||||
Real estate subject to BFT Contracts (2) | $ | 17,960 | $ | 17,960 | $ | 9,616 | $ | 9,616 | ||||||||
Financial liabilities: | ||||||||||||||||
Repurchase agreements | $ | 3,177,679 | $ | 3,177,806 | $ | 3,402,327 | $ | 3,402,237 | ||||||||
Investment related payable (1) | $ | 134,891 | $ | 134,891 | $ | 76,105 | $ | 76,105 |
(1) | Carrying value approximates fair value due to the short-term nature of the item and/or that such instruments are variable rate; if applicable. |
(2) | This item is included as a component of “Other investments” on our consolidated balance sheet. |
To determine the estimated fair value of our borrowings under repurchase agreements, contractual cash flows from such borrowings are discounted at estimated market interest rates, which rates may be based upon actual transactions executed by us or indicative rates quoted by brokers. The estimated fair values are not necessarily indicative of the amount we would realize on disposition of the financial instruments. Our borrowings under repurchase agreements had a weighted average remaining term to maturity of 79 days and 65 days at June 30, 2015 and December 31, 2014, respectively. Adjustments to valuations may be made as deemed appropriate to capture market information at the valuation date. Inputs used to arrive at the fair value of our repurchase agreement borrowings are generally observable and therefore the fair value of our repurchase agreement borrowings are classified as Level II valuations in the fair value hierarchy.
21
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 4 – Residential Mortgage-Backed Securities
(a) RMBS Portfolio Components
The following tables present certain information about our RMBS portfolio at June 30, 2015 and December 31, 2014:
June 30, 2015 | ||||||||||||||||||||||||||||||
Principal Balance | Premium/ (Discount), Net (1) | Amortized Cost (2) | Estimated Fair Value | Gross Unrealized Gain | Gross Unrealized Losses | Weighted Average Coupon | Estimated Weighted Average Yield (3) | |||||||||||||||||||||||
Agency pass-through RMBS - 30-Year Mortgages: | ||||||||||||||||||||||||||||||
ARMs | $ | 242,852 | $ | 17,082 | $ | 259,934 | $ | 258,956 | $ | 16 | $ | (994 | ) | 2.32 | % | 1.32 | % | |||||||||||||
3.5% coupon | 535,705 | 26,431 | 562,136 | 552,325 | — | (9,811 | ) | 3.50 | % | 2.79 | % | |||||||||||||||||||
4.0% coupon | 1,091,238 | 70,120 | 1,161,358 | 1,159,433 | 4,363 | (6,288 | ) | 4.00 | % | 3.02 | % | |||||||||||||||||||
1,869,795 | 113,633 | 1,983,428 | 1,970,714 | 4,379 | (17,093 | ) | 3.64 | % | 2.74 | % | ||||||||||||||||||||
Agency IO (4) | — | — | 55,388 | 57,218 | 2,598 | (768 | ) | 2.34 | % | 7.63 | % | |||||||||||||||||||
Agency Inverse IO (4) | — | — | 17,610 | 17,621 | 162 | (151 | ) | 6.65 | % | 13.63 | % | |||||||||||||||||||
Total Agency securities | 1,869,795 | 113,633 | 2,056,426 | 2,045,553 | 7,139 | (18,012 | ) | 3.46 | % | 2.96 | % | |||||||||||||||||||
Non-Agency RMBS | 1,574,086 | (259,667 | ) | 1,314,419 | 1,378,265 | 72,718 | (8,872 | ) | 1.54 | % | 6.40 | % | ||||||||||||||||||
Total RMBS | $ | 3,443,881 | $ | (146,034 | ) | $ | 3,370,845 | $ | 3,423,818 | $ | 79,857 | $ | (26,884 | ) | 2.72 | % | 4.30 | % | ||||||||||||
December 31, 2014 | ||||||||||||||||||||||||||||||
Principal Balance | Premium/ (Discount), Net (1) | Amortized Cost (2) | Estimated Fair Value | Gross Unrealized Gain | Gross Unrealized Losses | Weighted Average Coupon | Estimated Weighted Average Yield (3) | |||||||||||||||||||||||
Agency pass-through RMBS - 30-Year Mortgages: | ||||||||||||||||||||||||||||||
ARMs | $ | 98,079 | $ | 7,196 | $ | 105,275 | $ | 105,122 | $ | 6 | $ | (159 | ) | 2.36 | % | 1.14 | % | |||||||||||||
3.5% coupon | 495,214 | 20,245 | 515,459 | 515,628 | 1,536 | (1,367 | ) | 3.50 | % | 2.87 | % | |||||||||||||||||||
4.0% coupon | 1,173,972 | 82,353 | 1,256,325 | 1,256,724 | 8,357 | (7,958 | ) | 4.00 | % | 2.86 | % | |||||||||||||||||||
4.5% coupon | 336,353 | 25,863 | 362,216 | 366,472 | 4,256 | — | 4.50 | % | 2.83 | % | ||||||||||||||||||||
2,103,618 | 135,657 | 2,239,275 | 2,243,946 | 14,155 | (9,484 | ) | 3.89 | % | 2.78 | % | ||||||||||||||||||||
Agency Inverse Floater | 1,359 | 3,590 | 4,949 | 5,094 | 145 | — | 81.76 | % | 11.82 | % | ||||||||||||||||||||
Agency IO (4) | — | — | 11,948 | 11,941 | 62 | (69 | ) | 2.24 | % | 7.24 | % | |||||||||||||||||||
Agency Inverse IO (4) | — | — | 26,489 | 26,542 | 306 | (253 | ) | 6.30 | % | 8.69 | % | |||||||||||||||||||
Total Agency securities | 2,104,977 | 139,247 | 2,282,661 | 2,287,523 | 14,668 | (9,806 | ) | 3.93 | % | 2.87 | % | |||||||||||||||||||
Non-Agency RMBS | 1,682,858 | (289,345 | ) | 1,393,513 | 1,468,109 | 78,434 | (3,838 | ) | 1.46 | % | 5.86 | % | ||||||||||||||||||
Total RMBS | $ | 3,787,835 | $ | (150,098 | ) | $ | 3,676,174 | $ | 3,755,632 | $ | 93,102 | $ | (13,644 | ) | 2.91 | % | 4.00 | % |
Note: We apply trade-date accounting. Included in the above table are unsettled purchases with an aggregate cost of $134,698 and $76,009 at June 30, 2015 and December 31, 2014 respectively, with an estimated fair value of $134,433 and $75,990, respectively, at such dates.
(1) | A portion of the purchase discount on non-Agency RMBS is not expected to be recognized as interest income, and is instead viewed as a credit discount. See Note 4(h). |
(2) | Amortized cost is reduced by unrealized losses that are classified as OTTI. We recognized OTTI of $2,663 and $2,219 for the three months ended June 30, 2015 and June 30, 2014, respectively, and $88 and $3,390 for the six months ended June 30, 2015 and June 30, 2014, respectively. |
(3) | The estimated weighted average yield at the date presented incorporates estimates for future prepayment assumptions on all RMBS and loss assumptions on non-Agency RMBS. |
(4) | Agency IO and Agency Inverse IO have no principal balance and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on such securities. At June 30, 2015 and December 31, 2014, our Agency IO had a notional balance of $535,261 and $133,924, respectively, and our Agency Inverse IO had a notional balance of $85,217 and $138,293, respectively. |
22
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(b) Agency Pass-through RMBS
The following tables present certain information about our Agency pass-through RMBS at June 30, 2015 and December 31, 2014:
June 30, 2015 | ||||||||||||||||||||||||
Principal Balance | Unamortized Premium/ (Discount), Net | Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | |||||||||||||||||||
Fannie Mae: | ||||||||||||||||||||||||
ARMs | $ | 224,969 | $ | 15,864 | $ | 240,833 | $ | 239,950 | $ | 16 | $ | (899 | ) | |||||||||||
3.5% Coupon | 110,583 | 5,798 | 116,381 | 114,167 | — | (2,214 | ) | |||||||||||||||||
4.0% Coupon | 336,762 | 22,870 | 359,632 | 358,084 | 815 | (2,363 | ) | |||||||||||||||||
672,314 | 44,532 | 716,846 | 712,201 | 831 | (5,476 | ) | ||||||||||||||||||
Freddie Mac: | ||||||||||||||||||||||||
ARMs | 17,883 | 1,218 | 19,101 | 19,006 | — | (95 | ) | |||||||||||||||||
3.5% Coupon | 425,122 | 20,633 | 445,755 | 438,158 | — | (7,597 | ) | |||||||||||||||||
4.0% Coupon | 754,476 | 47,250 | 801,726 | 801,349 | 3,548 | (3,925 | ) | |||||||||||||||||
1,197,481 | 69,101 | 1,266,582 | 1,258,513 | 3,548 | (11,617 | ) | ||||||||||||||||||
Total Agency pass-through RMBS | $ | 1,869,795 | $ | 113,633 | $ | 1,983,428 | $ | 1,970,714 | $ | 4,379 | $ | (17,093 | ) |
December 31, 2014 | ||||||||||||||||||||||||
Principal Balance | Unamortized Premium/ (Discount), Net | Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | |||||||||||||||||||
Fannie Mae: | ||||||||||||||||||||||||
ARMs | $ | 78,731 | $ | 5,878 | $ | 84,609 | $ | 84,537 | $ | 6 | $ | (78 | ) | |||||||||||
3.5% Coupon | 149,436 | 6,200 | 155,636 | 155,895 | 417 | (158 | ) | |||||||||||||||||
4.0% Coupon | 271,031 | 19,397 | 290,428 | 289,903 | 1,531 | (2,056 | ) | |||||||||||||||||
4.5% Coupon | 294,177 | 22,712 | 316,889 | 320,653 | 3,764 | — | ||||||||||||||||||
793,375 | 54,187 | 847,562 | 850,988 | 5,718 | (2,292 | ) | ||||||||||||||||||
Freddie Mac: | ||||||||||||||||||||||||
ARMs | 19,348 | 1,318 | 20,666 | 20,585 | — | (81 | ) | |||||||||||||||||
3.5% Coupon | 345,778 | 14,045 | 359,823 | 359,733 | 1,119 | (1,209 | ) | |||||||||||||||||
4.0% Coupon | 902,941 | 62,956 | 965,897 | 966,821 | 6,826 | (5,902 | ) | |||||||||||||||||
4.5% Coupon | 42,176 | 3,151 | 45,327 | 45,819 | 492 | — | ||||||||||||||||||
1,310,243 | 81,470 | 1,391,713 | 1,392,958 | 8,437 | (7,192 | ) | ||||||||||||||||||
Total Agency pass-through RMBS | $ | 2,103,618 | $ | 135,657 | $ | 2,239,275 | $ | 2,243,946 | $ | 14,155 | $ | (9,484 | ) |
23
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(c) Non-Agency RMBS
The following tables present certain information about our non-Agency RMBS by type of underlying mortgage loan collateral type at June 30, 2015 and December 31, 2014:
June 30, 2015 | ||||||||||||||||||||||||
Underlying Loan Characteristics: | Principal Balance | Unamortized Premium/ (Discount), Net | Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | ||||||||||||||||||
Subprime | $ | 1,101,616 | $ | (153,163 | ) | $ | 948,453 | $ | 997,548 | $ | 53,754 | $ | (4,659 | ) | ||||||||||
Alt-A | 211,275 | (49,912 | ) | 161,363 | 173,405 | 13,127 | (1,085 | ) | ||||||||||||||||
Option ARMs | 261,195 | (56,592 | ) | 204,603 | 207,312 | 5,837 | (3,128 | ) | ||||||||||||||||
Total Non-Agency RMBS | $ | 1,574,086 | $ | (259,667 | ) | $ | 1,314,419 | $ | 1,378,265 | $ | 72,718 | $ | (8,872 | ) |
December 31, 2014 | ||||||||||||||||||||||||
Underlying Loan Characteristics: | Principal Balance | Unamortized Premium/ (Discount), Net | Amortized Cost | Estimated Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | ||||||||||||||||||
Subprime | $ | 1,257,231 | $ | (184,851 | ) | $ | 1,072,380 | $ | 1,129,045 | $ | 59,350 | $ | (2,685 | ) | ||||||||||
Alt-A | 220,220 | (53,283 | ) | 166,937 | 179,767 | 13,329 | (499 | ) | ||||||||||||||||
Option ARMs | 205,407 | (51,211 | ) | 154,196 | 159,297 | 5,755 | (654 | ) | ||||||||||||||||
Total Non-Agency RMBS | $ | 1,682,858 | $ | (289,345 | ) | $ | 1,393,513 | $ | 1,468,109 | $ | 78,434 | $ | (3,838 | ) |
(d) Unrealized Loss Positions on RMBS
The following table presents information about our RMBS that were in an unrealized loss position at June 30, 2015:
Unrealized Loss Position for Less than 12 Months | Unrealized Loss Position for 12 Months or More | |||||||||||||||||||
Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | |||||||||||||||
Agency RMBS | $ | 1,582,574 | $ | (13,506 | ) | 52 | $ | 145,016 | $ | (3,588 | ) | 4 | ||||||||
Agency IO | 19,179 | (768 | ) | 7 | — | — | 0 | |||||||||||||
Agency Inverse IO | 11,204 | (151 | ) | 3 | — | — | 0 | |||||||||||||
Total Agency Securities | 1,612,957 | (14,425 | ) | 62 | 145,016 | (3,588 | ) | 4 | ||||||||||||
Non-Agency RMBS | 476,561 | (8,111 | ) | 80 | 26,351 | (761 | ) | 11 | ||||||||||||
Total RMBS | $ | 2,089,518 | $ | (22,536 | ) | 142 | $ | 171,367 | $ | (4,349 | ) | 15 |
24
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(e) Interest Income on RMBS
The following tables present components of interest income on our Agency RMBS and non-Agency RMBS for the periods presented:
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||||||||||
Coupon Interest | (Premium Amortization)/ Discount Accretion, Net | Interest Income | Coupon Interest | (Premium Amortization)/ Discount Accretion, Net | Interest Income | |||||||||||||||||||
Agency RMBS | $ | 21,500 | $ | (5,670 | ) | $ | 15,830 | $ | 44,039 | $ | (11,688 | ) | $ | 32,351 | ||||||||||
Non-Agency RMBS | 5,840 | 14,148 | 19,988 | 11,642 | 27,439 | 39,081 | ||||||||||||||||||
Total | $ | 27,340 | $ | 8,478 | $ | 35,818 | $ | 55,681 | $ | 15,751 | $ | 71,432 |
Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 | |||||||||||||||||||||||
Coupon Interest | (Premium Amortization)/ Discount Accretion, Net | Interest Income | Coupon Interest | (Premium Amortization)/ Discount Accretion, Net | Interest Income | |||||||||||||||||||
Agency RMBS | $ | 24,717 | $ | (8,361 | ) | $ | 16,356 | $ | 50,524 | $ | (17,010 | ) | $ | 33,514 | ||||||||||
Non-Agency RMBS | 4,767 | 14,868 | 19,635 | 9,194 | 29,108 | 38,302 | ||||||||||||||||||
Total | $ | 29,484 | $ | 6,507 | $ | 35,991 | $ | 59,718 | $ | 12,098 | $ | 71,816 |
(f) Realized and Unrealized Gains and Losses on RMBS
The following tables present components of realized gains/(losses) and the change in unrealized gains/(losses), net on our RMBS portfolio for the periods presented:
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||
RMBS Type | Net Realized Gains/(Losses) | Net Unrealized Gains/(Losses) | Net Realized Gains/(Losses) | Net Unrealized Gains/(Losses) | ||||||||||||
Agency Pass-through | $ | (4,351 | ) | $ | (30,137 | ) | $ | (57 | ) | $ | (16,560 | ) | ||||
Agency Inverse | — | (613 | ) | 43 | (758 | ) | ||||||||||
Agency IO | (15 | ) | 1,458 | (127 | ) | 1,666 | ||||||||||
Agency Inverse IO | 74 | 199 | 311 | (44 | ) | |||||||||||
Agency ARM RMBS | 16 | (539 | ) | 15 | (825 | ) | ||||||||||
Non-Agency RMBS | (254 | ) | (11,722 | ) | 3,823 | (12,628 | ) | |||||||||
Total | $ | (4,530 | ) | $ | (41,354 | ) | $ | 4,008 | $ | (29,149 | ) |
Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 | |||||||||||||||
RMBS Type | Net Realized Gains/(Losses) | Net Unrealized Gains/(Losses) | Net Realized Gains/(Losses) | Net Unrealized Gains/(Losses) | ||||||||||||
Agency Pass-through | $ | (7,168 | ) | $ | 47,672 | $ | (21,467 | ) | $ | 90,340 | ||||||
Agency IO | 61 | (1,334 | ) | 61 | (293 | ) | ||||||||||
Agency Inverse IO | (263 | ) | 437 | 149 | 843 | |||||||||||
Agency ARM RMBS | — | — | (59 | ) | 62 | |||||||||||
Non-Agency RMBS | 298 | 4,815 | 2,434 | 11,285 | ||||||||||||
Total | $ | (7,072 | ) | $ | 51,590 | $ | (18,882 | ) | $ | 102,237 |
25
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(g) Contractual Maturities of RMBS
The following table presents the maturities of our RMBS, based on the contractual maturities of the underlying mortgages at June 30, 2015 and December 31, 2014:
Contractual Maturities of RMBS (1) | June 30, 2015 | December 31, 2014 | ||||||
> 10 years and < or equal to 20 years | $ | 454,271 | $ | 628,787 | ||||
> 20 years and < or equal to 30 years | 2,497,228 | 2,977,089 | ||||||
> 30 years | 472,319 | 149,756 | ||||||
Total | $ | 3,423,818 | $ | 3,755,632 |
(1) | Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal, and the payment priority structure of the security; therefore actual maturities are generally shorter than the stated contractual maturities of the underlying or referenced mortgages. |
(h) Non-Agency RMBS Discounts
The following tables present the changes in the components of our purchase discount on non-Agency RMBS between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented:
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||
Discount Designated as Credit Reserve and OTTI (1) | Accretable Discount | Discount Designated as Credit Reserve and OTTI (1) | Accretable Discount | |||||||||||||
Balance at beginning of period | $ | (85,221 | ) | $ | (181,209 | ) | $ | (95,504 | ) | $ | (194,451 | ) | ||||
Accretion of discount | — | 14,148 | — | 27,416 | ||||||||||||
Realized credit losses | (468 | ) | — | 489 | — | |||||||||||
Purchases | (1,386 | ) | (7,977 | ) | (1,471 | ) | (10,770 | ) | ||||||||
Sales and other | 1,276 | 852 | 6,083 | 10,013 | ||||||||||||
OTTI recognized | (88 | ) | — | (1,878 | ) | — | ||||||||||
Transfers/release of credit reserve | 15,702 | (15,702 | ) | 22,096 | (22,096 | ) | ||||||||||
Balance at end of period | $ | (70,185 | ) | $ | (189,888 | ) | $ | (70,185 | ) | $ | (189,888 | ) |
(1) | At June 30, 2015, our non-Agency RMBS had gross discounts of $260,073, which included credit discounts of $51,832 and OTTI of $18,353. At December 31, 2014, our non-Agency RMBS had gross discounts of $289,955, which included credit discounts of $76,914 and OTTI of $18,590. |
Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 | |||||||||||||||
Discount Designated as Credit Reserve and OTTI | Accretable Discount | Discount Designated as Credit Reserve and OTTI (1) | Accretable Discount | |||||||||||||
Balance at beginning of period | $ | (87,011 | ) | $ | (206,429 | ) | $ | (109,299 | ) | $ | (193,647 | ) | ||||
Accretion of discount | — | 14,837 | — | 29,059 | ||||||||||||
Realized credit losses | 1,125 | — | 2,305 | — | ||||||||||||
Purchases | (29,499 | ) | (2,916 | ) | (31,538 | ) | (10,858 | ) | ||||||||
Sales and other | 2,485 | (470 | ) | 8,998 | (1,727 | ) | ||||||||||
OTTI recognized in earnings | (1,462 | ) | — | (2,633 | ) | — | ||||||||||
Transfers/release of credit reserve | 3,278 | (3,278 | ) | 21,083 | (21,083 | ) | ||||||||||
Balance at end of period | $ | (111,084 | ) | $ | (198,256 | ) | $ | (111,084 | ) | $ | (198,256 | ) |
(1) | At June 30, 2014, our non-Agency RMBS had gross discounts of $309,340, which included credit discounts of $99,231 and OTTI of $11,853. |
26
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 5 – Securitized Mortgage Loans
Our investments in residential mortgage loans, which are held in securitization trusts that we consolidate, are presented at fair value on our consolidated balance sheets. (See Note 15.)
