UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the Fiscal Year Ended December 31, 20082011 |
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| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| | For the Transition Period From ____________ to ____________ |
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Commission File Number 001-32216
NEW YORK MORTGAGE TRUST, INC .
(Exact name of registrant as specified in its charter)
| Maryland | | 47-0934168 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
52 Vanderbilt Avenue, New York, NY 10017
(Address of principal executive office) (Zip Code)
(212) 792-0107
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | | Name of Each Exchange on Which Registered |
| Common Stock, par value $0.01 per share | | NASDAQ Stock Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o Nox
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yeso Nox
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. Yesx Noo
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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o x
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 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 o Non-Accelerated Filer x Smaller Reporting CompanyLarge Accelerated Filer o | Accelerated Filer o | Non-Accelerated Filer o | Smaller Reporting Company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Nox
The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 20082011 was approximately $48.6 million.$58,675,038.
The number of shares of the Registrant’s Common Stockregistrant’s common stock, par value $.01 per share, outstanding on March 20, 20098, 2012 was 9,320,094.13,938,273.
DOCUMENTS INCORPORATED BY REFERENCE
| Document | | Where Incorporated |
| | Part III, Items 10-14 |
| 1. | Portions of the Registrant's Definitive Proxy Statement relating to its 20092012 Annual Meeting of Stockholders scheduled for June 9, 2009May 2012 to be filed with the Securities and Exchange Commission by no later than April 30, 2009.2012. | | Part III, Items 10-14 |
NEW YORK MORTGAGE TRUST, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 20082011
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| Mine Safety Disclosures | 3536 |
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General
In this Annual Report on Form 10-K we refer to New York Mortgage Trust, Inc., together with its consolidated subsidiaries, (“NYMT”,as “we,” “us,” “Company,” or “our,” unless we specifically state otherwise or the “Company”, “we”, “our”context indicates otherwise. We refer to our wholly-owned taxable REIT subsidiaries as “TRSs” and our wholly-owned qualified REIT subsidiaries as “QRSs.” In addition, the following defines certain of the commonly used terms in this report: “RMBS” refers to residential adjustable-rate, hybrid adjustable-rate, fixed-rate, interest only and inverse interest only (collectively “IOs”), and “us”principal only (“POs”) mortgage-backed securities; “Agency RMBS” refers to RMBS representing interests in or obligations backed by pools of mortgage loans issued or guaranteed by a federally chartered corporation (“GSE”), issuch as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. government, such as the Government National Mortgage Association (“Ginnie Mae”); “non-Agency RMBS” refers to RMBS backed by prime jumbo and Alternative A-paper (“Alt-A”) mortgage loans; “ARMs” refers to adjustable-rate residential mortgage loans; “prime ARM loans” refers to prime credit quality residential ARM loans (“prime ARM loans”) held in securitization trusts; and “CMBS” refers to commercial mortgage-backed securities comprised of commercial mortgage pass-through securities, as well as IO or PO securities that represent the right to a self-advisedspecific component of the cash flow from a pool of commercial mortgage loans.
General
We are a real estate investment trust, or REIT, that investsin the business of acquiring, investing in, financing and managing primarily in real estate-related assets, including residential adjustable-rate mortgage-backed securities, which includes collateralized mortgage obligation floating rate securities (“RMBS”), and prime credit quality residential adjustable-rate mortgage (“ARM”) loans (“prime ARM loans”),mortgage-related and, to a lesser extent, in certain alternative real estate-related and financial assets that present greater credit risk and less interest rate risk than our investments in RMBS and prime ARM loans.assets. Our principal business objective is to generate net income for distributionmanage a portfolio of investments that will deliver stable distributions to our stockholders resulting from the spread between the interest and other income we earn on our interest-earning assets and the interest expense we pay on the borrowings that we useover diverse economic conditions. We intend to finance these assets, which we refer to as ourachieve this objective through a combination of net interest margin and net realized capital gains from our investment portfolio. Our portfolio includes investments sourced from distressed markets over the previous two years that create the potential for capital gains as well as more traditional types of mortgage-related investments, such as Agency ARMs and Agency IOs, that generate interest income.
OurWe were formed in 2003 and commenced operations as a vertically integrated mortgage origination and portfolio investment strategy historically has focused on investmentsmanager in RMBS issued or guaranteed by a U.S. government agency (such as the Government National Mortgage Association, or Ginnie Mae), or by a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, or Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac), prime ARM loans, and non-agency RMBS. We refer throughout this Annual Report on Form 10-K to RMBS issued by a U.S. government agency or U.S. Government-sponsored entity as “Agency RMBS”. Starting with2004 upon the completion of our initial public offering in June 2004,offering. Facing increasingly difficult operating conditions, we began building a leveraged investment portfolio comprised largely of RMBS purchased in the open market or through privately negotiated transactions, and prime ARM loans originated by us or purchased from third parties that we securitized and which are held in our securitization trusts. Since exitingelected to exit the mortgage lendingorigination business in 2007 to preserve our capital and focus on March 31, 2007, we have exclusively focused our resources and efforts on investing, on a leveraged basis, in RMBS and, since August 2007, we have employed a portfolio strategy that focuses on investments in Agency RMBS. We refer to our historic investment strategy throughout this Annual Report on Form 10-K as our “principal investment strategy.”
existing mortgage securities portfolio. In January 2008, we formed a strategic relationship withengaged an affiliate of JMP Group, Inc., a full-service investment banking and asset management firm, and certain of its affiliates (collectively, the “JMP Group”), for the purpose of improving our capitalization and diversifying our investment strategy away from a strategy exclusively focused on investments in Agency RMBS, in part to achieve attractive risk-adjusted returns, and to potentially utilize all or part of a $64.0 million net operating loss carry-forward that resulted from our exit from the mortgage lending business in 2007. In connection with this strategic relationship, the JMP Group made a $20.0 million investment in our Series A Cumulative Convertible Redeemable Preferred Stock (the “Series A Preferred Stock)” in January 2008 and purchased approximately $4.5 million of our common stock in a private placement in February, 2008. In addition, in connection with the JMP Group’s strategic investment in us, James J. Fowler, a managing director of HCS (defined below), became our Non-Executive Chairman of the Board of Directors. As of December 31, 2008, JMP Group Inc. and its affiliates beneficially owned approximately 33.7% of our outstanding common stock. The 33.7% includes shares of Series A preferred stock which may be converted into common stock.
In an effort to diversify our investment strategy, we entered into an advisory agreement with Harvest Capital Strategies LLC (“HCS”), formerly knownto serve as our investment advisor for the purpose of helping us increase our capital base and source certain types of alternative investments or nontraditional mortgage related investments that could provide significant net realized capital gains. Concurrent with our entry into this advisory relationship, we sold $20 million of preferred stock to JMP Asset Management LLC, concurrent with the issuanceGroup Inc. and certain affiliates, thereby providing a significant boost to our capital base. Shortly thereafter, we completed a $60 million private placement of our Series A Preferred Stockcommon stock.
Beginning in 2009 and continuing into 2010, we invested in several alternative assets, including a collateralized loan obligation (“CLO”), non-agency RMBS, individual loans and distressed residential single family loans. The CLO investment, which was purchased for approximately $0.20 on the dollar for a total investment of $9.0 million, has, from inception of our investment in these securities to December 31, 2011, contributed over $4.7 million in realized gains to us, $12.5 million in unrealized book value appreciation and has made a significant contribution to our net interest margin. The non-agency RMBS investment was sourced in mid 2009 and mostly sold in 2010 resulting in net realized capital gains of $4.8 million and returning approximately 29.8% on invested capital. In 2010, we invested $19.4 million in a limited partnership that acquired and managed a pool of distressed residential single family loans having an aggregate principal balance of $28.4 million, of which we have disposed of $17.8 million (as of December 31, 2011) for a cumulative net realized capital gain of $1.3 million as of December 31, 2011. We expect to dispose of the remaining portion of this investment in 2012. These investments have contributed significantly to the JMPimprovement in our book value, which has increased from $4.21 at December 31, 2008 to $6.12 at December 31, 2011, as well as an increased annual cash dividend paid to our stockholders.
Since 2009, we have endeavored to build a diversified investment portfolio that includes elements of interest rate and credit risk, as we believe a portfolio diversified among interest rate and credit risks is best suited to delivering stable cash flows over various economic cycles. In 2011, we refined our investment strategy from one focused on a broad range of alternative assets sponsored by HCS to an investment strategy focused on residential and multi-family loans and securities. In connection with this focus, we entered into separate investment management agreements with The Midway Group, pursuantL.P. (“Midway”) and RiverBanc, LLC (“RiverBanc”) to which HCS will implement and manageprovide investment management services with respect to certain of our investment strategies, including our investments in Agency RMBS comprised of IOs, which we sometimes refer to as Agency IOs, and CMBS backed by commercial mortgage loans on multi-family properties, which we refer to as multi-family CMBS with our investment focus having moved away from the alternative real estate-relatedassets sourced by HCS and financial assets. Pursuantan improved capital structure, our Board of Directors determined in December 2011 to terminate the advisory agreement with HCS is responsible for managing investments made by tworesulting in a one-time charge of approximately $2.2 million.
We believe we are well positioned heading into 2012 with seasoned investment managers, a focused residential strategy and an investment pipeline that we expect will produce long-term stable returns over diverse economic conditions. Our targeted assets currently include:
| · | Agency RMBS consisting of adjustable-rate and hybrid adjustable-rate RMBS, which we sometimes refer to as Agency ARMs, and Agency IOs; and |
Subject to maintaining our wholly-owned subsidiaries, Hypotheca Capital, LLC (“HC,”qualification as a REIT, we also formerly known as The New York Mortgage Company, LLC),may opportunistically acquire and New York Mortgage Funding, LLC, as well as any additional subsidiaries acquired or formed in the future to hold investments made on our behalf by HCS. We refer to these subsidiaries in our periodic reports filed with the Securities and Exchange Commission (“SEC”) as the “Managed Subsidiaries.” Due to market conditions andmanage various other factors in 2008, including the significant disruptions in the credit markets, we elected to forgo making investments in alternative real estate-relatedtypes of mortgage-related and financial assets and instead, exclusively focused our resources and efforts on preserving capital and investing in Agency RMBS. However,that we expect to beginbelieve will compensate us appropriately for the diversification of our investment strategy in 2009 by opportunistically investing in certain alternative real estate-related and financial assets, or equity interests therein,risks associated with them, including, without limitation, certain non-Agency RMBS (which may include IOs and other non-ratedPOs), collateralized mortgage assets, commercial mortgage-backed securities,obligations (“CMOs”), residential mortgage loans and certain commercial real estate loans, collateralized loan obligationsestate-related debt investments.
We have elected to be taxed as a REIT and other investments. We refer throughout this Annual Reporthave complied, and intend to continue to comply, with the provisions of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), with respect thereto. Accordingly, we do not expect to be subject to federal income tax on Form 10-Kour REIT taxable income that we currently distribute to our investment in alternative real estate-relatedstockholders if certain asset, income and financial assets, other than Agency RMBS, prime ARM loansownership tests and non-Agency RMBS that is already held in our investment portfolio, as our “alternative investment strategy” and such assets as our “alternative assets.” Generally,recordkeeping requirements are fulfilled. Even if we expect that our investment in alternative assets will be made on a non-levered basis, will be conducted through the Managed Subsidiaries and will be managed by HCS. Currently, we have established for our alternative assets a targeted range of 5% to 10% of our total assets, subject to market conditions, credit requirements and the availability of appropriate market opportunities.
We expect to benefit from the JMP Group’s and HCS’ investment expertise, infrastructure, deal flow, extensive relationships in the financial community and financial and capital structuring skills. Moreover, as a result of the JMP Group’s and HCS’ investment expertise and knowledge of investment opportunities in multiple asset classes, we believe we have preferred access to a unique source of investment opportunities that may be in discounted or distressed positions, many of which may not be available to other companies that we compete with. We intend to be selective in our investments in alternative assets, seeking out co-investment opportunities with the JMP Group where available, conducting substantial due diligence on the alternative assets we seek to acquire and any loans underlying those assets, and limiting our exposure to losses by investing in alternative assets on a non-levered basis. By diversifying our investment strategy, we intend to construct an investment portfolio that, when combined with our current assets, will achieve attractive risk-adjusted returns and that is structured to allow us to maintain our qualification as a REIT, and the requirements for exclusion from regulation under the Investment Company Act of 1940, as amended, or Investment Company Act.
Because we intend to continue to qualify as a REIT for federal income tax purposes and to operate our business so asexpect to be exempt from regulation under the Investment Company Act, we will be requiredsubject to invest a substantial majority ofsome federal, state and local taxes on our assetsincome generated in qualifying real estate assets, such as agency RMBS, mortgage loans and other liens on and interests in real estate. Therefore, the percentage of our assets we may invest in corporate investments and other types of instruments is limited, unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for exclusion from Investment Company Act regulation.TRSs.
The financial information requirements required under this Item 1 may be found in the Company’s auditedour consolidated financial statements beginning on page F-3.F-1 of this Annual Report.
Subsequent EventsRecent Developments
Restructuring of Principal Investment PortfolioInvestments in Multi-Family Loan Securitization Assets
We purchased the majority of the privately placed first loss security from the Freddie Mac Multifamily Loan Securitization Series 2011-K015 (the “K-015 Series”) in November 2011. In addition, we invested in an IO strip off of the K-015 Series. At December 31, 2011, our total investment in these K-015 Series’ assets was approximately $15.1 million. We used a portion of the net proceeds from our underwritten public offering in December 2011 to repay the short-term financing used by us to initially fund a portion of the investment in the K-015 Series. We funded the balance of the purchase price from working capital. The K-015 Series is backed by approximately 91 multi-family properties with mortgages totaling $1.2 billion.
On December 30, 2011, we acquired 100% of the privately placed first loss security from the Freddie Mac Multifamily Loan Securitization Series 2011-K03 (the “K-03 Series”) in the secondary market. We funded 50% of these multi-family CMBS assets on January 4, 2012 and the balance on February 1, 2012. Our total investment to date in the K-03 Series’ assets is approximately $21.7 million, which was funded through a combination of working capital and short-term financing. The K-03 Series is backed by approximately 62 multi-family properties with mortgages totaling $1.1 billion. As of March 5, 2012, our total investment in the multi-family CMBS sector equals approximately $41.2 million, all of which was sourced for us by RiverBanc.
Termination of Advisory Agreement
On December 30, 2011, we entered into a Notice of Termination and Letter Agreement, or Termination Agreement, with HCS pursuant to which we terminated the Amended and Restated Advisory Agreement (the “HCS Advisory Agreement”) between HCS and us effective as of December 31, 2008,2011. Pursuant to the Termination Agreement, we agreed to pay HCS a termination fee equal to approximately $2.2 million, which we recorded as an expense in our principal investment portfolio includedstatement of operations for the year ended December 31, 2011. We expect that the termination of the HCS Advisory Agreement will eliminate approximately $197.7$1.0 million of collateralized mortgage obligation floatinggeneral and administrative expenses in our 2012 fiscal year and thereafter. Pursuant to the terms of the HCS Advisory Agreement, we will continue to pay incentive compensation to HCS with respect to all assets of our company that were managed by HCS at December 31, 2011 (the “Incentive Tail Assets”) until such time as the Incentive Tail Assets are disposed of by us or mature. Prior to termination, at December 31, 2011, HCS managed approximately $34.0 million of assets under the terms of the HCS Advisory Agreement.
Amendment to Midway Management Agreement
On March 9, 2012, we entered into a First Amendment (the “Midway Amendment”) to Investment Management Agreement (as amended, the “Midway Management Agreement”) with Midway pursuant to which we amended the manner in which the incentive fee payable to Midway under the Midway Management Agreement shall be calculated and provide for the payment of equity compensation to Midway. Specifically, the Midway Amendment (i) raises the “high water mark” to 11%, (ii) reduces the incentive fee to 35% of the dollar amount by which adjusted net income (as defined in the Midway Management Agreement) exceeds the hurdle rate, securities issued(iii) reduces the hurdle rate to an annual 12.5% rate of return on invested capital, (iv) provides that the incentive fee will be calculated on a rolling 12-month basis, (v) amends the definition of adjusted net income (to the definition set forth under “―Our External Managers―The Midway Management Agreement”), (vi) provides that, upon mutual agreement of the parties, a portion of each incentive fee payable to Midway under the Midway Management Agreement may be paid in shares of our common stock, and (vii) provides for the grant, on or about the date of the Midway Amendment, of 213,980 shares of restricted stock to Midway that will vest annually in one-third increments beginning on December 31, 2012. Pursuant to the Midway Amendment, which is retroactively effective as of January 1, 2012, the initial term of the Midway Management Agreement will now expire on December 31, 2013.
For a description of the material terms of the Midway Management Agreement (as amended), see “―Our External Managers―The Midway Management Agreement” below.
Our Investment Strategy
We intend to continue our strategy of building a residential portfolio that includes elements of both interest rate and credit risk by focusing our investments on leveraged Agency RMBS, which we expect will include both Agency ARMs and Agency IOs, while also expanding our investments in “credit residential” assets, which we define as multi-family CMBS and other commercial real estate-related debt investments. At the same time we pursue these targeted assets, we will continue to actively manage our existing assets. Prior to deploying capital to any of our targeted asset classes, our management team will consider, among other things, the amount and nature of anticipated cash flows from the asset, our ability to finance or borrow against the asset, the related capital requirements, liquidity, the costs of financing, hedging, and managing the asset, relative value, expected future interest rate volatility and future expected changes to credit spreads.
Our investment strategy does not, subject to our continued compliance with applicable REIT tax requirements and the maintenance of our exemption from the Investment Company Act, limit the amount of our capital that may be invested in any of these investments or in any particular class or type of assets. Thus, our future investments may include asset types different from the targeted or other assets described in this report. The investment and capital allocation decisions of our company and our external managers depend on prevailing market conditions and may change over time in response to opportunities available in different economic and capital market environments. As a result, we cannot predict the percentage of our capital that will be invested in any particular investment at any given time.
For more information regarding our portfolio as of December 31, 2011, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.
Investments in Agency RMBS
We intend to achieve more stable cash flows on our collective investments in Agency RMBS across various market cycles, including, various interest rate, yield curve and prepayment cycles, primarily through investments in both Agency ARMs and Agency IOs. Our Agency ARMs consist of whole pool pass-through certificates, the principal and interest of which are guaranteed by Fannie Mae or Freddie Mac, which we refer to as Agency CMO Floaters. Following a review of our principal investmentare backed by ARMs or hybrid ARMs. Our current portfolio we determined in March 2009 that the Agency CMO Floaters held in our portfolio were no longer producing acceptable returns, and as a result, we decided to initiate a program to dispose of these securities on an opportunistic basis overtime. As of March 25, 2009, the Company had sold approximately $149.8 million in current par value of Agency CMO Floaters under this program resulting in a net gainARMs has interest reset periods generally less than two years and an average seasoning of approximately $0.2 million. As a resultfour years. We believe this amount of these sales and our intent to sellseasoning better protects the remaining Agency CMO Floaters in our principal investment portfolio, we concluded the reduction in value at December 31, 2008 was other-than-temporary and recorded an impairment charge of $4.1 million for the quarter and year ended December 31, 2008.
Our Investment Strategy
The following discusses the investments we have made and that we expect to make in the future:
Our Principal Investment Strategy
Our principal investment strategy has focused on the acquisition of high-credit quality ARM loans and RMBS that we believe are likely to generate attractive long-term risk-adjusted returns on capital invested. In managing our principal investment portfolio, we:
| · | invest in high-credit quality Agency and non-Agency RMBS, including ARM securities CMO Floaters, and high-credit quality mortgage loans; |
| · | finance our portfolio by entering into repurchase agreements, or issuing collateral debt obligations relating to our securitizations; |
| · | generally operate as a long-term portfolio investor; and |
| · | generate earnings from the return on our RMBS and spread income from our securitized mortgage loan portfolio. |
Under this investment strategy, we recently have and will continue to focus on the acquisition of Agency RMBS, taking into consideration the amount and nature of the anticipated returns from the investment, our ability to pledge the investment for secured, collateralized borrowings and the costs associated with obtaining, financing and managing these investments. As noted above, following a review of our principal investment portfolio, we determined in March 2009 that the Agency CMO Floaters held in our portfolio were no longer producing acceptable returns and initiated a program to dispose of these securities on an opportunistic basis; however, we may invest in Agency CMO Floaters in the future should the returns on such securities become attractive.
Targeted Assets Under Our Principal Investment Strategy
Hybrid ARM RMBS Issueddelinquency buyouts by Fannie Mae or Freddie Mac. and provides better overall prepayment behavior profiles.
Agency RMBS consist of Agency pass-through certificates and CMOs issued or guaranteed by an Agency. Pass-through certificates provide for a pass-throughIOs are securities that represent the right to receive the interest portion of the monthly interest and principal payments made by the borrowers on the underlying mortgage loans. CMOs dividecash flow from a pool of mortgage loans into multiple tranches with differentissued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Agency IOs allow us to make a direct investment in borrower prepayment trends in the current market environment. However, Agency IOs also introduce increased risk as these securities have no underlying principal cash flows, which will cause them to underperform in high prepayment environments as future interest payments will be reduced as a direct result of prepayments. Our investments in Agency IOs and interest payment characteristics.related hedging and borrowing activities are managed by Midway, which serves as one of our external managers pursuant to the Midway Management Agreement. We sometimes refer to these investments and related hedging and borrowing activities as our Agency IO strategy. For information regarding Midway’s management of certain of our assets and the Midway Management Agreement, see “―Our External Managers―The Midway Group, L.P.” below.
Since March 31, 2007, we have exclusively focused our resources and effortsIt should be noted that the guarantee provided by the GSEs on the purchase and management of hybrid ARMAgency RMBS issued by either Fannie Maethem does not protect us from prepayment risk. Moreover all of our Agency RMBS are at risk to new or modified government-sponsored homeowner stimulus programs that may induce unpredictable and excessively high prepayment speeds resulting in accelerated premium amortization and reduced net interest margin, both of which could materially adversely affect our business, financial condition and results of operations.