The following table presents a summary of the changes in the carrying value of our securitized mortgage loans for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Beginning balance | $ | 183,328 | $ | 110,307 | $ | 104,438 | $ | 110,984 | ||||||||
Mortgage loans securitized | — | — | 81,093 | — | ||||||||||||
Principal repayments | (1,816 | ) | (2,414 | ) | (5,512 | ) | (3,913 | ) | ||||||||
Discount accretion and other adjustments | (126 | ) | (223 | ) | (756 | ) | (264 | ) | ||||||||
Unrealized gain/(loss) during the period, net (1) | (1,866 | ) | 2,042 | 702 | 3,096 | |||||||||||
Loans transferred to REO | (616 | ) | — | (1,061 | ) | (191 | ) | |||||||||
Ending balance | $ | 178,904 | $ | 109,712 | $ | 178,904 | $ | 109,712 |
(1) | Amount is net of the recognition of provision for loan losses of $0 and $782 for the three months ended June 30, 2015 and June 30, 2014, respectively, and $0 and $2,967 for the six months ended June 30, 2015 and June 30, 2014, respectively. |
The following table presents certain information about mortgage loans underlying our securitized mortgage loans at June 30, 2015:
Securitized Mortgage Loans | June 30, 2015 | |||
Performing (1) | $ | 80,307 | ||
Re-performing (1) | 109,773 | |||
Non-performing (1) | 31,658 | |||
Purchase discount | (48,064 | ) | ||
Loan loss provision | (3,130 | ) | ||
Fair value adjustment | 8,360 | |||
Total | $ | 178,904 |
(1) | We consider loans that are no more than 60 days delinquent as “performing”, loans that have had their initial terms modified and are no more than 60 days delinquent as “re-performing” and loans that are more than 60 days past due as “non-performing”. |
At June 30, 2015, $5,009 of our securitized mortgage loans were in the process of foreclosure and we held REO of $311 which is included in “Other assets” on our consolidated balance sheet. The following table presents the five largest state concentrations, in the aggregate, for our securitized mortgage loans based on principal balance at June 30, 2015:
Property Location | Principal Balance | Total Concentration | |||||
Florida | $ | 40,396 | 18.2 | % | |||
California | 39,426 | 17.8 | |||||
Maryland | 17,987 | 8.1 | |||||
Texas | 14,071 | 6.3 | |||||
New York | 12,593 | 5.7 | |||||
Other states and the District of Columbia | 97,265 | 43.9 | |||||
Total | $ | 221,738 | 100.0 | % |
27
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 6 – Other Investment Securities
(a) Other Investment Securities
The following table presents certain information about our other investment securities portfolio at June 30, 2015 and December 31, 2014:
Principal Balance | Premium/ (Discount), Net | Amortized Cost (1) | Estimated Fair Value | Gross Unrealized Gain | Gross Unrealized Losses | Weighted Average Coupon | Estimated Weighted Average Yield (2) | |||||||||||||||||||||||
June 30, 2015 | ||||||||||||||||||||||||||||||
Risk Sharing Securities - Freddie Mac | $ | 45,249 | $ | 258 | $ | 45,507 | $ | 44,976 | $ | 259 | $ | (790 | ) | 3.53 | % | 5.30 | % | |||||||||||||
Risk Sharing Securities - Fannie Mae | 48,287 | (1,360 | ) | 46,927 | 45,936 | 13 | (1,004 | ) | 3.65 | 6.16 | ||||||||||||||||||||
SBC-MBS | 67,928 | (8,231 | ) | 59,697 | 58,889 | — | (808 | ) | 0.66 | % | 5.28 | % | ||||||||||||||||||
Total | $ | 161,464 | $ | (9,333 | ) | $ | 152,131 | $ | 149,801 | $ | 272 | $ | (2,602 | ) | 2.36 | % | 5.56 | % | ||||||||||||
December 31, 2014 | ||||||||||||||||||||||||||||||
Risk Sharing Securities - Freddie Mac | $ | 10,082 | $ | 38 | $ | 10,120 | $ | 10,395 | $ | 288 | $ | (13 | ) | 3.56 | % | 4.27 | % | |||||||||||||
SBC-MBS | 27,136 | (3,268 | ) | 23,868 | 23,833 | — | (35 | ) | 0.90 | 5.17 | ||||||||||||||||||||
Total | $ | 37,218 | $ | (3,230 | ) | $ | 33,988 | $ | 34,228 | $ | 288 | $ | (48 | ) | 1.62 | % | 4.91 | % |
(1) | Amortized cost is reduced by unrealized losses that are classified as OTTI, which was $317 and $109 at June 30, 2015 and December 31, 2014, respectively. |
(2) | The estimated weighted average yield presented incorporates estimates for future prepayment assumptions and forward interest rate assumptions. |
(b) Other Investment Securities Income
The following tables present components of interest income on our other investment securities for the periods presented:
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||||||||||
Coupon Interest | (Premium Amortization)/ Discount Accretion, net | Interest Income | Coupon Interest | (Premium Amortization)/ Discount Accretion, net (1) | Interest Income | |||||||||||||||||||
Risk Sharing Securities - Freddie Mac | $ | 376 | $ | 118 | $ | 494 | $ | 537 | $ | 140 | $ | 677 | ||||||||||||
Risk Sharing Securities - Fannie Mae | 239 | 78 | 317 | 287 | 89 | 376 | ||||||||||||||||||
SBC-MBS | 93 | 490 | 583 | 161 | 781 | 942 | ||||||||||||||||||
Total | $ | 708 | $ | 686 | $ | 1,394 | $ | 985 | $ | 1,010 | $ | 1,995 | ||||||||||||
Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 | |||||||||||||||||||||||
Coupon Interest | (Premium Amortization)/ Discount Accretion, net | Interest Income | Coupon Interest | (Premium Amortization)/ Discount Accretion, net (1) | Interest Income | |||||||||||||||||||
Risk Sharing Securities - Freddie Mac | $ | 102 | $ | 1 | $ | 103 | $ | 204 | $ | 4 | $ | 208 | ||||||||||||
Total | $ | 102 | $ | 1 | $ | 103 | $ | 204 | $ | 4 | $ | 208 |
28
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(c) Other Investment Securities Discounts
The following table presents the changes in the components of our purchase discount on other investment securities between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented.
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||
Discount Designated as Credit Reserve and OTTI (1) | Accretable Discount | Discount Designated as Credit Reserve and OTTI (1) | Accretable Discount | |||||||||||||
Balance at beginning of period | (109 | ) | (5,389 | ) | (364 | ) | (2,904 | ) | ||||||||
Accretion of discount | — | 686 | — | 1,010 | ||||||||||||
Realized credit losses | — | — | — | — | ||||||||||||
Purchases | — | (4,907 | ) | — | (7,461 | ) | ||||||||||
Sales and other | 36 | 36 | ||||||||||||||
OTTI recognized | (108 | ) | — | (108 | ) | — | ||||||||||
Transfers/release of credit reserve | — | — | 255 | (255 | ) | |||||||||||
Balance at end of period | $ | (217 | ) | $ | (9,574 | ) | $ | (217 | ) | $ | (9,574 | ) |
Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property. In some instances, certain mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principal(s) of the related business and/or borrowing entity. As part of underwriting small balance commercial loans, real estate appraisals of the underlying real estate are generally obtained at origination of the mortgage assets underlying the SBC-MBS.
(d) Other Investment Securities Unrealized Losses
The following table presents information about our Other Investment Securities that were in an unrealized loss position at June 30, 2015:
Unrealized Loss Position for Less than 12 Months | Unrealized Loss Position for 12 Months or More | |||||||||||||||||||||
Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | |||||||||||||||||
Risk Sharing Securities - Freddie Mac | $ | 44,976 | $ | (778 | ) | 4 | $ | — | $ | — | — | |||||||||||
Risk Sharing Securities - Fannie Mae | 45,936 | (991 | ) | 3 | — | — | — | |||||||||||||||
SBC-MBS | 58,889 | (808 | ) | 5 | — | — | — | |||||||||||||||
Total Other Investment Securities | $ | 149,801 | $ | (2,577 | ) | 12 | $ | — | $ | — | — |
Note 7 – Other Investments
Our other investments are comprised of our warehouse line, real estate subject to BFT Contracts and mortgage loans, all of which are associated with our Seller Financing Program.
BFT Contracts are agreements to finance the purchase of real property in which the seller provides the buyer with financing to purchase the property for an agreed-upon purchase price, and the buyer repays the loan in installments over the ensuing 20 to 30 years, depending on the term of the financing agreement. Pursuant to a BFT Contract, unlike a mortgage loan, the seller retains the legal title to the property, granting the buyer complete use of the property and requiring the buyer to maintain the property and bear the cost of property taxes. Pursuant to a BFT Contract, the seller generally conveys legal title of the property to the buyer when the full purchase price set forth in the contract has been paid, including all interest incurred through the date of final payment.
Our warehouse line receivable is secured by a pledge of substantially all the assets of the third-party borrower that owns the homes, BFT Contracts and mortgage loans during the time they are pledged on the warehouse line. All BFT Contracts purchased by us through June 30, 2015 are designated as “real estate subject to BFT Contracts,” which real estate is depreciated
29
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
until such time that the criteria for sale have been met. With respect to payments we receive under BFT Contracts, we record the principal component of the buyer’s monthly payment as a deposit liability and record the interest payment in interest income as received.
The following table presents components of the carrying value of our other investments at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||
Warehouse line receivable | $ | 20,464 | $ | 28,639 | ||||
Real estate subject to BFT Contracts, net of accumulated depreciation (1) (2) | 17,960 | 9,616 | ||||||
Mortgage loans purchased through Seller Financing Program | 5,665 | 2,306 | ||||||
Total | $ | 44,089 | $ | 40,561 |
(1) | BFT Contracts at June 30, 2015 had an aggregate principal balance of $18,186 with a weighted average stated interest rate of 8.35% and BFT Contracts at December 31, 2014 had an aggregate principal balance of $9,655 with a weighted average stated interest rate of 8.88%. |
(2) | Net of $226 and $48 of accumulated depreciation at June 30, 2015 and December 31, 2014, respectively. |
Note 8 – Receivables
(a) Interest Receivable
The following table presents our interest receivable by investment category at June 30, 2015 and December 31, 2014:
Investment Category | June 30, 2015 | December 31, 2014 | ||||||
Agency RMBS - Fannie Mae (1) | $ | 2,617 | $ | 3,101 | ||||
Agency RMBS - Freddie Mac (1) | 4,317 | 4,798 | ||||||
Agency RMBS - Ginnie Mae (1) | 79 | 30 | ||||||
Non-Agency RMBS | 1,095 | 1,068 | ||||||
Securitized mortgage loans | 1,007 | 719 | ||||||
Other investment securities | 207 | 10 | ||||||
Other investments | 1,067 | 609 | ||||||
Mortgage loans | — | 120 | ||||||
Total | $ | 10,389 | $ | 10,455 |
(1) | Includes interest income receivable on pass-through, IO, Inverse IO and Inverse Floater securities issued by an Agency, as applicable. |
(b) Investment Related Receivables
The following table presents the components of our investment related receivables at June 30, 2015 and December 31, 2014:
Investment Related Receivables | June 30, 2015 | December 31, 2014 | ||||||
Unsettled sales of Agency RMBS | $ | 132,149 | $ | 188,527 | ||||
Unsettled sales non-Agency RMBS | — | |||||||
Principal payments due from broker | 3,979 | 2,928 | ||||||
Total investment related receivables | $ | 136,128 | $ | 191,455 |
Note 9 – Borrowings Under Repurchase Agreements
As of June 30, 2015, we had master repurchase agreements with 23 counterparties and had outstanding borrowings of $3,177,679 with 17 counterparties.
30
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Our repurchase agreements bear interest at a contractually agreed-upon rate and typically have initial terms of one to six months, but in some cases may have initial terms that are shorter or longer, up to 24 months. The following table presents certain characteristics of our repurchase agreements at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | ||||||||||||||||||
Repurchase Agreement Borrowings | Weighted Average Borrowing Rate | Weighted Average Remaining Maturity (days) | Repurchase Agreement Borrowings | Weighted Average Borrowing Rate | Weighted Average Remaining Maturity (days) | ||||||||||||||
Securities Financed: | |||||||||||||||||||
Agency RMBS | $ | 1,868,994 | 0.38 | % | 21 | $ | 2,205,082 | 0.34 | % | 16 | |||||||||
Non-Agency RMBS (1) | 1,189,357 | 1.88 | 162 | 1,159,698 | 1.95 | 160 | |||||||||||||
Other investment securities | 119,328 | 1.76 | 173 | 28,805 | 1.74 | 13 | |||||||||||||
Mortgage loans | — | — | — | 8,742 | 2.79 | 120 | |||||||||||||
Total | $ | 3,177,679 | 1.00 | % | 79 | $ | 3,402,327 | 0.91 | % | 65 |
(1) | Includes $93,602 and $33,153 of repurchase borrowings collateralized by non-Agency RMBS of $128,933 and $47,786 at June 30, 2015 and December 31, 2014, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with the securitization transactions. |
A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and derivative contracts are subject to financial covenants, which if breached could cause an event of default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such agreements would be immediately payable by us. Through June 30, 2015, we remained in compliance with all of our financial covenants. (See Notes 10 and 11.)
The following table presents repricing information about our borrowings under repurchase agreements at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||||||||
Time Until Interest Rate Reset: | Balance | Weighted Average Interest Rate | Balance | Weighted Average Interest Rate | ||||||||||
Within 30 days | $ | 2,281,457 | 0.89 | % | $ | 2,658,515 | 0.73 | % | ||||||
Over 30 days to 60 days | 654,914 | 1.05 | 501,291 | 1.34 | ||||||||||
Over 60 days to 90 days | 48,887 | 1.70 | 116,196 | 1.92 | ||||||||||
Over 90 days to 120 days | 18,543 | 1.93 | 35,668 | 1.94 | ||||||||||
Over 120 days to 360 days | 173,878 | 1.91 | 90,657 | 2.01 | ||||||||||
Total | $ | 3,177,679 | 1.00 | % | $ | 3,402,327 | 0.91 | % |
31
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
The following table presents the contractual maturity of our repurchase agreements at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | ||||||||||||
Time Until Contractual Maturity: | Balance | Weighted Average Interest Rate | Balance | Weighted Average Interest Rate | |||||||||
Within 30 days | $ | 1,998,076 | 0.72 | % | $ | 2,461,835 | 0.61 | % | |||||
Over 30 days to 60 days | 564,233 | 0.87 | 393,555 | 1.10 | |||||||||
Over 60 days to 90 days | 60,804 | 1.67 | 116,196 | 1.92 | |||||||||
Over 90 days to 120 days | 18,543 | 1.93 | 35,668 | 1.56 | |||||||||
Over 120 days to 360 days | 234,326 | 2.11 | 287,337 | 2.18 | |||||||||
Over 360 days | 301,697 | 2.02 | 107,736 | 2.23 | |||||||||
Total | $ | 3,177,679 | 1.00 | % | $ | 3,402,327 | 0.91 | % |
Note 10 – Collateral Positions
(a) Collateral Pledged and Collateral Held
The following table presents the fair value of our collateral positions, reflecting assets pledged and collateral we held, with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||||||||||
Assets Pledged as Collateral | Collateral Held | Assets Pledged as Collateral | Collateral Held | |||||||||||||
Derivatives: | ||||||||||||||||
Restricted cash/cash (1) | $ | 13,371 | $ | 11,366 | $ | 14,176 | $ | 2,546 | ||||||||
Repurchase agreement borrowings: | ||||||||||||||||
Agency RMBS (2) | 1,923,880 | — | 2,297,050 | — | ||||||||||||
Non-Agency RMBS (3) | 1,524,927 | — | 1,499,296 | — | ||||||||||||
Other investment securities | 149,801 | — | 34,228 | — | ||||||||||||
Mortgage loans | — | 13,602 | ||||||||||||||
Restricted cash | 63,745 | — | 54,830 | — | ||||||||||||
3,662,353 | — | 3,899,006 | — | |||||||||||||
Clearing margin: | ||||||||||||||||
Agency RMBS | 4,174 | — | 3,998 | — | ||||||||||||
Total | $ | 3,679,898 | $ | 11,366 | $ | 3,917,180 | $ | 2,546 |
(1) | Cash pledged as collateral is reported as “Restricted cash” on our consolidated balance sheet. Cash held as collateral is unrestricted in use and therefore is included with cash with a corresponding liability,“Obligation to return cash held as collateral” on our consolidated balance sheet. |
(2) | Includes Agency RMBS of $131,407 and $168,705 that were sold but unsettled at June 30, 2015 and December 31, 2014, respectively. |
(3) | Includes non-Agency RMBS of $128,933 and $47,786 at June 30, 2015 and December 31, 2014, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with our securitizations. Our securitized mortgage loans collateralize the securities pledged. |
32
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(b) Collateral Pledged Components
The following tables present our collateral positions, reflecting assets pledged with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2015 and December 31, 2014:
June 30, 2015 | ||||||||||||||||
Assets Pledged at Fair Value | Amortized Cost | Accrued Interest | Fair Value of Assets Pledged and Accrued Interest | |||||||||||||
Assets pledged for borrowings under repurchase agreements: | ||||||||||||||||
Agency RMBS (1) | $ | 1,923,880 | $ | 1,934,569 | $ | 5,308 | $ | 1,929,188 | ||||||||
Non-Agency RMBS (2) | 1,524,927 | 1,332,377 | 1,150 | 1,526,077 | ||||||||||||
Other investment securities | 149,801 | 152,131 | 207 | 150,008 | ||||||||||||
Securitized mortgage loans | — | — | — | — | ||||||||||||
Mortgage loans | — | — | — | — | ||||||||||||
Cash | 63,745 | — | — | 63,745 | ||||||||||||
3,662,353 | 3,419,077 | 6,665 | 3,669,018 | |||||||||||||
Cash pledged for derivatives contracts | 13,371 | — | — | 13,371 | ||||||||||||
Agency RMBS pledged for clearing margin | 4,174 | 4,078 | 13 | 4,187 | ||||||||||||
Total | $ | 3,679,898 | $ | 3,423,155 | $ | 6,678 | $ | 3,686,576 |
December 31, 2014 | ||||||||||||||||
Assets Pledged- Fair Value | Amortized Cost | Accrued Interest | Fair Value of Assets Pledged and Accrued Interest | |||||||||||||
Assets pledged for borrowings under repurchase agreements: | ||||||||||||||||
Agency RMBS (1) | $ | 2,297,050 | $ | 2,287,498 | $ | 7,015 | $ | 2,304,065 | ||||||||
Non-Agency RMBS (3) | 1,499,296 | 1,423,853 | 1,144 | 1,500,440 | ||||||||||||
Other investment securities | 34,228 | 33,988 | 10 | 34,238 | ||||||||||||
Mortgage loans | 13,602 | 13,602 | 116 | 13,718 | ||||||||||||
Cash | 54,830 | — | — | 54,830 | ||||||||||||
3,899,006 | 3,758,941 | 8,285 | 3,907,291 | |||||||||||||
Cash pledged for derivative contracts | 14,176 | — | — | 14,176 | ||||||||||||
Agency RMBS pledged for clearing margin | 3,998 | 3,907 | 12 | 4,010 | ||||||||||||
Total | $ | 3,917,180 | $ | 3,762,848 | $ | 8,297 | $ | 3,925,477 |
(1) | Includes Agency RMBS of $131,407 and $168,705 that were sold but unsettled at June 30, 2015 and December 31, 2014, respectively. |
(2) | Includes a non-Agency RMBS with a fair value of $128,933, an amortized cost of $127,083 and the associated interest receivable of $620, all of which were eliminated in consolidation with VIEs at June 30, 2015. |
(3) | Includes a non-Agency RMBS with a fair value of $47,786, an amortized cost of $46,319 and the associated interest receivable of $110, all of which were eliminated in consolidation with a VIE at December 31, 2014. |
We consolidate the securitization trusts associated with our securitizations, which are VIEs, that were created to facilitate our securitization transactions. As part of the February 2013 Securitization, the most senior security created was sold to a third-party investor and as such, when we consolidate this securitization trust, this senior security is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value.” Our securitized mortgage loans are restricted in that they can only be used to fulfill the obligations of their associated securitization trust. (See Note 15.)
A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and other financial instruments are subject to financial covenants, which if breached could cause an event of
33
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such agreements would be immediately payable by us. Through June 30, 2015, we remained in compliance with all of our financial covenants. (See Notes 9, 10 and 11.)
34
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 11 – Offsetting Assets and Liabilities
All balances associated with the repurchase agreements and derivatives transactions are presented on a gross basis in our consolidated balance sheets. Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of set-off in the event of default or in the event of a bankruptcy of either party to the transaction.
The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset on our consolidated balance sheet at June 30, 2015 and December 31, 2014:
Offsetting of Financial Assets and Derivative Assets | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Consolidated Balance Sheet | ||||||||||||||||||||||||
Gross Amounts of Recognized Assets | Gross Amounts Offset in the Consolidated Balance Sheet | Net Amounts of Assets Presented in the Consolidated Balance Sheet | Financial Instruments (1) | Cash Collateral Received | Net Amount | |||||||||||||||||||
June 30, 2015 | ||||||||||||||||||||||||
Swaps and Swaptions, at fair value | $ | 17,617 | $ | — | $ | 17,617 | $ | (6,634 | ) | $ | (11,366 | ) | $ | (383 | ) | |||||||||
Total | $ | 17,617 | $ | — | $ | 17,617 | $ | (6,634 | ) | $ | (11,366 | ) | $ | (383 | ) | |||||||||
December 31, 2014 | ||||||||||||||||||||||||
Swaps and Swaptions, at fair value | $ | 11,098 | $ | — | $ | 11,098 | $ | (3,711 | ) | $ | (2,516 | ) | $ | 4,871 | ||||||||||
Long TBA Contracts, at fair value | 544 | — | 544 | — | (30 | ) | 514 | |||||||||||||||||
Total | $ | 11,642 | $ | — | $ | 11,642 | $ | (3,711 | ) | $ | (2,546 | ) | $ | 5,385 |
Offsetting of Financial Liabilities and Derivative Liabilities | ||||||||||||||||||||||||
Gross Amounts Not Offset in the Consolidated Balance Sheet | ||||||||||||||||||||||||
Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Consolidated Balance Sheet | Net Amounts of Liabilities Presented in the Consolidated Balance Sheet | Financial Instruments (2) (3) | Cash Collateral Pledged (2) (4) | Net Amount | |||||||||||||||||||
June 30, 2015 | ||||||||||||||||||||||||
Swaps and Swaptions, at fair value | $ | 8,641 | $ | — | $ | 8,641 | $ | (6,634 | ) | $ | (2,007 | ) | $ | — | ||||||||||
Short TBA contracts, at fair value | 95 | — | 95 | — | 900 | 995 | ||||||||||||||||||
Repurchase agreements | 3,177,679 | — | 3,177,679 | (3,177,679 | ) | — | — | |||||||||||||||||
Total | $ | 3,186,415 | $ | — | $ | 3,186,415 | $ | (3,184,313 | ) | $ | (1,107 | ) | $ | 995 | ||||||||||
December 31, 2014 | ||||||||||||||||||||||||
Swaps and Swaptions, at fair value | $ | 8,949 | $ | — | $ | 8,949 | $ | (3,711 | ) | $ | (5,238 | ) | $ | — | ||||||||||
Repurchase agreements | 3,402,327 | — | 3,402,327 | (3,402,327 | ) | — | — | |||||||||||||||||
Total | $ | 3,411,276 | $ | — | $ | 3,411,276 | $ | (3,406,038 | ) | $ | (5,238 | ) | $ | — |
(1) | Amounts represent derivative instruments in an asset position which could potentially be offset against interest rate derivatives in a liability position at June 30, 2015 and December 31, 2014, subject to a netting arrangement. |
(2) | Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, and interest rate derivatives. |
(3) | The fair value of securities pledged against our borrowings under repurchase agreements was $3,511,299 and $3,830,574 at June 30, 2015 and December 31, 2014, respectively. The amounts pledged include $128,933 and $47,786 of RMBS that are not included in our consolidated balance sheet at June 30, 2015 and December 31, 2014, respectively, as such assets were eliminated in consolidation with a VIE. |
(4) | Total cash pledged against our Swaps was $13,371 and $14,176 at June 30, 2015 and December 31, 2014, respectively. Total cash collateral pledged against our borrowings under repurchase agreements was $63,745 and $54,830 at June 30, 2015 and December 31, 2014, respectively. |
35
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 12 – Derivative Instruments
We enter into derivative contracts, which through June 30, 2015 have from time to time been comprised of Swaps, Swaptions, and TBA Contracts. We use derivative instruments to manage interest rate risk and, as such, view them as economic hedges. We have not elected hedge accounting under GAAP for any of our derivative instruments and, as a result, the fair value adjustments on such instruments are recorded in earnings. The fair value adjustments for our derivatives, along with the related interest income, interest expense and gains/(losses) on termination of such instruments, are reported as “Realized and unrealized gain/(loss) on derivative instruments, net” on our consolidated statements of operations.