Investments in Multi-Family CMBS and Other Credit Residential Assets
Our investments in credit residential assets has focused on CMBS comprised of the first loss security of multi-family CMBS series that are issued by Freddie Mac, (which has included both pass-through certificatesprimarily in the form of POs. Our investments in the privately placed first loss securities from two separate multi-family CMBS securitizations by Freddie Mac, as described above under “―Recent Developments,” is an example of the multi-family CMBS investments we intend to pursue in 2012 and CMO Floaters). Hybrid ARM RMBSbeyond. Each first loss piece represents approximately 7.5% of the overall securitization which totals approximately $1.0 -$1.2 billion in multi-family residential loans consisting of between 70 – 100 individual properties diversified across a wide geographic footprint. All loans have been underwritten to Freddie Mac underwriting guidelines and standards, however our securities are adjustable rate mortgage assets that have a rate that is fixed for a period of three to ten years initially, before becoming annual or semi-annual adjustable rate mortgages. Because the coupons earned on ARM RMBS adjust over time as interest rates change (typically after an initial fixed-rate period), the market values of these assets are generally less sensitive to changes in interest rates than are fixed-rate RMBS. In addition, the ARMs collateralizing our RMBS typically have interim and lifetime caps on interest rate adjustments.not guaranteed by Freddie Mac.
Fannie Mae guarantees toWe also may invest in other commercial real estate-related debt investments, such as mezzanine loans and preferred equity investments in commercial properties. In the holderevent we do pursue investments of Fannie Mae RMBS that it will distribute amounts representing scheduled principal and interest on the mortgage loansthis type in the pool underlyingfuture, we anticipate focusing on middle market opportunities with investment increments as low as $2 million secured by properties valued at $10 million or greater. We also may participate in structured investments such as the Fannie Mae certificate, whetheracquisition of seasoned or not received,distressed commercial loan portfolios. Our multi-family CMBS and the full principal amount of any such mortgage loan foreclosed or otherwise finally liquidated, whether or not the principal amount is actually received. Freddie Mac guarantees to each holder of certain Freddie Mac certificates the timely payment of interest at the applicable pass-through rate and principal on the holder’s pro rata share of the unpaid principal balance of the related mortgage loans. We prefer Fannie Mae hybrid ARM RMBS due to their shorter remittance cycle; the time between when a borrower makes a payment and the investor receives the net payment. There can be no assurance that the guarantee structure of Fannie Mae and Freddie Mac issued securities will continue in the future.other commercial real estate-related debt assets are managed by our other external investment manager, RiverBanc. For more information regarding RiverBanc, see “―Our External Managers―RiverBanc” below.
Typically, we seek to acquire hybrid ARM RMBS with fixed periods of five years or less. In most cases we are required to pay a premium, a price above the par value, for these assets, which generally is between 101% and 103% of the par value, depending on the pass-through rates of the security, the months remaining before it converts to an ARM, and other considerations.
Our investmentcurrent portfolio also includes prime ARM loans held in securitization trusts. The loans held in securitization trusts, which are loans that primarily were originated by our discontinued mortgage lending business, and to a lesser extent purchased from third parties, that we securitized in 2005 and early 2006.2005. These loans are substantially prime full documentation interest only hybrid ARMs on residential homesproperties and are all are first lien mortgages. The Company maintainsWe maintain the ownership trust certificates, or equity, of these securitizations, which includes rights to excess interest, if any.any, and also take an active role in managing delinquencies and default risk related to the loans.
As of December 31, 2008, our principal investment portfolio was comprised of approximately $477.4 million in RMBS, of which approximately $455.9 million was Agency RMBS and $21.5 million was non-Agency RMBS, and approximately $348.3 million of prime ARM loans held in securitization trusts. Of the non-Agency RMBS held in our portfolio at December 31, 2008, approximately $21.4 million was rated in the highest category by Moody’s Investor Service and Standard & Poor’s (collectively, the “Rating Agencies”).
Our Alternative Investment Strategy
During 2008, our alternative investment strategy was primarily focused on equity investments in unaffiliated third party entities that acquire or manage a portfolio of non-Agency RMBS. As of December 31, 2008, we had yet to make any investments under our alternative investment strategy. Beginning in 2009, our alternative investment strategy will expand the types of assets under investment consideration. The alternative investment strategy will focus on opportunistic investments in certain alternative financial assets, or equity interests therein, including, without limitation, certain non-agency RMBS, commercial mortgage-backed securities, commercial real estate loans, collateralized loan obligations and other investments, that are distressed or can be purchased at a discount and that we believe are likely to generate attractive risk-adjusted returns. Investments in alternative assets will generally expose us to greater credit risk and less interest rate risk than investments in Agency RMBS.
Pursuant to investment guidelines adopted by our Board of Directors in March 2009, each alternative investment must be approved by our Board of Directors. Our alternative investment strategy will vary from our principal investment strategy and we can provide no assurance that we will be successful at implementing this alternative investment strategy or that it will produce positive returns.
Potential Assets Under Our Alternative Investment Strategy
Non-Agency RMBS. The Company may invest in residential non-Agency RMBS, including investment-grade (AAA through BBB rated) and non-investment grade (BB and B rated and unrated) classes. The mortgage loan collateral for residential non-Agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by Fannie Mae, Freddie Mac or Ginnie Mae due to certain factors, including a mortgage balance in excess of Agency underwriting guidelines, borrower characteristics, loan characteristics and insufficient documentation.
Commercial Mortgage-Backed Securities. We may invest in commercial mortgage-backed securities, or CMBS, through the purchase of mortgage pass-through notes. CMBS are secured by, or evidence ownership interests in, a single commercial mortgage loan or a pool of mortgage loans secured by commercial properties. These securities may be senior, subordinated, investment grade or non-investment grade. We expect that most of our CMBS investments will be part of a capital structure or securitization where the rights of the class in which we invest are subordinated to senior classes but senior to the rights of lower rated classes of securities, although we may invest in the lower rated classes of securities if we believe the risk adjusted return is attractive. We generally intend to invest in CMBS that will yield high current interest income and where we consider the return of principal to be likely. We may acquire CMBS from private originators of, or investors in, mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, finance companies, investment banks and other entities.
The yields on CMBS depend on the timely payment of interest and principal due on the underlying mortgage loans and defaults by the borrowers on such loans may ultimately result in defaults on the CMBS. In the event of a default, the trustee for the benefit of the holders of CMBS has recourse only to the underlying pool of mortgage loans and, if a loan is in default, to the mortgaged property securing such mortgage loan. After the trustee has exercised all of the rights of a lender under a defaulted mortgage loan and the related mortgaged property has been liquidated, no further remedy will be available. However, holders of relatively senior classes of CMBS will be protected to a certain degree by the structural features of the securitization transaction within which such CMBS were issued, such as the subordination of the more junior classes of the CMBS.
High Yield Corporate Bonds. We may invest in high yield corporate bonds, which are below investment grade debt obligations of corporations and other nongovernmental entities. We expect that a significant portion of such bonds we may invest in will not be secured by mortgages or liens on assets, and may have an interest-only payment schedule, with the principal amount staying outstanding and at risk until the bond’s maturity. High yield bonds are typically issued by companies with significant financial leverage.
Collateralized Loan Obligations. We may invest in debentures, subordinated debentures or equity interests in a collateralized loan obligation, or CLO. A CLO is secured by, or evidences ownership interests in, a pool of assets that may include RMBS, non-agency RMBS, CMBS, commercial real estate loans or corporate loans. Typically a CLO is collateralized by a diversified group of assets either within a particular asset class or across many asset categories. These securities may be senior, subordinated, investment grade or non-investment grade. We expect the majority of our CLO investments to be part of a capital structure or securitization where the rights of the class in which we will invest to receive principal and interest are subordinated to senior classes but senior to the rights of lower rated classes of securities, although we may invest in the lower rated classes of securities if we believe the risk adjusted return is attractive. The Company would generally make CLO investments on a non-levered basis to reduce liquidity risks as these investments are generally less liquid in nature.
Equity Securities. To a lesser extent, subject to maintaining our qualification as a REIT, we also may invest in common and preferred equity, which may or may not be related to real estate. These investments may include direct purchases of common or preferred equity as well as purchases of interests in LLCs or other equity type investments. We will follow a value-oriented investment approach and focus on the anticipated cash flows generated by the underlying business, discounted by an appropriate rate to reflect both the risk of achieving those cash flows and the alternative uses for the capital to be invested. We will also consider other factors such as the strength of management, the liquidity of the investment, the underlying value of the assets owned by the issuer and prices of similar or comparable securities.
Our Financing Strategy
To finance the RMBS in our principal investment portfolio, we generally seek to borrow between seven and nine times the amount of our equity. At December 31, 2008 our leverage ratio for our RMBS investment portfolio, which we define as our outstanding indebtedness under repurchase agreements divided by sum of total stockholders’ equity and our Series A Preferred Stock, was 6.8 to 1. This definition of the leverage ratio is consistent with the manner in which the credit providers under our repurchase agreements calculate our leverage. The Company also has $44.6 million of subordinated trust preferred securities outstanding and $335.6 million of collateralized debt obligations outstanding, both of which are not dependent on market values of pledged assets or changing credit conditions by our lenders.
We strive to maintain and achieve a balanced and diverse funding mix to finance our principal investment portfolio. Weassets and operations. To achieve this, we rely primarily on a combination of short-term borrowings or repurchase agreements, and collateralized debt obligations (“CDOs”) in orderand long term subordinated debt. The Company's policy for leverage is based on the type of asset, underlying collateral and overall market conditions. Currently, the Company targets an 8 to finance1 maximum leverage ratio for Agency ARMs, a 2 to 1 maximum leverage ratio for Agency IOs and a maximum ratio of 3 to 1 for all other securities. We monitor all at risk or short term borrowings to ensure that we have adequate liquidity to satisfy margin calls and have the ability to respond to other market disruptions.
We primarily rely on repurchase agreements to fund our principal investmentAgency RMBS portfolio. Repurchase agreements provide us with short-term borrowings (typically 30 days) that are secured by the securities in our principal investment portfolio, primarily RMBS. These short-term borrowings bear interest rates that are linked to LIBOR,the London Interbank Offered Rate (“LIBOR”), a short term market interest rate used to determine short term loan rates. Pursuant to these repurchase agreements, the financial institution that serves as a counterparty will generally agree to provide us with financing based on the market value of the securities that we pledge as collateral, less a “haircut.” Our repurchase agreements may require us to deposit additional collateral pursuant to a margin call if the market value of our pledged collateral declines as a result of market conditions or if unscheduleddue to principal paymentsrepayments on the mortgages underlying our pledged securities. Interest rates and haircuts will depend on the underlying collateral pledged. In the case of Agency ARMs, we anticipate targeting a leverage ratio in the range of 6:1 to 8:1, while in the case of Agency IOs, we expect to target a significantly lower leverage ratio of 2:1, provided, however, that in each case, there may be occasional short-term increases or decreases in the amount of leverage used due to significant market events, and we may change our leverage strategy at any time. To calculate our leverage ratio, we divide our outstanding indebtedness under repurchase agreements collateralized by our investment securities increase at a higher than anticipated rate. To reduce the risk that we would be requireddivided by stockholders’ equity.
With respect to sell portions of our portfolio at a loss to meet margin calls,investments in multi-family CMBS and other commercial mortgage debt-related investments, we intend to maintain a balancefinance our investment in these assets through working capital and, subject to market conditions, both short-term and long-term borrowings, such as repurchase agreement borrowings with terms of cashone year or cash equivalent reserves and a balance of unpledged mortgage securities to use as collateral for additional borrowings. As ofless or longer term structured debt financing, preferred equity or any combination thereof.
At December 31, 2008,2011, we had repurchase agreements outstanding with six different counterparties totaling $402.3 million. As of December 31, 2008, we financed approximately $348.3 million offinance our prime ARM loans we holdheld in securitization trusts permanently with approximately $12.7$200.0 million of collateralized debt obligations (“CDOs”) that were issued in securitization transactions we completed in 2005. Finally, due in most cases to market conditions or the characteristics of the underlying collateral, we have primarily financed those assets on our own equity investmentbalance sheet that fall outside of our targeted assets and excluding the prime ARM loans held in the securitization trusts, and the issuance of approximately $335.6 million of CDOs. with available cash from our balance sheet.
We expect to financeFor more information regarding our alternative assets on a non-levered basis with available capital from operations. Seeoutstanding borrowings and debt instruments at December 31, 2011, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations and Financial Condition― Liquidity and Capital Resources” for further discussion on our financing activities.Operations” below.
Our Hedging and Interest Rate Risk Management StrategiesStrategy
A significant risk
We intend to our operations, relating to our portfolio management, is the risk that interest rates on our assets will not adjust at the same times or amounts that rates on our liabilities adjust. Even though we retain and invest in ARM securities, many of the underlying hybrid ARM loans in our principal investment portfolio have initial fixed rates of interest for a period of time ranging from two to five years. Our funding costs are variable and the maturities are short term in nature. We use hedging instruments to reduce our risk associated with changes in interest rates that could affect our principal investment portfolio of prime ARM loans and RMBS. Typically, we utilize interest rate swaps to effectively extend the maturity of our short term borrowings to better match the interest rate sensitivity to the underlying assets being financed. By extending the maturities on our short term borrowings, we attempt to lock in a spread between the interest income generated by the interest earning assets in our principal investment portfolio and the interest expense related to the financing of such assets in order to maintain a net duration gap of less than one year. As we acquire RMBS, we seek to hedge interest rate risk in order to stabilize net asset values and earnings during periods of rising interest rates. To do so, we use hedging instruments in conjunction with our borrowingsinvestment portfolio to reduce or mitigate risks associated with changes in interest rates, mortgage spreads, yield curve shapes and market volatility. These hedging instruments may include interest rate swaps, interest rate futures and options on interest rate futures, mortgage derivatives such as forward-settling purchases and sales of Agency RMBS where the underlying pools of mortgage loans are “To-Be-Announced,” or TBAs, and U.S. Treasuries.
We use interest rate swaps and Euro-dollar futures to hedge interest rate repricing mismatches between certain of our investments and the related borrowings. For example, the interest coupon reset period or our Agency RMBS is typically greater than the repricing period for the related liabilities, which is usually 30 days. We typically would use interest rate swaps or Euro-dollar futures to extend the liability repricing date to more closely approximate the re-pricing characteristicsrelated asset.
We commonly use TBA transactions to hedge interest rate and basis risks associated with our Agency IOs. Pursuant to our TBA transactions, we agree to purchase or sell, for future delivery, Agency RMBS with interest terms and certain types of such assets.underlying collateral, but the particular Agency RMBS to be delivered or received, as applicable, is not identified until shortly before the TBA settlement date. We typically do not take delivery of TBAs but, rather, settle with our trading counterparties on a net basis. By utilizing TBA transactions, we expect to reduce changes in portfolio values due to changes in interest rates. Although TBAs are liquid and have quoted market prices and represent the most actively traded class of RMBS, the use of TBAs exposes us to increased market value risk. We typically conduct TBA and other hedging transactions through one of our TRSs.
In connection with our hedging strategy, we, together with our external managers, utilize a model based risk analysis system to assist in projecting portfolio performances over a variety of different interest rates and market stresses. The model incorporatesscenarios. Such as, shifts in interest rates, changes in prepayments and other factors impacting the valuations of our financial securities, including mortgage-backed securities, repurchase agreements, interest rate swapsassets and interest rate caps.liabilities. However, given the uncertainties related to prepayment uncertainties on our RMBS,rates, it is not possible to definitivelyperfectly lock-in a spread between the earnings asset yield on our principal investment portfolio and the related cost of borrowings. Moreover, the cash flows and market values of certain types of structured Agency RMBS, such as the IOs we invest in, are more sensitive to prepayment risks than other Agency RMBS. Nonetheless, through active management and the use of evaluative stress scenarios, of the portfolio, we believe that we can mitigate a significant amount of both value and earnings volatility.
Our Investment Guidelines
In acquiring assets for our portfolio and subsequently managing those assets, management is required to adhere to the following investment guidelines, unless such guidelines are amended, repealed, modified or waived by our Board of Directors. Pursuant to our investment guidelines, we will focus on investments in securities in the following categories:
| · | Category I investments are mortgage-backed securities that are either rated within one of the two highest rating categories by either Moody’s Investor Services or Standard and Poor’s, or have their repayment guaranteed by Freddie Mac, Fannie Mae or Ginnie Mae; |
| · | Category II investments are all residential mortgage-related securities that do not fall within Category I; and |
| · | Category III investments are all commercial mortgage-backed securities and non-mortgage-related securities, including, without limitation, subordinated debentures or equity interests in a collateralized loan obligation, high yield corporate bonds and equity securities. |
The investment guidelines provide the following investment limitations:
| · | no investment shall be made which would cause us to fail to qualify as a REIT; |
| · | no investment shall be made which would cause us or our subsidiaries to register as an investment company under the Investment Company Act of 1940; |
CertainOur External Managers
The Midway Group, L.P.
A portion of our officers haveAgency RMBS portfolio is externally managed and advised by Midway pursuant to the authorityMidway Management Agreement. Midway was founded in 2000 by Mr. Robert Sherak, a mortgage industry veteran with more than 25 years experience, to approve, withoutserve as investment manager to the needMidway Market Neutral Fund LLC, a private investment fund. Midway has a greater than 10-year history of further authorizationmanaging a hedged portfolio of mortgage-related securities.
Midway is responsible for administering the business activities and day-to-day operations of our Boardinvestments in Agency IOs, which represent the right to receive the interest portion of Directors, the following transactionscash flow from a pool of mortgage loans, issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, and certain derivative instruments. These responsibilities include arranging and coordinating the purchase and sale of various investment assets and the financing and hedging associated with such assets, with direct oversight from our management team. Midway also may invest from time to time anyin, among other things, Agency RMBS consisting of whichpass-through certificates, CMOs, and POs and non-agency RMBS (which may be entered into by us or anyinclude IOs and POs). As part of our subsidiaries:its investment process, we expect that Midway will analyze significant amounts of data regarding the historical performance of mortgage-related securities transactions and collateral over various market cycles.
| · | the purchase and sale of Category I investments, subject to the limitations described above; |
| · | the purchase and sale of agency debt; |
| · | the purchase and sale of U.S. Treasury securities; |
| · | the purchase and sale of overnight investments; |
| · | the purchase and sale of money market funds; |
| · | hedging arrangements using: |
| · interest rate swaps and Eurodollar contracts;
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| · caps, floors and collars;
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| · options on any of the above; and
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| · | the incurrence of indebtedness using: |
| · repurchase agreements; and
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| · term repurchase agreements.
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Until further modified by our Board of Directors, all Category IIMidway has established portfolio management resources for the investment assets described above and Category III investments (regardless of the size of the investment) under our alternativean established infrastructure supporting those resources. We expect that we will benefit from Midway’s highly analytical investment strategy requires the prior approval of our Board of Directors.
Our Relationship with HCS and the Advisory Agreement
HCS, an external advisor to the managed subsidiaries, is a wholly-owned subsidiary of JMP Group Inc. that manages a family of single-strategy and multi-manager hedge fund products. HCS also sponsors and partners with other alternative investment firms. HCS was founded by Joseph Jolson in 1999. As of December 31, 2008, HCS had $443.0 million in client assets under management.
Concurrent and in connection with the issuance of our Series A Preferred Stock on January 18, 2008, we entered into an advisory agreement with HCS pursuant to which HCS advises the Managed Subsidiaries and manages our alternative investment strategy. Currently, any investment in Category II and III investments on behalf of the Managed Subsidiaries by HCS will require board approval and must adhere to investment guidelines adopted by our Board of Directors. HCS earns a base advisory fee of 1.5% of the “equity capital” (as definedprocesses, broad-based deal flow, extensive relationships in the advisory agreement)financial community and operational expertise. Moreover, during its more than ten year history of the Managed Subsidiariesinvesting in this space, we believe Midway has developed strong relationships with a wide range of dealers and is also eligibleother market participants that provide Midway access to earn incentive compensation if the Managed Subsidiaries achieve certain performance thresholds. Asa broad range of December 31, 2008, HCS was not managing any assets in the Managed Subsidiaries, but was earning a base advisory fee on the net proceeds to our Company from our private offerings in each of January 2008trading opportunities and February 2008.
In addition, pursuant to the stock purchase agreement providing for the sale of the Series A Preferred Stock to the JMP Group, James J. Fowler and Steven M. Abreu were appointed to our Board of Directors, with Mr. Fowler being appointed the Non-Executive Chairman of our Board of Directors. Mr. Fowler, who also serves as the non-compensated Chief Investment Officer of HC and New York Mortgage Funding, LLC, is a managing director of HCS, a subsidiary of JMP Group Inc.
On February 21, 2008, we completed the issuance of 7.5 million shares of our common stock in a private placement to certain accredited investors, resulting in $56.5 million in net proceeds to our company. JMP Securities LLC, an affiliate of HCS and the JMP Group, served as the sole placement agent for the transaction and was paid a $3.0 million placement fee from the gross proceeds.market information.
As of December 31, 2008, each2011, we had allocated approximately $39.5 million of HCS, JMP Group Inc.capital to investments managed by Midway.
The Midway Management Agreement
We entered into an investment management agreement with Midway on February 11, 2011, as amended on March 9, 2012. The Midway Management Agreement has a current term that expires on December 31, 2013, and Joseph A. Jolson,will be automatically renewed for successive one-year terms thereafter unless a termination notice is delivered by either party to the Chairmanother party at least six months prior to the end of the then current term. Pursuant to the Midway Management Agreement, Midway implements our Agency IO investment strategy and Chief Executive Officerrelated hedging and borrowing activities and has complete discretion and authority to manage these assets and related hedging and borrowing activities, subject to compliance with the written investment guidelines included in the Midway Management Agreement and the other terms and conditions of JMP Group Inc., beneficially owned approximately 16.8%, 12.2%the Midway Management Agreement, including our authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a REIT and 9.5%, respectively, of our outstanding common stock. In addition, in November 2008 our Board of Directors approved an exemption from the ownership limitations contained in our charter to permit Mr. Jolson to beneficially own up to 25%Investment Company Act. During the initial term of the aggregate valueMidway Management Agreement, Midway has agreed not to establish a separate account with any other publicly-listed residential or commercial mortgage REIT. Midway will provide performance reports to us on a monthly basis with respect to the performance of our outstanding capital stock. As a result these stockholders exert significant influence over us.
Advisory Agreementthe assets under their management.
As described above, on January 18, 2008, we entered into an advisory agreement with HCS. The following is a summarytable summarizes the fees that we pay to Midway pursuant to the Midway Management Agreement. We will reimburse Midway for all transaction costs and expenses incurred in connection with the management and administration of the key economic terms of the advisory agreement:assets and liabilities managed on our behalf by Midway.
| Type | | Description |
Base Advisory Fee
| | A
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| Base management fee | | We pay a base advisorymanagement fee monthly in arrears in a cash amount equal to the product of (i) 1.50% per annum of our invested capital in the “equity capital” of the Managed Subsidiaries is payableassets managed by us to HCS in cash, quarterly in arrears.Equity capital of the Managed Subsidiaries is defined as, for any fiscal quarter, the greater of (i) the net asset value of the investments of the Managed SubsidiariesMidway as of the endlast business day of the fiscal quarter, excluding any investments made priorprevious month, multiplied by (ii) 1/12th.
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Incentive fee | | In addition to the datebase management fee, Midway will be entitled to a quarterly incentive fee (the “Midway Incentive Fee”) that is calculated quarterly and paid in cash in arrears. The Midway Incentive Fee is subject to a high water mark equal to an 11% return on our invested capital in assets managed by Midway (the “High Water Mark”), and shall be payable in an amount equal to the excess, if any, of (i) 35% of the advisory agreement and any assets contributeddollar amount by uswhich adjusted net income (as defined below) attributable to the Managed Subsidiariesassets managed by Midway, on a rolling 12-month basis and before accounting for the purposeMidway Incentive Fee, exceeds an annual 12.5% rate of facilitating compliance with our exclusion from regulation under the Investment Company Act, orreturn on invested capital (the “Hurdle Rate”) over (ii) the sum of $20,000,000 plus 50%the Midway Incentive Fees paid or accrued for each of the three immediately preceding fiscal quarters (or, in the case of the first three quarters of 2012 only, the sum of the Midway Incentive Fees for the one or two immediately preceding quarters commencing January 1, 2012). The return rate for each rolling 12-month period (the “Calculation Period”) shall be determined by dividing (i) the adjusted net proceeds to us orincome for the Calculation Period by (ii) the weighted average of our subsidiaries of any offering of common or preferred stock completedinvested capital in assets managed by usMidway during the termCalculation Period; provided, however, that with respect to the first three quarterly periods commencing on January 1, 2012, adjusted net income will be calculated on the basis of each of the advisory agreement. |
| previously completed quarters on an annualized basis. Incentive Compensation
| | The advisoryFrom time to time in the future and upon mutual agreement calls for incentive compensationof the parties to be paid by us to HCS under certain circumstances. If earned, incentive compensation is paid quarterly in arrears in cash; provided, however, thatthe Midway Management Agreement, a portion of the incentive compensationeach Midway Incentive Fee payable to Midway may be paid in shares of our common stock. The specific terms and conditions for any issuance of our common stock as payment of a portion of any Midway Incentive Fee will be determined and approved by the parties prior to any such issuance.
ForAdjusted net income is defined as net income (loss) calculated in accordance with generally accepted accounting principles in the first three fiscal quarters of each fiscal year, 25% ofUnited States (“GAAP”), including any unrealized gains and losses, after giving effect to certain expenses. All securities managed for us by Midway will be valued in accordance with GAAP.
Unlike the core earnings ofHurdle Rate, which is calculated on a rolling 12 month basis, the Managed Subsidiaries attributableHigh Water Mark is calculated on a calendar 12 month basis, and will reset every 24 months. The High Water Mark will be a static dollar figure that Midway will be required to recoup, to the investments that are managed by HCS that exceedextent there is a hurdle rate equaldeficit in the prior High Water Mark calculation period before it is eligible again to the greater of (i) 2.00% or (ii) 0.50% plus one-fourth of the ten year treasury rate for such quarter. For the fourth fiscal quarter of each fiscal year, the difference between (i) 25% of the GAAP (as defined in Item 7 below) net income of the Managed Subsidiaries attributable to the investments that are managed by HCS that exceedsreceive a hurdle rate equal to the greater of (a) 8.00% and (b) 2.00% plus the ten year treasury rate for such fiscal year, and (ii) the amount of incentive compensation paid for the first three fiscal quarters of such fiscal year.Midway Incentive Fee.
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Termination FeeEquity Compensation
| | IfIn addition to the base management and incentive fees provided for in the Midway Management Agreement, we terminateagreed to issue 213,980 shares of restricted stock to Midway on or about the advisory agreementdate of the Midway Amendment. The restricted shares vest annually in one-third increments beginning on December 31, 2012. In the event Midway terminates the Midway Management Agreement for cause, no termination fee is payable. Otherwise,any reason prior to the end of the restricted period, Midway will forfeit those restricted shares that have not vested at the time of the termination. All of the restricted shares will vest if we terminate the advisory agreement or elect notfor any reason. The restricted shares have voting rights and are entitled to renew it, we will pay a cash termination fee equal to the sum of (i) the average annual base advisory fee and (ii) the average annual incentive compensation earned during the 24-month period immediately preceding the date of termination.
receive dividends. |
Although the assets and invested capital managed by Midway are held in an account that is wholly owned by our company, we may only redeem invested capital in an amount equal to the lesser of 10% of our invested capital managed by Midway or $10 million as of the last calendar day of the month upon not less than 75 days written notice, subject to our authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a REIT and exemption from the Investment Company Act. Pursuant to the terms of the Midway Management Agreement, we are only permitted to make one such redemption request in any 75-day period.
In April 2011, we formed a relationship with RiverBanc, a privately owned investment management and specialty finance company founded by Kevin Donlon, for the purpose of investing in multi-family CMBS, such as Freddie Mac Multifamily Loan Securitization K-Series’ assets, and, to a lesser extent, other commercial real estate-related debt investments, such as mezzanine loans and preferred equity investments in commercial properties. Pursuant to an investment management agreement between RiverBanc and us (the “RiverBanc Management Agreement”), RiverBanc will source, structure and manage our investments in these asset classes.
RiverBanc Management Agreement
The RiverBanc Management Agreement has a term that will expire on April 5, 2013, subject to automatic annual one-year renewals thereafter. Pursuant to the terms of the RiverBanc Management Agreement, RiverBanc will receive a monthly base management fee in arrears in a cash amount equal to the product of (i) 1.50% per annum of our invested capital in one of our wholly-owned subsidiaries, RB Commercial Mortgage LLC (“RBCM”), as of the last business day of the previous month, multiplied by (ii) 1/12th. In addition, RiverBanc will be entitled to an incentive fee that is calculated quarterly and paid in cash in arrears. The incentive fee is based upon the average invested capital in RBCM during the fiscal quarter, subject to a high water mark equal to a 9% return on invested capital, and shall be payable in an amount equal to 35% of the dollar amount by which adjusted net income (as defined in the RiverBanc Management Agreement) attributable to the invested capital in RBCM, on a calendar 12-month basis and before accounting for any incentive fees payable to RiverBanc, exceeds an annual 12% rate of return on invested capital. We may terminate the RiverBanc Management Agreement or elect not to renew the agreement, subject to certain conditions and subject, in certain cases, to paying a termination fee equal to the product of (A) 24 and (B) the monthly base management earned by RiverBanc during the month immediately preceding the month in which the termination occurs.
As part of this transaction, subject to our funding of investments at various thresholds, we are eligible, through one of our TRSs, to receive an ownership interest in RiverBanc of up to 17.5%. As of March 1, 2012, we owned an approximately 7.5% ownership interest in RiverBanc.
Termination of HCS Advisory Agreement
As described above under “―Recent Developments―Termination of Advisory Agreement,” on December 30, 2011, we entered into a Termination Agreement, with HCS pursuant to which we terminated the HCS Advisory Agreement effective as of December 31, 2011. HCS had served as an external advisor to us and certain of our subsidiaries since January 2008 when we concurrently entered into an original advisory agreement with HCS (the “Prior Advisory Agreement”) and sold $20 million of our Series A Preferred Stock to JMP Group Inc. and certain of its affiliates in a private placement. We redeemed the $20 million of our Series A Preferred Stock in full on December 31, 2010.
Pursuant to the advisory agreement,terms of the HCS was paid $0.7 million in management fees for the twelve months endedAdvisory Agreement, we will continue to pay incentive compensation to HCS with respect to all Incentive Tail Assets at December 31, 2008.2011 until such time as the Incentive Tail Assets are disposed of by the Company or mature. Prior to termination, at December 31, 2011, HCS managed approximately $34.0 million of assets under the terms of the HCS Advisory Agreement, which consists mainly of CLOs. Incentive compensation on the Incentive Tail Assets is payable in an amount equal to 25% of the GAAP net income of certain of our subsidiaries that is attributable to the Incentive Tail Assets that exceeds a hurdle rate equal to the greater of (a) 8.00% and (b) 2.00% plus the ten year treasury rate for such fiscal year. The incentive fee is payable in cash, quarterly in arrears.
Pursuant to the terms of the Termination Agreement, HCS has agreed to provide us with transitional consulting services for a period of time upon request. The transitional consulting services will terminate effective upon the earlier of (i) the day immediately prior to our annual stockholders’ meeting in May or June 2012 (the “2012 Annual Meeting”) or (ii) a majority vote of our independent directors to terminate such transitional consulting services. As part of the transitional consulting services to be provided by HCS, James J. Fowler, an employee of HCS and the current Chairman of our Board of Directors, has agreed to continue to serve as a director and our Chairman until the earlier of (a) the 2012 NYMT Annual Meeting, (b) his successor is duly qualified and appointed by our Board of Directors or (c) he determines that his resignation is legally or for regulatory reasons advisable or appropriate under the circumstances. We commenced a search for a director to fill the opening that will be created upon Mr. Fowler’s departure during the first quarter of 2012, but have yet to appoint a successor.
HCS is a wholly-owned subsidiary of JMP Group Inc. As of December 31, 2011, JMP Group Inc. and certain of its affiliates collectively owned approximately 10.3% of our outstanding shares of common stock.
Conflicts of Interest with HCS;Our External Managers; Equitable Allocation of Investment Opportunities; Other Information Regarding the Advisory AgreementOpportunities
HCSEach of Midway and RiverBanc manages, and is expected to continue to manage, other client accounts with similar or overlapping investment strategies. HCSIn connection with the services provided to those accounts, these managers may be compensated more favorably than for the services provided under our external management agreements, and such discrepancies in compensation may affect the level of service provided to us by our external managers. Moreover, each of our external managers may have an economic interest in the accounts they manage or the investments they propose. In addition, we have in the recent past engaged in certain co-investment opportunities with an external manager or one of its affiliates and we may participate in future co-investment opportunities with our external managers or their affiliates. In these cases, it is possible that our interests and the interests of our external managers will not always be aligned and this could result in decisions that are not in the best interests of our company.
Each of Midway and RiverBanc has agreed that, when making investment allocation decisions between us and its other client accounts, it will, in the case of RiverBanc, allocate investments in a fair and equitable manner and, in the case of Midway, seek to make available to the Managed Subsidiaries allallocate investment opportunities thaton an equitable basis and in a manner it determines,believes is in the best interests of its reasonable and good faith judgment, based on their investment objectives, policies and strategies, and other relevant factors, are appropriate for them in accordance with HCS’s written allocation procedures and policies.
accounts. Since manycertain of the Managed Subsidiaries’our targeted investmentsassets are typically available only in specified quantities and since manycertain of theirthese targeted investments mayassets will also be targeted investmentsassets for other HCS accounts HCSmanaged by or associated with our external managers, our external managers may not be able to buy as much of any given investmentcertain assets as required to satisfy the needs of all of its clients’ or associated accounts. In these cases, HCS’swe understand that the allocation procedures and policies of our external managers would typically allocate such investmentsassets to multiple accounts in proportion to, among other things, the objectives, strategy, stage of development or needs of each account. TheMoreover, the investment allocation policies of Midway may permit departure from proportional allocation when the total HCS allocation would result in an inefficiently small amount of the security being purchased for an account. InAlthough we believe that case,each of our external managers will seek to allocate investment opportunities in a manner which it believes to be in the policy allows for a “rotational” protocolbest interests of allocating subsequent investments so that,all accounts involved and will seek to allocate, on an overallequitable basis, each accountinvestment opportunities believed to be appropriate for us and the other accounts it manages or is treated equitably.associated with, there can be no assurance that a particular investment opportunity will be allocated in any particular manner.
We expect that HCS will source substantially all of our investments in alternative assets as advisor to the Managed Subsidiaries. Pursuant to the advisory agreement, HCSMidway is authorized to follow broad investment guidelines in determining which alternative assets the Managed Subsidiariesit will invest in. Currently,Although our Board of Directors will ultimately determine when and how much capital to allocate to assets managed by Midway, we generally will not approve transactions in advance of their execution. As a result, because Midway has great latitude to determine the types of assets it may decide are proper investments for us, there can be no assurance that we would otherwise approve of these investments individually or that they will be successful. RiverBanc, meanwhile has complete discretion and authority to manage assets on our behalf subject to investment guidelines requireapproved by the Board of Directors to approve each investment in alternative assets pursuant to our investment guidelines.Directors. However, as our alternative investment portfolio expands in the future, our Board of Directors may elect to not review individual investmentschange the investment guidelines or grant HCS greater investment discretion.waive them for various investments. In addition to conducting their review of the investments held by our Managed Subsidiaries, our directorsperiodic reviews, we will rely primarily on information provided to themus by HCS and our management. Furthermore, the Managed Subsidiariesexternal managers. Complicating matters further, our external managers may use complex investment strategies and transactions, which may be difficult or impossible to unwind. Although our Board
Pursuant to the terms of Directors must first approvethe Midway Management Agreement, we may only redeem invested capital in an alternative investment opportunity, HCS has great latitude within our Managed Subsidiaries’ broad investment guidelinesamount equal to determine the typeslesser of 10% of the invested capital in assets it will recommendmanaged by Midway or $10 million as of the last calendar day of the month upon not less than 75 days written notice, subject to our Boardauthority to direct Midway to modify its investment strategy for purposes of Directorsmaintaining our qualification as proper investmentsa REIT and exemption from the Investment Company Act, and we are only permitted to make one such redemption request in any 75-day period. In the event of a significant market event or shock, we may be unable to effect a redemption of invested capital in greater amounts or at a greater rate unless we obtain the consent of Midway. Because a reduction of invested capital would reduce the base management fee under the Midway Management Agreement, Midway may be less inclined to consent to such redemptions.
None of our external managers is obligated to dedicate any specific personnel exclusively to us, nor are they or their personnel obligated to dedicate any specific portion of their time to the management of our business. As a result, we cannot provide any assurances regarding the amount of time our external managers will dedicate to the management of our business. Moreover, each of our external managers has significant responsibilities for other investment vehicles and may not always be able to devote sufficient time to the Managed Subsidiaries. Somemanagement of these investment opportunitiesour business. Consequently, we may present a conflictnot receive the level of interest for HCSsupport and Mr. Fowler, particularly in the case of certain co-investment opportunities where affiliates of the JMP Group will be co-investment partners. The investment guidelines do not permit HCS to invest in Agency RMBS, since these investments are madeassistance that we otherwise might receive if such services were provided internally by us.
The advisory agreement does not restrict the ability of HCS or its affiliates from engaging in other business ventures of any nature (including other REITs), whether or not such ventures are competitive with the Managed Subsidiaries’ business so long as HCS’s management of other REITs or funds does not disadvantage us or the Managed Subsidiaries.
HCS may engage other parties, including its affiliates, to provide services to us or our subsidiaries; provided that any such agreements with affiliates of HCS shall be on terms no more favorable to such affiliate than would be obtained from a third party on an arm’s-length basis and, in certain circumstances, approved by a majority of our independent directors. With respect to portfolio management services, any agreements with affiliates shall be subject to our prior written approval and HCS shall remain liable for the performance of such services. With respect to monitoring services, any agreements with affiliates shall be subject to our prior written approval and the base advisory fee payable to HCS shall be reduced by the amount of any fees payable to such other parties, although we will reimburse any out-of-pocket expenses incurred by such other parties that are reimbursable by us.
Pursuant to a Schedule 13D filed with the SEC on February 17, 2009, HCS and JMP Group, Inc., beneficially owned approximately 16.8% and 12.2%, respectively, of our outstanding common stock as of December 31, 2008. In addition, pursuant to a Schedule 13G/A filed with the SEC on December 4, 2008, Joseph A. Jolson, the Chairman and Chief Executive Officer of JMP Group Inc. and HCS, beneficially owned approximately 9.5% of our outstanding common stock. HCS is an investment adviser that manages investments and trading accounts of other persons, including certain accounts affiliated with JMP Group, Inc., and is deemed the beneficial owner of shares of our common stock held by these accounts. As noted above, Mr. Fowler is a managing director of HCS, which is a wholly-owned subsidiary of JMP Group, Inc. As a result of the combined voting power of HCS, JMP Group, Inc. and Joseph A. Jolson, these stockholders exert significant influence over matters submitted to a vote of stockholders, including the election of directors and approval of a change in control or business combination of our company, and strategic direction of our Company. This concentration of ownership may result in decisions affecting us that are not in the best interests of all our stockholders. In addition, Mr. Fowler may have a conflict of interest in situations where the best interests of our company and stockholders do not align with the interests of HCS, JMP Group, Inc. or its affiliates, which may result in decisions that are not in the best interests of all our stockholders.
Company History
We were formed as a Maryland corporation in September 2003. In June 2004, we completed our initial public offering, or IPO, that resulted in approximately $122 million in net proceeds to our company. Prior to the IPO, we did not have recurring business operations. As part of our formation transactions, concurrent with our IPO, we acquired 100% of the equity interests in HC, which at the time was a residential mortgage origination company that historically had sold or brokered all of the mortgage loans it originated to third parties. Effective with the completion of our IPO, we operated two business segments: (i) our mortgage portfolio management segment and (ii) our mortgage lending segment. Under this business model, we would retain and either finance in our portfolio selected adjustable-rate and hybrid mortgage loans that we originated or we would sell them to third parties, while continuing to sell all fixed-rate loans originated by HC to third parties.
Commencing in March 2006, we stopped retaining all loans originated by HC and began to sell these loans to third parties. With the mortgage lending business facing increasingly difficult operating conditions, we began considering strategic alternatives for our business in mid-2006. After an extensive review of the Company’s strategic and financial alternatives, our Board of Directors determined that the sale of substantially all of the assets of our retail and wholesale residential mortgage lending platform was in the best interests our stockholders and company. On February 22, 2007, we completed the sale of our wholesale lending business to Tribeca Lending Corp., a subsidiary of Franklin Credit Management Corporation, for an estimated purchase price of $0.5 million. Shortly thereafter, on March 31, 2007, we completed the sale of substantially all of the operating assets related to the retail mortgage lending platform of HC to Indymac Bank, F.S.B., (“Indymac”), for a purchase price of approximately $13.5 million in cash and the assumption of certain of our liabilities. Since this sale, which effectively marked our exit from the mortgage lending business, we have exclusively focused our resources and efforts on investing, on a leveraged basis, in RMBS.
During 2007, due in part to continued difficult operating conditions and our small market capitalization as compared to our peers, our Board of Directors continued to consider and review our strategic and financial alternatives. In January 2008 we formed a strategic relationship with the JMP Group, whereby HCS became the contractual advisor to the Managed Subsidiaries and the JMP Group purchased 1.0 million shares of our Series A Preferred Stock for an aggregate purchase price of $20.0 million. We formed this relationship with the JMP Group for the purpose of improving our capitalization and diversifying our investment portfolio. The Series A Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. The Series A Preferred Stock is convertible into shares of the Company's common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. The Series A Preferred Stock matures on December 31, 2010, at which time any outstanding shares must be redeemed by the Company at the $20.00 per share liquidation preference. Pursuant to Statement of Financial Accounting Standards (“SFAS”) No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, because of this mandatory redemption feature, the Company classifies these securities as a liability on its balance sheet.
Upon completion of the issuance and sale of the Series A Preferred Stock to the JMP Group on January 18, 2008 and pursuant to the stock purchase agreement providing for the sale of the shares, James J. Fowler and Steven M. Abreu were appointed to our Board of Directors, with Mr. Fowler being appointed the Non-Executive Chairman of our Board of Directors. Mr. Fowler also serves as the Chief Investment Officer of the Managed Subsidiaries. In addition, concurrent with these actions, Steven B. Schnall, Mary Dwyer Pembroke, Jerome F. Sherman and Thomas W. White resigned as members of our Board of Directors.
On February 21, 2008, we completed the issuance and sale of 7.5 million shares of our common stock to certain accredited investors in a private placement at a price of $8.00 per share. This private offering of our common stock generated net proceeds to us of $56.5 million after payment of private placement fees and expenses. In connection with this private offering of our common stock, we entered into a registration rights agreement, pursuant to which we were required to file with the Securities and Exchange Commission, or SEC, a resale shelf registration statement registering for resale the 7.5 million shares sold in the private offering. We filed a resale shelf registration statement on Form S-3 on April 4, 2008, which was declared effective by the SEC on April 18, 2008. We used substantially all of the net proceeds from the January and February 2008 offerings to acquire approximately $712.4 million of Agency RMBS for our principal investment portfolio.
On February 3, 2009, David A. Akre resigned his positions as our Co-Chief Executive Officer and as a member of our Board of Directors. In connection with Mr. Akre’s resignation, Steven R. Mumma, our Co-Chief Executive Officer, President and Chief Financial Officer, was appointed as our Chief Executive Officer, effective immediately. Mr. Mumma also retained his other positions with the Company and will continue to serve as a member of our Board of Directors.