(a) Derivative Instruments Summary
Information with respect to our derivative instruments as presented on our consolidated balance sheets at June 30, 2015 and December 31, 2014 was as follows:
June 30, 2015 | December 31, 2014 | |||||||||||||||
Notional Amount | Estimated Fair Value | Notional Amount | Estimated Fair Value | |||||||||||||
Swaps - assets | $ | 957,000 | $ | 8,528 | $ | 957,000 | $ | 9,543 | ||||||||
Swaptions - assets | 1,065,000 | 9,089 | 1,250,000 | 1,555 | ||||||||||||
Swaps - (liabilities) | 730,000 | (8,641 | ) | 730,000 | (8,949 | ) | ||||||||||
Short TBA Contracts - (liabilities) | 200,000 | (95 | ) | — | — | |||||||||||
Long TBA Contracts - assets | — | — | 100,000 | 544 | ||||||||||||
Total | $ | 2,952,000 | $ | 8,881 | $ | 3,037,000 | $ | 2,693 |
(b) Swaps
The variable amount that we receive from our Swap counterparties is typically based on three-month LIBOR. The following table summarizes the average fixed-pay rate and average maturity for our Swaps as of June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||||||||||||
Term to Maturity | Notional Amount | Weighted Average Fixed-Pay Rate | Weighted Average Maturity (Years) | Notional Amount | Weighted Average Fixed-Pay Rate | Weighted Average Maturity (Years) | ||||||||||||
More than one year up to and including three years | $ | 1,109,000 | 1.06 | % | 2.0 | $ | 920,000 | 1.07 | % | 2.4 | ||||||||
More than three years up to and including five years | 14,000 | 1.51 | 4.7 | 189,000 | 1.02 | 3.2 | ||||||||||||
More than five years | 564,000 | 2.15 | 7.5 | 578,000 | 2.13 | 7.9 | ||||||||||||
Total | $ | 1,687,000 | 1.43 | % | 3.9 | $ | 1,687,000 | 1.43 | % | 4.4 |
36
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(c) Swaptions
We pay a premium to our Swaption counterparties to purchase a Swaption. Each of our Swaptions gives us the right, at the expiration of the option period, to either: (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money, as prescribed in the Swaption confirmation.
At June 30, 2015, the Swaps underlying our Swaptions had a weighted average fixed-pay rate of 3.11%. The following table presents information about our Swaptions at June 30, 2015:
Option | Underlying Swap | ||||||||||||||
Fixed-Pay Rate for Underlying Swap | Fair Value | Weighted Average Months Until Option Expiration | Notional Amount | Weighted Average Swap Term (Years) | Weighted Average Fixed-Pay Rate | ||||||||||
2.34% - 2.75% | $ | 678 | 6.7 | $ | 100,000 | 5.0 | 2.34 | % | |||||||
2.76% - 3.00% | 6,093 | 7.3 | 425,000 | 10.0 | 2.93 | ||||||||||
3.01% - 3.25% | 1,714 | 11.4 | 125,000 | 10.0 | 3.24 | ||||||||||
3.26% - 3.50% | 604 | 4.3 | 265,000 | 10.0 | 3.31 | ||||||||||
3.51% - 3.68% | — | 0.2 | 150,000 | 10.0 | 3.64 | ||||||||||
Total | $ | 9,089 | 6.0 | $ | 1,065,000 | 9.5 | 3.11 | % |
(d) Gains/(Losses) on Derivatives
The following table summarizes the amounts recognized on our consolidated statements of operations related to our derivative instruments for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
Character of Loss on Derivative Instruments | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Net interest payments/accruals on Swaps (1) | $ | (4,920 | ) | $ | (5,081 | ) | $ | (9,884 | ) | $ | (9,870 | ) | ||||
Losses on the termination and expiration of Swaptions, net (1) | (6,170 | ) | (7,585 | ) | (10,032 | ) | (14,112 | ) | ||||||||
Losses on settlement of TBA Contracts, net (1) | — | — | (1,977 | ) | (7,156 | ) | ||||||||||
Change in fair value of Swaps (2) | 14,769 | (15,244 | ) | (707 | ) | (26,168 | ) | |||||||||
Change in fair value of Swaptions (2) | 8,879 | 777 | 9,181 | (6,267 | ) | |||||||||||
Change in fair value of TBA Contracts (2) | (95 | ) | — | (639 | ) | (750 | ) | |||||||||
Total | $ | 12,463 | $ | (27,133 | ) | $ | (14,058 | ) | $ | (64,323 | ) |
Note: Each of the items presented is included as a component of “Realized and unrealized gain/(loss) on derivative instruments, net” on our consolidated statements of operations for the periods presented.
(1) | Amounts are realized. |
(2) | Amounts are unrealized. |
37
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(e) Derivative Activity
The following table provides information with respect to our use of derivative instruments during the periods presented:
Three Months Ended June 30, 2015 | Six Months Ended June 30, 2015 | |||||||||||||||||||||||||||
Short TBA Contracts | Swaps | Swaptions | Short TBA Contracts | Long TBA Contracts | Swaps | Swaptions | ||||||||||||||||||||||
Beginning Notional Balance | $ | — | $ | 1,687,000 | $ | 1,425,000 | $ | — | $ | 100,000 | $ | 1,687,000 | $ | 1,250,000 | ||||||||||||||
Notional amount of contracts entered | (200,000 | ) | — | 200,000 | (200,000 | ) | 500,000 | — | 650,000 | |||||||||||||||||||
Notional amount of contracts terminated | — | — | (560,000 | ) | (600,000 | ) | — | (835,000 | ) | |||||||||||||||||||
Ending Notional Balance | $ | (200,000 | ) | $ | 1,687,000 | $ | 1,065,000 | $ | (200,000 | ) | $ | — | $ | 1,687,000 | $ | 1,065,000 | ||||||||||||
Three Months Ended June 30, 2014 | Six Months Ended June 30, 2014 | |||||||||||||||||||||||||||
Short TBA Contracts | Swaps | Swaptions | Short TBA Contracts | Long TBA Contracts | Swaps | Swaptions | ||||||||||||||||||||||
Beginning Notional Balance | $ | — | $ | 1,687,000 | $ | 1,275,000 | $ | 400,000 | $ | — | $ | 1,587,000 | $ | 1,375,000 | ||||||||||||||
Notional amount of contracts entered | — | — | 560,000 | — | — | 100,000 | 1,010,000 | |||||||||||||||||||||
Notional amount of contracts terminated | — | — | (500,000 | ) | (400,000 | ) | — | — | (1,050,000 | ) | ||||||||||||||||||
Ending Notional Balance | $ | — | $ | 1,687,000 | $ | 1,335,000 | $ | — | $ | — | $ | 1,687,000 | $ | 1,335,000 |
(f) Financial Covenants
Our agreements with certain of our derivative counterparties contain financial covenants; through June 30, 2015 we were in compliance with the terms of all such covenants. We have minimum collateral posting thresholds with certain of our Swap counterparties, for which we typically pledge cash. (See Notes 10 and 11.) If we had breached any of these provisions at June 30, 2015, we could have been required to settle our obligations under our Swaps at their termination value. At June 30, 2015, the estimated termination value of our Swaps was $11,056, which amount reflects the estimated fair value of our Swaps that were in a liability position, plus accrued interest.
Note 13 – Interest Payable
The following table presents the components of our interest payable at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||
Repurchase borrowings collateralized by Agency RMBS | $ | 1,159 | $ | 1,569 | ||||
Repurchase borrowings collateralized by non-Agency RMBS (1) | 4,316 | 8,234 | ||||||
Repurchase borrowings collateralized by other investment securities | 171 | 127 | ||||||
Repurchase borrowings collateralized by mortgage loans | — | 9 | ||||||
Securitized debt | 86 | 110 | ||||||
Swaps | 2,819 | 2,977 | ||||||
Total | $ | 8,551 | $ | 13,026 |
(1) | Includes $132 and $103 of interest payable on repurchase borrowings collateralized by non-Agency RMBS issued by consolidated VIEs at June 30, 2015 and December 31, 2014, respectively, which securities were eliminated from our balance sheet in consolidation. |
Note 14 – Commitments and Contingencies
(a) Management Agreement – Related Party Transactions
In connection with our initial public offering in July 2011, we entered into a management agreement with our Manager (or, Management Agreement), which describes the services to be provided for us by our Manager and compensation for such services. Our Manager is responsible for managing our day-to-day operations, subject to the direction and oversight of our board of directors.
38
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of adjusted stockholders’ equity (as defined in the Management Agreement), calculated and payable quarterly in arrears.
The term of our Management Agreement currently runs through July 27, 2016. Absent certain action by the independent directors of our board of directors, as described below, the Management Agreement will automatically renew on each anniversary for a one year term. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors, based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us; or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
We incurred management fees of $2,895 and $2,774 for the three months ended June 30, 2015 and 2014, respectively. In addition to the management fee, we are responsible for reimbursing our Manager for certain expenses paid by our Manager on behalf of us and for certain services provided by our Manager to us. Expenses incurred by our Manager and reimbursed by us are typically included in our general and administrative expense on the consolidated statement of operations, or may be reflected on the consolidated balance sheet and associated consolidated statement of changes in stockholders’ equity, based on the nature of the item. At June 30, 2015 and December 31, 2014, $2,895 and $2,840, respectively, for management fees incurred but not yet paid were included in “Payable to related party” on the consolidated balance sheet.
(b) Representations and Warranties in Connection with Securitization
In connection with our February 2013 Securitization, we have the obligation under certain circumstances to repurchase assets from the VIE upon breach of certain representations and warranties. In February 2014, the substantial majority of these obligations expired, with only the representations and warranties surviving such obligations, which may expose us to losses, being that the loans transferred to the VIE are qualified mortgages under Section 860G(a)(3) of the Internal Revenue Code. Through June 30, 2015, no repurchase claims had been made against us, and we do not believe that the amount of any future potential liability with respect to such item (the maximum of which would be the current unpaid principal balance of any such loan plus accrued interest, unreimbursed advances and any expenses) is material to us. At June 30, 2015, we had no reserve established for repurchases of loans and were not aware of any repurchase claims that would require the establishment of such a reserve. (See Note 15.)
Note 15 – Use of Special Purpose Entities and Variable Interest Entities
Special purpose entities (or, SPEs) are entities designed to fulfill a specific limited need of the entity that organizes it. SPEs are often used to facilitate transactions that involve securitizing financial assets. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis. Securitization involves transferring assets to an SPE to convert all or a portion of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of debt or equity instruments. Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall structure of the transaction, may benefit from various forms of credit enhancement, such as over-collateralization in the form of excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement.
(a) Securitization Transactions
We have entered into two securitization transactions for which we consolidate the associated trusts, as VIEs, that were created to facilitate the transactions and to which the underlying assets in connection with the securitizations were transferred. (See Note 2(o) for a discussion of the accounting policies applied to the consolidation of VIEs and transfers of financial assets in connection with securitization transactions.)
As of June 30, 2015 and December 31, 2014, the aggregate fair value of securitized mortgage loans underlying our securitizations was $178,904 and $104,438, respectively, and are included in “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value,” on our consolidated balance sheet.
39
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
The mortgage loans in our securitizations are comprised of performing, re-performing and non-performing mortgage loans with characteristics similar to the mortgage loans underlying our non-Agency RMBS.
The following table summarizes the key details of our securitization transactions as of June 30, 2015:
March 2015 Securitization | February 2013 Securitization | Total | ||||||||||
Name of securitization trust consolidated as a VIE | AMST 2015-1 | AMST 2013-1 | ||||||||||
Principal value of mortgage loans sold into the securitization trust | $ | 90,802 | $ | 155,001 | $ | 245,803 | ||||||
Current principal value of mortgage loan in securitization trust | $ | 89,243 | $ | 132,495 | $ | 221,738 | ||||||
Face amount of senior security issued by the VIE and sold to a third-party investor | $ | — | $ | 50,375 | $ | 50,375 | ||||||
Outstanding balance of senior security at June 30, 2015 (1) | $ | 80,598 | $ | 25,828 | $ | 106,426 | ||||||
Year of final contractual maturity of senior debt | 2054 | 2047 | ||||||||||
Face/Par value of certificates received by us (2) | $ | 82,287 | $ | 1,046 | $ | 83,333 | ||||||
Cash received from sale of the senior security sold to third-party investor | $ | — | $ | 50,375 | $ | 50,375 | ||||||
Gross securitization expenses incurred ($555 net of amortization as of June 30, 2015) (3) | $ | 174 | $ | 829 | $ | 1,003 | ||||||
Pass-through interest rate for senior security issued - fixed rate | 5.75 | % | 4.00 | % |
(1) | With respect to the March 2015 Securitization, amount reflects 100% of the single security issued, which we retained, in connection with the securitization. |
(2) | With respect to our February 2013 Securitization, the certificates we received are subordinate to and provide credit support for the sequential senior security sold to a third-party investor. While the RMBS that we retained in connection with February 2013 Securitization do not appear on our balance sheet, as they are eliminated in consolidation with the VIE/securitization trust, we legally own such securities and we, as legally, permitted pledge such securities as collateral. |
(3) | Certain expenses incurred in connection with our securitizations were capitalized as deferred charges and are amortized to interest expense based upon the actual repayments of the associated senior security sold to a third party, or the initial term of the associated borrowing facility. |
(b) Consolidation Assessment
On a quarterly basis, we complete an analysis to determine whether the VIEs associated with our securitizations should be consolidated by us. As part of this analysis, we consider our involvement in the creation of the VIE, including the design and purpose of the VIE and whether our involvement reflects a controlling financial interest that results in us being deemed the primary beneficiary of the VIE. In determining whether we would be considered the primary beneficiary, we consider: (i) whether we have both the power to direct the activities that most significantly impact the economic performance of the VIE; and (ii) whether we have a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. Based on our evaluation of these factors, including our involvement in the design of the VIE, we determined that we were required to consolidate the VIE created to facilitate the March 2015 Securitization and February 2013 Securitization for each reporting period from inception through June 30, 2015.
(c) Activities of Securitization Trusts
The securitization trusts receive principal and interest on the underlying mortgage loans and distribute those payments to the certificate holders. The assets and other instruments held by the securitization trusts are restricted in that they can only be used to fulfill the obligations of their respective securitization trust. The risks associated with our involvement with the VIEs is limited to the risks and rights as a certificate holder of the securities we retained.
The activities of the securitization trusts are substantially set forth in the securitization transaction documents, primarily the mortgage loan trust agreements, the trust agreements, the indenture and the securitization servicing agreements (or collectively, the Securitization Agreements). Neither the trusts nor any other entity may sell or replace any assets of the trust except in connection with: (i) certain loan defects or breaches of certain representations and warranties which have a material adverse effect on the value of the related assets; (ii) loan defaults; (iii) certain trust events of default or (iv) an optional termination of the trust, each as specifically permitted under the Securitization Agreements.
Prior to the completion of our first securitization transaction in February 2013, we had not transferred assets to VIEs or QSPEs and other than acquiring RMBS issued by such entities, had no other involvement with VIEs or QSPEs.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
(d) Securitized Debt
We consolidate the underlying trust associated with our February 2013 Securitization. As a result, the senior security that was sold to a third-party investor is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value” and the residential mortgage loans held by the trust that collateralize the securities issued by the trust are included as a component of “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value” on our consolidated balance sheet. The third-party beneficial interest holders in the VIE have no recourse against us, except that we may have an obligation to repurchase assets from the VIE in the event that we breach certain representations and warranties in relation to the mortgage loans sold to the VIE. Other than the foregoing, we have no obligation to provide, nor have we provided, any other explicit or implicit support to this or any other VIE that we consolidate.
Our securitized debt is carried at fair value, which is based on the fair value of the senior security held by third parties. The following table presents the estimated principal repayment schedule of the par value of the securitized debt at June 30, 2015, based on expected cash flows of the securitized residential mortgage loans, as adjusted for projected losses on such loans.
Estimated Maturity | June 30, 2015 | |||
One year or less | $ | 7,389 | ||
More than one year, up to and including three years | 14,754 | |||
More than three years, up to and including five years | 3,685 | |||
Total | $ | 25,828 |
Repayment of our securitized debt will be dependent upon the cash flows generated by the mortgage loans in the February 2013 Securitization trust that collateralize such debt. The actual cash flows from the securitized mortgage loans are comprised of coupon interest, scheduled principal payments, prepayments and liquidations of the underlying mortgage loans. The actual term of the securitized debt may differ significantly from our estimate given that actual interest collections, mortgage prepayments and/or losses on liquidation of mortgages may differ significantly from those expected. (See Note 5 for more information about the mortgage loans collateralizing our securitized debt.)
(e) VIEs - Impact on the Consolidated Financial Statements
The following table reflects the assets and liabilities recorded in our consolidated balance sheet related to our consolidated VIEs at June 30, 2015 and December 31, 2014:
June 30, 2015 | December 31, 2014 | |||||||
Assets: | ||||||||
Securitized mortgage loans, at fair value | $ | 178,904 | $ | 104,438 | ||||
Interest receivable | $ | 1,006 | $ | 719 | ||||
Liabilities: | ||||||||
Borrowings under repurchase agreements (1) | $ | 93,602 | $ | 33,153 | ||||
Non-recourse securitized debt, at fair value | $ | 25,893 | $ | 34,176 | ||||
Accrued interest payable (1) | $ | 218 | $ | 213 |
(1) | Prior presentation is conformed to the current presentation. |
41
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
The following table reflects the income and expense amounts recorded in our consolidated statements of operations related to our consolidated VIEs for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Interest income - securitized mortgage loans | $ | 3,623 | $ | 1,927 | $ | 5,790 | $ | 4,173 | ||||||||
Interest expense - securitized debt | $ | (333 | ) | $ | (432 | ) | $ | (699 | ) | $ | (874 | ) | ||||
Interest expense- repurchase agreements | $ | (648 | ) | $ | — | $ | (958 | ) | $ | — | ||||||
Unrealized gain/(loss) on securitized mortgage loans, net | $ | (1,896 | ) | $ | 2,042 | $ | 466 | $ | 3,096 | |||||||
Unrealized gain/(loss) on securitized debt | $ | 1,001 | $ | (364 | ) | $ | 1,014 | $ | (354 | ) | ||||||
Other, net | $ | — | $ | (68 | ) | $ | — | $ | (68 | ) |
The following table reflects the amounts included on our consolidated statements of cash flows related to our consolidated VIEs for the periods presented:
Six Months Ended June 30, | ||||||||
2015 | 2014 (1) | |||||||
Net income | $ | 6,557 | $ | 5,973 | ||||
Premium amortization/(discount accretion), net | $ | 214 | $ | 263 | ||||
Amortization of deferred financing costs | $ | 163 | $ | 83 | ||||
Unrealized (gain) on securitized mortgage loans, net | $ | (466 | ) | $ | (3,096 | ) | ||
Unrealized (gain)/loss on securitized debt | $ | (1,014 | ) | $ | 354 | |||
Realized loss on real estate owned, net | $ | 133 | $ | 68 | ||||
(Increase) in accrued interest receivable, less purchased interest | $ | (287 | ) | $ | (60 | ) | ||
(Decrease) in accrued interest payable | $ | (24 | ) | $ | (17 | ) | ||
Purchase of mortgage loans, simultaneously securitized | $ | (67,357 | ) | $ | — | |||
Proceeds from issuance of real estate owned | $ | 351 | $ | 30 | ||||
Other, net | $ | 1 | $ | 1 | ||||
Principal payments received on securitized mortgage loans | $ | 5,512 | $ | 3,913 | ||||
Proceeds from repurchase agreement borrowings | $ | 372,215 | $ | — | ||||
Repayments of repurchase agreement borrowings | $ | (311,766 | ) | $ | — | |||
Principal payments on securitized debt | $ | (7,269 | ) | $ | (5,052 | ) |
(1) | Prior presentation is conformed to the current presentation. |
Note 16 – Equity Award Plan
On July 21, 2011, our board of directors approved the Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan (or, LTIP). The LTIP provides for grants of restricted common stock, RSUs and other equity-based awards up to an aggregate of 5% of the issued and outstanding shares of our common stock (on a fully diluted basis). The LTIP is administered by the compensation committee of our board of directors, which also must approve grants made under the LTIP. At June 30, 2015, 1,281,910 awards were available for grant under the LTIP.
The following table presents expenses related to our equity-based compensation awards for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Restricted Common Stock | $ | 105 | $ | 103 | $ | 211 | $ | 193 | ||||||||
RSUs | 198 | 305 | 586 | 674 | ||||||||||||
Total | $ | 303 | $ | 408 | $ | 797 | $ | 867 |
At June 30, 2015, we had estimated unrecognized compensation expense of $1,872 and $667 related to RSUs and restricted common stock, respectively. The unrecognized compensation expense at June 30, 2015 is expected to be recognized
42
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
over a weighted average period of 1.7 years. As of June 30, 2015, we had an expected average forfeiture rate of 0% with respect to restricted common stock and 5% with respect to RSUs.
Through June 30, 2015, we have not settled RSUs in cash. However, the LTIP provides that we may allow RSU recipients to elect to settle their tax liabilities with a reduction of their share delivery from the originally granted and vested RSUs, which is referred to herein as “net share settlement.” Net share settlement results in us making a cash payment to an affiliate of our Manager related to this tax liability and a corresponding adjustment to additional paid-in-capital.
The following table presents information about our equity awards for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||||||||||||||
Number of Awards (1) | Weighted Average Grant Date Fair Value (1) | Number of Awards (1) | Weighted Average Grant Date Fair Value (1) | Number of Awards (1) | Weighted Average Grant Date Fair Value(1) | Number of Awards (1) | Weighted Average Grant Date Fair Value (1) | |||||||||||||||||||||
RSUs outstanding at beginning of period | 291,777 | $ | — | 182,359 | $ | 19.48 | 292,088 | $ | — | 183,922 | $ | 19.47 | ||||||||||||||||
RSUs canceled upon delivery of common stock (2) | (5,000 | ) | — | (1,562 | ) | 17.95 | (5,000 | ) | — | (3,125 | ) | 17.95 | ||||||||||||||||
RSUs canceled or forfeited | (2,289 | ) | — | — | — | — | — | — | — | |||||||||||||||||||
RSUs outstanding at end of period | 284,488 | $ | — | 180,797 | $ | 19.50 | 284,488 | $ | — | 180,797 | $ | 19.50 | ||||||||||||||||
Vested RSUs | 98,916 | $ | — | 62,160 | $ | 19.76 | 98,916 | — | 62,160 | 19.76 | ||||||||||||||||||
Unvested RSUs | 185,572 | $ | — | 118,637 | $ | 19.36 | 185,572 | — | 118,637 | 19.36 | ||||||||||||||||||
Unvested restricted common stock awards outstanding at beginning of period | 41,980 | $ | — | 25,140 | $ | 20.52 | 43,992 | $ | — | 28,040 | $ | 20.37 | ||||||||||||||||
Restricted common stock granted | 9,332 | — | 9,208 | 16.29 | 9,332 | — | 9,208 | 16.29 | ||||||||||||||||||||
Restricted common stock vested | (2,008 | ) | — | (2,908 | ) | 19.03 | (4,020 | ) | — | (5,808 | ) | 19.03 | ||||||||||||||||
Unvested restricted common stock outstanding at end of period | 49,304 | $ | — | 31,440 | $ | 19.42 | 49,304 | $ | — | 31,440 | $ | 19.42 |
(1) | Amounts are not in thousands. |
(2) | Includes amounts deemed issued in connection with payment of grantee’s tax liability. |
Note 17 – Stockholders’ Equity
(a) Common Stock Dividends
The following table presents cash dividends declared by our board of directors on our common stock from January 1, 2014 through June 30, 2015:
Declaration Date | Record Date | Payment Date | Dividend Per Share | |||||
June 17, 2015 | June 30, 2015 | July 31, 2015 | $ | 0.48 | ||||
March 19, 2015 | March 31, 2015 | April 30, 2015 | $ | 0.48 | ||||
December 18, 2014 | December 31, 2014 | January 30, 2015 | $ | 0.45 | ||||
September 17, 2014 | September 30, 2014 | October 31, 2014 | $ | 0.44 | ||||
June 19, 2014 | June 30, 2014 | July 31, 2014 | $ | 0.42 | ||||
March 13, 2014 | March 31, 2014 | April 30, 2014 | $ | 0.40 |
(b) Preferred Stock
At June 30, 2015 and December 31, 2014, we had outstanding 6,900,000 shares of 8.0% Series A Cumulative Redeemable Perpetual Preferred Stock (or, Preferred Stock) with a liquidation preference of $25.00 per share and a par value $0.01 per share. Holders of our Preferred Stock are entitled to receive dividends at an annual rate of 8.0% of the liquidation
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Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
preference of $25.00 per share, or $2.00 per share per annum. These dividends are cumulative and payable quarterly in arrears. Generally, we may not redeem the Preferred Stock until September 20, 2017, except under certain limited circumstances intended to preserve our qualification as a REIT and upon the occurrence of a change in control as defined in the final prospectus supplement related to the Preferred Stock filed with the Securities Exchange Commission (or, SEC) on September 17, 2012. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. Based upon the characteristics of the Preferred Stock, such instruments are characterized as equity instruments.