Since June 5, 2008 the Company’s shares of common stock have been listed on the NASDAQ Capital Market (“NASDAQ”) under the symbol “NYMT.” The Company’s common stock was previously listed on the New York Stock Exchange (“NYSE”) from the time of our IPO until September 11, 2007, at which time our common stock was de-listed from the NYSE because our average market capitalization was less than $25 million over a consecutive 30-trading day period. Between September 11, 2007 and June 5, 2008, our common stock was reported on the Over-the-Counter Bulletin Board (“OTCBB”).
In connection with the minimum listing price requirements of NASDAQ, we have completed two separate reverse stock splits on our common stock. In October 2007, we completed a 1-for-5 reverse split of our common stock, and in May 2008, we completed a 1-for-2 reverse split of our common stock. The information in this Annual Report on Form 10-K gives effect to these reverse stock splits as if they occurred at the Company’s inception.
Certain Federal Income Tax Considerations and Our Status as a REIT
We have elected to be taxed as a REIT under Sections 856-860 of the Internal Revenue Code (IRC) of 1986, as amended, for federal income tax purposes, commencing with our taxable year ended December 31, 2004, and we believe that our current and proposed method of operation will enable us to continue to qualify as a REIT for our taxable year endedending December 31, 20082012 and thereafter. We hold our mortgage portfolio investments directly or in a qualified REIT subsidiary, or QRS. Accordingly, the net interest income we earn on theseour assets is generally not subject to federal income tax as long as we distribute at least 90% of our REIT taxable income in the form of a dividend to our stockholders each year and comply with various other requirements. Taxable income generated by HC, our taxable REIT subsidiary, or TRS, isTRSs are subject to regular corporate income tax.
The benefit of REIT tax status is a tax treatment that avoids “double taxation,” or taxation at both the corporate and stockholder levels, that generally applies to distributions by a corporation to its stockholders. Failure to qualify as a REIT would subject our Companyus to federal income tax (including any applicable minimum tax) on itsour taxable income at regular corporate rates and distributions to its stockholders in any such year would not be deductible by our Company.us.
Summary Requirements for Qualification
Organizational Requirements
A REIT is a corporation, trust, or association that meets each of the following requirements:
1) It is managed by one or more trustees or directors.
2) Its beneficial ownership is evidenced by transferable shares, or by transferable certificates of beneficial interest.
3) It would be taxable as a domestic corporation, but for the REIT provisions of the federal income tax laws.
4) It is neither a financial institution nor an insurance company subject to special provisions of the federal income tax laws.
5) At least 100 persons are beneficial owners of its shares or ownership certificates.
6) Not more than 50% in value of its outstanding shares or ownership certificates is owned, directly or indirectly, by five or fewer individuals, which the federal income tax laws define to include certain entities, during the last half of any taxable year.
7) It elects to be a REIT, or has made such election for a previous taxable year, and satisfies all relevant filing and other administrative requirements established by the IRS that must be met to elect and maintain REIT status.
8) It meets certain other qualification tests, described below, regarding the nature of its income and assets.
a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months.
Qualified REIT Subsidiaries. A corporation that is a “qualified REIT subsidiary”QRS is not treated as a corporation separate from its parent REIT. All assets, liabilities, and items of income, deduction, and credit of a “qualified REIT subsidiary” are treated as assets, liabilities, and items of income, deduction, and credit of the REIT. A “qualified REIT subsidiary” is a corporation, all of the capital stock of which is owned by the REIT. Thus, in applying the requirements described herein, any “qualified REIT subsidiary” that we own will be ignored, and all assets, liabilities, and items of income, deduction, and credit of such subsidiary will be treated as our assets, liabilities, and items of income, deduction, and credit.
Taxable REIT Subsidiaries. A REIT is permitted to own up to 100% of the stock of one or more “taxable REIT subsidiaries,” or TRSs. A TRS is a fully taxable corporation that may earn income that would not be qualifying income if earned directly by the parent REIT. Overall, no more than 25% (20% for taxable years prior to 2009) of the value of a REIT’s assets may consist of stock or securities of one or more TRSs.
A TRS will pay income tax at regular corporate rates on any income that it earns. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to assure that the TRS is subject to an appropriate level of corporate taxation. We have elected for HCeach of Hypotheca Capital, LLC and New York Mortgage Funding, LLC to be treated as a TRS. HC isTRSs. Our TRSs are subject to corporate income tax on itstheir taxable income.
Qualified REIT Assets
. On the last day of each calendar quarter, at least 75% of the value of our assets (which includes any assets held through a qualified REIT subsidiary)QRS must consist of qualified REIT assets — primarily real estate, mortgage loans secured by real estate, and certain mortgage-backed securities (“Qualified REIT Assets”), government securities, cash, and cash items. We believe that substantially all of our assets are and will continue to be Qualified REIT Assets. On the last day of each calendar quarter, of the assets not included in the foregoing 75% asset test, the value of securities that we hold issued by any one issuer may not exceed 5% in value of our total assets and we may not own more than 10% of the voting power or value of any one issuer’s outstanding securities (with an exception for securities of a qualified REIT subsidiaryQRS or of a taxable REIT subsidiary)TRS). In addition, the aggregate value of our securities in taxable REIT subsidiariesTRSs cannot exceed 25% of our total assets. We monitor the purchase and holding of our assets for purposes of the above asset tests and seek to manage our portfolio to comply at all times with such tests.
We may from time to time hold, through one or more taxable REIT subsidiaries,TRSs, assets that, if we held them directly, could generate income that would have an adverse effect on our qualification as a REIT or on certain classes of our stockholders.
Gross Income Tests
We must meet the following separate income-based tests each year:
1. The 75% Test. At least 75% of our gross income for the taxable year must be derived from Qualified REIT Assets. Such income includes interest (other than interest based in whole or in part on the income or profits of any person) on obligations secured by mortgages on real property, rents from real property, gain from the sale of Qualified REIT Assets, and qualified temporary investment income or interests in real property. The investments that we have made and intend to continue to make will give rise primarily to mortgage interest qualifying under the 75% income test.
2. The 95% Test. At least 95% of our gross income for the taxable year must be derived from the sources that are qualifying for purposes of the 75% test, and from dividends, interest or gains from the sale or disposition of stock or other assets that are not dealer property.
Distributions
We must distribute to our stockholders on a pro rata basis each year an amount equal to at least (i) 90% of our taxable income before deduction of dividends paid and excluding net capital gain, plus (ii) 90% of the excess of the net income from foreclosure property over the tax imposed on such income by the Internal Revenue Code, less (iii) any “excess non-cash income.” We have made and intend to continue to make distributions to our stockholders in sufficient amounts to meet the distribution requirement for REIT qualification.
Investment Company Act Exemption
We operate our business so as to be exempt from registration under the Investment Company Act. We rely on the exemption provided by Section 3(c)(5)(C) of the Investment Company Act. We monitor our portfolio periodically and prior to each investment to confirm that we continue to qualify for the exemption. To qualify for the exemption, we make investments so that at least 55% of the assets we own consist of qualifying mortgages and other liens on and interests in real estate, which are collectively referred to as “qualifying real estate assets,” and so that at least 80% of the assets we own consist of real estate-related assets (including our qualifying real estate assets, both as measured on an unconsolidated basis). We generally expect that our investments will be considered either qualifying real estate assets or real estate-related assets under Section 3(c)(5)(C) of the Investment Company Act. Qualification for the Section 3(c)(5)(C) exemption may limit our ability to make certain investments. In addition, we must ensure that each of our subsidiaries qualifies for the Section 3(c)(5)(C) exemption or another exemption available under the Investment Company Act.
Competition
Our success depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. When we invest in mortgage-backed securities, mortgage loans and other investment assets, we compete with a variety of institutional investors, including other REITs, insurance companies, mutual funds, hedge funds, pension funds, investment banking firms, banks and other financial institutions that invest in the same types of assets. Many of these investors have greater financial resources and access to lower costs of capital than we do. The existence of these competitive entities, as well as the possibility of additional entities forming in the future, may increase the competition for the available supply of mortgagedo..
Corporate Offices and other investment assets suitable for purchase, resulting in higher prices and lower yields on assets.
Personnel
As of December 31, 2008 we employed six people.
Corporate Office
We were formed as a Maryland corporation in 2003. Our corporate headquarters are located at 52 Vanderbilt Avenue, Suite 403, New York, New York, 10017 and our telephone number is (212) 792-0107. As of December 31, 2011, we employed three full-time employees.
Access to our Periodic SEC Reports and Other Corporate Information
Our internet website address is www.nymtrust.com.www.nymtrust.com. We make available free of charge, through our internet website, our annual report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments thereto that we file or furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Corporate Governance Guidelines and Code of Business Conduct and Ethics and the charters of our Audit, Compensation and Nominating and Corporate Governance Committees are also available on our website and are available in print to any stockholder upon request in writing to New York Mortgage Trust, Inc., c/o Secretary, 52 Vanderbilt Avenue, Suite 403, New York, New York, 10017. Information on our website is neither part of nor incorporated into this Annual Report on Form 10-K.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
ThisWhen used in this Annual Report on Form 10-K, contains certain forward-looking statements. Forward lookingin future filings with the SEC or in press releases or other written or oral communications, statements are those which are not historical in nature, and can often be identified by their inclusion ofincluding those containing words such as “will,“believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “expect,“would,” “believe,“could,” “intend”“goal,” “objective,” “will,” “may” or similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and similar expressions. Any projectionSection 21E of revenues, earnings or losses, capital expenditures, distributions, capital structure or other financial terms is a forward-looking statement. Certain statements regarding the following particularly are forward-looking in nature:
| · | future performance, developments, market forecasts or projected dividends; |
| · | projected acquisitions or joint ventures; and |
| · | projected capital expenditures. |
It is important to note that the descriptionSecurities Exchange Act of our business is general1934, as amended, and, our investment in real estate-relatedas such, may involve known and certain alternative assets in particular, is a statement about our operations as of a specific point in timeunknown risks, uncertainties and is not meant to be construed as an investment policy. The types of assets we hold, the amount of leverage we use or the liabilities we incur and other characteristics of our assets and liabilities disclosed in this report as of a specified period of time are subject to reevaluation and change without notice.assumptions.
Our forward-lookingForward-looking statements are based uponon our management's beliefs, assumptions and expectations of our future operations and economic performance, taking into account theall information currently available to us. Forward-looking statements involveThese beliefs, assumptions and expectations are subject to risks and uncertainties someand can change as a result of many possible events or factors, not all of which are not currently known to usus. If a change occurs, our business, financial condition, liquidity and manyresults of whichoperations may vary materially from those expressed in our forward-looking statements. The following factors are beyond our control andexamples of those that mightcould cause our actual results performance or financial condition to be materially differentvary from our forward-looking statements: changes in interest rates and the expectationsmarket value of future results, performance or financial condition we express or imply in any forward-looking statements. Someour securities; the impact of the importantdowngrade of the long-term credit ratings of the U.S., Fannie Mae, Freddie Mac, and Ginnie Mae; market volatility; changes in the prepayment rates on the mortgage loans underlying our investment securities; increased rates of default and/or decreased recovery rates on our assets; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for federal tax purposes; our ability to maintain our exemption from registration under the Investment Company Act; and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, thatincluding the risk factors described in Item 1A of this Annual Report on Form 10-K, could cause our actual results performance or financial condition to differ materially from expectations are:
| · | our portfolio strategy and operating strategy may be changed or modified by our management without advance noticethose projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which 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, you or stockholder approval and we may suffer losses as a result of such modifications or changes; |
| · | market changes in the terms and availability of repurchase agreements used to finance our investment portfolio activities; |
| · | reduced demand for our securities in the mortgage securitization and secondary markets; |
| · | interest rate mismatches between our interest-earning assets and our borrowings used to fund such purchases;
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| · | changes in interest rates and mortgage prepayment rates; |
| · | changes in the financial markets and economy generally, including the continued or accelerated deterioration of the U.S. economy;
|
| · | effects of interest rate caps on our adjustable-rate mortgage-backed securities; |
| · | the degree to which our hedging strategies may or may not protect us from interest rate volatility; |
| · | potential impacts of our leveraging policies on our net income and cash available for distribution; |
| · | our board's ability to change our operating policies and strategies without notice to you or stockholder approval; |
| · | our ability to successfully implement and grow our alternative investment strategy and to identify suitable alternative assets;
|
| · | our ability to manage, minimize or eliminate liabilities stemming from the discontinued operations including, among other things, litigation, repurchase obligations on the sales of mortgage loans and property leases; |
| | actions taken by the U.S. and foreign governments, central banks and other governmental and regulatory bodies for the purpose of stabilizing the financial credit and housing markets, and economy generally, including loan modification programs; |
| | changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac; and |
| · | the other important factors identified, or incorporated by reference into this report, including, but not limited to those under the captions “Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures about Market Risk”, and those described in Part I, Item 1A – “Risk Factors,” and the various other factors identified in any other documents filed by us with the SEC. |
We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the events described by our forward-looking events might not occur. We qualify any and all of our forward-looking statements by these cautionary factors. In addition, you should carefully review the risk factors described in other documents we file from time to time with the SEC.
Set forth below are the risks that we believe are material to stockholders. You should carefully consider the following risk factors and the various other factors identified in or incorporated by reference into any other documents filed by us with the SEC in evaluating our company and our business. The risks discussed herein can adversely affect our business, liquidity, operating results, prospects, and financial condition. This could cause the market price of our securities to decline. The risk factors described below are not the only risks that may affect us. Additional risks and uncertainties not presently known to us also may adversely affect our business, liquidity, operating results, prospects, and financial condition.
Risks Related to Our Business and Our Company
Interest rate mismatches between the interest-earning assets held in our investment portfolio particularly RMBS, and the borrowings used to fund the purchases of those assets may reduce our net income or result in a loss during periods of changing interest rates.
Certain of the RMBSassets held in our investment portfolio, particularly RMBS, have a fixed coupon rate, generally for a significant period, and in some cases, for the average maturity of the asset. At the same time, our repurchase agreements and other borrowings typically provide for a payment reset period of 30 days or less. In addition, the average maturity of our borrowings generally will be shorter than the average maturity of the RMBS currently in our portfolio and shorter than the RMBS and certain other targeted assets in which we seek to invest. Historically, we have used swap agreements as a means for attempting to fix the cost of certain of our liabilities over a period of time; however, these agreements will generally not be sufficient to match the cost of all our liabilities against all of our investment securities. In the event we experience unexpectedly high or low prepayment rates on our RMBS or other mortgage-related securities or loans, our strategy for matching our assets with our liabilities is more likely to be unsuccessful.unsuccessful which may result in reduced earnings or losses and reduced cash available for distribution to our stockholders.
In addition, the RMBS we invest in may be backed by ARMs that are subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase over the life of the security. Our borrowings typically are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while interest rate caps could limit the interest rates on RMBS in our portfolio that are backed by ARMs. This problem is magnified for RMBS backed by ARMs and hybrid ARMs that are not fully indexed. Further, some RMBS backed by ARMs and hybrid ARMs may be subject to periodic payment caps that result in a portion of the interest being deferred and added to the principal outstanding. As a result, the payments we receive on RMBS backed by ARMs and hybrid ARMs may be lower than the related debt service costs. These factors could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Interest rate fluctuations will also cause variances in the yield curve, which may reduce our net income. The relationship between short-term and longer-term interest rates is often referred to as the “yield curve.” If short-term interest rates rise disproportionately relative to longer-term interest rates (a flattening of the yield curve), our borrowing costs may increase more rapidly than the interest income earned on the RMBS and other interest-earning assets in our investment portfolio. BecauseFor example, because the RMBS in our investment portfolio typically bear interest based on longer-term rates while our borrowings typically bear interest based on short-term rates, a flattening of the yield curve would tend to decrease our net income and the market value of these securities. Additionally, to the extent cash flows from investments that return scheduled and unscheduled principal are reinvested, the spread between the yields of the new investments and available borrowing rates may decline, which would likely decrease our net income. It is also possible that short-term interest rates may exceed longer-term interest rates (a yield curve inversion), in which event our borrowing costs may exceed our interest income and we could incur significant operating losses. A flat or inverted yield curve may also result in an adverse environment for adjustable-rate RMBS volume, as there may be little incentive for borrowers to choose the underlying mortgage loans over a longer-term fixed-rate loan. If the supply of adjustable-rate RMBS decreases, yields may decline due to market forces.
Declines in the market values of assets in our investment portfolio may adversely affect periodic reported results and credit availability, which may reduce earnings and, in turn, cash available for distribution to our stockholders.
The market value of the interest-bearing assets in which we invest, most notably RMBS and purchased prime ARM loans and any related hedging instruments, may move inversely with changes in interest rates. We anticipate that increases in interest rates will generally tend to decrease our net income and the market value of our interest-bearing assets. Substantially allA significant percentage of the RMBSsecurities within our investment portfolio isare classified for accounting purposes either as “trading securities” or as “available for sale.” Changes in the market values of trading securities will be reflected in earnings and changes in the market values of available for sale securities, such as CLOs, will be reflected in stockholders’ equity. As a result, a decline in market values of certain of our investment securities may reduce the book value of our assets. Moreover, if the decline in market value of an available for sale security is other than temporary, such decline will reduce earnings.
A decline in the market value of our RMBS and other interest-bearing assets such as the decline we experienced during the market disruption in March 2008, may adversely affect us, particularly in instances where we have borrowed money based on the market value of those assets. If the market value of those assets declines, the lender may require us to post additional collateral to support the loan, which would reduce our liquidity and limit our ability to leverage our assets.
In March 2008, due in part to decreases in the market value of certain of the RMBS held in our portfolio caused by the March 2008 market disruption and the related increase in collateral requirements by our lenders, we elected to improve our liquidity position by selling an aggregate of approximately $598.9 million of Agency RMBS, resulting in a net loss in earnings during that quarter. Similar to March 2008,addition, if we are, or anticipate being, unable to post the additional collateral, we would have to sell the assets at a time when we might not otherwise choose to do so. In the event that we do not have sufficient liquidity to meet such requirements, lending institutions may accelerate indebtedness, increase interest rates and terminate our ability to borrow, any of which could result in a rapid deterioration of our financial condition and cash available for distribution to our stockholders. Moreover, if we liquidate the assets at prices lower than the amortized cost of such assets, we will incur losses.
We may change our investment strategy, operating policies and/or asset allocations without stockholder consent, any of which could result in losses.
We may change our investment strategy, operating policies and/or asset allocation with respect to investments, acquisitions, leverage, growth, operations, indebtedness, capitalization and distributions at any time without the consentMarket values of our stockholders, whichinvestments may resultalso decline without any general increase in riskier investments. Althoughinterest rates for a number of reasons, such as increases in defaults, actual or perceived increases in voluntary prepayments for those investments that we have most recently employed a portfolio strategy that focuses on investments in Agency RMBS, we expectare subject to commence investments under our alternative investment strategy in 2009. In connection with a $20.0 million preferred equity investment in our company by JMP Group, Inc.prepayment risk, and certainwidening of its affiliates in January 2008, we entered into an advisory agreement with HCS, pursuant to which HCS will manage any alternative investment strategy conducted throughcredit spreads. If the Managed Subsidiaries during the term of the advisory agreement. Since entering into the advisory agreement, we have explored and will continue to consider alternative investments, including those outsidemarket values of our targeted asset class, that we believe will be accretiveinvestments were to earnings and may allow us to utilize all or a portion of an approximately $64.0 million net operating loss carry-forward. Such alternative investments may include, without limitation, lower rated non-Agency RMBS, CMBS and corporate CLO securities as well as equity participations in funds or companies that invest in similar type assets. A change in our investment strategy may increase our exposure to interest rate and/or credit risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from our historical investments and in which we have limited or no investment experience. These changes could result in a decline in earnings or losses which could adversely affect our financial condition, results of operations, the market price of our common stock or our ability to pay dividends.
Continued adverse developments in the residential mortgage market, and the economy generally, may adversely affect our business, particularly our ability to acquire Agency RMBS andfor any reason, the value of the Agency RMBS that we hold in our portfolio as well as our ability to finance or sell our Agency RMBS.
In recent years, the residential mortgage market in the United States has experienced a variety of difficulties and changed economic conditions, including declining home values, heightened defaults, credit losses and liquidity concerns. Over the past year, news of potential and actual security liquidations has increased the volatility of many financial assets, including Agency RMBS and other high-quality residential MBS assets. These recent disruptions have materially adversely affected the performance and market value of the RMBS in our portfolio and prime ARM loans held in securitization trusts, as well as other interest-earning assets that we may consider acquiring in the future. Securities backed by residential mortgage loans originated in 2006 and 2007 have had higher and earlier than expected rates of delinquencies. In addition, the U.S. economy is presently mired in a recession, with housing prices that continue to fall in many areas around the country while unemployment rates continue to rise, further increasing the risk for higher delinquency rates. Many RMBS and other interest-earning assets have been downgraded by rating agencies in recent years, and rating agencies may further downgrade these securities in the future. Lenders have imposed additional and more stringent equity requirements necessary to finance these assets and frequent impairments based on mark-to-market valuations have generated substantial collateral calls in the industry. As a result of these difficulties and changed economic conditions, many companies operating in the mortgage specialty finance sectors have failed and others, including Fannie Mae and Freddie Mac, are facing serious operating and financial challenges. While the U.S. Federal Reserve has taken certain actions in an effort to ameliorate the current market conditions, and the U.S. Treasury and the Federal Housing Finance Agency, or FHFA, which is the federal regulator now assigned to oversee Fannie Mae and Freddie Mac, areyour investment could also taking actions, these efforts may be ineffective. As a result of these factors, among others, the market for these securities may be adversely affected for a significant period of time.decline.
During the past year, housing prices and appraisal values in many states have declined or stopped appreciating, after extended periods of significant appreciation. A continued decline or an extended flattening of those values may result in additional increases in delinquencies and losses on residential mortgage loans generally, particularly with respect to second homes and investor properties and with respect to any residential mortgage loans, the aggregate loan amounts of which (including any subordinate liens) are close to or greater than the related property values.