The Preferred Stock generally has no voting rights. However, if dividends on the Preferred Stock are in arrears for six quarterly dividend periods, whether or not consecutive, the holders of the Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) will have the right to elect two additional directors to our board until we pay (or declare and set aside for payment) all dividends that are then in arrears. In addition, the affirmative vote of at least two-thirds of the votes entitled to be cast by holders of outstanding shares of Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) is required for us to authorize, create or increase the number of any class or series of senior equity securities or to amend our charter (including the Articles Supplementary designating the Preferred Stock, or the Articles Supplementary) in a manner that materially and adversely affects the rights of the Preferred Stock.
(c) Shelf Registration
On July 23, 2012, we filed a shelf registration statement on Form S-3 with the SEC under the Securities Act of 1933, as amended (or, the Securities Act), with respect to up to $750,000 of common stock, preferred stock, depositary shares, warrants and/or rights that may be sold by us from time to time pursuant to Rule 415 of the Securities Act. This registration statement was declared effective by the SEC on August 10, 2012. At June 30, 2015, we had $405,460 available under this shelf registration statement.
(d) Direct Stock Purchase and Dividend Reinvestment Plan
On November 13, 2012, we filed a Registration Statement on Form S-3 with the SEC under the Securities Act reserving 2,000,000 shares of common stock available under the terms of our Direct Stock Purchase and Dividend Reinvestment Plan (or, Stock Purchase Plan). Under the Stock Purchase Plan, stockholders who participate may purchase shares of our common stock directly from us. Stockholders may also automatically reinvest all or a portion of their dividends for additional shares of our stock. Through June 30, 2015, all shares issued pursuant to the Stock Purchase Plan were issued from shares purchased on the open market.
(e) Stock Repurchase Program
On November 6, 2013, our board of directors authorized a stock repurchase program (or, the Repurchase Program), to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program, if any, will be canceled and, until reissued by us, will be deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior notice. Through June 30, 2015, we had not repurchased any shares of common stock under the Repurchase Program.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
Note 18 – Earnings per Common Share
The following table presents basic and diluted net EPS of common stock using the two-class method for the periods presented:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Numerator: | ||||||||||||||||
Net Income/(Loss) | $ | (10,032 | ) | $ | 44,004 | $ | 11,375 | $ | 71,886 | |||||||
Less: | ||||||||||||||||
Dividends declared on Preferred Stock | 3,450 | 3,450 | 6,900 | 6,900 | ||||||||||||
Dividends, dividend equivalents and undistributed earnings allocated to participating securities (1) | 153 | 263 | 307 | 416 | ||||||||||||
Net income/(loss) allocable to common stock – basic and diluted | $ | (13,635 | ) | $ | 40,291 | $ | 4,168 | $ | 64,570 | |||||||
Denominator: | ||||||||||||||||
Weighted average common shares - basic | 32,048 | 32,020 | 32,047 | 32,018 | ||||||||||||
Weighted average common shares - diluted | 32,048 | 32,106 | 32,057 | 32,085 | ||||||||||||
Earnings per common share - basic | $ | (0.43 | ) | $ | 1.26 | $ | 0.13 | $ | 2.02 | |||||||
Earnings per common share - diluted | $ | (0.43 | ) | $ | 1.25 | $ | 0.13 | $ | 2.01 |
(1) | For the three and six months ended June 30, 2015, 284,488 and 187,028 RSUs and 49,304 and 49,304 shares of restricted stock outstanding were not included in the calculation of diluted earnings per common share, as their inclusion would have been anti-dilutive. These instruments may have a dilutive impact on future EPS. |
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ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
(All currency figures are presented in thousands, except per share data or as otherwise noted.)
FORWARD-LOOKING INFORMATION
We make forward-looking statements in this Quarterly Report on Form 10-Q and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (or, the Exchange Act). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may,” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in our industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; our business and investment strategy; our operating results and potential asset performance; availability of opportunities to acquire Agency RMBS, non-Agency RMBS, residential mortgage loans and other residential mortgage assets or other real estate related assets; changes in the prepayment rates on the mortgage loans securing our RMBS; management’s assumptions regarding default rates on the mortgage loans securing our non-Agency RMBS and our SBC-MBS; our ability to borrow to finance our assets and the terms, including the cost, maturity and other terms, of any such borrowing; our estimates regarding taxable income, the actual amount of which is dependent on a number of factors, including, but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market discount on non-Agency RMBS, realized losses and changes in the composition of our Agency RMBS and non-Agency RMBS portfolios that may occur during the applicable tax period, including gain or loss on any RMBS disposals; expected leverage; general volatility of the securities markets in which we participate; our expected portfolio and scope of our target assets; our expected investment and underwriting process; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; rates of default or decreased recovery rates on our assets; the degree to which our hedging strategies may or may not protect us from interest rate volatility and the effects of hedging instruments on our assets; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters affecting our business; the timing and amount of distributions to stockholders, which are declared and paid at the discretion of our board of directors and will depend on, among other things, our taxable income, our financial results and overall financial condition and liquidity; maintenance of our qualification as a REIT for U.S. Federal income tax purposes and such other factors as our board of directors deems relevant; our ability to maintain our exclusion from registration as an investment company under the1940 Act; availability of qualified personnel through our Manager; and our understanding of our competition.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. See “Part I, Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2014. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in our Annual Report on Form 10-K filed for the year ended December 31, 2014.
General
We were incorporated in Maryland on March 15, 2011 and commenced operations on July 27, 2011. We are structured as a holding company and conduct our business primarily through ARM Operating, LLC and our other operating subsidiaries. We have elected and operate to qualify as a REIT for U.S. Federal income tax purposes commencing with our taxable year ended December 31, 2011. We also operate our business in a manner that we believe will allow us to remain excluded from
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registration as an investment company under the 1940 Act. We are externally managed and advised by our Manager, an indirect subsidiary of Apollo Global Management, LLC.
At June 30, 2015, our portfolio was comprised of Agency RMBS (comprised of pass-through, IO and Inverse IO securities), non-Agency RMBS, securitized mortgage loans, and other mortgage and mortgage related assets. Over time, we expect that we may invest in a broader range of other residential mortgage and mortgage-related assets. (See “Target Assets,” below.)
We use leverage as part of our business strategy in order to increase potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon our Manager’s assessment of a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties.
We use derivatives to hedge a portion of our interest rate risk and not for speculative purposes. As of June 30, 2015, our derivatives included Swaps, Swaptions and TBA Contracts.
Factors Impacting Our Operating Results
Our results of operations are driven by, among other things, our net interest income, changes in the market value of our investments and derivative instruments and, from time to time, realized gains and losses on the sale of our investments and termination of our derivative instruments. The supply and demand for RMBS and other mortgage assets in the market place, the terms and availability of financing for such assets, general economic and real estate conditions, the impact of U.S Government actions that impact the real estate and mortgage sector, and the credit performance of our credit sensitive investments impact our overall performance. Our net interest income varies primarily as a result of changes in market interest rates and the slope of the yield curve (i.e., the differential between long-term and short-term interest rates) and constant prepayment rates (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on RMBS as a percentage of the principal balance, and includes the conditional repayment rate (or, CRR), which measures voluntary prepayments of mortgages collateralizing a particular RMBS and conditional default rates (or, CDR), which measures involuntary prepayments resulting from defaults of the underlying mortgage loans. CPRs vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. In addition, our borrowing costs and available credit are further affected by the collateral pledged and general conditions in the credit market.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS, Inverse IO and Inverse Floater securities and Long TBA Contracts to decline; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts, if any, Swaps and Swaptions to improve. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.
Premiums arise when we purchase a security at a price in excess of the security’s par value and discounts arise when we purchase a security at a price below the security’s par value. Premiums on our RMBS are amortized against interest income over the life of the security, while discounts (excluding credit discounts, as discussed below) are accreted to income over the life of the security. The speeds at which premiums are amortized and discounts are accreted are significantly impacted by the CPR for each security. CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. CPRs on Agency RMBS and non-Agency RMBS may differ significantly.
We are exposed to credit risk with respect to our non-Agency RMBS, other investment securities, securitized mortgage loans, mortgage loans and other investments. Such credit risk is associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such investments. The credit risk on our non-Agency RMBS is generally mitigated by the credit support built into non-Agency RMBS structures and the purchase discounts on such securities, which provides a level of credit protection in the event that we receive less than 100% of the par value of these securities. The credit risk associated with our warehouse line receivable is mitigated by a pledge of substantially all the equity of the third-party borrower/guarantor, which borrower has legal title to the homes, BFT Contracts and mortgage loans that we finance on a warehouse line. To date we purchased substantially all of our non-Agency RMBS at a discount to par value; a portion of such
47
discount may be viewed as a credit discount which is not expected to be amortized into interest income. The amount designated as credit discount on a security may change over time based on the security’s performance and its anticipated future performance. (See “Credit Risk”, included under Item 3 of this Quarterly Report on Form 10-Q.)
Our non-Agency RMBS investment process involves analysis focused primarily on quantifying and pricing credit risk. Interest income on our non-Agency RMBS is recorded at an effective yield, which reflects an estimate of expected cash flows for each security. In forecasting cash flows on our non-Agency RMBS, our Manager makes certain assumptions about the underlying mortgage loans which assumptions include, but are not limited to, future interest rates, voluntary prepayment rates, default rates, modifications and loss severities. As part of our non-Agency RMBS surveillance, we review, on at least a quarterly basis, each security’s performance. To the extent that actual performance and our current assessment of future performance differs from our prior assessment, such changes are reflected in the yield/income recognized on such securities prospectively. Credit losses greater than those anticipated, or in excess of purchase discount on a given security, could materially adversely impact our operating results.
We receive interest payments only with respect to the notional amount of Agency IO and Agency Inverse IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency pass-through RMBS, the market prices of Agency IO generally have a positive correlation to increases in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO are expected to decrease, which in turn is expected to extend/increase the cash flow and the value of such securities; we expect the inverse to occur with respect to decreases in market interest rates. In addition to viewing Agency IO as investments, we also note that such instruments serve as a partial economic hedge against the impact that an increase in market interest rates would have on the value of our Agency RMBS in the marketplace. While Agency IO and Agency Inverse IO comprised a relatively small portion of our investments at June 30, 2015, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments.
Target Assets
We primarily invest in residential mortgage and mortgage related assets throughout the United States. As of June 30, 2015, we held investments in RMBS, including Agency pass-through RMBS (whose underlying collateral is primarily comprised of 30 year fixed-rate mortgages), Agency Inverse Floaters, Agency IO, Agency Inverse IO, non-Agency RMBS, securitized mortgage loans, other mortgage-related securities, mortgage loans and other real estate related investments associated with our Seller Financing Program. The Seller Financing Program refers to our initiative whereby we provide advances through a warehouse line to a third party to finance the acquisition and improvement of single-family homes. Once the homes are improved, they are marketed for sale, with the seller providing financing to the buyer in the form of a mortgage loan or a BFT Contract. We believe that the continued diversification of our portfolio of assets, our expertise within our target asset classes and the flexibility of our strategy will enable us to achieve attractive risk-adjusted returns under a variety of market conditions and economic cycles over time. In the future, we may invest in assets other than our target assets listed below, in each case subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes and our exclusion from registration as an investment company under the 1940 Act. Our board of directors may, without stockholder approval, amend our investment strategy at any time.
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The following is a summary of our target assets at June 30, 2015:
Asset Classes | Principal Assets | |
Agency RMBS | Agency RMBS, primarily comprised of whole-pool pass-through securities, CMOs, Agency IO, Agency Inverse IO, Agency Inverse Floater and Agency principal-only securities. | |
Non-Agency RMBS and Real Estate Related Asset-Backed Securities | Non-Agency RMBS, including highly rated, as well as non-investment grade and unrated, tranches backed by Alt-A mortgage loans, Option ARMs, Subprime mortgage loans and prime mortgage loans, and other real estate related asset-backed securities. | |
Residential Mortgage Loans | Prime mortgage loans, jumbo mortgage loans, Alt-A mortgage loans, Option ARMs, Subprime mortgage loans or other mortgage-like financing arrangements, including, but not limited to, BFT Contracts. These investments may be performing, re-performing, sub-performing or non-performing. | |
Other Residential Mortgage-Related Assets | Non-Agency RMBS comprised of interest-only securities, principal-only securities, floating rate inverse interest-only securities, and floating rate securities, and other Agency and non-Agency RMBS derivative securities, as well as other financial assets, including, but not limited to, common stock, preferred stock and debt of other real estate-related entities, mortgage servicing rights, excess servicing spreads, advances on our warehouse line and mortgage loans to investors in residential properties. In addition, we may own real estate incidental to our financing arrangements associated with such properties. |
We rely on our Manager’s expertise in identifying assets within our target asset classes and to efficiently finance those assets. We expect that our Manager will make decisions based on a variety of factors, including expected risk-adjusted returns on our assets, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our qualification as a REIT and our exclusion from registration as an investment company under the 1940 Act.
Financing Strategy
We use leverage primarily for the purpose of financing our investment portfolio and increasing potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We had an aggregate debt-to-equity multiple of 4.21 times at June 30, 2015. Our debt-to-equity multiple reflects the aggregate of our borrowings under repurchase agreements and securitized debt (based upon fair value) to our total stockholders’ equity.
We continue to have available capacity under our master repurchase agreements. However, such agreements are generally uncommitted and are renewable at the discretion of our lenders. We finance our Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio in the range between approximately eight-to-one and ten-to-one and finance our non-Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio of approximately three-to-one. Our target and actual leverage may vary from time to time based on availability of financing and our assessment of market conditions. The terms of our repurchase agreements are typically one to six months at inception, but in some cases may have initial terms that are shorter or longer, up to 24 months. At June 30, 2015, we had master repurchase agreements with 23 counterparties. As a matter of routine business, we may have discussions with additional financial institutions with respect to expanding our repurchase agreement borrowing capacity. As of June 30, 2015, we had $3,177,679 of borrowings outstanding under our repurchase agreements with 17 counterparties collateralized by $1,923,880 of Agency RMBS (which includes $131,407 of RMBS that were sold but unsettled at June 30, 2015), $1,524,927 of non-Agency RMBS (which included $128,933 of non-Agency RMBS that were eliminated from our balance sheet in consolidation with a VIE), and $149,801 of other investment securities. (See Notes 9, 10 and 11 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
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We have engaged in and expect, subject to market conditions, to continue to engage in securitization transactions. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or financing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis.
In addition to repurchase borrowings and securitized debt, subject to market conditions, we may utilize other sources of leverage in the future, including, but not limited to, securitized debt associated with resecuritizations, warehouse facilities, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. Our future use of these alternative forms of financing is subject to market conditions. (See “Recent Market Conditions and Our Strategy” below).
Hedging Strategy
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we pursue various hedging strategies with the objective of reducing our exposure to increases in interest rates. The U.S. Federal income tax rules applicable to REITs may necessitate that we implement certain of these techniques through a TRS that will generally be subject to U.S. Federal and state income taxation. Our hedging activity may vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions.
Our Swaps and Swaptions are intended to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings; in addition, these derivative instruments may also mitigate the impact of increases in interest rates on the value of our Agency RMBS portfolio.
At June 30, 2015, our Swaps had an aggregate notional balance of $1,687,000 with a weighted average fixed-pay rate of 1.43% and a weighted average term to maturity of 3.9 years. Our Swaps have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of our Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. Our Swaptions provide that when a Swaption is “in the money” (when the Swaption has intrinsic value) at the expiration of the option period, we may enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount, or receive a cash payment equal to the fair value of the underlying Swap. The method of settlement at expiration of the option period is prescribed in each Swaption confirmation. At June 30, 2015, our Swaptions had an aggregate notional of $1,065,000 and a weighted average term of six months until expiration. At June 30, 2015, the Swaps underlying our Swaptions had a weighted average fixed-pay rate of 3.11% and a weighted average term of 9.5 years.
In addition to Swap and Swaptions, we also enter into TBA Contracts from time to time. Short TBA Contracts may serve as an economic hedge against decreases in the value of Agency RMBS held in our portfolio, in an amount equivalent to the TBA Contract notional balance, with the same characteristics as those stipulated in the TBA Contract, or may serve as an economic hedge of indebtedness incurred or to be incurred to acquire real estate assets.
We expect that any gains recognized in connection with the settlement of our derivative transactions that we identify for tax purposes to hedge indebtedness incurred or to be incurred to acquire real estate assets would not constitute gross income for purposes of the REIT 75% and 95% gross income tests. To date, we have identified our Swap and Swaptions as tax hedges.
To date, we have not elected to apply hedge accounting pursuant to GAAP for our derivatives and, as a result, we record changes in the estimated fair value of such instruments, along with the associated net Swap interest in earnings, as a component of the net gain/(loss) on derivatives instruments in our consolidated statements of operations.
Certain Swap trades are required to be cleared through a clearinghouse, in accordance with the Commodities Futures Trading Commission (or, CFTC) Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties. The change in Swap margin collateral requirements generally increases the inherent cost of cleared Swaps, as higher amounts of cash are required to be pledged to meet the initial margin requirement on such transactions. For additional information about our derivative instruments, see Note 12 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.
Variances between GAAP Income and Taxable Income
Our net income for financial reporting purposes differs from our taxable income. Certain of the differences between our GAAP net income and our taxable income arise from variations among the methods prescribed under GAAP and the Internal Revenue Code for recognizing certain items of income and/or expense. Certain of these variations give rise to “timing differences” between GAAP net income and taxable income while other variations cause “permanent differences” between GAAP net income and taxable net income. The differences are expected to reverse over time and may cause significant short-term variances between GAAP and taxable net income.
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We hold certain securities that were issued with original issue discount (or, OID). We generally recognize OID in our current gross interest income over the term of the applicable securities as the OID accrues. The rate at which the OID is recognized into taxable income is calculated using a constant rate of yield to maturity, without a loss assumption provision. As a result, for tax purposes, REIT taxable income may be recognized in excess of GAAP income or in advance of the corresponding cash flow from these assets. Differences with respect to GAAP versus tax amortization of purchase premiums and accretion of purchase discounts on our Agency and non-Agency RMBS may also impact the difference between net gains we recognized under GAAP compared to tax. In addition, certain permanent differences between our GAAP income and our taxable income arise when items are recognized for GAAP purposes and never affect the calculation of taxable income.
Depending on the structure of securitization/resecuritization transactions, for tax purposes such transactions may be treated either as a sale or a financing of the underlying assets. Income recognized from securitization and resecuritization transactions will generally differ for tax and GAAP purposes.
Critical Accounting Policies and Use of Estimates
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q. A summary of our critical accounting policies is set forth in our Annual Report on Form 10-K for the year ended December 31, 2014 under “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Use of Estimates.”
Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2015
General:
While the outlook for monetary policy remains uncertain, minutes from the June 2015 Federal Reserve Open Market committee (or, FOMC) meeting are believed to indicate that the FOMC is preparing to begin increasing interest rates. Employment conditions remained relatively firm, with non-farm payrolls increasing over 200,000 for each month during the second quarter. With this backdrop, interest rates moved higher and the yield curve steepened, with ten-year U.S. Treasury notes increasing by 43 basis points, ending the second quarter at 2.35%, compared to 1.92% at the end of the first quarter of 2015, while rates on two-year U.S. Treasury rates increased eight basis points to close the quarter at 0.64%.
The table below presents quarterly information about rates for two and ten-year U.S. Treasuries, ten-year Swap rates and the spread between the two and ten year U.S. Treasury rate for the first six months of 2015:
Table 1 | ||||||||||||||||||||||||
High | Low | Average | Quarter End | High | Low | Average | Quarter End | |||||||||||||||||
Quarter Ended | Ten-Year U.S. Treasury Rate | Ten-Year Swap Rate | ||||||||||||||||||||||
June 30, 2015 | 2.48 | % | 1.84 | % | 2.16 | % | 2.35 | % | 2.56 | % | 1.95 | % | 2.24 | % | 2.43 | % | ||||||||
March 31, 2015 | 2.24 | % | 1.64 | % | 1.96 | % | 1.92 | % | 2.36 | % | 1.80 | % | 2.08 | % | 2.04 | % | ||||||||
Two-Year U.S. Treasury Rate | Spread Between Two and Ten Year U.S. Treasury Rate | |||||||||||||||||||||||
June 30, 2015 | 0.73 | % | 0.48 | % | 0.60 | % | 0.64 | % | 1.75 | % | 1.36 | % | 1.56 | % | 1.71 | % | ||||||||
March 31, 2015 | 0.72 | % | 0.41 | % | 0.59 | % | 0.56 | % | 1.52 | % | 1.23 | % | 1.37 | % | 1.36 | % |
While our net income for the second quarter of 2015 was negatively impacted by unrealized and realized losses due to market conditions described above, our operating earnings (which is a non-GAAP financial measure, see Table 23, below) increased for the second quarter ended June 30, 2015, compared to the first quarter of 2015. The improvement in our operating earnings primarily reflects the improved performance of our non-Agency RMBS, which performance reflects our more positive expectations about the future cash flows of such securities, and the decline in our borrowing costs associated with such investments. Further, the full impact of our March 2015 loan pool purchase and securitization and incremental purchases of Risk Sharing Securities and SBC-MBS were experienced in the second quarter. These increases were partially offset by a decrease in net interest income on our Agency RMBS portfolio, as we have continued to reduce our Agency holdings to fund our expansion of credit investments.
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Investment Strategy:
The following table presents the composition of our investment portfolio as a percentage of total investments as of June 30, 2015 and March 31, 2015:
Table 2 | June 30, 2015 | March 31, 2015 | ||||
Agency pass-through RMBS | 51.9 | % | 55.9 | % | ||
Agency Inverse Floater | — | — | ||||
Agency IO and Agency Inverse IO | 2.0 | 1.5 | ||||
Total Agency RMBS | 53.9 | 57.4 | ||||
Non-Agency RMBS | 36.3 | 34.5 | ||||
Securitized mortgage loans (1) | 4.7 | 4.6 | ||||
Mortgage loans held at fair value | — | — | ||||
Other investments | 1.2 | 1.1 | ||||
Other investment securities (2) | 3.9 | 2.4 | ||||
Total credit investments | 46.1 | 42.6 | ||||
Total | 100.0 | % | 100.0 | % |
(1) | Securitized mortgage loans include securitized mortgage loans associated with our February 2013 Securitization and March 2015 Securitization transactions. |
(2) | Other investment securities were comprised of investments in Risk Sharing Securities issued by Freddie Mac and Fannie Mae and SBC-MBS. |
Agency RMBS Portfolio/Interest Rate Hedges:
The FOMC continues to replace the runoff of its Agency RMBS holdings, supporting Agency RMBS valuations. However, in June such support was offset by an increase in spreads, which we believe was due to heightened concerns around a default in Greece, a potential recession in China and an upcoming shift in monetary policy in the U.S. Premiums for prepayment protected securities decreased as mortgage rates increased throughout the second quarter of 2015, pushing fundamental valuations wider for such securities.