Fannie Mae and Freddie Mac guarantee the payments of principal and interest on the Agency RMBS in our portfolio even if the borrowers of the underlying mortgage loans default on their payments. However, rising delinquencies and market perception can still negatively affect the value of our Agency RMBS or create market uncertainty about their true value. While the market disruptions have been most pronounced in the non-Agency RMBS market, the impact has extended to Agency RMBS. During a significant portion of 2008, the value of Agency RMBS were unstable and relatively illiquid compared to prior periods.
Agency RMBS guaranteed by Fannie Mae and Freddie Mac are not supported by the full faith and credit of the United States. Fannie Mae and Freddie Mac have suffered significant losses and on September 6, 2008, FHFA placed Fannie Mae and Freddie Mac into conservatorship. Despite these steps, Fannie Mae and Freddie Mac could default on their guarantee obligations which would materially and adversely affect the value of our Agency RMBS or other Agency indebtedness in which we may invest in the future.
We generally post our Agency RMBS as collateral for our borrowings under repurchase agreements. Any decline in their value, or perceived market uncertainty about their value, would make it more difficult for us to obtain financing on favorable terms or at all, or to maintain our compliance with the terms of any financing arrangements. The value of Agency RMBS may decline for several reasons, including, for example, rising delinquencies and defaults, increases in interest rates, falling home prices and credit uncertainty at Fannie Mae or Freddie Mac. In addition, since early 2008, repurchase lenders have been requiring higher levels of collateral to support loans collateralized by Agency RMBS than they have in the past, making borrowings more difficult and expensive. At the same time, market uncertainty about residential mortgage loans in general could continue to depress the market for Agency RMBS, which means that it may be more difficult for us to sell Agency RMBS on favorable terms or at all. Further, a decline in the value of Agency RMBS could subject us to margin calls, for which we may have insufficient liquidity to support, resulting in forced sales of our assets at inopportune times. If market conditions result in a decline in available purchasers of Agency RMBS or the value of our Agency RMBS, our financial position and results of operations could be adversely affected.
The conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. government, may adversely affect our business.
The payments we expect to receive on the Agency RMBS we hold in our portfolio and in which we invest depend upon a steady stream of payments on the mortgages underlying the securities and are guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae is part of a U.S. government agency and its guarantees are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are U.S. government-sponsored enterprises, but their guarantees are not backed by the full faith and credit of the United States.
Since 2007, Fannie Mae and Freddie Mac have reported substantial losses and a need for substantial amounts of additional capital. In response to the deteriorating financial condition of Fannie Mae and Freddie Mac and the recent credit market disruption, Congress and the U.S. Treasury undertook a series of actions to stabilize these government-sponsored entities and the financial markets, generally, including placing Fannie Mae and Freddie Mac into conservatorship on September 7, 2008. The conservatorship of Fannie Mae and Freddie Mac and certain other actions taken by the U.S. Treasury and U.S. Federal Reserve were designed to boost investor confidence in Fannie Mae’s and Freddie Mac’s debt and mortgage-backed securities. The U.S. government program includes contracts between the U.S. Treasury and each government-sponsored enterprise to seek to ensure that each enterprise maintains a positive net worth. Each contract has a capacity of $100 billion and provides for the provision of cash by the U.S. Treasury to the government-sponsored enterprise if FHFA determines that its liabilities exceed its assets. Each of Fannie Mae and Freddie Mac has already requested or expects to request significant funds from these facilities. It is possible that each of Freddie Mac and Fannie Mae may seek and require amounts in excess of the $100 billion capacity and such amounts may be unavailable. In addition to these contracts between the U.S. Treasury and each of Fannie Mae and Freddie Mac that provide for an infusion of capital, the U.S. Treasury has established a secured credit facility for these entities and initiated a temporary program to purchase Agency RMBS issued by Fannie Mae and Freddie Mac. Although the U.S. government has described some specific steps and reforms that it intends to take as part of the conservatorship process, Fannie Mae and Freddie Mac have continued to incur losses and efforts to stabilize these entities may not be successful and the outcome and impact of these events remain highly uncertain.
Although the U.S. government has committed capital to Fannie Mae and Freddie Mac, there can be no assurance that the credit facilities and other capital infusions will be adequate for their needs. If the financial support is inadequate, these companies could continue to suffer losses and could fail to honor their guarantees and other obligations. Since Fannie Mae and Freddie Mac were placed in conservatorship, then-current U.S. Treasury Secretary Paulson began urging Congress to re-examine the fundamental structure of Fannie Mae and Freddie Mac. Mr. Paulson later commented that allowing the two companies to return to their previous operating approach was not a viable option. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantees could be considerably limited relative to historical measurements. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac could redefine what constitutes Agency RMBS and could have broad adverse implications for the market and for our business.
Recently, Federal Reserve indicated that it will purchase up to an additional $750 billion of Agency RMBS, bringing its total purchase commitments to $1.25 trillion. The U.S. Treasury also implemented a temporary program to purchase RMBS. Purchases under the U.S. Treasury’s program began in September 2008 and the Federal Reserve’s program in January 2009, but there is no certainty that the U.S. Treasury or the Federal Reserve will continue to purchase additional Agency RMBS in the future. Each of the U.S. Treasury and the Federal Reserve may hold its portfolio of Agency RMBS to maturity, and, based on mortgage market conditions, may make adjustments to the portfolio. This flexibility may adversely affect the pricing and availability for our target assets. It is also possible that the U.S. Treasury’s commitment to purchase Agency RMBS in the future could create additional demand that would increase the pricing of Agency RMBS held in our portfolio and in which we invest.
The U.S. Treasury could also stop providing credit support to Fannie Mae and Freddie Mac in the future. The U.S. Congress granted the U.S. Treasury authority to purchase RMBS and to provide financial support to Fannie Mae and Freddie Mac in The Housing and Economic Recovery Act of 2008. This authority expires on December 31, 2009. The problems faced by Fannie Mae and Freddie Mac resulting in their being placed into conservatorship have stirred debate among some federal policy makers regarding the continued role of the U.S. government in providing liquidity for mortgage loans. Following expiration of the current authorization, each of Fannie Mae and Freddie Mac could be dissolved and the U.S. government could determine to stop providing liquidity support of any kind to the mortgage market. If Fannie Mae or Freddie Mac were eliminated, we would not be able, or if their structures were to change radically, we might not be able, to acquire Agency RMBS from these companies, which would adversely affect our current business model.
Our income also could be negatively affected in a number of ways depending on the manner in which related events unfold. For example, the current credit support provided by the U.S. Treasury to Fannie Mae and Freddie Mac, and any additional credit support it may provide in the future, could have the effect of lowering the interest rates we expect to receive from the Agency RMBS in our portfolio and in which we invest, thereby tightening the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio. A reduction in the supply of Agency RMBS could also negatively affect the pricing of the Agency RMBS held in our portfolio and in which we invest by reducing the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio.
As indicated above, recent legislation has changed the relationship between Fannie Mae and Freddie Mac and the U.S. government. Future legislation could further change the relationship between Fannie Mae and Freddie Mac and the U.S. government, and could also nationalize or eliminate such entities entirely. Any law affecting these government-sponsored enterprises may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on investments in Fannie Mae and/or Freddie Mac Agency RMBS. It also is possible that such laws could adversely impact the market for such securities and spreads at which they trade. All of the foregoing could materially adversely affect our business, operations and financial condition.
There can be no assurance that the actions taken by the U.S. and foreign governments, central banks and other governmental and regulatory bodies for the purpose of seeking to stabilize the financial markets will achieve the intended effect or benefit our business, and further government or market developments could adversely affect us.
In response to the financial issues affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, EESA was enacted by the U.S. Congress. EESA provides the Secretary of the U.S. Treasury with the authority to establish TARP to purchase from financial institutions up to $700 billion of residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008. In addition, under TARP, the U.S. Treasury, after consultation with the Chairman of the Board of Governors of the U.S. Federal Reserve, may purchase any other financial instrument deemed necessary to promote financial market stability, upon transmittal of such determination, in writing, to the appropriate committees of the U.S. Congress. EESA also provides for a program that would allow companies to insure their troubled assets.
The U.S. Treasury used the first $350 billion available under TARP to make preferred equity investments in certain financial institutions rather than purchase illiquid mortgage-related assets held by these financial institutions. On February 10 ,2009, the Secretary of the U.S. Treasury announced the U.S. government’s plan for the remaining balance of funds available under TARP, which includes a capital assistance program for banking institutions, a public-private investment fund that is expected to purchase certain illiquid mortgage-related assets, a consumer and business lending initiative that will improve the flow of credit to businesses and consumers, and a commitment to the continued purchase of RMBS issued by GSEs. On February 18, 2009, the President of the United States announced a plan designed to reverse the trend of increasing home foreclosures, which will be funded under TARP. The U.S. government has indicated that the new plan will involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment terms of the loans, an amendment of the bankruptcy laws to permit the modification of mortgage loans in bankruptcy proceedings, and an additional $200 billion capital infusion to Fannie Mae and Freddie Mac to improve credit availability for residential mortgages. However, the U.S. government has provided few specific details regarding this new foreclosure mitigation plan. On March 23, 2009, the U.S. Treasury announced the creation of a public-private investment program designed to attract private capital to purchase eligible legacy loans from participating banks and eligible legacy securities in the secondary market through FDIC debt guarantees, equity co-investment by the U.S. Treasury and government-supported term asset-backed loan facilities as applicable. It remains unclear whether this initiative will achieve its intended effects.
On November 25, 2008, the U.S. Federal Reserve announced that it would initiate a program to purchase $500 billion in Agency RMBS backed by Fannie Mae, Freddie Mac and Ginnie Mae. The U.S. Federal Reserve stated that its actions are intended to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally. The purchases of Agency RMBS began on January 5, 2009. In March 2009, the Federal Reserve announced that it would purchase up to an additional $750 billion of Agency RMBS, bringing its total purchase commitment for Agency RMBS to $1.25 trillion. The U.S. Federal Reserve’s program to purchase Agency RMBS could cause an increase in the price of Agency MBS, which would negatively impact the net interest margin with respect to the Agency RMBS that we may acquire in the future.
There can be no assurance that EESA or the U.S. Federal Reserve’s actions will have a beneficial impact on the financial markets. To the extent the markets do not respond favorably to TARP, or TARP does not function as intended, our business may not receive the anticipated positive impact from the legislation and such result may have broad adverse market implications. In addition, U.S. and foreign governments, central banks and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis, such as the U.S. government’s recent passage of a $787 billion economic stimulus plan. We cannot predict whether or when such actions may occur or what effect, if any, such actions could have on our business, results of operations and financial condition.
Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns, on the interest-earning assets in which we invest.
During the six months ended December 31, 2008, the U.S. government, through the Federal Housing Authority and the Federal Deposit Insurance Corporation, or FDIC, commenced implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. More recently, on February 18, 2009, the President of the United States announced the Homeowner Affordability and Stability Plan, or HASP, which is intended to stabilize the housing market by providing relief to distressed homeowners in an effort to reduce or forestall home foreclosures. Among other things, the HASP is designed to (i) enable responsible homeowners to refinance in certain instances where their home value has fallen below the amount outstanding on the homeowner’s mortgage, (ii) address certain “at-risk” homeowners by providing cash incentives to lenders to refinance the homeowner’s mortgage to a lower interest rates and subsidizing in part a reduction in the outstanding mortgage principal, (iii) provide for an amendment of the bankruptcy laws to permit the modification of mortgage loans in bankruptcy proceedings and (iv) support lower mortgage interest rates by increasing the U.S. Treasury’s preferred stock investment in each of Fannie Mae and Freddie Mac to $200 billion, increasing the size of the companies’ retained mortgage portfolios to $900 billion each and reaffirming its commitment to continue purchasing Fannie Mae and Freddie Mac issued RMBS. This new U.S. government program, as well as future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may adversely affect the value of, and the returns on, the interest-earning assets in which we invest.
Changes in prepayment rates on our RMBS may decrease our net interest income.
Pools of mortgage loans underlie the mortgage-backed securities that we hold in our investment portfolio and in which we invest. We will generally receive principal distributions from the principal payments that are made on these underlying mortgage loans. When borrowers repay their mortgage loans faster than expected, this will result in prepayments that are faster than expected on the related-RMBS. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors, all of which are beyond our control. Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict. Prepayment rates also may be affected by conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage loans. Faster than expected prepayments could adversely affect our profitability, including in the following ways:
| · | We have purchased RMBS, and may purchase in the future investment securities, that have a higher interest rate than the market interest rate at the time of purchase. In exchange for this higher interest rate, we are required to pay a premium over the face amount of the security to acquire the security. In accordance with accounting rules, we amortize this premium over the anticipated term of the mortgage security. If principal distributions are received faster than anticipated, we would be required to expense the premium faster. We may not be able to reinvest the principal distributions received on these investment securities in similar new mortgage-related securities and, to the extent that we can do so, the effective interest rates on the new mortgage-related securities will likely be lower than the yields on the mortgages that were prepaid. |
| · | We also may acquire RMBS or other investment securities at a discount. If the actual prepayment rates on a discount mortgage security are slower than anticipated at the time of purchase, we would be required to recognize the discount as income more slowly than anticipated. This would adversely affect our profitability. Slower than expected prepayments also may adversely affect the market value of a discount mortgage security. |
A flat or inverted yield curve may adversely affect prepayment rates on and supply of our RMBS.RMBS in which we invest.
Our net interest income varies primarilyin substantial part as a result of changes in interest rates as well as changes in interest rates across the yield curve. We believe that when the yield curve is relatively flat, borrowers have an incentive to refinance into hybrid mortgages with longer initial fixed rate periods and fixed rate mortgages, causing our RMBS or investment securities, to experience faster prepayments. In addition, a flatter yield curve generally leads to fixed-rate mortgage rates that are closer to the interest rates available on hybrid ARMs and ARMs, possibly decreasing the supply of the RMBS we seek to acquire. At times, short-term interest rates may increase and exceed long-term interest rates, causing an inverted yield curve. When the yield curve is inverted, fixed-rate mortgage rates may approach or be lower than hybrid ARMs or ARM rates, further increasing prepayments on, and negatively impacting the supply of, our RMBS. Increases in prepayments on our portfolio will cause our premium amortization to accelerate, lowering the yield on such assets. If this happens, we could experience a decrease in net income or incur a net loss during these periods, which may negatively impact our distributions to stockholders.
Interest rate caps onPrepayment rates can change, adversely affecting the performance of our adjustable-rate RMBS may reduce our income or cause us to suffer a loss during periods of rising interest rates.assets.
The frequency at which prepayments (including both voluntary prepayments by the borrowers and liquidations due to defaults and foreclosures) occur on mortgage loans underlying our adjustable-rate RMBS typically will be subject to periodic and lifetime interest rate caps. Additionally, we may invest in ARMs with an initial “teaser” rate that will provide us withis affected by a lower than market interest rate initially, which may accordingly have lower interest rate caps than ARMs without such teaser rates. Periodic interest rate caps limitvariety of factors, including the amount an interest rate can increase during a given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturityprevailing level of a mortgage loan. If these interest rate caps apply to the mortgage loans underlying our adjustable-rate RMBS, the interest distributions made on the related RMBS will be similarly impacted. Our borrowings may not be subject to similar interest rate caps. Accordingly, in a period of rapidly increasing interest rates as well as economic, demographic, tax, social, legal, legislative and other factors. Generally, borrowers tend to prepay their mortgages when prevailing mortgage rates fall below the interest rates paid on our borrowings could increase without limitation while caps would limit the interest distributions on our adjustable-rate RMBS. Further, sometheir mortgage loans. A significant percentage of the mortgage loans underlying our adjustable-rateexisting RMBS were originated in a relatively higher interest rate environment than currently in effect and, thus, could be prepaid if borrowers are eligible for refinancings.
In general, “premium” securities (securities whose market values exceed their principal or par amounts) are adversely affected by faster-than-anticipated prepayments because the above-market coupon that such premium securities carry will be earned for a shorter period of time. Generally, “discount” securities (securities whose principal or par amounts exceed their market values) are adversely affected by slower-than-anticipated prepayments. Since many RMBS will be discount securities when interest rates are high, and will be premium securities when interest rates are low, these RMBS may be adversely affected by changes in prepayments in any interest rate environment.
The adverse effects of prepayments may impact us in various ways. First, particular investments, such as IOs, may experience outright losses in an environment of faster actual or anticipated prepayments. Second, particular investments may under-perform relative to any hedges that we may have constructed for these assets, resulting in a loss to us. In particular, prepayments (at par) may limit the potential upside of many RMBS to their principal or par amounts, whereas their corresponding hedges often have the potential for unlimited loss. Furthermore, to the extent that faster prepayment rates are due to lower interest rates, the principal payments received from prepayments will tend to be reinvested in lower-yielding assets, which may reduce our income in the long run. Therefore, if actual prepayment rates differ from anticipated prepayment rates, our business, financial condition and results of operations and ability to make distributions to our stockholders could be materially adversely affected.
Our targeted assets and other asset classes we may pursue in the future include various forms of structured Agency RMBS, including IOs, POs and CMOs. Although these assets are generally subject to periodicthe same risks as other Agency RMBS in our portfolio, certain types of risks may be enhanced depending on the type of structured Agency RMBS in which we invest.
Our target assets and other asset classes we may pursue in the future include various forms of structured Agency RMBS, including IOs, POs and CMOs, which are securitizations (i) issued by Fannie Mae, Freddie Mac or Ginnie Mae, (ii) that are collateralized by Agency RMBS and (iii) that are divided into various tranches that have different characteristics (such as different maturities or different coupon payments). These securities may carry greater risk than an investment in other types of Agency RMBS. For example, the Agency IOs or POs we invest in, are more sensitive to prepayment risks than Agency ARMs. In addition, many support securities and securities purchased at a significant premium from certain CMO tranches are more sensitive to prepayment risk. Because a significant portion of our portfolio is invested in these assets, our overall portfolio and results of operations may be more sensitive to prepayment risk.
Increased levels of prepayments on the mortgages underlying our structured Agency RMBS, particularly Agency IOs, might decrease net interest income or result in a net loss, which could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
When we acquire structured Agency RMBS, such as Agency IOs, we anticipate that the underlying mortgages will prepay at a projected rate, generating an expected yield. When the prepayment rates on the mortgages underlying our structured Agency RMBS are higher than expected, our returns on those securities may be materially adversely affected. For example, the value of our Agency IOs is extremely sensitive to prepayments because holders of these securities do not have the right to receive any principal payments on the underlying mortgages. Agency IOs currently comprise a large percentage of our interest earning assets. Therefore, if the mortgage loans underlying our Agency IOs are prepaid at a higher than anticipated rate, such securities would decline in value and provide less cash flow, which, in turn, could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns on, the Agency RMBS in which we invest.
During the second half of 2008, the U.S. Government, through the Federal Housing Authority, (“FHA”), and the Federal Deposit Insurance Corporation (“FDIC”), commenced implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. These and any future programs may involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans or the rate of interest payable on the loans, or to extend the payment capsterms of the loans.
In addition, in February 2009 the U.S. Treasury announced the Homeowner Affordability and Stability Plan, or HASP, which is a multi-faceted plan, intended to prevent residential mortgage foreclosures by, among other things:
allowing certain homeowners whose homes are encumbered by Fannie Mae or Freddie Mac conforming mortgages to refinance those mortgages into lower interest rate mortgages with either Fannie Mae or Freddie Mac;
creating the Homeowner Stability Initiative, which is intended to utilize various incentives for banks and mortgage servicers to modify residential mortgage loans with the goal of reducing monthly mortgage principal and interest payments for certain qualified homeowners; and
allowing judicial modifications of Fannie Mae and Freddie Mac conforming residential mortgage loans during bankruptcy proceedings.
In September 2011, the White House announced they are working on a major plan to allow some of the 11 million homeowners who owe more on their mortgages than their homes are worth to refinance. In November 2011, the Federal Housing Financing Authority (“FHFA”) announced changes to the Home Affordable Refinance Program (“HARP”) that expands access to refinancing for qualified individuals and families whose homes have lost value, among other things, increasing the HARP loan-to-value ratio above 125%. However, this would only apply to mortgages guaranteed by the GSEs. There are many challenging issues to this program, notably the question as to whether a loan with a loan-to-value ratio of 125% qualifies as a mortgage or an unsecured consumer loan. The chances of this initiative’s success have created additional uncertainty in the RMBS market, particularly with respect to possible increases in prepayment rates.
On January 4, 2012, the U.S. Federal Reserve , or Federal Reserve, issued a white paper outlining additional ideas with regard to refinancings and loan modifications. It is likely that loan modifications would result in increased prepayments on some Agency RMBS and possibly some loans held in securitization trusts. These initiatives, any future loan modification programs and future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may adversely affect the value of, and the returns on, the Agency RMBS in which we invest and the prime ARM loans held in our securitization trusts.
Certain actions by the Federal Reserve could cause a flattening of the yield curve, which could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
On September 21, 2011, the Federal Reserve announced “Operation Twist,” which is a program by which it intends to purchase, by the end of June 2012, $400 billion of U.S. Treasury securities with remaining maturities between six and 30 years and sell an equal amount of U.S. Treasury securities with remaining maturities of three years or less. The effect of Operation Twist could be a flattening in the yield curve, which could result in increased prepayment rates due to lower long-term interest rates and a narrowing of our net interest margin. Consequently, Operation Twist and any other future securities purchase programs by the Federal Reserve could materially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
The ongoing debt crisis in Europe could have an adverse effect on our business and liquidity.
During the past several years, several large European financial institutions have experienced financial difficulty and have been either rescued by government assistance or by other large European banks. Several European governments have coordinated plans to attempt to shore up their financial sectors through loans, credit guarantees, capital infusions, promises of continued liquidity funding and interest rate cuts. Additionally, other governments of the world’s largest economic countries have also implemented interest rate cuts in response to the crisis. There is no assurance that these and other plans and programs will be successful in halting the European credit crisis or in preventing other financial institutions from failing. If unsuccessful, this could materially adversely affect our business, financial condition and results of operations as well as those of the entire mortgage industry.