During the second quarter of 2015, prepayments driven by housing turnover were higher than recent history, as seasonal activity was coupled with a relatively strong housing market. During the second quarter of 2015, our Agency RMBS portfolio experienced a monthly fair value weighted average CPR of 8.6%, comprised of 8.4% CPR on Agency pass-through securities and 14.8% on Agency IO and Agency Inverse IO securities, in the aggregate. During the second quarter of 2015, the maximum average monthly CPR of our Agency RMBS was experienced in June, with an overall Agency CPR of 11.1% comprised of 11.0% on Agency pass-through securities and 15.7% on Agency IO and Agency Inverse IO securities in the aggregate. We expect prepayments to decrease as we move into the fall and winter, as June historically has the highest seasonal turnover, and higher rates on mortgages later in the year could slow housing turnover and refinance activity.
The following table presents the composition and estimated fair value and net unrealized gain/(loss) position with respect to our Agency RMBS portfolio at June 30, 2015 and March 31, 2015:
Table 3 | June 30, 2015 | March 31, 2015 | ||||||||||||||
Agency RMBS Collateral Type | Estimated Fair Value | Unrealized Gain/(Loss), net | Estimated Fair Value | Unrealized Gain/(Loss), net | ||||||||||||
30-Year Fixed: | ||||||||||||||||
3.5% coupon | $ | 552,325 | $ | (9,811 | ) | $ | 978,178 | $ | 4,368 | |||||||
4.0% coupon | 1,159,433 | (1,925 | ) | 1,042,378 | 14,032 | |||||||||||
1,711,758 | (11,736 | ) | 2,020,556 | 18,400 | ||||||||||||
ARMs | 258,956 | (978 | ) | 206,715 | (439 | ) | ||||||||||
Agency IO | 57,218 | 1,830 | 39,971 | 373 | ||||||||||||
Agency Inverse IO | 17,621 | 11 | 19,762 | 424 | ||||||||||||
Total | $ | 2,045,553 | $ | (10,873 | ) | $ | 2,287,004 | $ | 18,758 |
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The following table presents information with respect to our Swaps and Swaptions at June 30, 2015 and March 31, 2015:
Table 4 | June 30, 2015 | March 31, 2015 | ||||||
Swaps: | ||||||||
Notional amount | $ | 1,687,000 | $ | 1,687,000 | ||||
Estimated fair value | $ | (113 | ) | $ | (14,881 | ) | ||
Unrealized gain/(loss), net | $ | (707 | ) | $ | (15,476 | ) | ||
Weighted average fixed pay rate | 1.43 | % | 1.43 | % | ||||
Weighted average months to maturity | 47 | 50 | ||||||
Swaptions: | ||||||||
Notional amount | $ | 1,065,000 | $ | 1,425,000 | ||||
Estimated fair value | $ | 9,089 | $ | 4,020 | ||||
Unrealized gain, net | $ | 9,181 | $ | 302 | ||||
Weighted average term to expiration (months) | 6 | 5 | ||||||
Weighted average underlying Swap term (months) | 114 | 112 | ||||||
Weighted average underlying Swap fixed pay rate | 3.11 | % | 3.24 | % |
Credit Investments:
Market prices for non-Agency RMBS and our other investment securities were stable in the earlier part of the second quarter of 2015, however as volatility increased, with heightened concerns around a national debt default by Greece and a potential recession in China, market prices weakened. As a result, valuations on such instruments ended the second quarter down slightly from levels at March 31, 2015. There was a continued increase in new issue mortgage offerings and in general with the exception of Risk Sharing Securities, yields on such offerings remained stable as a result of strong demand. Prices, which move inversely with yields, on securities backed by non-performing loans and re-performing loans decreased as spreads widened, reflecting the increase in volatility. We used price weakness at quarter-end as an opportunity to purchase additional Risk Sharing Securities and SBC-MBS, as reflected in Table 5, below.
Our credit investments, were comprised of the following at June 30, 2015 and March 31, 2015:
Table 5 | June 30, 2015 | March 31, 2015 | ||||||
Non-Agency RMBS (at fair value) | $ | 1,378,265 | $ | 1,374,966 | ||||
Securitized mortgage loans (at fair value) | 178,904 | 183,328 | ||||||
Other investments | 44,089 | 42,828 | ||||||
Other investment securities: | ||||||||
Risk Sharing Securities - Freddie Mac (at fair value) | 44,976 | 36,774 | ||||||
Risk Sharing Securities - Fannie Mae (at fair value) | 45,936 | 20,359 | ||||||
SBC-MBS (at fair value) | 58,889 | 39,916 | ||||||
Total | $ | 1,751,059 | $ | 1,698,171 |
Non-Agency valuations continue to be supported by market technicals, such as the continued pay down of legacy non-Agency securities, as well as fundamentals, such as the recovering housing market, which factors support positive future performance with respect to borrower defaults and loss severities on liquidated properties. Our non-Agency RMBS continued to perform well over the second quarter, as we experienced stable voluntary prepayments and defaults continued to decrease.
As of June 30, 2015, we had: (a) $20,464 of advances outstanding under a warehouse line; (b) $17,960 of legal title to real estate associated with BFT Contracts; and (c) $5,665 of mortgage loans, all of which were related to our Seller Financing Program. We provide warehouse advances to our Seller Financing Program counterparty to fund the acquisition of single-family homes primarily located in the southeastern U.S. We view this program as a way to gain exposure to residential real estate and as a complement to our strategy of acquiring non-Agency RMBS and other credit securities. We anticipate that we will purchase additional BFT Contracts and/or mortgage loans originated in connection with the Seller Financing Program over time. Our ultimate investment in BFT Contracts and/or mortgage loans through this program will be dependent on, among other things, market conditions, including our ability to obtain leverage on such assets under favorable terms, and the ability of one or more of our counterparties to efficiently and economically purchase, rehabilitate and sell such properties to individuals. Given that such investments are less liquid than non-Agency securities, we have grown the program at a measured pace.
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During the second quarter of 2015, we purchased $22,086 of SBC-MBS, with a weighted average purchase price of 86.75% of par value; at June 30, 2015, these securities had a weighted average unlevered yield of 5.53%. We view the credit and collateral attributes of SBC-MBS as being similar to those of our non-Agency RMBS. Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property. In some instances, certain of the mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principals of the related business and/or borrowing entity.
Borrowings:
Financing rates on Agency RMBS increased during the second quarter compared to the first quarter of 2015. We believe that balance sheet tightening at banks, regulatory requirements, and interest rate concerns drove increases in interest rates on repurchase borrowings.
On the non-Agency side, additional dealers continue to offer non-Agency financing on bonds purchased from others leading to more options and haircuts have continued to decline. Following quarter-end, we entered into a $300,000 whole loan repurchase facility which provides for financing of residential mortgage loan products. The terms of future borrowings under this facility will vary based on the characteristics of the products pledged as collateral.
We believe that there is an increased likelihood that increases in interest rates will impact borrowing costs for Agency, non-Agency and other investment securities for the remainder of 2015.
Over time, as market conditions change, in addition to repurchase borrowings we may use other forms of leverage, including, but not limited to, warehouse facilities, additional securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities), and public and private equity and debt issuances. In the second quarter, our average leverage remained fairly constant at 4.12 times, up marginally from 4.09 times for the first quarter of 2015. We ended the quarter at 4.21 times leverage.
Results of Operations
Three Months Ended June 30, 2015 compared to the Three Months Ended June 30, 2014
For the three months ended June 30, 2015, we had a net loss of $10,032, or $0.43 per basic and diluted common share, compared to net income of $44,004, resulting in net income of $1.26 per basic or, $1.25 per diluted common share, for the three months ended June 30, 2014. Our results of operations for the three months ended June 30, 2015 were significantly impacted by declines in the value of our investment portfolio. As a result, we experienced both unrealized and, to a lesser extent, realized losses; these losses were partially offset by increases in the value of our derivatives. (See “Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2015,” above.)
Net Interest Income
Our net interest income is significantly impacted by the amount of leverage we use, our interest rate spread and our net interest margin. Interest rate spread measures the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities, while net interest margin reflects net interest income divided by average interest-earning assets. The $2,753 increase in our net interest income reflects the increase in our leverage and the increase in net interest rate spread and net interest margin for the three months ended June 30, 2015, compared to June 30, 2014. For the three months ended June 30, 2015, we had average debt-to-equity of 4.12 times, compared to 3.72 times for the three months ended June 30, 2014. We had an interest rate spread and net interest margin of 3.34% and 3.48% for the three months ended June 30, 2015, respectively, compared to 3.32% and 3.44%, respectively, for the three months ended June 30, 2014. The increase in our interest rate spread and net interest margin reflects our continued reallocation of capital into our credit investments which generate higher yields and spreads, relative to Agency RMBS.
For the three months ended June 30, 2015 and June 30, 2014, we earned interest income of $41,618 and $38,141, respectively, and incurred interest expense of approximately $8,234 and $7,510, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher borrowing expense reflects our increase in non-Agency RMBS and associated repurchase borrowings, which borrowings have higher interest rates than repurchase agreements on Agency RMBS.
Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS and resulting yields to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income and resulting yields recognized on our non-Agency RMBS in future periods on such investments.
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The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the three months ended June 30, 2015 and 2014:
Table 6 | Three Months Ended June 30, 2015 | |||||||||||||||
Collateral | Agency | Non-Agency and Other Credit Investments (1) | Securitized Mortgage Loans and Mortgage Loans | Total | ||||||||||||
Average balance (2) | $ | 2,145,667 | $ | 1,479,534 | $ | 172,627 | $ | 3,797,828 | ||||||||
Total interest income | $ | 15,830 | $ | 22,165 | $ | 3,623 | $ | 41,618 | ||||||||
Weighted average CPR | 8.6 | % | 4.8 | % | 5.1 | % | 6.2 | % | ||||||||
Yield on average assets | 2.92 | % | 5.93 | % | 8.31 | % | 4.34 | % | ||||||||
Average balance of associated repurchase agreements | $ | 1,957,927 | $ | 1,163,225 | $ | 94,330 | $ | 3,215,482 | ||||||||
Average balance of securitized debt (3) | $ | — | $ | — | $ | 28,582 | $ | 28,582 | ||||||||
Total interest expense | $ | 1,881 | $ | 5,361 | $ | 992 | $ | 8,234 | ||||||||
Average cost of funds (4) (5) | 0.38 | % | 1.82 | % | 3.19 | % | 1.00 | % | ||||||||
Net interest income | $ | 13,949 | $ | 16,804 | $ | 2,631 | $ | 33,384 | ||||||||
Net interest rate spread | 2.54 | % | 4.11 | % | 5.12 | % | 3.34 | % | ||||||||
Total interest expense including net interest cost of Swaps (6) | $ | 6,667 | $ | 5,361 | $ | 1,126 | $ | 13,154 | ||||||||
Effective cost of funds (6) | 1.35 | % | 1.82 | % | 3.62 | % | 1.60 | % | ||||||||
Net interest income including net interest cost of Swaps | $ | 9,163 | $ | 16,804 | $ | 2,498 | $ | 28,464 | ||||||||
Effective net interest rate spread (6) | 1.57 | % | 4.11 | % | 4.69 | % | 2.74 | % |
Three Months Ended June 30, 2014 | ||||||||||||||||
Collateral | Agency | Non-Agency and Other Credit Investments (1) | Securitized Mortgage Loans | Total | ||||||||||||
Average balance (2) | $ | 2,150,645 | $ | 1,273,563 | $ | 102,062 | $ | 3,526,270 | ||||||||
Total interest income | $ | 16,356 | $ | 19,858 | $ | 1,927 | $ | 38,141 | ||||||||
Weighted average CPR | 6.7 | % | 4.2 | % | 3.6 | % | 4.8 | % | ||||||||
Yield on average assets | 3.04 | % | 6.24 | % | 7.55 | % | 4.33 | % | ||||||||
Average balance of associated repurchase agreements | $ | 1,866,797 | $ | 1,004,942 | $ | 28,543 | $ | 2,900,282 | ||||||||
Average balance of securitized debt (3) | $ | — | $ | — | $ | 39,133 | $ | 39,133 | ||||||||
Total interest expense | $ | 1,688 | $ | 5,254 | $ | 568 | $ | 7,510 | ||||||||
Average cost of funds (4) (5) | 0.36 | % | 2.07 | % | 3.32 | % | 1.01 | % | ||||||||
Net interest income | $ | 14,668 | $ | 14,604 | $ | 1,359 | $ | 30,631 | ||||||||
Net interest rate spread | 2.68 | % | 4.17 | % | 4.23 | % | 3.32 | % | ||||||||
Total interest expense including net interest cost of Swaps (6) | $ | 6,631 | $ | 5,254 | $ | 706 | $ | 12,591 | ||||||||
Effective cost of funds (6) | 1.41 | % | 2.07 | % | 4.13 | % | 1.69 | % | ||||||||
Net interest income including net interest cost of Swaps | $ | 9,725 | $ | 14,604 | $ | 1,221 | $ | 25,550 | ||||||||
Effective net interest rate spread (6) | 1.63 | % | 4.17 | % | 3.42 | % | 2.64 | % |
(1) | Other credit investments includes other investment securities and other investments. |
(2) | Amount reflects amortized cost, which does not include unrealized gains and losses. |
(3) | Reflects the average unpaid principal balance. |
(4) | Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral. |
(5) | Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, those costs are included in gain/(loss) on derivative instruments in our consolidated statement of operations. |
(6) | The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.) |
As of June 30, 2015, our repurchase agreement borrowings collateralized by Agency RMBS had initial terms of up to three months with haircut requirements ranging from 3.0% to 5.0% and financing rates from 0.37% to 0.40%; our repurchase
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agreement borrowings collateralized by non-Agency RMBS had initial terms of up to twenty four months with haircut requirements ranging from 10.0% to 45.0% and financing rates from 1.18% to 2.69%. (The “haircut” represents the percentage by which the collateral value is contractually required to exceed the loan amount.)
The following table presents the cost of funds and effective cost of funds for our repurchase agreement borrowings by type of collateral pledged for the periods presented:
Table 7 | Three Months Ended June 30, | |||||||||||
2015 | 2014 | |||||||||||
Collateral Pledged: | Cost of Funds | Effective Cost of Funds(1) | Cost of Funds | Effective Cost of Funds(1) | ||||||||
Agency RMBS | 0.38 | % | 1.35 | % | 0.36 | % | 1.41 | % | ||||
Non-Agency RMBS and other credit investments(2) | 1.82 | 1.82 | 2.07 | 2.07 | ||||||||
Securitized mortgage loans(3) | 3.19 | 3.62 | 3.32 | 4.13 | ||||||||
Total | 1.00 | % | 1.6 | % | 1.01 | % | 1.69 | % |
(1) | The effective cost of funds for the periods presented include interest expense for the periods and the net interest component for Swaps during the periods of $4,920 and $5,081, respectively. While we have not elected to apply hedge accounting for our Swaps, we view such instruments as an economic hedge against the impact of increases in interest rates on our borrowing costs. (See “Non-GAAP Financial Measures,” below.) |
(2) | For the periods presented, other credit investments were comprised of other investment securities and other investments. |
(3) | The non-Agency RMBS associated with our securitization transactions are eliminated in consolidation with the VIE and the mortgage loans in the VIE are consolidated by us. The interest expense on repurchase agreement borrowings associated with non-Agency RMBS associated with our securitization transactions are included with the cost of funds for our securitized mortgage loans. |
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Gains/(Losses) on Derivative Instruments
The following table presents components of our gain/(loss) on derivative instruments for the periods presented:
Table 8 | Three Months Ended June 30, | |||||||
Components of Gain/(Loss) on Derivative Instruments | 2015 | 2014 | ||||||
Net interest (payments/accruals) on Swaps(1) | $ | (4,920 | ) | $ | (5,081 | ) | ||
Losses on the termination and expiration of Swaptions, net(1) | (6,170 | ) | (7,585 | ) | ||||
Losses on settlement of TBA Contracts, net(1) | — | — | ||||||
Change in fair value of Swaps(2) | 14,769 | (15,244 | ) | |||||
Change in fair value of Swaptions(2) | 8,879 | 777 | ||||||
Change in fair value of TBA Contracts(2) | (95 | ) | — | |||||
Total | $ | 12,463 | $ | (27,133 | ) |
(1) | Amounts are realized. |
(2) | Amounts are unrealized. |
At June 30, 2015, we had Swaps with an aggregate notional amount of $1,687,000, a weighted average fixed pay rate of 1.43% and weighted average term to maturity of 3.9 years. At June 30, 2015, our Swaptions had an aggregate notional amount of $1,065,000 and a weighted average term of six months until expiration; Swaps underlying our Swaptions had a weighted average fixed pay rate of 3.11% and a weighted average term of 9.5 years.
We expect that changes in the fair value of our derivative instruments will move inversely to changes in the fair value of our Agency pass-through RMBS, however we do not expect that the changes in valuations of such derivatives relative to our Agency pass-through RMBS will off-set entirely. We note that the terms and benchmark interest rates associated with our derivatives are not matched with our investments, that the notional amount of our derivatives is not equal to our investments and the value of our Swaps and Swaptions do not mitigate the impact of spread widening, which occurs when market spreads widen between the yield on RMBS relative to certain benchmark interest rates. The timing and amount of realized and unrealized gains/(losses) associated with our derivative instruments cannot be predicted, as the value of such instruments generally moves inversely with changes in interest rates which cannot be predicted with any certainty. (For more information about derivative instruments we held at June 30, 2015 and December 31, 2014, see Note 12 to the consolidated financial statements included under Item 1 of this quarterly report on Form 10-Q.)
The following table presents the notional amount and estimated fair value for each of our derivative instrument types at June 30, 2015 and December 31, 2014:
Table 9 | June 30, 2015 | December 31, 2014 | ||||||||||||||
Notional Amount | Estimated Fair Value | Notional Amount | Estimated Fair Value | |||||||||||||
Swaps - assets | $ | 957,000 | $ | 8,528 | $ | 957,000 | $ | 9,543 | ||||||||
Swaptions - assets | 1,065,000 | 9,089 | 1,250,000 | 1,555 | ||||||||||||
Swaps - (liabilities) | 730,000 | (8,641 | ) | 730,000 | (8,949 | ) | ||||||||||
Long TBA Contracts - assets | — | — | 100,000 | 544 | ||||||||||||
Short TBA Contracts - (liabilities) | 200,000 | (95 | ) | — | — | |||||||||||
Total derivative instruments, net | $ | 2,952,000 | $ | 8,881 | $ | 3,037,000 | $ | 2,693 |
57
The following tables present our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the periods presented: (See “Non-GAAP Financial Measures,” below.)
Table 10 | Repurchase Borrowings on Agency RMBS | Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1) | Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2) | Total | ||||||||||||
Three Months Ended June 30, 2015 | ||||||||||||||||
Effective interest expense | $ | 6,667 | $ | 5,361 | $ | 1,126 | $ | 13,154 | ||||||||
Effective cost of funds | 1.35 | % | 1.82 | % | 3.62 | % | 1.60 | % | ||||||||
Effective net interest income | $ | 9,163 | $ | 16,804 | $ | 2,498 | $ | 28,464 | ||||||||
Effective net interest rate spread | 1.57 | % | 4.11 | % | 4.69 | % | 2.74 | % | ||||||||
Three Months Ended June 30, 2014 | ||||||||||||||||
Effective interest expense | $ | 6,631 | $ | 5,254 | $ | 706 | $ | 12,591 | ||||||||
Effective cost of funds | 1.41 | % | 2.07 | % | 4.13 | % | 1.69 | % | ||||||||
Effective net interest income | $ | 9,725 | $ | 14,604 | $ | 1,221 | $ | 25,550 | ||||||||
Effective net interest rate spread | 1.63 | % | 4.17 | % | 3.42 | % | 2.64 | % |
(1) | Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the quarter ended June 30, 2015. Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended June 30, 2014. |
(2) | Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented. |
Realized and Unrealized Gains/(Losses) on Investments and Securitized Debt
During the three months ended June 30, 2015, as we identified attractive investment opportunities in residential credit investment securities, we sold certain Agency RMBS and non-Agency RMBS, reinvesting such net sale proceeds in Agency Risk Sharing Securities and SBC-MBS. During the three months ended June 30, 2015 and 2014, we sold Agency RMBS of $792,820 and $248,122, respectively, realizing net losses of $4,276 and $7,370, respectively, and sold non-Agency RMBS of $29,056 and $4,742, respectively, realizing net gains/(losses) of $(254) and $298, respectively. As we find attractive investment opportunities in non-Agency RMBS, whole loans and mortgage related assets, we may continue to sell Agency and/or certain non-Agency RMBS to provide funds to make such purchases. With respect to non-Agency RMBS, we continue to emphasize investments in seasoned securities, backed by Subprime, Alt-A and Option ARMs.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, mortgage loan pools, other investment securities and securitized debt and, as a result, record changes in the estimated fair value of such instruments in earnings. As described above, in “Recent Market Conditions and our Strategy,” we experienced declines in the value of our investments that resulted in unrealized and, to a lesser extent, realized losses during the three months ending June 30, 2015.
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The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of our assets and liabilities carried at fair value for the three months ended June 30, 2015 and June 30, 2014:
Table 11 | Three Months Ended | |||||||
June 30, 2015 | June 30, 2014 | |||||||
Realized (loss) on sale of Agency RMBS, net | $ | (4,276 | ) | $ | (7,370 | ) | ||
Realized gain/(loss) on sale of Non-Agency RMBS, net | (254 | ) | 298 | |||||
Realized gain on sale of Other Investment Securities, net | 102 | — | ||||||
Unrealized gain/(loss) on Agency RMBS, net | (29,632 | ) | 46,775 | |||||
Unrealized gain/(loss) on Non-Agency RMBS, net | (11,722 | ) | 4,815 | |||||
Realized (loss) on derivatives, net (1) | (11,090 | ) | (12,666 | ) | ||||
Unrealized gain/(loss) on derivatives, net (2) | 23,553 | (14,467 | ) | |||||
Unrealized gain/(loss) on other investment securities | (2,649 | ) | 54 | |||||
Unrealized gain/(loss) on securitized mortgage loans, net | (1,896 | ) | 2,042 | |||||
Unrealized gain/(loss) on securitized debt | 1,001 | (364 | ) | |||||
Total | $ | (36,863 | ) | $ | 19,117 |
(1) | Realized losses on derivatives include net interest payments/accruals on Swaps, net losses on the termination and expiration of Swaptions and net losses on the settlement of TBA Contracts. |
(2) | Unrealized gains/losses on derivatives include |
Expenses
General and Administrative Expenses: We reimburse our Manager for our allocable share of the compensation of our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance, and miscellaneous other operating costs. Costs for our third-party investment accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $3,655 and $2,921 for the three months ended June 30, 2015 and 2014, respectively. The increase in our expenses during the three months ended June 30, 2015 compared to the three months ended June 30, 2014 primarily reflects our expanded use of analytical tools associated with our credit investments and incremental expenses associated with our Seller Financing Program, servicing costs associated with our securitized mortgage loan portfolios and accounting support functions. To the extent that we continue to expand our portfolio to include a broader spectrum of investments, we expect to incur costs for associated legal work, due diligence, contract finance, credit analysis and asset surveillance.
Management Fee Expense: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of adjusted stockholders’ equity as defined in the Management Agreement, per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel, who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fees of $2,895 and $2,774 for the three months ended June 30, 2015 and 2014, respectively.
The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 14 to the consolidated financial statements included under Item 1 of this quarterly report Form 10-Q.
Six Months Ended June 30, 2015 compared to the Six Months Ended June 30, 2014
For the six months ended June 30, 2015, we had net income of $11,375, or $0.13 per basic share and diluted share, compared to net income of $71,886, or $2.02 per basic share, or $2.01 per diluted share, for the six months ended June 30, 2014. Our results of operations for the six months ended June 30, 2015 were significantly impacted by declines in the value of our investment portfolio which occurred during the second quarter of 2015, which were partially offset by increases in the value of our derivatives. (See “Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2015,” above.)
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Net Interest Income
Our net interest income was $64,848 for the six months ended June 30, 2015 compared to $61,543 for the comparative period in 2014. For the six months ended June 30, 2015 and June 30, 2014, we earned interest income of $80,913 and $76,321, respectively, and incurred interest expense of $16,065 and $14,778, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher borrowing expense reflects our increase in non-Agency RMBS and securitized mortgage loans and associated repurchase borrowings, which borrowings have higher interest rates than repurchase agreements on Agency RMBS. At June 30, 2015, we had securitized debt with a contractual balance of $25,828 with a fixed stated interest rate of 4.00%.
For the six months ended June 30, 2015, we had average debt-to-equity of 4.10 times, compared to 3.75 times for the six months ended June 30, 2014. This increase in leverage reflects the use of additional leverage on our Agency and non-Agency RMBS. Our interest rate spread and net interest margin were 3.33% and 3.41% for the six months ended June 30, 2015, respectively, compared to 3.34% and 3.48%, respectively, for the six months ended June 30, 2014.
The impact of our Swaps is not reflected in our net interest rate spread and net interest margin. However, when making investment decisions, we consider our effective cost of borrowings, which includes the net interest component of our Swaps. (See Tables 14, 21 and 22 below.)
Our yield on Agency RMBS for the six months ended June 30, 2015 decreased to 2.93% compared to 3.03% for six months ended June 30, 2014. This decrease primarily reflects our migration to Agency RMBS backed by ARMs and lower coupon fixed rate bonds since the second quarter of 2014. Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income recognized in future periods on such investments.
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the six months ended June 30, 2015 and 2014:
Table 12 | ||||||||||||||||
Six Months Ended June 30, 2015 | ||||||||||||||||
Collateral | Agency | Non-Agency and Other Credit Investments (1) | Securitized Mortgage Loans | Total | ||||||||||||
Average balance (2) | $ | 2,194,127 | $ | 1,447,923 | $ | 145,164 | $ | 3,787,214 | ||||||||
Total interest income | $ | 32,351 | $ | 42,772 | $ | 5,790 | $ | 80,913 | ||||||||
Yield on average assets | 2.93 | % | 5.88 | % | 9.56 | % | 4.31 | % | ||||||||
Average balance of associated repurchase agreements | $ | 2,010,378 | $ | 1,133,198 | $ | 92,443 | $ | 3,236,019 | ||||||||
Average balance of securitized debt | $ | — | $ | — | $ | 29,995 | $ | 29,995 | ||||||||
Total interest expense | $ | 3,761 | $ | 10,527 | $ | 1,777 | $ | 16,065 | ||||||||
Average cost of funds (3) (4) | 0.37 | % | 1.85 | % | 2.89 | % | 0.98 | % | ||||||||
Net interest income | $ | 28,590 | $ | 32,245 | $ | 4,013 | $ | 64,848 | ||||||||
Net interest rate spread | 2.56 | % | 4.03 | % | 6.67 | % | 3.33 | % | ||||||||
Total interest expense including net interest cost of Swaps | $ | 13,376 | $ | 10,527 | $ | 2,046 | $ | 25,949 | ||||||||
Effective cost of funds | 1.32 | % | 1.85 | % | 3.32 | % | 1.58 | % | ||||||||
Net interest income including net interest cost of Swaps | $ | 18,975 | $ | 32,245 | $ | 3,744 | $ | 54,964 | ||||||||
Effective net interest rate spread (5) | 1.61 | % | 4.03 | % | 6.24 | % | 2.73 | % |
(Tables and notes continued on next page.)
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(Tables and notes continued.)
Table 13 | ||||||||||||||||
Six Months Ended June 30, 2014 | ||||||||||||||||
Collateral | Repurchase Borrowings on Agency RMBS | Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1) | Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2) | Total | ||||||||||||
Average balance (2) | $ | 2,213,781 | $ | 1,201,487 | $ | 104,169 | $ | 3,519,437 | ||||||||
Total interest income | $ | 33,514 | $ | 38,634 | $ | 4,173 | $ | 76,321 | ||||||||
Yield on average assets | 3.03 | % | 6.43 | % | 8.01 | % | 4.34 | % | ||||||||
Average balance of associated repurchase agreements | $ | 1,905,722 | $ | 959,665 | $ | 28,329 | $ | 2,893,716 | ||||||||
Average balance of securitized debt | $ | — | $ | — | $ | 40,477 | $ | 40,477 | ||||||||
Total interest expense | $ | 3,575 | $ | 10,048 | $ | 1,155 | $ | 14,778 | ||||||||
Average cost of funds (3) (4) (5) | 0.37 | % | 2.08 | % | 3.34 | % | 1.00 | % | ||||||||
Net interest income | $ | 29,939 | $ | 28,586 | $ | 3,018 | $ | 61,543 | ||||||||
Net interest rate spread | 2.66 | % | 4.35 | % | 4.67 | % | 3.34 | % | ||||||||
Total interest expense including net interest cost of Swaps | $ | 13,171 | $ | 10,048 | $ | 1,429 | $ | 24,648 | ||||||||
Effective cost of funds | 1.37 | % | 2.08 | % | 4.19 | % | 1.67 | % | ||||||||
Net interest income including net interest cost of Swaps | $ | 20,343 | $ | 28,586 | $ | 2,744 | $ | 51,673 | ||||||||
Effective net interest rate spread (5) | 1.66 | % | 4.35 | % | 3.82 | % | 2.67 | % |
(1) | Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the quarter ended June 30, 2015. Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended June 30, 2014. |
(2) | Amount reflects amortized cost, which does not include unrealized gains and losses. |
(3) | Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral. |
(4) | Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, such costs are included in “Gain/(loss) on derivative instruments, net” in our consolidated statements of operations. |
(5) | The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction as well as the associated net interest component of Swaps. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.) |
(6) | Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented. |
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Swaps and Swaptions
While we view our Swaps and Swaptions as an economic hedge against increases in future market interest rates associated with our repurchase agreement borrowings, we have not elected hedge accounting under GAAP. Alternatively, we present the “effective cost of funds” to reflect our interest expense adjusted to include the interest component for our Swaps that would be reported had we elected and qualified for hedge accounting for such instruments. We believe that the presentation of our effective cost of funds, which is a non-GAAP financial measure, is useful for investors as it presents our borrowing costs as viewed by us. (See “Non-GAAP Financial Measures,” below and Note 12 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
The following table presents our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the six months ended June 30, 2015 and June 30, 2014. (See Tables 21 and 22, below.)
Table 14 | ||||||||||||||||
Six Months Ended June 30, 2015 | Repurchase Borrowings on Agency RMBS | Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1) | Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (6) | Total | ||||||||||||
Effective interest expense | $ | 13,376 | $ | 10,527 | $ | 2,046 | $ | 25,949 | ||||||||
Effective cost of funds | 1.32 | % | 1.85 | % | 3.32 | % | 1.58 | % | ||||||||
Effective net interest income | $ | 18,975 | $ | 32,245 | $ | 3,744 | $ | 54,964 | ||||||||
Effective net interest rate spread | 1.61 | % | 4.03 | % | 6.24 | % | 2.73 | % | ||||||||
Six Months Ended June 30, 2014 | ||||||||||||||||
Effective interest expense | $ | 13,171 | $ | 10,048 | $ | 1,429 | $ | 24,648 | ||||||||
Effective cost of funds | 1.37 | % | 2.08 | % | 4.19 | % | 1.67 | % | ||||||||
Effective net interest income | $ | 20,343 | $ | 28,586 | $ | 2,744 | $ | 51,673 | ||||||||
Effective net interest rate spread | 1.66 | % | 4.35 | % | 3.82 | % | 2.67 | % |
(1) | Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the quarter ended June 30, 2015. Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended June 30, 2014. |
(2) | Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented. |
Realized and Unrealized Gains/(Losses) on Investments and Securitized Debt
During the six months ended June 30, 2015 and 2014, we sold Agency RMBS of $1,275,059 and $614,566, respectively, realizing net gains/(losses) of $185 and $(21,316), respectively, and sold non-Agency RMBS of $179,496 and $11,309, respectively, realizing net gains of $3,823 and $2,434, respectively (some of which may have settled in a subsequent period). From time to time we sell certain securities to balance our portfolio in light of current and anticipated market conditions. In addition, as we find attractive investment opportunities in non-Agency RMBS and whole loans and mortgage-related assets, we may sell additional Agency RMBS to fund such purchases. With respect to non-Agency RMBS, we continue to emphasize investment in securities backed by subprime and other credit sensitive mortgage loans, targeting securities at or near the top of the capital structure.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, other investment securities and securitized debt and given that we do not apply hedge accounting, our derivatives are carried at fair value. As a result, we record the change in estimated fair value of each of these instruments in earnings.
The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS, securitized mortgage loans, securitized debt, other investment securities and derivative instruments, all of which are included in our consolidated statements of operations, for the six months ended June 30, 2015 and June 30, 2014:
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Table 15 | Six Months Ended | |||||||
June 30, 2015 | June 30, 2014 | |||||||
Realized gain/(loss) on sale of Agency RMBS, net | $ | 185 | $ | (21,316 | ) | |||
Realized gain on sale of Non-Agency RMBS, net | 3,823 | 2,434 | ||||||
Realized gain on sale on Other Investment Securities, net | 102 | — | ||||||
Unrealized gain/(loss) on Agency RMBS, net | (16,521 | ) | 90,952 | |||||
Unrealized gain/(loss) on Non-Agency RMBS, net | (12,628 | ) | 11,285 | |||||
Realized (loss) on derivatives, net (1) | (21,893 | ) | (31,138 | ) | ||||
Unrealized gain/(loss) on derivatives, net (2) | 7,835 | (33,185 | ) | |||||
Unrealized gain/(loss) on other investment securities | (2,678 | ) | 176 | |||||
Unrealized gain on securitized mortgage loans, net | 466 | 3,096 | ||||||
Unrealized gain on securitized debt | 1,014 | (354 | ) | |||||
Total | $ | (40,295 | ) | $ | 21,950 |
(1) | For the six months ended June 30, 2015 and June 30, 2014 amounts include net interest payments (made)/received, including accrued amounts, of $(9,884) and ($9,870), respectively, associated with our Swaps, $(10,032) and ($14,112), respectively, of realized losses on terminations and expirations of Swaptions and $(1,976) and $(7,156), respectively, of (losses) on settlement of Short TBA Contracts, respectively. |
(2) | For the six months ended June 30, 2015 and June 30, 2014, we recognized net unrealized gains/(losses) of $(707) and ($26,168), respectively, related to the change in fair value of our Swaps, $9,181 and ($6,267), respectively, related to the change in fair value of our Swaptions and $(639) and($750), respectively, related to the change in fair value of our Short TBA Contracts, respectively. |
At June 30, 2015, we had Swaps with an aggregate notional amount of $1,687,000, a weighted average fixed pay rate of 1.43% and a weighted average term to maturity of 3.9 years. At June 30, 2015, our Swaptions had an aggregate notional balance of $1,065,000 and a weighted average term of six months until expiration. At June 30, 2015, the Swaps underlying our Swaptions had a weighted average fixed pay rate of 3.11% and a weighted average term of 9.5 years. At June 30, 2015, we had gross unrealized gains of $8,528 and $0 on Swaps and Swaptions, respectively, and gross unrealized losses of $8,641 and $4,539 on Swaps and Swaptions, respectively.
Expenses
General and Administrative Expenses: We are responsible for our operating expenses, which include the cost of data and analytical systems, outsourced accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. We reimburse our Manager, or its affiliates, for our allocable share of the compensation of our Chief Financial Officer based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. Costs we incur for our third-party accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $7,505 and $6,016 for the six months ended June 30, 2015 and June 30, 2014, respectively. The increase in our general and administrative expenses was primarily driven by costs incurred in connection with the pool of mortgage loans we purchased in March 2015. While these costs are expensed when incurred under GAAP, we consider such costs in assessing the total return on our investment. The remaining increases in our expenses primarily reflect our expanded use of analytical tools associated with our credit investments and incremental expenses associated with our Seller Financing Program, servicing costs associated with our securitized mortgage loan portfolios and accounting support functions. To the extent that we continue to expand our portfolio to include a broader spectrum of investments, we expect to incur costs for associated legal work, due diligence, contract finance, credit analysis and asset surveillance.
Management Fee: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement), per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fee expenses of $5,682 and $5,560 for the six months ended June 30, 2015 and June 30, 2014, respectively.
The management fees, expense reimbursements and the relationship with our Manager are discussed further in Note 14 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.
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Dividends
We have had 6,900,000 shares of Preferred Stock outstanding since September 20, 2012. No dividends may be paid on our common stock unless full cumulative dividends have been paid on our Preferred Stock, all of which have been paid to date. The following table presents cash dividends we have declared on our Preferred Stock from January 1, 2014 through June 30, 2015:
Table 16 | ||||||||
Declaration Date | Record Date | Payment Date | Dividend per Share | |||||
June 17, 2015 | June 30, 2015 | July 31, 2015 | $ | 0.50 | ||||
March 19, 2015 | March 31, 2015 | April 30, 2015 | $ | 0.50 | ||||
December 18, 2014 | December 31, 2014 | January 30, 2015 | $ | 0.50 | ||||
September 17, 2014 | September 30, 2014 | October 31, 2014 | $ | 0.50 | ||||
June 19, 2014 | June 30, 2014 | July 31, 2014 | $ | 0.50 | ||||
March 13, 2014 | March 31, 2014 | April 30, 2014 | $ | 0.50 |
As a REIT we are required to distribute at least 90% of our annual net taxable income. As of December 31, 2014, for tax purposes we had estimated non-deductible net capital losses of approximately $84 million which may be carried forward and applied against future net capital gains, of which approximately $20 million may be carried forward five years and approximately $64 million may be carried forward four years. This capital loss carryforward will reduce the amount of future capital gains, if any, that we would otherwise expect to distribute, as capital gains would first be reduced by capital loss carryforward amounts. In addition, as of June 30, 2015, we had estimated net deferred tax gains from terminated Swaps of $17.5 million and estimated net deferred tax losses from terminated Swaptions of $24.0 million which will be amortized into future ordinary taxable income over the remaining terms of the underlying Swaps.
The following table presents cash dividends we declared on our common stock for the quarterly periods presented:
Table 17 | ||||||||
Declaration Date | Record Date | Payment Date | Dividend per Share | |||||
June 17, 2015 | June 30, 2015 | July 31, 2015 | $ | 0.48 | ||||
March 19, 2015 | March 31, 2015 | April 30, 2015 | $ | 0.48 | ||||
December 18, 2014 | December 31, 2014 | January 30, 2015 | $ | 0.45 | ||||
September 17, 2014 | September 30, 2014 | October 31, 2014 | $ | 0.44 | ||||
June 19, 2014 | June 30, 2014 | July 31, 2014 | $ | 0.42 | ||||
March 13, 2014 | March 31, 2014 | April 30, 2014 | $ | 0.40 |
Liquidity and Capital Resources
General
To maintain our qualification as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our net taxable income, excluding net capital gains. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations.
Our principal sources of cash generally consist of borrowings under repurchase agreements, payments of principal and interest received on the RMBS portfolios, cash generated from operating results and, depending on market conditions, proceeds from capital market transactions, which to date have reflected issuances of our common stock and preferred stock (collectively our “capital stock”). As part of managing our investment portfolio, we may also generate cash through sales of RMBS. Cash is needed to fund our ongoing obligations, make payments of principal and interest on repurchase agreement borrowings, purchase target assets, meet margin calls, make dividend distributions to stockholders and for other general business and operating purposes.
Our primary sources of cash for the six months ended June 30, 2015 consisted of proceeds from repurchase facility borrowings, proceeds from sales of Agency and non-Agency RMBS and payments of principal and interest we received on our investment portfolio. We expect that in the future, subject to market conditions, that we may issue additional shares of our common stock, other types of debt and/or equity securities and engage in additional securitization/resecuritization transactions.
Under our repurchase agreements, lenders retain the right to mark the collateral pledged to estimated fair value. A reduction in the value of the collateral pledged will require us to provide additional securities or cash as collateral. As part of
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our risk management process, our Manager closely monitors our liquidity position and subjects our balance sheet to scenario testing designed to assess our liquidity in the face of different economic and market developments.
We believe we have adequate financial resources to meet our obligations, including margin calls, as they come due, to actively hold and acquire our target assets, to fund dividends we declare on our capital stock and to pay our operating expenses. However, should the value of our pledged assets suddenly decrease, significant margin calls on repurchase agreement borrowings could result and our liquidity position could be materially and adversely affected. Further, should market liquidity tighten, our repurchase agreement counterparties could increase the percentage by which the collateral value is required to exceed the loan amount on new financings, reducing our ability to use leverage. Access to financing may also be negatively impacted by the ongoing volatility in the global financial markets, potentially adversely impacting our current or potential lenders’ ability to provide us with financing.
Share Repurchase Plan
On November 6, 2013, our Board of Directors authorized a Repurchase Program to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program are canceled and, until reissued by us, are deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior notice. We have not repurchased any shares of common stock under the Repurchase Program through June 30, 2015.
Investing Activity
During the six months ended June 30, 2015, we: (i) invested; $1,158,143 in Agency pass-through RMBS, at a weighted average purchase price of 106.1% of par value, $59,810 in Agency IOs, $10,251 in Agency Inverse IO, $183,838 in non-Agency RMBS with a weighted average purchase price of 94.0% of par value, $623,126 in other investments and $3,525 for advances on a warehouse line; (ii) received prepayments and scheduled amortization of $103,083 for Agency RMBS, $91,944 for non-Agency RMBS and $6,555 for other investments; and (iii) sold Agency RMBS of $1,221,301, realizing aggregate net gains of $185 and $172,931 of non-Agency RMBS, realizing gains of $3,823.
We receive interest-only payments with respect to the notional amount of Agency IO and Agency Inverse IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency RMBS, the market prices of Agency IO generally have a positive correlation to changes in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO will decrease, which in turn is expected to increase the cash flow and the value of such securities; inverse results are expected with respect to decreases in market interest rates. In addition to viewing Agency IO as attractive investments, we also view such instruments as an economic hedge, in part, against the impact that an increase in market interest rates would have on our Agency RMBS. However, given that we had Agency IO of $57,218 with an aggregate notional balance of $535,261, the overall impact of Agency IO in off-setting the impact of increases in interest rates on the value of our Agency RMBS portfolio is limited. During the six months ended June 30, 2015, we sold $29,693 of Agency IO and Agency Inverse IO securities, realizing an aggregate net gains of $184.
As of June 30, 2015, our non-Agency RMBS consisted primarily of RMBS backed by seasoned Subprime mortgages and, to a lesser extent, Alt-A and Option ARMs. The average cost basis of our non-Agency RMBS portfolio was 83.5% and 82.8% of par as of June 30, 2015 and December 31, 2014, respectively. (For additional information about our RMBS portfolios as of June 30, 2015, see Note 4 to the consolidated financial statements included under Item 1 of this quarterly report on Form 10-Q.)
Financing Activity
We use repurchase agreements to finance a substantial majority of our Agency RMBS and non-Agency RMBS with such securities pledged as collateral to secure such borrowings. At June 30, 2015, we had outstanding repurchase agreement borrowings with 17 counterparties totaling $3,177,679 We continue to have available capacity under our repurchase agreements; however, our repurchase agreements are generally uncommitted and renewable at the discretion of our lenders. As of June 30, 2015, we had master repurchase agreements with 23 counterparties and as a matter of routine business we may have discussions with other financial institutions in order to potentially provide us with additional repurchase agreement capacity.