As the European credit crisis continues, there is a growing risk to the financial condition and stability of major European financial institutions. Some of these financial institutions have U.S. banking subsidiaries which have provided financing to us, particularly repurchase agreement financing collateralized by Agency RMBS. Some of the U.S. banking subsidiaries of these major European financial institutions have recently been placed on credit watch. If the European credit crisis continues to impact these major European financial institutions, there is the possibility that it will also impact the operations and lending activities of their U.S. banking subsidiaries, which could have an adverse impact on our ability to access financing sources on favorable terms, or at all, or result in counterparty default under our repurchase agreements. In addition, it is possible that certain of our U.S. based counterparties could have significant exposure to European sovereign debt or affected European financial institutions. This could adversely affect our business, liquidity, financial condition and results of operations as well as those of the entire mortgage industry.
The downgrade of the U.S.’s, certain European countries’ and certain European financial institutions’ credit ratings and any future downgrades of the U.S.’s, certain European countries’ or certain European financial institutions’ credit ratings may materially adversely affect our business, financial condition and results of operations.
On August 5, 2011, Standard & Poor’s downgraded the U.S.’s credit rating for the first time in history. Because Fannie Mae and Freddie Mac are in conservatorship of the U.S. Government, downgrades to the U.S.’s credit rating could impact the credit risk associated with Agency RMBS and certain CMBS and, therefore, decrease the value of the Agency RMBS and certain CMBS in our portfolio. In addition, the downgrade of the U.S. Government’s credit rating, the credit ratings for certain European countries and certain financial institutions domiciled in Europe has created broader financial turmoil and uncertainty, which has weighed heavily on the global banking system. Therefore, the recent downgrade of the U.S.’s credit rating and the credit ratings of certain European countries and certain financial institutions domiciled in Europe, and any future downgrades of the U.S.’s credit rating or the downgrade of credit ratings for certain European countries or certain financial institutions domiciled in Europe, may materially adversely affect our business, financial condition and results of operations.
Difficult conditions in the mortgage real estate markets have caused and may cause us to experience losses and these conditions may persist for the foreseeable future.
Our business is materially affected by conditions in the residential mortgage market, the residential and commercial real estate market, the financial markets and the economy generally. Furthermore, because a significant portion of our current assets and our targeted assets are credit sensitive, we believe the interestrisks associated with our investments will be more acute during periods of economic slowdown or recession, especially if these periods are accompanied by declining real estate values and defaults. Concerns about the residential and commercial mortgage markets and a declining real estate market generally, as well as inflation, energy costs, sovereign debt and geopolitical issues and the availability and cost of credit have contributed to increased volatility and diminished expectations for the economy and markets going forward. The residential and commercial mortgage markets have been adversely affected by changes in the lending landscape, the severity of which was largely unanticipated by the markets. There is no assurance that these markets will return to prior levels or that they will not worsen.
In addition, an economic slowdown or delayed recovery may result in continued decreased demand for residential and commercial property, which would likely further compress homeownership rates and place additional pressure on home price performance, while forcing commercial property owners to lower rents on properties with excess supply. We believe there is a strong correlation between home price growth rates and mortgage loan delinquencies. Moreover, to the extent that a property owner has fewer tenants or receives lower rents, such property owners will generate less cash flow on their properties, which increases significantly the likelihood that such property owners will default on their debt service obligations. If the borrowers of our mortgage loans, or the loans underlying certain of our investment securities, default, we may incur losses on those loans being deferred and added to the principal outstanding. As a result, weor investment securities. Any sustained period of increased payment delinquencies, foreclosures or losses could receive less interest distributions on adjustable-rate RMBS, particularly those with an initial teaser rate, than we need to pay interest on our related borrowings. These factors could loweradversely affect both our net interest income cause usand our ability to sufferacquire our targeted assets in the future on favorable terms or at all. The further deterioration of the residential or commercial mortgage markets, the financial markets and the economy generally may result in a net lossdecline in the market value of our investments or cause us to incur additional borrowingsexperience losses related to fund interest payments during periods of rising interest rates or sell our investments at a loss.
Competition may prevent us from acquiring mortgage-related assets at favorable yields, which would negatively impact our profitability.
Our net income largely depends on our ability to acquire mortgage-related assets at favorable spreads over our borrowing costs. In acquiring mortgage-related assets, we compete with other REITs, investment banking firms, savings and loan associations, banks, insurance companies, mutual funds, other lenders and other entities that purchase mortgage-related assets, many of which have greater financial resources than us. As a result, we may not in the future be able to acquire sufficient mortgage-related assets at favorable spreads over our borrowing costs which, would adversely affect our profitability.
We may experience periods of illiquidity for our assets, which could adversely affect our ability to finance our business or operate profitably.
We bear the risk of being unable to dispose of our interest-earning assets at advantageous times or in a timely manner because these assets generally experience periods of illiquidity. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, legal or contractual restrictions on resale or disruptions in the secondary markets. This illiquidity may adversely affect our profitabilityresults of operations, the availability and cost of credit and our ability to financemake distributions to our business and could cause us to incur substantial losses.stockholders.
An increaseChanges in interest rates can have negative effects on us, including causing a decrease inlaws and regulations affecting the volume of newly-issued, or investor demand for, RMBS, which could harm our financial conditionrelationship between Fannie Mae and Freddie Mac and the U.S. government, may adversely affect our business.
Payments on the Agency RMBS in which we invest are guaranteed by Fannie Mae and Freddie Mac. As broadly publicized, Fannie Mae and Freddie Mac have experienced significant losses in recent years, causing the U.S. Government to place Fannie Mae and Freddie Mac under federal conservatorship and to inject significant capital in these businesses. Questions regarding the continued viability of Fannie Mae and Freddie Mac, as currently structured, including the guarantees that back the RMBS issued by them, and the U.S. Government’s participation in the U.S. residential mortgage market through the GSEs, continue to persist. In February 2011, the U.S. Department of the Treasury along with the U.S. Department Housing and Urban Development released a much-awaited report titled “Reforming America’s Housing Finance Market”, which outlines recommendations for reforming the U.S. housing system, specifically the roles of Fannie Mae and Freddie Mac and transforming the government’s involvement in the housing market and its relationship to Fannie Mae and Freddie Mac. It is unclear how future legislation may impact the housing finance market and the investing environment for mortgage-related securities and more specifically, Agency RMBS and non-Agency RMBS, as the method of reform is undecided and has not yet been defined by the regulators. New regulations and programs related to Fannie Mae and Freddie Mac, including those affecting the relationship between the GSEs and the U.S. Government or the guarantees that back the RMBS issued by the GSEs, may adversely affect the pricing, supply, liquidity and value of Agency RMBS and otherwise materially harm our business and operations.
An increaseOur income could be negatively affected in a number of ways depending on the manner in which events related to Fannie Mae and Freddie Mac unfold. For example, the current credit support provided by the U.S. to Fannie Mae and Freddie Mac, and any additional credit support it may provide in the future, could have the effect of lowering the interest rates can have various negative affectswe expect to receive from Agency RMBS, thereby tightening the spread between the interest we earn on us. Increases in interest rates may negatively affect the fair market value of our RMBS and other interest-earning assets. When interest rates rise, the value of RMBS and fixed-rate investment securities generally declines. Typically, as interest rates rise, prepayments on the underlying mortgage loans tend to slow. The combination of rising interest rates and declining prepayments may negatively affect the price of RMBS, and the effect can be particularly pronounced with fixed-rate RMBS. In accordance with GAAP, we will be required to reduce the carrying value of our RMBS by the amount of any decrease in the fair value of our RMBS compared to amortized cost. If unrealized losses in fair value occur, we will either have to reduce current earnings or reduce stockholders’ equity without immediately affecting current earnings, depending on how we classify ourthose assets under GAAP. In either case, our net stockholders’ equity will decrease to the extent of any realized or unrealized losses in fair value and our financial position will be negatively impacted.
Furthermore, rising interest rates generally reduce the demand for consumer and commercial credit, including mortgage loans, due to the higher cost of borrowing.financing those assets. A reduction in the volumesupply of mortgage loans originated mayAgency RMBS could also negatively affect the volumepricing of Agency RMBS available to us, which could adversely affectby reducing the spread between the interest we earn on our ability to acquire assets that satisfy our investment objectives. Rising interest rates may also cause Agency RMBS and other interest-earning assets that wereour cost of financing those assets. In addition, any law affecting these government-sponsored enterprises may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities issued prior to an interest rateor guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volumethe risk of loss on investments in Agency RMBS and other interest-earning assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and pay dividends, may be materially and adversely affected.
Changes in interest rates, particularly higher interest rates, can also harm the credit performance of our interest-earning assets. Higher interest rates could reduce the ability of borrowers to make interest paymentsissued by Fannie Mae or to refinance their loans and could reduce property values, all of which could increase our credit losses. In the event we experience a significant increase in credit losses as a result of higher interest rates, our earnings and financial condition will be materially adversely affected.
Recent market conditions may upset the historical relationship between interest rate changes and prepayment trends, which would make it more difficult for us to analyze our investment portfolio.Freddie Mac.
Our success depends on our ability to analyze the relationship of changing interest rates on prepayments of theCommercial mortgage loans that underliewe may acquire or that back our Agency RMBS. Changes in interest ratesCMBS are subject to risks of delinquency and prepayments affect the market priceforeclosure and risks of the Agency RMBSloss that we hold in our portfolio and in which we intend to invest. In managing our investment portfolio, to assess the effects of interest rate changes and prepayment trends on our investment portfolio, we typically rely on certain assumptions that are based upon historical trendsmay be greater than similar risks associated with respect to the relationship between interest rates and prepayments under normal market conditions. If the recent dislocations in the residential mortgage market or other developments change the way that prepayment trends have historically responded to interest rate changes, our ability to (i) assess the market value of our investment portfolio, (ii) effectively hedge our interest rate risk and (iii) implement techniques to reduce our prepayment rate volatility would be significantly affected, which could materially adversely affect our financial position and results of operations.loans.
A substantial majority of the RMBS within our investment portfolio is recorded at fair value as determined in good faith by our management based on market quotations from brokersWe currently own and dealers. Although we currently are able to obtain market quotations for assets in our portfolio, we may be unable to obtain quotations from brokers and dealers for certain assets within our investment portfolioacquire in the future in which case our management may need to determine in good faith the fair value of these assets.
Substantially all of the assets held within our investment portfolio are in the form of securities that are not publicly traded on a national securities exchange or quotation system. The fair value of securities and other assets that are not publicly traded in this manner may not be readily determinable. A substantial majority of the assets in our investment portfolio are valuedCMBS backed by us at fair value as determined in good faith by our management based on market quotations from brokers and dealers. Although we currently are able to obtain quotations from brokers and dealers for assets within our investment portfolio, we may be unable to obtain such quotations on other assets in our investment portfolio in the future, in which case, our manager may need to determine in good faith the fair value of these assets. Because such quotations and valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a public market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these assets are materially higher than the values that we ultimately realize upon their disposal. Misjudgments regarding the fair value of our assets that we subsequently recognize may also result in impairments that we must recognize.
Loan delinquencies on our prime ARM loans held in securitization trusts may increase as a result of significantly increased monthly payments required from ARM borrowers after the initial fixed period.
The scheduled increase in monthly payments on certain adjustable ratecommercial mortgage loans held in our securitization trustsor may result in higher delinquency rates on those mortgage loans and could have a material adverse affect on our net income and results of operations. This increase in borrowers' monthly payments, together with any increase in prevailing market interest rates, may result in significantly increased monthly payments for borrowers with adjustable ratedirectly acquire commercial mortgage loans. Borrowers seeking to avoid these increased monthly payments by refinancing their mortgage loans may no longer be able to fund available replacement loans at comparably low interest rates or at all. A decline in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance their loans or sell their homes. In addition, these mortgage loans may have prepayment premiums that inhibit refinancing.
We may be required to repurchase loans if we breached representations and warranties from loan sale transactions, which could harm our profitability and financial condition.
Loans from our discontinued mortgage lending operations that were sold to third parties under agreements include numerous representations and warranties regarding the manner in which the loan was originated, the property securing the loan and the borrower. If these representations or warranties are found to have been breached, we may be required to repurchase the loan. We may be forced to resell these repurchased loans at a loss, which could harm our profitability and financial condition.
Under our alternative investment strategy, the mortgage loans we may invest directly in and those underlying our CMBS and RMBS are subject to delinquency, foreclosure and loss, which could result in losses to us.
Under our alternative investment strategy, we may invest in CMBS, non-Agency RMBS and other mortgage assets, including mortgage loans. Commercial mortgage loans are secured by multi-familymultifamily or commercial property. Theyproperty and are subject to risks of delinquency and foreclosure and risks of loss that are greater than similar risks associated with loans made on the security of single-family residential property.mortgage loans. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of thesuch property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Such income can be affected by many factors.
ResidentialIf we incur losses on CMBS, or commercial mortgage loans, are secured by single-family residential property. They are subjectour business, financial condition and results of operations and our ability to risks of delinquency and foreclosure, and risks of loss. The ability of a borrowermake distributions to repay a loan secured by a residential property depends on the income or assets of the borrower. Many factorsour stockholders may impair borrowers’ abilities to repay their loans. ABS are bonds or notes backed by loans or other financial assets.be materially adversely affected.
In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan. This could impair our cash flow from operations. In the event of the bankruptcy of a mortgage loan borrower, the loan will be deemed secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court). The lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure of a mortgage loan can be expensive and lengthy. This could impair our anticipated return on the foreclosed mortgage loan. Moreover, RMBS represent interests in or are secured by pools of residential mortgage loans and CMBS represent interests in or are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. To the extent a foreclosure or loss occurs on the underlying mortgage loan, we will receive less principal and interest from that security in the future. Accordingly, the CMBS and non-Agency RMBS weWe may invest in are subject to all of the risks of the underlying mortgage loans.
Our investments in subordinated CMBS or RMBS could subject us to increased risk of losses.
Under our alternative investment strategy, we may invest in securities that represent subordinated tranches of CMBS or non-Agency RMBS. In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by any cash reserve fund or letter of credit provided by the borrower, and then by the first loss subordinated security holder. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit—and any classes of securities junior to those in which we invest—we may not be able to recover all of our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline and, as a result, less collateral is available to satisfy delinquent interest and principal payments due on the related CMBS or RMBS, the securities in which we invest may effectively become the first loss position behind the more senior securities, which may result in significant losses to us.
The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying mortgage-backed securities to make principal and interest payments or to refinance may be impaired. In this case, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.
Our alternative assets may include high yield or subordinated corporateand lower rated securities that have greater risks of loss than other investments, which could adversely affect our business, financial condition and cash available for dividends.
Under alternative investment strategy, our assetsWe may includeinvest in high yield or subordinated or lower rated securities, including subordinated tranches of CMBS or non-Agency RMBS, which involve a higher degree of risk than other investments. Numerous factors may affect a company’s ability to repay its high yield or subordinated securities, including the failure to meet its business plan, a downturn in its industry or negative economic conditions. These securities may not be secured by mortgages or liens on assets. Our right to payment and security interest with respect to such securities may be subordinated to the payment rights and security interests of the senior lender. Therefore, we may be limited in our ability to enforce our rights to collect these loans and to recover any of the loan balance through a foreclosure of collateral.
Our due diligence may not reveal all the liabilities associated with an alternative investmentFailure to procure adequate funding and capital would adversely affect our results and may, not reveal other investment performance issues.in turn, negatively affect the value of our common stock and our ability to distribute cash to our stockholders.
Before investing in an alternative asset,We depend upon the availability of adequate funding and capital for our operations. To maintain our status as a REIT, we review the loans or other assets comprising the investment and other factors that we believe are materialrequired to distribute at least 90% of our REIT taxable income annually, determined without regard to the performance of the investment. In this process, we rely on the resourcesdeduction for dividends paid and excluding net capital gain, to our stockholders and therefore are not able to retain our earnings for new investments. We cannot assure you that any, or sufficient, funding or capital will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding and capital on acceptable terms, there may be a negative impact on the value of our common stock and our ability to make distributions to our stockholders, and you may lose part or all of your investment.
Competition may prevent us from acquiring assets on favorable terms or at all, which could have a material adverse effect on our business, financial condition and results of operations.
We operate in a highly competitive market for investment opportunities. Our net income largely depends on our ability to acquire our targeted assets at favorable spreads over our borrowing costs. In acquiring our targeted assets, we compete with other REITs, investment banking firms, savings and loan associations, banks, insurance companies, mutual funds, other lenders and other entities that purchase mortgage-related assets, many of which have greater financial resources than us. Additionally, many of our potential competitors are not subject to REIT tax compliance or required to maintain an exemption from the Investment Company Act. As a result, we may not in the future be able to acquire sufficient quantities of our targeted assets at favorable spreads over our borrowing costs, which could have a material adverse effect on our business, financial condition and results of operations.
We may experience periods of illiquidity for our assets which could adversely affect our ability to finance our business or operate profitably.
We bear the risk of being unable to dispose of our interest-earning assets at advantageous times or in a timely manner because these assets can experience periods of illiquidity. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, legal or contractual restrictions on resale or disruptions in the secondary markets. This illiquidity may adversely affect our profitability and our ability to finance our business and could cause us to incur substantial losses.
Our portfolio investments are recorded at fair value based on market quotations from pricing services and broker/dealers. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal.
All of our current portfolio investments are, and some cases, an investigationof our future portfolio investments will be, in the form of securities that are not publicly traded. The fair value of securities and other investments that are not publicly traded may not be readily determinable. We currently value and will continue to value these investments on a quarterly-basis at fair value as determined by HCS, its affiliatesour management based on market quotations from pricing services and brokers/dealers. Because such quotations and valuations are inherently uncertain, they may fluctuate over short periods of time and may be based on estimates, and our determinations of fair value may differ materially from the values that would have been used if a public market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these investments were materially higher than the values that we ultimately realize upon their disposal.
Lack of diversification in the number of assets we acquire would increase our dependence on relatively few individual assets.
Our management objectives and policies do not place a limit on the size of the amount of capital used to support, or third parties. This processthe exposure to (by any other measure), any individual asset or any group of assets with similar characteristics or risks. In addition, because we are a small company, we may be unable to sufficiently deploy capital into a number of assets or asset groups. As a result, our portfolio may be concentrated in a small number of assets or may be otherwise undiversified, increasing the risk of loss and the magnitude of potential losses to us and our stockholders if one or more of these assets perform poorly. For example, our portfolio may at times be concentrated in or consist of a substantial amount of Agency IOs that are more sensitive to prepayment risk, or we may invest in CMBS secured by properties concentrated in a limited number of geographic locations. To the extent that our portfolio is particularly importantconcentrated in any one region or type of security, downturns relating generally to such region or type of security may result in defaults on a number of our assets within a short time period, which may materially adversely affect our business, financial condition and subjectiveresults of operations and our ability to make distributions to our stockholders.
We may change our investment strategy, hedging strategy and asset allocation and operational and management policies without stockholder consent, which may result in the purchase of riskier assets and materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We may change our investment strategy, hedging strategy and asset allocation and operational and management policies at any time without the consent of our stockholders, which could result in our purchasing assets or entering into hedging transactions that are different from, and possibly riskier than, the assets and hedging transactions described in this report. A change in our investment strategy or hedging strategy may increase our exposure to real estate values, interest rates, prepayment rates, credit risk and other factors. A change in our asset allocation could result in us purchasing assets in classes different from those described in this report. Our board of directors determines our operational policies and may amend or revise our policies, including those with respect to newour acquisitions, growth, operations, indebtedness, capitalization and distributions or private companies because there may be littleapprove transactions that deviate from these policies without a vote of, or no information publicly available about them. Our due diligence processes might not uncover all relevant facts, thus resultingnotice to, our shareholders. In addition, certain of our external managers have great latitude in making investment losses.
and hedging decisions on our behalf. Changes in our investment strategy, hedging strategy and asset allocation and operational and management policies could materially adversely affect our business, financial condition and results of operations and ability to make distributions to our stockholders.
Residential whole mortgage loans, including subprime residential mortgage loans and non-performing and sub-performing residential mortgage loans, are subject to increased risks.
We may acquire and manage pools of Contentsresidential whole mortgage loans. Residential whole mortgage loans, including subprime mortgage loans and non-performing and sub-performing mortgage loans, are subject to increased risks of loss. Unlike Agency RMBS, whole mortgage loans generally are not guaranteed by the U.S. Government or any GSE, though in some cases they may benefit from private mortgage insurance. Additionally, by directly acquiring whole mortgage loans, we do not receive the structural credit enhancements that benefit senior tranches of RMBS. A whole mortgage loan is directly exposed to losses resulting from default. Therefore, the value of the underlying property, the creditworthiness and financial position of the borrower and the priority and enforceability of the lien will significantly impact the value of such mortgage. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, and any costs or delays involved in the foreclosure or liquidation process may increase losses.
Whole mortgage loans are also subject to “special hazard” risk (property damage caused by hazards, such as earthquakes or environmental hazards, not covered by standard property insurance policies), and to bankruptcy risk (reduction in a borrower’s mortgage debt by a bankruptcy court). In addition, claims may be assessed against us on account of our position as mortgage holder or property owner, including assignee liability, responsibility for tax payments, environmental hazards and other liabilities. In some cases, these liabilities may be “recourse liabilities” or may otherwise lead to losses in excess of the purchase price of the related mortgage or property.
Loan delinquencies on our prime ARM loans held in securitization trusts may increase as a result of significantly increased monthly payments required from ARM borrowers after the initial fixed period.
The scheduled increase in monthly payments on certain ARM loans held in our securitization trusts may result in higher delinquency rates on those mortgage loans and could have a material adverse affect on our net income and results of operations. This increase in borrowers' monthly payments, together with any increase in prevailing market interest rates, may result in significantly increased monthly payments for borrowers with ARM loans, who in turn, may no longer be able to prepay the loan or refinance the loan at comparably low interest rates or at all. A decline in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance their loans or sell their homes
We have acquired and may acquire in the future non-Agency RMBS collateralized by subprime and Alt A mortgage loans, which are not guaranteed by any government-sponsored entity or agency and are subject to increased risks.