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The following table presents certain information about our borrowings for the periods presented:
Table 18 | ||||||||||||||||||||||||
Repurchase Agreements | Securitized Debt (1) | |||||||||||||||||||||||
Quarter Ended | Quarterly Average Balance | End of Period Balance | Maximum Balance at Month-End | Quarterly Average Balance | End of Period Balance | Maximum Balance at Month-End | ||||||||||||||||||
June 30, 2015 | $ | 3,215,482 | $ | 3,177,679 | $ | 3,240,446 | $ | 28,582 | $ | 25,828 | $ | 28,883 | ||||||||||||
March 31, 2015 | $ | 3,217,137 | $ | 3,303,385 | $ | 3,303,385 | $ | 31,321 | $ | 29,240 | $ | 31,026 | ||||||||||||
December 31, 2014 | $ | 3,178,580 | $ | 3,402,327 | $ | 3,402,327 | $ | 34,176 | $ | 33,098 | $ | 34,519 | ||||||||||||
September 30, 2014 | $ | 2,998,470 | $ | 3,076,808 | $ | 3,076,808 | $ | 36,500 | $ | 34,947 | $ | 36,692 | ||||||||||||
June 30, 2014 | $ | 2,900,282 | $ | 2,991,989 | $ | 2,991,989 | $ | 39,133 | $ | 37,348 | $ | 39,066 | ||||||||||||
March 31, 2014 | $ | 2,887,060 | $ | 2,859,344 | $ | 2,956,389 | $ | 41,835 | $ | 40,281 | $ | 41,292 |
(1) | The balances presented for securitized debt reflect the balance of such debt, which does not reflect the impact of changes in the fair value of such liability. |
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The following table presents information about our borrowings by type of collateral pledged, and the fair value of collateral pledged as of the dates presented and the weighted average interest rate, the cost of funds and effective cost of funds for the quarterly periods then ended:
Table 19 | ||||||||||||||
Quarterly Period Ended: | Principal Balance of Borrowing | Fair Value of Collateral Pledged (1) | Weighted Average Cost of Funds | Effective Cost of Funds (2) | ||||||||||
June 30, 2015 | ||||||||||||||
Agency RMBS repurchase borrowings | $ | 1,868,994 | $ | 1,955,767 | 0.38 | % | 1.35 | % | ||||||
Non-Agency RMBS and Other Investment repurchase borrowing | 1,215,083 | 1,577,653 | 1.82 | % | 1.82 | % | ||||||||
Securitized mortgage loans and mortgage loan repurchase borrowings (3) | 93,602 | 128,933 | 2.76 | % | 3.33 | % | ||||||||
Total repurchase borrowings | 3,177,679 | 3,662,353 | 0.97 | % | 1.57 | % | ||||||||
Securitized debt (4) | 25,828 | 98,223 | 4.60 | % | 4.60 | % | ||||||||
Total | $ | 3,203,507 | $ | 3,760,576 | 1.00 | % | 1.60 | % | ||||||
March 31, 2015 | ||||||||||||||
Agency RMBS repurchase borrowings | $ | 2,074,306 | $ | 2,192,291 | 0.37 | % | 1.30 | % | ||||||
Non-Agency RMBS and Other Investment repurchase borrowing | 1,134,211 | 1,492,830 | 1.88 | % | 1.88 | % | ||||||||
Securitized mortgage loans and mortgage loan repurchase borrowings (3) | 94,868 | 130,672 | 2.15 | % | 3.08 | % | ||||||||
Total repurchase borrowings | 3,303,385 | 3,815,793 | 0.93 | % | 1.52 | % | ||||||||
Securitized debt (4) | 29,240 | 101,261 | 4.69 | % | 4.69 | % | ||||||||
Total | $ | 3,332,625 | $ | 3,917,054 | 0.96 | % | 1.58 | % | ||||||
December 31, 2014: | ||||||||||||||
Agency RMBS repurchase borrowings | $ | 2,205,082 | $ | 2,313,124 | 0.34 | % | 1.30 | % | ||||||
Non-Agency RMBS and Other Investment repurchase borrowing | 1,164,092 | 1,538,096 | 1.95 | % | 1.95 | % | ||||||||
Securitized mortgage loans repurchase borrowings (3) | 33,153 | 47,786 | 2.20 | % | 3.84 | % | ||||||||
Total repurchase borrowings | 3,402,327 | 3,899,006 | 0.93 | % | 1.56 | % | ||||||||
Securitized debt (4) | 33,098 | 104,438 | 4.20 | % | 4.20 | % | ||||||||
Total | $ | 3,435,425 | $ | 4,003,444 | 0.96 | % | 1.58 | % | ||||||
September 30, 2014 | ||||||||||||||
Agency RMBS repurchase borrowings | 1,934,669 | 2,022,839 | 0.34 | % | 1.37 | % | ||||||||
Non-Agency RMBS and Other Investment repurchase borrowing | 1,112,962 | 1,486,250 | 2.01 | % | 2.01 | % | ||||||||
Securitized mortgage loans repurchase borrowings (3) | 29,177 | 48,036 | 1.88 | % | 3.76 | % | ||||||||
Total repurchase borrowings | 3,076,808 | 3,557,125 | 0.95 | % | 1.62 | % | ||||||||
Securitized debt (4) | 34,947 | 106,947 | 4.27 | % | 4.27 | % | ||||||||
Total | $ | 3,111,755 | $ | 3,664,072 | 0.99 | % | 1.65 | % | ||||||
June 30, 2014 | ||||||||||||||
Agency RMBS repurchase borrowings | 1,905,783 | 2,029,915 | 0.36 | % | 1.41 | % | ||||||||
Non-Agency RMBS repurchase borrowings | 1,057,637 | 1,390,446 | 2.07 | % | 2.07 | % | ||||||||
Securitized mortgage loans repurchase borrowings (3) | 28,569 | 48,638 | 1.88 | % | 3.80 | % | ||||||||
Total repurchase borrowings | 2,991,989 | 3,468,999 | 0.97 | % | 1.66 | % | ||||||||
Securitized debt (4) | 37,348 | 109,712 | 4.36 | % | 4.36 | % | ||||||||
Total | $ | 3,029,337 | $ | 3,578,711 | 1.01 | % | 1.69 | % |
(1) | Includes cash collateral pledged for Agency RMBS and non-Agency RMBS. (See Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.) |
(2) | The effective cost of funds for the quarterly periods are calculated on an annualized basis and adjusts interest expense to include the net interest component for Swaps. (See “Non-GAAP Financial Measures,” below.) |
(3) | Repurchase agreements collateralized by securitized mortgage loans represent borrowings associated with non-Agency RMBS retained in connection with our securitizations. Non-Agency RMBS associated with our securitizations are eliminated in consolidation with the VIE associated with such securitizations, and we consolidate the mortgage loans held by the securitization trust. (See Notes 5 and 15 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.) |
(4) | Fair value of collateral pledged reflects the fair value of the securitized mortgage loans held by the applicable securitization trust. |
With respect to our repurchase agreement borrowings, the “haircut” represents the percentage by which the collateral value is contractually required to exceed the loan amount. At June 30, 2015, haircuts ranged from 3.0% to 5.0% for our
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repurchase borrowings secured by Agency RMBS, 10.0% to 45.0% for repurchase borrowings secured by non-Agency RMBS. Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call. Margin calls are satisfied when we pledge additional collateral in the form of securities and/or cash to the lender. We have met all margin calls to date.
Certain repurchase agreements and other transactional agreements subject us to financial covenants. An event of default or termination event would give certain of our counterparties the option to terminate all existing repurchase transactions with us and require amounts due to the counterparties by us to be payable immediately. We were in compliance with all of our financial covenants through June 30, 2015. At June 30, 2015, RMBS pledged as collateral to lenders as security for repurchase agreements totaled $3,319,874 (including securities that are eliminated in consolidation with VIEs) and RMBS held as a component of clearing margin totaled $4,174. Cash collateral held by counterparties is reported on our balance sheet as “Restricted cash” and, at June 30, 2015, was comprised of $63,745 provided in connection with repurchase borrowings and $13,371 provided in connection with derivative contracts.
Cash Flows and Liquidity for the Six Months Ended June 30, 2015
Our cash and cash equivalents decreased by $1,093 during the six months ended June 30, 2015, reflecting $277,944 used by financing activities, $22,810 provided by operating activities and $254,041 provided by investing activities. We held cash and cash equivalents of $113,350 at June 30, 2015. (See “Consolidated Statements of Cash Flows,” included under Item 1 with our consolidated Financial Statements in this Quarterly Report on Form 10-Q.)
Contractual Obligations and Commitments
The following table summarizes the effect on our liquidity and cash flows of our contractual obligations for principal and interest as of June 30, 2015:
Table 20 | ||||||||||||||||||||
Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | Total | ||||||||||||||||
Borrowings under repurchase agreements | $ | 2,875,982 | $ | 301,697 | $ | — | $ | — | $ | 3,177,679 | ||||||||||
Interest on repurchase agreements borrowings (1) | 9,712 | 8,804 | — | — | 18,516 | |||||||||||||||
Total | $ | 2,885,694 | $ | 310,501 | $ | — | $ | — | $ | 3,196,195 |
(1) | Interest expense is calculated based on the interest rate in effect at June 30, 2015 and includes all interest expense incurred and expected to be incurred in the future through the contractual maturity of the associated repurchase agreement. |
The table above does not include amounts due under the Management Agreement as such obligations, discussed below, do not have fixed and determinable payments, or our anticipated dividend on our Preferred Stock. (See Notes 14 and 17 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q for a discussion with respect to our Management Agreement and Preferred Stock.) At June 30, 2015, we had securitized debt with a balance of $25,828 (and a fair value of $25,893) with a contractual interest rate of 4.00%. Our securitized debt is not included in the table above, as such debt is non-recourse to us and is only paid to the extent of the performance of the mortgage loans in the February 2013 Securitization trust, which collateralize such debt.
Management Agreement
Pursuant to the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement) per annum. Our management fee is used, in part, to pay compensation to officers and personnel of the Manager who may also be our officers, but receive no cash compensation directly from us. We reimburse our Manager and/or its affiliates for the allocable share of the compensation of (1) our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and (2) other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs based on the percentage of time devoted by such personnel to our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. To the extent that our Manager or its affiliates pay for services provided on our behalf, we are required to reimburse our Manager and/or its affiliates for such items. Expense reimbursements to our Manager and/or its affiliates are made in cash generally on a monthly basis in arrears. Our reimbursement obligation is not subject to any dollar limitation.
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Our Management Agreement currently runs through July 27, 2016, with automatic one year renewals thereafter provided that the independent directors of our board do not provide notice of termination. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. Following a meeting of our independent directors in January 2015, which included a discussion of the Manager’s performance and the level of the management fees, we determined not to seek termination of the Management Agreement.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment to provide additional funding to any such entities.
Dividends on Our Capital Stock
We have outstanding 6,900,000 shares of Preferred Stock, which entitles holders to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. The dividends on Preferred Stock are cumulative and payable quarterly in arrears. Except under certain limited circumstances, the Preferred Stock is generally not convertible into or exchangeable for any other property or any other of our securities at the election of the holders. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. No dividends may be paid on our common stock unless full cumulative dividends have been paid on the Preferred Stock, all of which have been paid to date.
We intend to make regular quarterly dividend distributions to holders of our capital stock. U.S. Federal income tax law
generally requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains and
without regard to the deduction for dividends paid, and that it pay tax at regular corporate rates to the extent that it annually
distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders in an
amount at least equal to our net taxable income, if and to the extent authorized by our board of directors. Before we pay any
dividend, whether for U.S. Federal income tax purposes or otherwise, we must first meet both our operating requirements and
debt service on our repurchase agreements and other debts payable. If our cash available for distribution is less than our net
taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the
required distribution in the form of a taxable stock distribution or distribution of debt securities. (See “Variances between
GAAP Income and Taxable Income,” above.)
Non-GAAP Financial Measures
We have included in this Form 10-Q disclosures about our “operating earnings,” “operating earnings per common share” and “effective cost of funds” which disclosures constitute non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. We believe that the non-GAAP financial measures presented, when considered together with GAAP financial measures, provide information that is useful to investors in understanding our operating results. An analysis of any non-GAAP financial measures should be made in conjunction with results presented in accordance with GAAP.
Operating earnings and operating earnings per common share presented exclude, as applicable: (i) certain realized and unrealized gains and losses recognized through earnings; (ii) non-cash equity compensation; (iii) one-time events pursuant to changes in GAAP; and (iv) certain other non-cash charges. Operating Earnings is a non-GAAP financial measure that is used by us to assess our business results.
While we have not elected hedge accounting under GAAP for our Swaps, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates. To present for investors how we view our Swaps, we provide the “effective cost of funds” which is comprised of GAAP interest expense plus the interest expense component for our Swaps. The interest expense component of our Swaps reflects the net interest payments made or accrued on our Swaps. We believe that the presentation of the effective cost of funds is useful for investors, as it presents borrowing costs as viewed by us.
We believe that the non-GAAP measures we present provide investors and other readers of this Quarterly Report on Form 10-Q with useful measures to assess the performance of our ongoing business and useful supplemental information to both management and investors in evaluating our financial results. The primary limitation associated with operating earnings as a
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measure of our financial performance over any period is that it excludes, except for the net interest component of Swaps, the effects of net realized and unrealized gains/(losses) from investments and derivative instruments. Our presentation of operating earnings may not be comparable to similarly-titled measures of other companies, who may use different definitions or calculations for such term. As a result, operating earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP.
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A reconciliation of the GAAP items discussed above to their non-GAAP measures presented in this Quarterly Report on Form 10-Q are as follows:
Table 21 | Three Months Ended | |||||||||||||
June 30, 2015 | June 30, 2014 | |||||||||||||
Reconciliation | Cost of Funds/Effective Cost of Funds | Reconciliation | Cost of Funds/Effective Cost of Funds | |||||||||||
Interest expense | $ | 8,234 | 1.00 | % | $ | 7,510 | 1.01 | % | ||||||
Adjustment: | ||||||||||||||
Net interest component of Swaps | 4,920 | 0.60 | % | 5,081 | 0.68 | % | ||||||||
Effective cost of funds | $ | 13,154 | 1.60 | % | $ | 12,591 | 1.69 | % | ||||||
Average balance of borrowings | $ | 3,215,482 | $ | 2,939,415 | ||||||||||
Six Months Ended | ||||||||||||||
June 30, 2015 | June 30, 2014 | |||||||||||||
Reconciliation | Cost of Funds/Effective Cost of Funds | Reconciliation | Cost of Funds/Effective Cost of Funds | |||||||||||
Interest expense | $ | 16,065 | 0.98 | % | $ | 14,778 | 1.00 | % | ||||||
Adjustment: | ||||||||||||||
Net interest paid for Swaps | 9,884 | 0.60 | % | 9,870 | 0.67 | % | ||||||||
Effective interest expense/effective cost of funds | $ | 25,949 | 1.58 | % | $ | 24,648 | 1.67 | % | ||||||
Average balance of borrowings | $ | 3,236,019 | $ | 2,934,193 |
Table 22 | Three Months Ended | |||||||||||||
June 30, 2015 | June 30, 2014 | |||||||||||||
Reconciliation | Yield/Effective Cost of Funds/Spread | Reconciliation | Cost of Funds/Effective Cost of Funds/Spread | |||||||||||
Interest income | $ | 41,618 | 4.34 | % | $ | 38,141 | 4.33 | % | ||||||
Less: effective interest expense/effective cost of funds (1) | 13,154 | 1.60 | % | 12,591 | 1.69 | % | ||||||||
Effective net interest income | $ | 28,464 | 2.74 | % | $ | 25,550 | 2.64 | % | ||||||
Average balance of interest-earning assets | $ | 3,797,828 | $ | 3,526,270 | ||||||||||
Six Months Ended | ||||||||||||||
June 30, 2015 | June 30, 2014 | |||||||||||||
Reconciliation | Yield/Effective Cost of Funds/Spread | Reconciliation | Cost of Funds/Effective Cost of Funds/Spread | |||||||||||
Interest income | 80,913 | 4.31 | % | 76,321 | 4.34 | % | ||||||||
Less: effective interest expense/effective cost of funds (1) | 25,949 | 1.58 | % | 24,648 | 1.67 | % | ||||||||
Effective net interest income | $ | 54,964 | 2.73 | % | $ | 51,673 | 2.67 | % | ||||||
Average balance of interest-earning assets | $ | 3,787,214 | $ | 3,519,437 |
(1) | As reconciled above in Table 21. |
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The following table presents the reconciliation from net income/(loss) allocable to common stockholders to operating earnings:
Table 23 | Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2015 | 2014 (1) | 2015 | 2014 | |||||||||||||
Net income/(loss) allocable to common stockholders | $ | (13,635 | ) | $ | 40,291 | $ | 4,168 | $ | 64,570 | |||||||
Adjustments to arrive at operating earnings: | ||||||||||||||||
Realized (gain)/loss on sale of RMBS, net | 4,530 | 7,072 | (4,008 | ) | 18,882 | |||||||||||
Realized (gain) on sale of other investment securities, net | (102 | ) | (102 | ) | ||||||||||||
Unrealized (gain)/loss on RMBS, net | 41,354 | (51,590 | ) | 29,149 | (102,237 | ) | ||||||||||
Unrealized (gain)/loss on derivative instruments, net | (23,553 | ) | 14,467 | (7,835 | ) | 33,185 | ||||||||||
Unrealized (gain)/loss on securitized mortgage loans, net | 1,896 | (2,042 | ) | (466 | ) | (3,096 | ) | |||||||||
Unrealized (gain)/loss on securitized debt | (1,001 | ) | 364 | (1,014 | ) | 354 | ||||||||||
Unrealized (gain)/loss on other investment securities | 2,649 | (54 | ) | 2,678 | (176 | ) | ||||||||||
Non-cash stock-based compensation expense | 304 | 408 | 797 | 867 | ||||||||||||
Realized loss on Swap and Swaption terminations, net | 6,170 | 7,585 | 10,032 | 14,112 | ||||||||||||
Realized loss on TBA Contracts | — | — | 1,977 | 7,156 | ||||||||||||
Other | — | 68 | — | 68 | ||||||||||||
Tax amortization of (loss) on Swaption terminations and expirations, net | (620 | ) | (48 | ) | (1,058 | ) | (92 | ) | ||||||||
Total adjustments to arrive at operating earnings | 31,627 | (23,770 | ) | 30,150 | (30,977 | ) | ||||||||||
Operating earnings | $ | 17,992 | $ | 16,521 | $ | 34,318 | $ | 33,593 | ||||||||
Basic and diluted operating earnings per share of common stock | $ | 0.56 | $ | 0.52 | $ | 1.07 | $ | 1.05 | ||||||||
Weighted average common shares outstanding- basic (2) | 32,048 | 32,020 | 32,047 | 32,018 |
(1) | Prior presentation is conformed to the current presentation. |
(2) | Amounts in thousands. |
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ITEM 3. | Quantitative and Qualitative Disclosures about Market Risk. |
(Dollar amounts in thousands – except per share data.)
We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from our assets through ownership of our capital stock. While we do not seek to avoid risk completely, we believe that risk can be quantified from historical experience and seek to actively manage risk, to earn sufficient returns to justify taking such risks and to maintain capital levels consistent with the risks we undertake.
Credit Risk
We are subject to varying degrees of credit risk in connection with our assets. Although we do not expect to encounter credit risk in our Agency RMBS, we do expect to encounter credit risk related to our non-Agency RMBS, other investment securities, securitized mortgage loans, mortgage loans and other investments. The credit support built into non-Agency RMBS and SBC-MBS transaction structures is designed to mitigate credit losses. In addition, to date, we have purchased the substantial majority of our non-Agency RMBS at a discount to par value, which is expected to further mitigate our risk of loss in the event that less than 100% of the par value of such securities is received. However, credit losses greater than those anticipated or in excess of the recorded purchase discount could occur, which could materially adversely impact our operating results. The credit risk associated with our warehouse line receivable is mitigated by a pledge of substantially all the equity of the third-party borrower/guarantor, which borrower has legal title to the homes, BFT Contracts and mortgage loans that we finance on a warehouse line. With respect to our securitized mortgage loans, we retain the risk of potential credit losses. Our Manager seeks to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and overseeing the servicer.
Investment decisions are made following a bottom-up credit analysis and specific risk assumptions. As part of the risk management process our Manager uses detailed proprietary models to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure frequency, cost and timing.
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The following table presents information about our non-Agency RMBS and the mortgages underlying such securities at June 30, 2015. Information presented with respect to weighted average original loan-to-value, weighted average credit score reported by Fair Isaac Corporation (or, FICO) and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 24 | Year of Securitization (1) | |||||||||||||||||||||||||||
2014 | 2007 | 2006 | 2005 | 2004 | 2003 & Prior | Total | ||||||||||||||||||||||
Portfolio Characteristics: | ||||||||||||||||||||||||||||
Number of Securities | 2 | 15 | 34 | 63 | 82 | 46 | 242 | |||||||||||||||||||||
Carrying Value/Estimated Fair Value | $ | 7,910 | $ | 73,671 | $ | 273,207 | $ | 305,049 | $ | 486,731 | $ | 231,697 | $ | 1,378,265 | ||||||||||||||
Amortized Cost | 7,922 | 66,309 | 258,706 | 291,189 | 469,577 | 220,717 | 1,314,420 | |||||||||||||||||||||
Current Par Value | 8,428 | 81,737 | 320,177 | 368,574 | 538,801 | 256,368 | 1,574,085 | |||||||||||||||||||||
Carrying Value to Current Par | 93.86 | % | 90.13 | % | 85.33 | % | 82.76 | % | 90.34 | % | 90.38 | % | 87.56 | % | ||||||||||||||
Amortized Cost to Current Par | 94.00 | % | 81.12 | % | 80.80 | % | 79.00 | % | 87.15 | % | 86.09 | % | 83.50 | % | ||||||||||||||
Net Weighted Average Coupon | 0.48 | % | 1.41 | % | 1.56 | % | 1.29 | % | 1.76 | % | 1.49 | % | 1.54 | % | ||||||||||||||
Collateral Attributes: | ||||||||||||||||||||||||||||
Weighted Average Loan Age (in months) | 121 | 122 | 116 | 123 | 121 | 122 | 121 | |||||||||||||||||||||
Weighted Average Original Loan-to-Value | 73.73 | % | 82.59 | % | 84.33 | % | 81.19 | % | 79.42 | % | 80.87 | % | 81.16 | % | ||||||||||||||
Weighted Average Original FICO | 691 | 645 | 631 | 644 | 643 | 620 | 637 | |||||||||||||||||||||
Performance: | ||||||||||||||||||||||||||||
60+ Days Delinquent | 19.51 | % | 27.19 | % | 37.05 | % | 28.90 | % | 27.90 | % | 34.29 | % | 30.92 | % | ||||||||||||||
Average Credit Enhancement (2) | 44.84 | % | 23.79 | % | 33.82 | % | 25.28 | % | 30.44 | % | 30.45 | % | 29.70 | % | ||||||||||||||
3 Month CRR (3) | 5.00 | % | 4.14 | % | 2.94 | % | 3.31 | % | 3.51 | % | 3.24 | % | 3.35 | % |
(1) | Certain of our non-Agency RMBS have been resecuritized; however, the vintage and information presented is based on the initial year of securitization and the data available at that time. |
(2) | Credit enhancement is expressed as a percentage of all outstanding mortgage loan collateral. Our RMBS may incur losses if credit enhancement is reduced to zero. |
(3) | Amounts presented reflect the weighted average monthly performance for the three months ended June 30, 2015. |
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The following table presents certain characteristics about mortgage loans underlying the February 2013 Securitization at June 30, 2015. All of the mortgage liens underlying the February 2013 Securitization are first liens on residential properties. Information presented with respect to weighted average original loan-to-value, weighted average FICO score, and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 25 | Year of Origination | |||||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 & Prior | Total | |||||||||||||||||||
Portfolio Characteristics: | ||||||||||||||||||||||||
Number of loans | 57 | 588 | 13 | 6 | 2 | 666 | ||||||||||||||||||
Current unpaid principal balance | $ | 11,391 | $ | 117,252 | $ | 2,560 | $ | 1,148 | $ | 144 | $ | 132,495 | ||||||||||||
Loan Attributes: | ||||||||||||||||||||||||
Weighted average loan age (in months) | 87 | 96 | 102 | 119 | 131 | 95 | ||||||||||||||||||
Weighted average original loan-to-value | 74.08 | % | 80.10 | % | 82.60 | % | 80.67 | % | 100.00 | % | 79.65 | % | ||||||||||||
Weighted average original FICO score | 603 | 631 | 624 | 609 | 669 | 628 | ||||||||||||||||||
Net weighted average coupon rate | 6.94 | % | 5.97 | % | 4.90 | % | 5.39 | % | 6.32 | % | 6.02 | % | ||||||||||||
Performance: | ||||||||||||||||||||||||
Current | 62.17 | % | 71.06 | % | 71.56 | % | 83.98 | % | — | % | 70.34 | % | ||||||||||||
30 day delinquent | 8.30 | % | 9.48 | % | 1.08 | % | 16.02 | % | — | % | 9.26 | % | ||||||||||||
60 days delinquent | 3.39 | % | 2.76 | % | — | % | — | % | — | % | 2.73 | % | ||||||||||||
90+ days delinquent | 19.08 | % | 10.50 | % | — | % | — | % | 42.58 | % | 10.98 | % | ||||||||||||
Bankruptcy/foreclosure | 7.07 | % | 6.21 | % | 27.36 | % | — | % | 57.42 | % | 6.69 | % |
The following table presents certain characteristics about mortgage loans underlying the March 2015 Securitization at June 30, 2015. All of the mortgage liens underlying the March 2015 Securitization are first liens on residential properties. Information presented with respect to weighted average original loan-to-value, weighted average FICO score, and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 26 | Year of Origination | |||||||||||||||||||||||||||
2009 | 2008 | 2007 | 2006 | 2005 | 2004 & Prior | Total | ||||||||||||||||||||||
Portfolio Characteristics: | ||||||||||||||||||||||||||||
Number of loans | 3 | 9 | 112 | 149 | 99 | 301 | 673 | |||||||||||||||||||||
Current unpaid principal balance | $ | 471 | $ | 3,060 | $ | 21,335 | $ | 25,703 | $ | 14,465 | $ | 24,208 | $ | 89,242 | ||||||||||||||
Loan Attributes: | ||||||||||||||||||||||||||||
Weighted average loan age (in months) | 71 | 86 | 96 | 105 | 118 | 152 | 117 | |||||||||||||||||||||
Weighted average original loan-to-value | 72.75 | % | 70.87 | % | 80.06 | % | 81.07 | % | 76.53 | % | 83.78 | % | 80.44 | % | ||||||||||||||
Weighted average original FICO score | 518 | 721 | 638 | 620 | 654 | 606 | 627 | |||||||||||||||||||||
Net weighted average coupon rate | 7.28 | % | 5.02 | % | 5.48 | % | 5.96 | % | 5.26 | % | 6.49 | % | 5.85 | % | ||||||||||||||
Performance: | ||||||||||||||||||||||||||||
Current | — | % | 53.33 | % | 78.04 | % | 74.21 | % | 80.92 | % | 75.25 | % | 75.39 | % | ||||||||||||||
30 day delinquent | 76.42 | % | 37.01 | % | 14.46 | % | 16.81 | % | 12.99 | % | 16.50 | % | 16.55 | % | ||||||||||||||
60 days delinquent | 23.58 | % | 9.66 | % | 2.22 | % | 3.31 | % | 2.13 | % | 4.32 | % | 3.46 | % | ||||||||||||||
90+ days delinquent | — | % | — | % | 3.26 | % | 5.58 | % | 3.41 | % | 1.42 | % | 3.32 | % | ||||||||||||||
Bankruptcy/foreclosure | — | % | — | % | 2.02 | % | 0.09 | % | 0.55 | % | 2.51 | % | 1.28 | % |
At June 30, 2015, our other investment securities included investments in Agency Risk Sharing Securities and SBC-MBS. The performance of our SBC-MBS is based upon the performance of the underlying loans collateralizing the SBC-MBS securitization and the performance of our Agency Risk Sharing securities is based upon the performance of the referenced securities.
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The table below presents certain information about the credit characteristics of the underlying referenced mortgage pools or, underlying assets as applicable, associated with such securities at June 30, 2015:
Table 27 | Risk Sharing Securities-Freddie Mac | Risk Sharing Securities- Fannie Mae | SBC-MBS | |||||||||
Portfolio Characteristics: | ||||||||||||
Carrying value/estimated fair value | $ | 44,976 | $ | 45,935 | $ | 58,889 | ||||||
Amortized cost | 45,507 | 46,927 | 59,697 | |||||||||
Current par value | 45,249 | 48,287 | 67,928 | |||||||||
Net weighted average coupon | 3.53 | % | 3.70 | % | 0.66 | % | ||||||
Collateral Attributes: | ||||||||||||
Weighted average loan age (in months) | 27 | 22 | 104 | |||||||||
Weighted average original loan-to-value | 60.82 | % | 72.11 | % | 67.63 | % | ||||||
Weighted average original FICO score | 763 | 761 | 702 | |||||||||
Performance: | ||||||||||||
60+ days delinquent | 0.04 | % | 0.03 | % | 19.90 | % | ||||||
Average credit enhancement | 1.11 | % | 0.37 | % | 22.73 | % |
The following table presents the fair value of our non-Agency RMBS at June 30, 2015, by original purchase price as a percentage of our par value by year of acquisition:
Table 28 | Year of Acquisition | ||||||||||||||||||||||||||
Acquisition Price (1) | 2015 | 2014 | 2013 | 2012 | 2011 | Total | Percent of Total | ||||||||||||||||||||
>100% | 5,533 | $ | 7,521 | $ | 2,454 | $ | — | $ | — | $ | 15,508 | 1.1 | % | ||||||||||||||
100% to 95% | 78,558 | 130,975 | 25,603 | — | — | 235,136 | 17.1 | ||||||||||||||||||||
<95% to 85% | 64,694 | 117,744 | 214,521 | 35,233 | 3,009 | 435,201 | 31.6 | ||||||||||||||||||||
<85% to 75% | 9,310 | 89,191 | 163,343 | 84,643 | 6,645 | 353,132 | 25.6 | ||||||||||||||||||||
<75% to 65% | 4,561 | 23,896 | 51,845 | 86,377 | 15,911 | 182,590 | 13.2 | ||||||||||||||||||||
<65% | — | 7,784 | 8,070 | 122,242 | 18,601 | 156,697 | 11.4 | ||||||||||||||||||||
Total | $ | 162,656 | $ | 377,111 | $ | 465,836 | $ | 328,495 | $ | 44,166 | $ | 1,378,264 | 100.0 | % |
(1) | Prices are expressed as a percentage of par value. |
The mortgages underlying our non-Agency RMBS are located in various states across the U.S. The following table presents the five largest concentrations by state for the mortgages collateralizing our non-Agency RMBS at June 30, 2015 based on fair value:
Table 29 | |||
Property Location | Percent (1) | ||
California | 27.7 | % | |
New York | 11.0 | ||
Florida | 8.1 | ||
New Jersey | 5.1 | ||
Texas | 4.6 | ||
Other (2) | 43.5 | ||
Total | 100.0 | % |
(1) | Percentages are weighted to reflect our proportional share for each of the securities we own. |
(2) | Includes mortgages on properties located in each of the remaining 45 states and the District of Columbia, with no state concentration exceeding 3.2% of the total. |
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The following table presents certain information about the mortgage loans underlying our non-Agency RMBS at June 30, 2015:
Table 30 | |||||||
Underlying Mortgage Loan Collateral Type | Market Value | Percent of Total | |||||
Subprime | $ | 997,548 | 72.38 | % | |||
Alt-A | 173,405 | 12.58 | |||||
Option ARMs | 207,312 | 15.04 | |||||
Total | $ | 1,378,265 | 100.0 | % |
To the extent we invest in residential mortgage loans, we may retain the risk of potential credit losses on the mortgage loans that we hold in our portfolio. With respect to any residential mortgage loans in which we may invest, we expect to seek to obtain representations and warranties from each seller stating that each loan was underwritten to our requirements or, in the event underwriting exceptions were made, that we are informed of the exceptions so that we may evaluate whether to accept or reject the loans. A seller who breaches these representations and warranties in making a loan that we purchase may be obligated to repurchase the loan from us. In the event we invest in residential mortgage loans, our Manager will seek to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and will proactively manage positions.
The following table presents the five largest state concentrations, in the aggregate, for mortgage loans included in our securitizations based on principal balance at June 30, 2015:
Table 31 | |||||||
Property Location | Principal Balance | Total Concentration | |||||
Florida | $ | 40,396 | 18.2 | % | |||
California | 39,426 | 17.8 | |||||
Maryland | 17,987 | 8.1 | |||||
Texas | 14,071 | 6.3 | |||||
New York | 12,593 | 5.7 | |||||
Other states and the District of Columbia | 97,265 | 43.9 | |||||
Total | $ | 221,738 | 100.0 | % |
Interest Rate Risk
Interest rates are sensitive to many factors, including fiscal and monetary policies, domestic and international economic and political considerations, as well as other factors, all of which are beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset specific funding arrangements.
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments to mitigate the impact of increases in interest rates. Increases in interest rates may impact the cost of our repurchase borrowings and reduce the value of our Agency RMBS. Our hedges are not designed to protect against market value fluctuations in our assets caused by changes in the spread between our investments and other benchmark rates such as Swaps and Treasury bonds. Therefore, the risk of adverse spread changes is inherent to our business. Our asset composition and general market conditions may cause the amount of interest rate protection provided by our derivatives to vary considerably over time. We also may utilize a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS, Inverse IO and Inverse Floater securities and Long TBA Contracts to decline; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts, if any, Swaps and Swaptions to improve. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change,
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the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.
Interest Rate Cap Risk
Certain of our RMBS and securitized mortgage loans are subject to interest rate caps, which could cause such assets to acquire characteristics similar to fixed-rate securities if interest rates were to rise above the cap levels. Interim interest rate caps limit the amount that interest rates on a particular instrument can adjust periodically. Lifetime interest rate caps limit the amount interest rates can adjust upward from inception through maturity of a particular instrument. Investments that are subject to caps could result in us receiving income on such investments that is less than the interest expense we may incur on borrowings to finance such investments. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under “Interest Rate Risk.”
Interest Rate Effects on Estimated Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease differently from our derivative instruments.
The impact of changing interest rates on estimated fair value can change significantly when interest rates change materially. Accordingly, changes in actual interest rates may have a material adverse effect on us. Therefore, the volatility in the estimated fair value of our assets could increase significantly in the event that interest rates change materially. In addition, other factors impact the estimated fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions.
Our RMBS are carried at their estimated fair value with unrealized gains and losses included in earnings. The estimated fair value of these securities fluctuates primarily due to changes in interest rates, and with respect to our non-Agency RMBS, credit changes, and other factors. Generally, in a rising interest rate environment, the estimated fair value of our RMBS portfolio, on a net basis, would generally be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would generally be expected to increase.
Our securitized mortgage loans are carried at their estimated fair value with unrealized gains and losses included in earnings. Such assets, which are credit sensitive, are comprised of both ARMs and fixed rate mortgage loans. As a result, changes in the fair value of our securitized mortgage loans are expected to be impacted by delinquencies, changes in housing prices, jobless rates and other factors to a greater extent than by changes in interest rates.
Nearly all of our Agency pass-through RMBS, which comprise the substantial majority of our Agency portfolio, are fixed- rate securities. In general, as market interest rates increase the market prices for fixed-rate securities generally decrease; conversely, as market interest rates decrease the market prices for fixed-rate securities generally increase. We monitor the duration of our Agency RMBS and derivatives, using empirical data as well as third-party models and may adjust our portfolio to maintain duration at a level that we believe is prudent in the current or anticipated interest rate environment. In a rising interest rate environment, the weighted average life of our Agency RMBS could extend significantly beyond the terms of our Swaps or other hedging instruments. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed beyond the term of the hedging instrument while the income earned on the remaining Agency RMBS would remain fixed for a period of time. This situation may also cause the market value of our Agency RMBS to decline with insufficient or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses. Variations in models and methodologies in measuring duration may produce differing results for the same securities or portfolio.
Our non-Agency RMBS and securitized mortgage loans, are backed by Hybrid, ARMs and fixed rate mortgage loans. These loans may be performing, re-performing or non-performing and, as such, are more significantly impacted by the performance of the underlying collateral (i.e., credit) than by changes in interest rates.
Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call, which we satisfy by pledging additional collateral in the form of securities and/or cash to the lender. In general, decreases in the fair value of our RMBS and MBS will reduce the amount we are able to borrow.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including derivative instruments and net interest income at June 30, 2015, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilizes our Manager’s assumptions, models and estimates, which are based on our
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Manager’s judgment and experience. For example, given the low level of interest rates at June 30, 2015, we have assumed a floor on repurchase agreement borrowing rates of 25 basis points and we have assumed a floor of six basis points with respect to the variable rate that we receive on our Swaps.
Table 32 | ||||
Basis Point Change in Interest Rates | Percentage Change in Projected Portfolio Value | Percentage Change in Projected Net Interest Income and Periodic Interest Settlements for Swaps | ||
+100 | (0.23)% | 6.04% | ||
+50 | 1.53% | 4.62% | ||
(50) | (1.19)% | (10.00)% | ||
(100) | (2.72)% | (20.07)% |
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at June 30, 2015. The analysis presented utilizes assumptions and estimates based on our Manager’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.
Prepayment Risk
The value of our assets may be affected by prepayment rates on residential mortgage loans. If we acquire residential mortgage loans and mortgage related securities, we anticipate that the residential mortgage loans or the underlying residential mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated.
Counterparty Risk
We finance the acquisition of a significant portion of our investments with repurchase agreements. The aggregate of our repurchase agreement financings are reflected as a liability in our consolidated balance sheet. In connection with these financing arrangements, we pledge our securities as collateral to secure the borrowing. The amount of collateral pledged will typically exceed the amount of the borrowing, as lenders apply a haircut to the collateral value, whereby the haircut reflects the percentage by which the collateral value is discounted to determine the loan amount. As a result, we are exposed to the counterparty if, during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral. (For additional information about our assets pledged as collateral as of June 30, 2015, see Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
We enter into Swaps, Swaptions, and TBA Contracts to manage our interest rate risk and are required to pledge cash or securities as collateral as part of a margin arrangement in connection with such contracts. The amount of margin that we are required to post will vary by counterparty and generally reflects collateral posted with respect to Swaps and TBA Contracts that are in an unrealized loss position to us and a percentage of the aggregate notional amount of Swaps and Swaptions per counterparty. In the event that a counterparty to one of these contracts were to default on its obligation, we would be exposed to a loss when the amount of cash or securities pledged by us exceeds the unrealized loss on such contracts and to the extent that we are not able to recover our excess collateral. In addition, if a counterparty to a Swap cannot perform under the terms of the Swap, we may not receive payments due under that agreement, and thus, may lose any unrealized gain associated with the Swap or, be unable to collect the cash value, if any, at expiration. Therefore, upon a default by a Swap counterparty, the Swap would no longer mitigate the impact of changes in interest rates as intended. If a counterparty to a Swaption cannot perform under the terms of a Swaption, we would lose our ability to exercise our option to enter into a Swap and could lose the amount by which the Swaption is in-the-money.
During the past several years, certain repurchase agreement and derivative counterparties in the U.S. and Europe have experienced financial difficulty and have been either rescued by government assistance or otherwise benefited from
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accommodative monetary policy of their respective central banks. Certain Swap trades entered into since June 10, 2013 are required to be cleared through a clearinghouse, in accordance with the CFTC Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties.
The following table summarizes our exposure to our repurchase agreements and derivative counterparties at June 30, 2015:
Table 33 | ||||||||||||||||||
Number of Counter- parties | Repurchase Agreement Borrowings | Derivatives at Fair Value | Exposure (1) | Exposure as Percent of Total Assets | ||||||||||||||
North America: | ||||||||||||||||||
United States (2) | 7 | $ | 1,520,683 | $ | 7,502 | $ | 222,621 | 5.4 | % | |||||||||
Canada (3) | 2 | 389,851 | — | 82,895 | 2.0 | |||||||||||||
9 | 1,910,534 | 7,502 | 305,516 | 7.4 | ||||||||||||||
Europe: (3) | ||||||||||||||||||
Switzerland | 2 | 266,511 | — | 95,058 | 2.3 | |||||||||||||
United Kingdom | 2 | 162,997 | (2,007 | ) | 34,485 | 0.8 | ||||||||||||
Netherlands | 1 | 199,479 | — | 11,497 | 0.3 | |||||||||||||
France | 1 | 241,428 | — | 29,754 | 0.7 | |||||||||||||
6 | 870,415 | (2,007 | ) | 170,794 | 4.1 | |||||||||||||
Asia: (3) | ||||||||||||||||||
Japan | 2 | 396,730 | 3,386 | 23,068 | 0.6 | |||||||||||||
Total | 17 | $ | 3,177,679 | $ | 8,881 | $ | 499,378 | 12.1 | % |
(1) | Represents the amount of cash and/or securities pledged as collateral to counterparties and associated accrued interest receivable less the aggregate of repurchase agreement borrowings, associated accrued interest payable and unrealized loss on Swaps for each counterparty net of collateral pledged to us, and the fair value of our Swaptions. |
(2) | Includes $3,969 of exposure associated with a Swap that is cleared through a U.S. based clearing house. |
(3) | Includes foreign based counterparties as well as U.S. domiciled subsidiaries of such counterparties, as such transactions are generally entered into with a U.S. domiciled subsidiary of such counterparties. |
We extend credit to our Seller Financing Program counterparty through a warehouse line, which is used by the counterparty to fund home purchases and improvements. Subsequent to purchasing and rehabilitating a home, our Seller Financing Program counterparty markets the home for sale, offering seller financing through either a BFT Contract or mortgage loan. Once the Seller Financing Program counterparty completes the transaction cycle, by entering into a BFT Contract or mortgage loan with a home buyer, we have the right of first refusal to purchase the corresponding BFT Contract or mortgage loan. The warehouse line is collateralized by a pledge of the ownership interest in the equity of our Seller Financing Program counterparty which holds title to the real estate properties funded with the warehouse line. At June 30, 2015, we had $20,464 outstanding under our warehouse line. If our Seller Financing Program counterparty becomes distressed, we may have difficulty in taking possession of the properties and completing improvements necessary to market the homes for sale.
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We had outstanding balances under repurchase agreements with 17 counterparties at June 30, 2015. The following table presents information with respect to any counterparty for repurchase agreements for which we had greater than 5% of stockholders’ equity at risk in the aggregate at June 30, 2015:
Table 34 | ||||||||||||
Counterparty | Counterparty Rating(1) | Amount of Risk(2) | Weighted Average Months to Maturity for Repurchase Agreements | Percent of Stockholders’ Equity | ||||||||
J.P. Morgan Securities LLC | A+/Aa3/AA- | $ | 39,699 | 1 | 5.2 | % | ||||||
Credit Suisse (USA) LLC | A/A1/A | $ | 45,618 | 4 | 6.0 | % | ||||||
UBS(3) | A/A2 | $ | 49,440 | 11 | 6.5 | % | ||||||
Wells Fargo(4) | AA-/Aa2/AA | $ | 77,437 | 13 | 10.2 | % | ||||||
Royal Bank of Canada(5) | AA-/Aa3/AA | $ | 79,822 | 3 | 10.5 | % |
(1) | The counterparty rating presented is the long-term issuer credit rating as rated at June 30, 2015 by Standard & Poor’s Ratings Services, Moody’s Investor Services, Inc. and Fitch, Inc., respectively. |
(2) | The amount at risk reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities. |
(3) | Includes amounts at risk with UBS AG, London Branch and UBS Securities, LLC. UBS AG, London Branch was rated A and A2 by Standard & Poor’s Ratings Services and Moody’s Investor Services, Inc., respectively, at June 30, 2015. UBS Securities, LLC was rated A by Standard & Poor’s Ratings Services at June 30, 2015. |
(4) | Includes amounts at risk with Wells Fargo Bank, N.A. and Wells Fargo Securities, LLC. Counterparty rating is the rating for Wells Fargo Bank, N.A. which represents $68,251 of the total exposure. The remaining exposure is to Wells Fargo Securities, LLC which was rated AA- by Standard & Poor’s Ratings Services as of June 30, 2015. |
(5) | Includes amounts at risk with Royal Bank of Canada and RBC (Barbados) Trading Bank Corporation. Counterparty rating is the rating for Royal Bank of Canada. which represents $42,349 of the total exposure. The remaining exposure is to RBC (Barbados) Trading Bank Corporation which was rated A2 by Moody’s Investor Services, Inc. at June 30, 2015. |
We maintain cash deposits with what we believe to be high credit quality financial institutions and invest in money market funds. Money market funds are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other U.S. Government agency. At June 30, 2015, we had cash and cash equivalents of $113,350, reflecting $40,005 invested in a money market fund and the remainder was primarily comprised of deposits with our prime broker domiciled in the U.S., substantially all of which was in excess of applicable insurance limits.
Funding Risk
We have financed a substantial majority of our securities and mortgage loans with repurchase agreement borrowings. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.
Liquidity Risk
The assets that comprise our asset portfolio are not traded on an exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than exchange-traded securities. Certain of our assets may from time to time become illiquid, making it difficult for us to sell such assets if the need or desire arises, or sell such assets at prices that are detrimental to us, including in response to changes in economic and other conditions.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation. Our financial statements are prepared in accordance with GAAP and dividends are based upon net ordinary income as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.
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ITEM 4. | Controls and Procedures. |
The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as of June 30, 2015, our disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder.
During the period ended June 30, 2015, there was no change in our internal control over financial reporting that has materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.
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PART II – OTHER INFORMATION
ITEM 1. | Legal Proceedings |
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of June 30, 2015, we were not involved in any legal proceedings that could have a material adverse impact on our financial condition or results of operations.
ITEM 1A. | Risk Factors |
There were no material changes to the Risk Factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.
ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
ITEM 3. | Defaults Upon Senior Securities |
None.
ITEM 4. | Mine Safety Disclosures |
Not Applicable.
ITEM 5. | Other Information |
None.
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ITEM 6. | Exhibits |
Exhibit No. | Description | ||
3.1 | Articles of Amendment and Restatement of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.1 of the Registrant’s Form S-8 (Registration No. 333-175824). | ||
3.2 | Articles Supplementary designating Apollo Residential Mortgage, Inc.’s 8.00% Series A Cumulative Redeemable Perpetual Preferred Stock, liquidation preference $25.00 per share, par value $0.01 per share, incorporated by reference to Exhibit 3.2 of the Registrant’s Form 8-A (File No.: 001-35246), filed on September 19, 2012. | ||
3.3 | Amended and Restated Bylaws of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.2 of the Registrant’s Form S-8 (Registration No. 333-175824). | ||
4.1 | Specimen Common Stock Certificate of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 4.1 of the Registrant’s Form S-11, as amended (Registration No. 333-172980). | ||
4.2 | Specimen Preferred Stock Certificate of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 4.2 of the Registrant’s Form 10-Q for the period ended September 30, 2012. | ||
10.1 | Registration Rights Agreement, dated as of July 27, 2011, between Apollo Residential Mortgage, Inc. and the parties named therein, incorporated by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the period ended September 30, 2011. | ||
10.2 | Management Agreement, dated as of July 21, 2011 and effective as of July 27, 2011, between Apollo Residential Mortgage, Inc., ARM Operating, LLC and ARM Manager, LLC, incorporated by reference to Exhibit 10.2 of the Registrant’s Form 10-Q for the period ended September 30, 2011. | ||
10.3 | License Agreement, dated as of July 21, 2011, between Apollo Residential Mortgage, Inc. and Apollo Global Management, LLC, incorporated by reference to Exhibit 10.3 of the Registrant’s Form 10-Q for the period ended September 30, 2011. | ||
10.4 | Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan, incorporated by reference to Exhibit 10.1 of the Registrant’s Form S-8 (Registration No. 333- 175824). | ||
10.5 | Form of Restricted Stock Award Agreement, incorporated by reference to Exhibit 10.3 of the Registrant’s Form S-11, as amended (Registration No. 333-172980). | ||
10.6 | Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K filed January 5, 2015. | ||
10.7 | Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.4 of the Registrant’s Form S-11, as amended (Registration No. 333-172980). | ||
31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of 18 U.S.C. Section 1350 as adopted pursuant to the Sarbanes-Oxley Act of 2002. | ||
101.INS | XBRL Instance Document | ||
101.SCH | XBRL Taxonomy Extension Schema Document | ||
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101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase Document | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
APOLLO RESIDENTIAL MORTGAGE, INC. | ||||||
August 10, 2015 | ||||||
By: | /s/ Michael A. Commaroto | |||||
Michael A. Commaroto | ||||||
President and Chief Executive Officer | ||||||
(Principal Executive Officer) | ||||||
By: | /s/ Teresa D. Covello | |||||
Teresa D. Covello | ||||||
Chief Financial Officer | ||||||
(Principal Financial Officer and Principal Accounting Officer) |
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