We have acquired and may acquire in the future non-Agency RMBS, which are backed by residential real estate property but, in contrast to Agency RMBS, their principal and interest are not guaranteed by a GSE such as Fannie Mae or Freddie Mac. We may acquire non-Agency RMBS backed by collateral pools of mortgage loans that have been originated using underwriting standards that are less restrictive than those used in underwriting “prime mortgage loans” and “Alt A mortgage loans.” These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories, mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to current economic conditions and other factors, many of the mortgage loans backing the non-Agency RMBS have in recent periods experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with these mortgage loans, the performance of non-Agency RMBS could be adversely affected, which could materially and adversely impact our results of operations, financial condition and business.
We may be required to repurchase loans if we breached representations and warranties from loan sale transactions, which could harm our profitability and financial condition.
Loans from our discontinued mortgage lending operations that were sold to third parties under sale agreements include numerous representations and warranties regarding the manner in which the loan was originated, the property securing the loan and the borrower. If these representations or warranties are found to have been breached, we may be required to repurchase the loan. We may be forced to resell these repurchased loans at a loss, which could harm our profitability and financial condition.
The mezzanine loan assets that we may acquire or originate will involve greater risks of loss than senior loans secured by income-producing properties.
We may acquire or originate mezzanine loans, which take the form of subordinated loans secured by second mortgages on the underlying property or loans secured by a pledge of the ownership interests of either the entity owning the property or a pledge of the ownership interests of the entity that owns the interest in the entity owning the property. These types of assets involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property, because the loan may become unsecured as a result of foreclosure by the senior lender. In addition, mezzanine loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal. If a borrower defaults on our mezzanine loan or debt senior to our loan, or in the event of a borrower bankruptcy, our mezzanine loan will be satisfied only after the senior debt is paid in full. Where debt senior to our loan exists, the presence of intercreditor arrangements between the holder of the mortgage loan and us, as the mezzanine lender, may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some or all of our investment, which could result in losses. In addition, even if we are able to foreclose on the underlying collateral following a default on a mezzanine loan, we would be substituted for the defaulting borrower and, to the extent income generated on the underlying property is insufficient to meet outstanding debt obligations on the property, may need to commit substantial additional capital to stabilize the property and prevent additional defaults to lenders with existing liens on the property. Significant losses related to mezzanine loans originated or acquired by us could have a material adverse effect on our results of operations and our ability to make distributions to our stockholders.
To the extent that due diligence is conducted on potential assets, such due diligence may not reveal all of the risks associated with such assets and may not reveal other weaknesses in such assets, which could lead to losses.
Before acquiring certain assets, such as whole mortgage loans, CMBS or other mortgage-related or other fixed income assets, we or the external manager responsible for the acquisition and management of such asset may decide to conduct (either directly or using third parties) certain due diligence. Such due diligence may include (i) an assessment of the strengths and weaknesses of the asset’s credit profile, (ii) a review of all or merely a subset of the documentation related to the asset, or (iii) other reviews that we or the external manager may deem appropriate to conduct. There can be no assurance that we or the external manager will conduct any specific level of due diligence, or that, among other things, the due diligence process will uncover all relevant facts or that any purchase will be successful, which could result in losses on these assets, which, in turn, could adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
Our real estate assets are subject to risks particular to real property.
We own assets secured by real estate and may own real estate directly in the future, either through direct acquisitions or upon a default of mortgage loans. Real estate assets are subject to various risks, including:
| · | acts of God, including earthquakes, floods and other natural disasters, which may result in uninsured losses; |
| · | acts of war or terrorism, including the consequences of terrorist attacks, such as those that occurred on September 11, 2001; |
| · | adverse changes in national and local economic and market conditions; and |
| · | changes in governmental laws and regulations, fiscal policies and zoning ordinances and the related costs of compliance with laws and regulations, fiscal policies and ordinances; |
The occurrence of any of the foregoing or similar events may reduce our return from an affected property or asset and, consequently, materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our shareholders.
We are highly dependent on information systems and system failures could significantly disrupt our business, which may, in turn, materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our shareholders.
Our business is highly dependent on communications and information systems. Any failure or interruption of our systems could cause delays or other problems in our securities trading activities, including RMBS trading activities, which could materially adversely affect on our business, financial condition and results of operations and our ability to make distributions to our stockholders.
A change in the Federal Reserve's intention to hold the Federal Funds Target Rate near zero through mid-2014 that would result in higher interest rates may adversely affect the market value of our interest earning assets and, therefore, also our book value.
In response to the 2008 financial and credit crisis, the Federal Reserve lowered the Federal Funds Target Rate to near zero in an effort to stabilize markets and improve liquidity. Recently, the Federal Reserve announced that it intends to hold the Federal Funds Target Rate near zero through mid-2014. These actions have resulted in favorable borrowing terms under many of our repurchase agreeements. However, a change in the Federal Reserve's stated intention to hold the Federal Funds Target Rate near zero would result in higher short-term interest rates, which may negatively affect the market value of our investment securities because in a period of rising interest rates, the relative value of the interest earning assets we own can be expected to fall and reduce our book value. In addition, our fixed-rate interest earning assets, generally, are more negatively affected by these increases because in a period of rising interest rates, our interest payments could increase while the interest we earn on our fixed-rate interest earning assets would not change.
Risk Related to Our Debt Financing and Hedging
Continued adverse developments in the residential mortgage market and financial markets, including recent mergers, acquisitions or bankruptcies of potential repurchase agreement counterparties, as well as defaults, credit losses and liquidity concerns, could make it difficult for usOur access to borrow money to fund our investment strategy or continue to fund our investment portfolio on a leveraged basis,financing sources, which may not be available on favorable terms, or at all, which couldespecially in light of current market conditions, may be limited, and this may materially adversely affect our profitability.business, financial condition and results of operations and our ability to make distributions to our stockholders.
We rely ondepend upon the availability of adequate capital and financing to acquire Agency RMBS andsources to fund our investment portfoliooperations. However, as previously discussed, the capital and credit markets have experienced unprecedented levels of volatility and disruption in recent years, as most recently caused by the U.S. deficit debate and Eurozone sovereign debt concerns which exerted downward pressure on a leveraged basis. Since March 2008, there have been several announcements of proposed mergers, acquisitions or bankruptcies of investment banksstock prices and commercial banks that have historically acted as repurchase agreement counterparties. This has resulted in a fewer number of potential repurchase agreement counterparties operating in the market and reduced financing capacity. In addition, many commercial banks, investment banks and insurance companies have announced extensive losses from exposure to the residential mortgage market. These losses have reduced financial industry capital, leading to reduced liquiditycredit capacity for some institutions. Institutions from which we seek to obtain financing may have owned or financed RMBS which have declined in value and caused them to suffer losses as a result of the recent downturn in the residential mortgage market.lenders. If these conditions persist, these institutions may be forced to exit the repurchase market, merge with another counterparty, become insolvent or further tighten their lending standards or increase the amount of equity capital or haircut required to obtain financing. Moreover, because our equity market capitalization places us at the low endlevels of market capitalization among all mortgage REITs, continued adverse developments in the residential mortgage market mayvolatility and disruption continue or worsen, it could materially adversely affect one or more of our lenders and could cause someone or more of our lenders to reducebe unwilling or terminateunable to provide us with financing, or to increase the costs of that financing, or to become insolvent. Moreover, we are currently party to repurchase agreements of a short duration and there can be no assurance that we will be able to roll over or re-set these borrowings on favorable terms, if at all. In the event we are unable to roll over or re-set our access to future borrowings before those of our competitors. Any of these events could makereverse repos, it may be more difficult for us to obtain debt financing on favorable terms or at all. Our profitability willIn addition, if regulatory capital requirements imposed on our lenders change, they may be adversely affected ifrequired to limit, or increase the cost of, financing they provide to us. In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell assets at an inopportune time or price. Under current market conditions, securitizations are generally unavailable or limited, which has also limited borrowings under warehouse facilities and other credit facilities that are intended to be refinanced by such securitizations. Consequently, depending on market conditions at the relevant time, we are unablemay have to obtain cost-effectiverely on additional equity issuances to meet our capital and financing needs, which may be dilutive to our stockholders, or we may have to rely on less efficient forms of debt financing that consume a larger portion of our cash flow from operations, thereby reducing funds available for our investments.operations, future business opportunities, cash distributions to our stockholders and other purposes. We cannot assure you that we will have access to such equity or debt capital on favorable terms (including, without limitation, cost and term) at the desired times, or at all, which may cause us to curtail our investment activities and/or dispose of assets, which could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We may incur increased borrowing costs related to repurchase agreements and that would adversely affect our profitability.
Currently, a significant portion of our borrowings are collateralized borrowings in the form of repurchase agreements. If the interest rates on these agreements increase at a rate higher than the increase in rates payable on our investments, our profitability would be adversely affected.
Our borrowing costs under repurchase agreements generally correspond to short-term interest rates such as LIBOR or a short-term Treasury index, plus or minus a margin. The margins on these borrowings over or under short-term interest rates may vary depending upon a number of factors, including, without limitation:
| · | the movement of interest rates; |
| · | the the availability of financing in the market; and |
| · | the the value and liquidity of our mortgage-related assets. |
Currently,During 2008 and 2009, many repurchase agreement lenders are requiringrequired higher levels of collateral than they havehad required in the past to support repurchase agreements collateralized by Agency RMBS and if this continues itRMBS. Although these collateral requirements have been reduced to more appropriate levels, we cannot assure you that they will make our borrowings and use of leverage less attractive and more expensive. Many financial institutions have increased lending margins for Agency RMBS to approximately 5.0% on average, which means that we are required to pledge Agency RMBS havingnot again experience a value of 105% of the amount of our borrowings. These increased lending margins may require us to post additional cash collateral for our Agency RMBS.dramatic increase. If the interest rates, lending margins or collateral requirements under these repurchase agreements increase, or if lenders impose other onerous terms to obtain this type of financing, our results of operations will be adversely affected.
Failure to procure adequate debt financing, or to renew or replace existing debt financing as it matures, would adversely affect our results and may, in turn, negatively affect the value of our common stock and our ability to distribute dividends.
We use debt financing as a strategy to increase our return on investments in our investment portfolio. However, we may not be able to achieve our desired debt-to-equity ratio for a number of reasons, including the following:
| · | our lenders do not make debt financing available to us at acceptable rates; or |
| · | our lenders require that we pledge additional collateral to cover our borrowings, which we may be unable to do. |
The dislocations in the residential mortgage market and credit markets have led lenders, including the financial institutions that provide financing for our investments, to heighten their credit review standards, and, in some cases, to reduce or eliminate loan amounts available to borrowers. As a result, we cannot assure you that any, or sufficient, debt funding will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding on acceptable terms, there may be a negative impact on the value of our common stock and our ability to make distributions, and you may lose part or all of your investment.
Furthermore, because we rely primarily on short-term borrowings to finance our investment portfolio, our ability to achieve our investment objective depends not only on our ability to borrow money in sufficient amounts and on favorable terms, but also on our ability to renew or replace on a continuous basis our maturing short-term borrowings. As of December 31, 2008, substantially all of our borrowings under repurchase agreements bore maturities of 30 days or less. If we are not able to renew or replace maturing borrowings, we will have to sell some or all of our assets, possibly under adverse market conditions.
The repurchase agreements that we use to finance our investments may require us to provide additional collateral, which could reduce our liquidity and harm our financial condition.
We intend to use repurchase agreements to finance our investments. If the market value of the loans or securities pledged or sold by us to a funding source decline in value, we may be required by the lending institution to provide additional collateral or pay down a portion of the funds advanced, but we may not have the funds available to do so. Posting additional collateral to support our repurchase agreements will reduce our liquidity and limit our ability to leverage our assets. In the event we do not have sufficient liquidity to meet such requirements, lending institutions can accelerate our indebtedness, increase our borrowing rates, liquidate our collateral at inopportune times and terminate our ability to borrow. This could result in a rapid deterioration of our financial condition and possibly require us to file for protection under the U.S. Bankruptcy Code.
We currentlyintend to leverage our equity, which will exacerbate any losses we incur on our current and future investments and may reduce cash available for distribution to our stockholders.
We currentlyintend to leverage our equity through borrowings, generally through the use of repurchase agreements and other short-term borrowings or through longer-term structured debt, such as CDOs, which are obligations issued in multiple classes secured by an underlying portfolio of securities, and wesecurities. We may, in the future, utilize other forms of borrowing. The amount of leverage we incur varies depending on our ability to obtain credit facilitiesborrowings, the cost of the debt and our lenders’ estimates of the value of our portfolio’s cash flow. The return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets we hold in our investment portfolio. Further, the leverage on our equity may exacerbate any losses we incur.
Our debt service payments will reduce the net income available for distribution to our stockholders. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to sale to satisfy our debt obligations. A decrease in the value of the assets may lead to margin calls under our repurchase agreements which we will have to satisfy. Significant decreases in asset valuation, such as occurred during March 2008, could lead to increased margin calls, and we may not have the funds available to satisfy any such margin calls. WeAlthough we have aestablished target overall leverage amountamounts for many of our RMBS investment portfolio of seven to nine times our equity, butassets, there is no established limitation, other than may be required by our financing arrangements, on our leverage ratio or on the aggregate amount of our borrowings.
If we are unable to leverage our equity to the extent we currently anticipate, the returns on certain of our RMBS portfolioassets could be diminished, which may limit or eliminate our ability to make distributions to our stockholders.
If we are limited in our ability to leverage certain of our assets, such as Agency RMBS or certain commercial mortgage-related securities, the returns on our portfoliothese assets may be harmed. A key element of our strategy is our use of leverage to increase the size of our RMBS portfolio in an attempt to enhance our returns. To finance our RMBS investment portfolio, we generally seek to borrow between seven and nine times the amount of our equity. At December 31, 2008 our leverage ratio for our RMBS investment portfolio, which we define as our outstanding indebtedness under repurchase agreements divided by total stockholders’ equity and our Series A Preferred Stock, was 6.8:1. This definition of the leverage ratio is consistent with the manner in which the credit providers under our repurchase agreement calculate our leverage. Our repurchase agreements are not currently committed facilities, meaning that the counterparties to these agreements may at any time choose to restrict or eliminate our future access to the facilities and we have no other committed credit facilities through which we may leverage our equity. If we are unable to leverage our equity to the extent we currently anticipate, the returns on our portfolio could be diminished, which may limit or eliminate our ability to make distributions to our stockholders.
If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us at the end of the transaction term or if we default on our obligations under the repurchase agreement, we would incur losses.
When we engage in repurchase transactions, we generally sell RMBS to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same RMBS back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the RMBS to the lender is less than the value of those RMBS (this difference is referred to as the “haircut”), if the lender defaults on its obligation to resell the same RMBS back to us we would incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the RMBS). Certain of the assets that we pledge as collateral, including Agency IOs and CLOs, are currently subject to significant haircuts. Further, if we default on one of our obligations under a repurchase transaction, the lender can terminate the transaction and cease entering into any other repurchase transactions with us. Our repurchase agreements contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. Any losses we incur on our repurchase transactions could adversely affect our earnings and thus our cash available for distribution to our stockholders.
Our use of repurchase agreements to borrow funds may give our lenders greater rights in the event that either we or a lender files for bankruptcy.
Our borrowings under repurchase agreements may qualify for special treatment under the bankruptcy code, giving our lenders the ability to avoid the automatic stay provisions of the bankruptcy code and to take possession of and liquidate our collateral under the repurchase agreements without delay in the event that we file for bankruptcy. Furthermore, the special treatment of repurchase agreements under the bankruptcy code may make it difficult for us to recover our pledged assets in the event that a lender files for bankruptcy. Thus, the use of repurchase agreements exposes our pledged assets to risk in the event of a bankruptcy filing by either a lender or us.
The Company'sOur liquidity may be adversely affected by margin calls under itsour repurchase agreements because theywe are dependent in part on the lenders' valuation of the collateral securing the financing.
Each of these repurchase agreements allows the lender, to varying degrees, to revalue the collateral to values that the lender considers to reflect market value. If a lender determines that the value of the collateral has decreased, it may initiate a margin call requiring the Companyus to post additional collateral to cover the decrease. When the Company iswe are subject to such a margin call, itwe must provide the lender with additional collateral or repay a portion of the outstanding borrowings with minimal notice. Any such margin call could harm the Company'sour liquidity, results of operation and financial condition. Additionally, in order to obtain cash to satisfy a margin call, the Companywe may be required to liquidate assets at a disadvantageous time, which could cause it to incur further losses and adversely affect itsour results of operations and financial condition.
Our hedging transactions may limit our gains or result in losses.
We use derivatives, primarilyHedging against credit events and interest rate swapschanges and caps,other risks may materially adversely affect our business, financial condition and results of operations and our ability to hedge our liabilities and this has certain risks, including the risk that losses on a hedging transaction will reduce the amount of cash available for distributionmake distributions to our stockholders and that such losses may exceedshareholders.
Subject to compliance with the amount invested in such instruments. Our Board of Directors has adopted a general policy with respectrequirements to the use of derivatives, and which generally allows us to use derivatives when we deem appropriate for risk management purposes, but does not set forth specific guidelines. To the extent consistent with maintaining our statusqualify as a REIT, we may use derivatives, including interest rate swaps and caps, options, term repurchase contracts, forward contracts and futures contracts,engage in our risk management strategycertain hedging transactions to limit the effects ofour exposure to changes in interest rates onand therefore may expose ourselves to risks associated with such transactions. We may utilize instruments such as interest rate swaps, caps, collars and floors and Eurodollar and U.S. Treasury futures to seek to hedge the interest rate risk associated with our operations.portfolio. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, we may establish other hedging positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, at any point in time we may choose not to hedge all or a portion of these risks, and we generally will not hedge maythose risks that we believe are appropriate for us to take at such time, or that we believe would be impractical or prohibitively expensive to hedge.
Even if we do choose to hedge certain risks, for a variety of reasons we generally will not be effective in eliminatingseek to establish a perfect correlation between our hedging instruments and the risks inherent in any particular position. Our profitabilitybeing hedged. Any such imperfect correlation may be adversely affected during any period as a result ofprevent us from achieving the use of derivatives in a hedging transaction.
Our use of hedging strategies to mitigate our interest rate exposure may not be effectiveintended hedge and may expose us to counterparty risks.
In accordance with our operating policies, we may pursue various typesrisk of hedging strategies, including swaps, caps and other derivative transactions, to seek to mitigate or reduce our exposure to losses from adverse changes in interest rates.loss. Our hedging activity will vary in scope based on the composition of our portfolio, our market views, and changing market conditions, including the level and volatility of interest rates, the type of assets held and financing sources used and other changing market conditions. No hedging strategy, however, can completely insulate us from the interest rate risksrates. When we do choose to which we are exposed or that the implementation of any hedging strategy would have the desired impact on our results of operations or financial condition. Certain of the U.S. federal income tax requirements that we must satisfy in order to qualify as a REIT may limit our ability to hedge, against such risks. We will not enter into derivative transactions if we believe that they will jeopardize our qualification as a REIT.
Interest rate hedging may fail to protect or could materially adversely affect us because, among other things:
| · | either we or our external managers may fail to correctly assess the degree of correlation between the performance of the instruments used in the hedging strategy and the performance of the assets in the portfolio being hedged; |
| · | either we or our external managers may fail to recalculate, re-adjust and execute hedges in an efficient and timely manner; |
| · | the hedging transactions may actually result in poorer over-all performance for us than if we had not engaged in the hedging transactions; |
| · | credit hedging can be expensive, particularly when the market is forecasting future credit deterioration and when markets are more illiquid; |
| | · | interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates; |
| | · | available interest rate hedges may not correspond directly with the interest rate riskrisks for which protection is sought; |
| | · | the durationdurations of the hedgehedges may not match the durationdurations of the related liability;assets or liabilities being hedged; |
| | · | many hedges are structured as over-the-counter contracts with counterparties whose creditworthiness is not guaranteed, raising the amount of incomepossibility that a REITthe hedging counterparty may earn from hedging transactions (other than through taxable REIT subsidiaries (or TRSs)) to offset interest rate losses is limited by U.S. federal tax provisions governing REITs;default on their payment obligations; and |
| | · | to the credit qualityextent that the creditworthiness of the party owing money on the hedgea hedging counterparty deteriorates, it may be downgradeddifficult or impossible to such an extent that it impairs our ability to sellterminate or assign our side of theany hedging transaction; andtransactions with such counterparty. |
| · | the party owing money in the hedging transaction may default on its obligation to pay. |
We primarily use swaps to hedge against anticipated future increases in interest rates onFor these and other reasons, our repurchase agreements. Should a swap counterparty be unable to make required payments pursuant to such swap, the hedged liability would cease to be hedged for the remaining term of the swap. In addition, wehedging activity may be at risk for any collateral held by a hedging counterparty to a swap, should such counterparty become insolvent or file for bankruptcy. Our hedging transactions, which are intended to limit losses, may actuallymaterially adversely affect our earnings, which could reducebusiness, financial condition and results of operations and our cash available for distributionability to make distributions to our stockholders.
Hedging instruments involve risk since they often areand other derivatives historically have not, in many cases, been traded on regulated exchanges, or been guaranteed or regulated by an exchangeany U.S. or its clearing house,foreign governmental authorities and involve risks and costs that could result in material losses.
Hedging instruments and other derivatives involve risk because they historically have not, in many cases, been traded on regulated exchanges and have not been guaranteed or regulated by any U.S. or foreign governmental authorities. Consequently, for these instruments there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of hedging instruments may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. We are restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with one counterparty. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its default.a default under the hedging agreement. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profitslosses and may force us to cover our commitments, if any,re-initiate similar hedges with other counterparties at the then currentthen-prevailing market price. Although generallylevels. Generally we will seek to reserve the right to terminate our hedging positions, ittransactions upon a counterparty’s insolvency, but absent an actual insolvency, we may not always be possibleable to dispose of or close outterminate a hedging positiontransaction without the consent of the hedging counterparty, and we may not be able to assign or otherwise dispose of a hedging transaction to another counterparty without the consent of both the original hedging counterparty and the potential assignee. If we terminate a hedging transaction, we may not be able to enter into an offsettinga replacement contract in order to cover our risk. We cannot assure youThere can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and therefore we may be required to maintain aany hedging position until exercise or expiration, which could resultmaterially adversely affect our business, financial condition and results of operations.
The U.S. Commodity Futures Trading Commission and certain commodity exchanges have established limits referred to as speculative position limits or position limits on the maximum net long or net short position which any person or group of persons may hold or control in losses.particular futures and options. Limits on trading in options contracts also have been established by the various options exchanges. It is possible that trading decisions may have to be modified and that positions held may have to be liquidated in order to avoid exceeding such limits. Such modification or liquidation, if required, could materially adversely affect our business, financial condition and results of operation and our ability to make distributions to our stockholders.
Our delayed delivery transactions, including TBAs, subject us to certain risks, including price risks and counterparty risks.
We purchase a significant portion of our Agency RMBS through delayed delivery transactions, including TBAs. In a delayed delivery transaction, we enter into a forward purchase agreement with a counterparty to purchase either (i) an identified Agency RMBS, or (ii) a to-be-issued (or “to-be-announced”) Agency RMBS with certain terms. As with any forward purchase contract, the value of the underlying Agency RMBS may decrease between the contract date and the settlement date. Furthermore, a transaction counterparty may fail to deliver the underlying Agency RMBS at the settlement date. If any of the above risks were to occur, our financial condition and results of operations may be materially adversely affected.
Risks Related to the Advisory AgreementOur Agreements with HCSOur External Managers
We are dependent on HCSour external managers and certain of itstheir key personnel and may not find a suitable replacement if HCS terminates the advisory agreementthey terminate their respective management agreements with us or such key personnel are no longer available to us.
PursuantWe historically were organized as a self-advised company that acquired, originated, sold and managed its assets; however, as we modified our business strategy and the targeted assets we seek to acquire in response to changing market conditions, we began to outsource the advisory agreement, subjectmanagement of certain targeted asset classes for which we had limited internal resources or experience. We presently are a party to oversight bytwo separate management agreements with Midway and RiverBanc that provide for the external management of certain of our Boardassets and investment strategies. Each of Directors, HCS advises the Managed Subsidiaries. HCSour external managers, in some manner, identifies, evaluates, negotiates, structures, closes and monitors certain investments on our behalf. In each case, we have engaged these third parties because of the Managed Subsidiaries, other than assets that we contributed to the Managed Subsidiaries to facilitate compliance withexpertise of certain key personnel of our exclusion from regulation under the Investment Company Act.external managers. The departure of any of the senior officers of HCS,our external managers, or of a significant number of investment professionals or principals of HCS,our external managers, could have a material adverse effect on our ability to achieve our investment objectives. We are subject to the risk that HCSour external managers will terminate the advisorytheir respective management agreement with us or that we may deem it necessary to terminate the advisorysuch agreement or prevent certain individuals from performing services for us, and that no suitable replacement will be found to manage the Managed Subsidiaries.certain of our assets and investment strategies.
Pursuant to the advisory agreement, HCS isour management agreements, our external managers are entitled to receive an advisorya management fee that is payable regardless of the performance of the assets of the Managed Subsidiaries.under their management.
We will pay HCSeach of Midway and RiverBanc substantial advisorybase management fees, based on the Managed Subsidiaries’ equityour invested capital (as such term is defined in the advisory agreement)respective management agreements), regardless of the performance of the Managed Subsidiaries’ portfolio. In addition, pursuant to the advisory agreement, we will pay HCS a base advisory fee even if they are not managing any assets of the Managed Subsidiaries' portfolio. HCS’sunder their management. The external managers’ entitlement in many cases to non-performance based compensation may reduce its incentive to devote the time and effort of its professionals to seeking profitable investment opportunities for the Managed Subsidiaries’ portfolio,our company, which could result in a lower performancethe under-performance of assets under their portfoliomanagement and negatively affect our ability to pay distributions to our stockholders or to achieve capital appreciation.
Pursuant to the advisory agreement, HCS isterms of our management agreements, our external managers are generally entitled to receive an incentive fee, which may induce itthem to make certain investments, including speculative or high risk investments.investments.
In addition to its advisory fee, HCS isthe base management fees, payable to our external managers, our external managers are generally entitled to receive incentive compensation based, in part, upon the Managed Subsidiaries’ achievement of targeted levels of net income. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net income may lead HCSour external managers to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, maintaining liquidity and/or management of interest rate, credit risk or market risk,risks, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. In addition, HCSMidway has broad discretion regarding the types of investments it will make pursuant to the advisory agreement.its management agreement with us. This could result in increased risk to the value of our assets under the Managed Subsidiaries’ invested portfolio.management of our external managers.
We compete with HCS’sour external managers’ other clients for access to HCS.them.
HCS has sponsored and/or currentlyEach of Midway and RiverBanc manages, other pools of capital and investment vehicles with an investment focus that overlaps with the Managed Subsidiaries’ investment focus, and is expected to continue to do somanage, other client accounts with similar or overlapping investment strategies. In connection with the services provided to those accounts, these managers may be compensated more favorably than for the services provided under our external management or advisory agreements, and such discrepancies in compensation may affect the level of service provided to us by our external managers. Moreover, each of our external managers may have an economic interest in the future. Furthermore, HCS is not restricted in any way from sponsoringaccounts they manage or accepting capital from new clients or vehicles, even for investing in asset classes or investment strategies that are similar to, or overlappingthe investments they propose. As a result, we will compete with the Managed Subsidiaries’ asset classes or investment strategies. Therefore, the Managed Subsidiaries competethese other accounts and interests for access to Midway and RiverBanc and the benefits that their relationship with HCS provides them.derived from those relationships. For the same reasons, the personnel of HCSeach of Midway and RiverBanc may be unable to dedicate a substantial portion of their time managing our investments to the Managed Subsidiaries’ investments if HCS managesextent they manage or are associated with any future investment vehicles.vehicles not related to us.
There are conflicts of interest in our relationshiprelationships with HCS,our external managers, which could result in decisions that are not in the best interests of our stockholders.
The Managed SubsidiariesWe may acquire or sell assets in which an external manager or its affiliates have or may have an interest, or pursue investmentswe may participate in securitiesco-investment opportunities with our external managers or their affiliates. In these cases, it is possible that our interests and the interests of our external managers will not always be aligned and this could result in decisions that are not in the best interests of our company. Similarly, our external managers or its affiliates may acquire or sell assets in which HCS has or is seeking an interest. Similarly, HCS may invest in securities in which the Managed Subsidiarieswe have or may have an interest. Although such investmentsacquisitions or dispositions may present conflicts of interest, we nonetheless may pursue and consummate such transactions. Additionally, the Managed Subsidiarieswe may engage in transactions directly with HCS,our external managers or their affiliates, including the purchase and sale of all or a portion of a portfolio investment.targeted asset.
HCS may from time to time simultaneously seek to purchase investments for the Managed Subsidiaries and other entities with similar investment objectives for which it serves as a manager, or for its clients or affiliates and has no duty to allocate such investment opportunities in a manner that favors the Managed Subsidiaries. Additionally, such investmentsAcquisitions made for entities with similar investment objectives may be different from those made on the Managed Subsidiaries’our behalf. HCSOur external managers may have economic interests in or other relationships with others in whose obligations or securities we may acquire. In particular, such persons may make and/or hold an investment in securities that we acquire that may be pari passu, senior or junior in ranking to our interest in the Managed Subsidiaries may invest.securities or in which partners, security holders, officers, directors, agents or employees of such persons serve on boards of directors or otherwise have ongoing relationships. Each of such ownership and other relationships may result in securities laws restrictions on transactions in such securities and otherwise create conflicts of interest. In such instances, HCSthe external managers may, in itstheir sole discretion, make investment recommendations and decisions regarding such securities for other entities that may be the same as or different from those made with respect to the Managed Subsidiaries’ investmentssecurities acquired by us and may take actions (or omit to take actions) in the context of these other economic interests or relationships, the consequences of which may be adverse to the Managed Subsidiaries’our interests.
Although the officersThe key personnel of our external managers and employees of HCSits affiliates devote as much time to the Managed Subsidiariesus as HCS deemsour external managers deem appropriate, the officers and employeeshowever, these individuals may have conflicts in allocating their time and services among the Managed Subsidiariesus and HCS’s and its affiliates' other accounts. In addition, HCS and its affiliates, in connection with their other business activities,accounts and investment vehicles. During turbulent conditions in the mortgage industry, distress in the credit markets or other times when we will need focused support and assistance from our external managers, other entities for which our external managers serve as manager, or their accounts, will likewise require greater focus and attention, placing the resources of our external managers in high demand. In such situations, we may acquire material non-publicnot receive the necessary support and assistance we require or would otherwise receive if we were internally managed.
We, directly or through our external managers, may obtain confidential information thatabout the companies or securities in which we have invested or may restrict HCS from purchasinginvest. If we do possess confidential information about such companies or securities, or selling securities for itself or its clients (includingthere may be restrictions on our ability to dispose of, increase the Managed Subsidiaries)amount of, or otherwise usingtake action with respect to the securities of such information for the benefit of its clients or itself.
HCS and JMP Group, Inc. beneficially owned approximately 16.8% and 12.2%, respectively, of our outstanding common stock as of December 31, 2008. HCS is an investment adviser that manages investments and trading accountscompanies. Our external managers’ management of other persons, including certain accounts affiliated with JMP Group, Inc., and is deemed the beneficial owner of shares of our common stock held by these accounts. James J. Fowler, the Non-Executive Chairman of our Board of Directors and also the non-compensated chief investment officer of the Managed Subsidiaries, is a managing director of HCS. HCS is an affiliate of JMP Group, Inc. Joseph A. Jolson, the Chairman and Chief Executive Officer of JMP Group Inc. and HCS, beneficially owned approximately 9.5% of the Company’s outstanding common stock as of December 3, 2008. In addition, in November 2008, our Board of Directors approved an exemption from the ownership limitations contained in our Charter, to permit Mr. Jolson to beneficially own up to 25% of the aggregate value of our outstanding capital stock. As a result of the combined voting power of HCS, JMP Group, Inc. and Mr. Jolson, these stockholders exert significant influence over matters submitted to a vote of stockholders, including the election of directors and approval of a change in control or business combination of our company. This concentration of ownership may result in decisions affecting us that are not in the best interests of all our stockholders. In addition, Mr. Fowler may havecould create a conflict of interest to the extent such external manager is aware of material non-public information concerning potential investment decisions and this in situations where the best intereststurn could impact our ability to make necessary investment decisions. Any limitations that develop as a result of our companyaccess to confidential information could therefore materially adversely affect our business, financial condition and stockholders do not align withresults of operations and our ability to make distributions to our stockholders.
There are limitations on our ability to withdraw invested capital from the interestsaccount managed by Midway and our inability to withdraw our invested capital when necessary may materially adversely affect our business, financial condition and results of HCS, JMP Group, Inc. or its affiliates, whichoperations and our ability to make distributions to our stockholders.
Pursuant to the terms of the Midway Management Agreement, we may resultonly redeem invested capital in decisions that are notan amount equal to the lesser of 10% of the invested capital in the best interestsaccount managed by Midway or $10 million as of allthe last calendar day of the month upon not less than 75 days written notice, subject to our stockholders.authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a REIT and exemption from the Investment Company Act. In addition, we are only permitted to make one such redemption request in any 75-day period. In the event of a significant market event or shock, we may be unable to effect a redemption of invested capital in greater amounts or at a greater rate unless we obtain the consent of Midway. Moreover, because a reduction of invested capital would reduce the base management fee under the Midway Management Agreement, Midway may be less inclined to consent to such redemptions. If we are unable to withdraw invested capital as needed to meet our obligations in the future, our business and financial condition could be materially adversely affected.
Termination of the advisory agreementour external management agreements may be difficult and costly.
Termination of the advisory agreementRiverBanc Management Agreement without cause is subject to several conditions which may make such a termination difficult and costly. The advisory agreementRiverBanc Management Agreement provides that itwe may only be terminatedterminate RiverBanc without cause followingand not be obligated to pay a termination fee unless we realize a negative 15% return on the assets managed for us by RiverBanc. Moreover, except as described in the preceding sentence, we can not terminate RiverBanc without cause until expiration of the initial three year periodterm in 2013, and then only upon the affirmative vote of at least two-thirds of our independent directors, based either upon unsatisfactory performance by HCS that is materially detrimental to us or upon a determination that the management fee payable to HCS is not fair,providing 180 days advance notice and subject to HCS’s right to prevent such a termination by accepting a mutually acceptable reductionthe payment of management fees. HCS will be paid a termination fee equal to the amountproduct of two times(A) 24 and (B) the sum of the average annual base advisorymanagement fee and the average annual incentive compensation earned by itRiverBanc during the 24-monthone month period immediately preceding the datetermination date. Thus, in the event we elect not to renew the RiverBanc Management Agreement for any reason other than cause or as otherwise described in this paragraph, we will be required to pay this termination fee. In addition, the RiverBanc Management Agreement provides RiverBanc with an exclusive right of termination, calculated asfirst refusal to purchase any of our assets managed by it subject to certain exceptions, in the endevent we terminate them for any reason. This provision could result in our loss of the most recently completed fiscal quarterassets that our earnings are dependent upon or may cause us to sell assets prior to the dateour recovery of termination.lost value. These provisions may increase the effective cost to us of terminating the advisory agreement,RiverBanc Management Agreement, thereby adversely affecting our ability to terminate HCSRiverBanc without cause.
Pursuant to the Midway Management Agreement, we are not permitted to terminate our agreement with Midway prior to the end of the initial term, and while we have agreed with Midway that we could suspend additional capital contributions to Midway in the event we experience a 20% decline in cumulative return on our invested capital in assets managed by Midway during any calendar year in the initial term, we do not have the right to cause Midway to liquidate the assets in that account. In the event we determine to terminate the Midway Management Agreement at any time in the future following expiration of the initial term, Midway has the right to liquidate the assets it manages on our behalf in its sole discretion. Moreover, as discussed above, there are certain restrictions on our ability to redeem invested capital under the Midway Management Agreement. As a result, we may have little control over the liquidation of any of our assets that are managed by Midway or the timing of the full redemption of our invested capital, which may make it more difficult to terminate our agreement with Midway and could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to an Investment in Our Capital Stock
The market price and trading volume of our common stock may be volatile.
The market price of our common stock is highly volatile and subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Some of the factors that could result in fluctuations in the price or trading volume of our common stock include, among other things: actual or anticipated changes in our current or future financial performance; changes in market interest rates and general market and economic conditions. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly.
No active trading market for the Series A Preferred Stock currently exists and one may not develop in the future.
The shares of Series A Preferred Stock were issued in a private placement transaction pursuant to Section 4(2) of the Securities Act of 1933, as amended, and are not listed on the NASDAQ Capital Market or any other market. Furthermore, even if the Series A Preferred Stock is accepted for listing on the NASDAQ Capital Market or another securities exchange, an active trading market may not develop and the market price of the Series A Preferred Stock may be volatile. As a result, an investor in our Series A Preferred Stock may be unable to sell his/her shares of Series A Preferred Stock at a price equal to or greater than that which the investor paid, if at all.
We have not established a minimum dividend payment level for our common stockholders and there are no assurances of our ability to pay dividends to common or preferred stockholders in the future.
We intend to pay quarterly dividends and to make distributions to our common stockholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. This, along with other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code of 1986, as amended, or Internal Revenue Code. We have not established a minimum dividend payment level for our common stockholders and our ability to pay dividends may be harmed by the risk factors described herein. From July 2007 until April 2008, our Board of Directors elected to suspend the payment of quarterly dividends on our common stock. Our Board’sBoard’s decision reflected our focus on the elimination of operating losses through the sale of our mortgage lending business and the conservation of capital to build future earnings from our portfolio management operations. All distributions to our common stockholders will be made at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board of Directors may deem relevant from time to time. There are no assurances of our ability to pay dividends in the future.future at the current rate or at all.
In addition, in the event that we do not have legally available funds, or any of our financing agreements in the future restrict our ability, to pay cash dividends on shares of our Series A Preferred Stock, we will be unable to pay cash dividends on our Series A Preferred Stock, unless, in the case of restrictions imposed by our financing agreements, we can refinance amounts outstanding under those agreements. Although the dividends on our Series A Preferred Stock would continue to accrue, we may pay dividends on shares of our Series A Preferred Stock only if we have legally available funds for such payment.
Upon conversion of our Series A Preferred Stock, we will be required to issue shares of common stock to holders of our Series A Preferred Stock, which will dilute the holders of our outstanding common stock. Our outstanding shares of Series A Preferred Stock are senior to our common stock for purposes of dividend and liquidation distributions and have voting rights equal to those of our common stock.
On January 18, 2008, we completed the issuance and sale of 1.0 million shares of Series A Preferred Stock to the JMP Group for an aggregate purchase price of $20.0 million. The Series A Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. Holders of our Series A Preferred Stock have dividend and liquidating distribution preferences over holders of our common stock, which may negatively affect a Series A Preferred Stockholder’s ability to receive dividends or liquidating distributions on his or her shares. The Series A Preferred Stock also has voting rights equal to the voting rights attached to our common stock, except that each share of Series A Preferred Stock is entitled to a number of votes equal to the conversion rate for the Series A Preferred Stock.
The shares of Series A Preferred Stock are convertible into shares of our common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. Upon conversion of the Series A Preferred Stock, we will issue common stock to the holders of our Series A Preferred Stock, which will dilute the holders of our outstanding common stock.
The Series A Preferred Stock represents approximately 21% of our outstanding capital stock, on a fully diluted basis, as of March 1, 2009. Therefore, the holders of our Series A Preferred Stock have voting control over us.
The Series A Preferred Stock represents approximately 21% of our outstanding capital stock, on a fully diluted basis, as of March 1, 2009. The Series A Preferred Stock also has voting rights equal to the voting rights attached to our common stock, except that each share of Series A Preferred Stock is entitled to a number of votes equal to the conversion rate. Therefore, the holders of our Series A Preferred Stock have voting control over us, which may limit your ability to effect corporate change through the shareholder voting process.
Future offerings of debt securities, which would rank senior to our common stock and preferred stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings of equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our preferred stock and common stock, with holders of our preferred stock having priority over holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our Series A Preferred Stock has a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock, and any preferred stock issued by us in the future could have similar terms. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
We may not be able to pay the redemption price of our Series A Preferred Stock on the redemption date.
We have an obligation to redeem any remaining outstanding shares of our Series A Preferred Stock on or about December 31, 2010, at a redemption price equal to 100% of the $20.00 per share liquidation preference, plus all accrued and unpaid dividends. We may be unable to finance the redemption on favorable terms, or at all. Consequently, we may not have sufficient cash to purchase the shares of our Series A Preferred Stock.
We may not issue preferred stock that is senior to the Series A Preferred Stock without the consent of the holders of 66 2/3% of the shares of Series A Preferred Stock, which limits the flexibility of our capital structure.
As long as the Series A Preferred Stock is outstanding, we may not issue preferred stock that is senior to the Series A Preferred Stock with respect to dividend or liquidation rights without the consent of the holders of 66 2/3% of the shares of Series A Preferred Stock. This limitation restricts the flexibility of our capital structure and may prevent us from issuing equity that would otherwise be in the best interests of our company and common stockholders.
Future sales of our common stock could have an adverse effect on our common stock price.
We cannot predict the effect, if any, of future sales of common stock, or the availability of shares for future sales, on the market price of our common stock. For example, upon conversion of our Series A Preferred Stock, we will be required to issue shares of our common stock to holders of our Series A Preferred Stock, which will increase the number of shares available for sale and dilute existing holders of our common stock. Sales of substantial amounts of common stock, or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.
Risks Related to Our Company, Structure and Change in Control Provisions
Our directors have approved broad investment guidelines for us and do not approve each investment we make.
Our Board of Directors has given us substantial discretionexternal managers are generally authorized to invest in accordance with ourfollow broad investment guidelines. Our Boardguidelines in determining which assets we will invest in. Although our board of Directors periodically reviewsdirectors will ultimately determine when and how much capital to allocate to our investment guidelines and our portfolio. However, our Boardstrategies, we generally will not, with certain exceptions, approve transactions in advance of Directors does not review each proposed investment.their execution by these managers. In addition, in conducting periodic reviews, our directorswe will rely primarily on information provided to themus by our executive officersexternal managers. Complicating matters further, our external managers may use complex investment strategies and HCS. Furthermore, transactions, entered into by uswhich may be difficult or impossible to unwind by the time they are reviewed byunwind. As a result, because our directors. Our management and HCSexternal managers have substantial discretion within our broad investment guidelines in determininggreat latitude to determine the types of assets weit may decide are proper investments for us.us, there can be no assurance that we would otherwise approve of these investments individually or that they will be successful.
We are dependent on certain key personnel.
We are a small company with only three full-time employees and are dependent upon the efforts of certain key individuals, including James J. Fowler, the Chairman of our Board of Directors, and Steven R. Mumma, our Chief Executive Officer and President, Steven R. Mumma, and Chief Financial Officer.certain key individuals employed by our external managers. The loss of any key personnel or their services could have an adverse effect on our operations.
Our Chief Executive Officer has an agreement with us that provides him with benefits in the event his employment is terminated following a change in control.
We have entered into an agreement with our Chief Executive Officer, Steven R. Mumma, that provides him with severance benefits if his employment ends under specified circumstances following a change in control. These benefits could increase the cost to a potential acquirer of us and thereby prevent or discourage a change in control that might involve a premium price for your shares or otherwise be in your best interest.
The stock ownership limit imposed by our charter may inhibit market activity in our common stock and may restrict our business combination opportunities.
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of the issued and outstanding shares of our capital stock may be owned, actually or constructively, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year (other than our first year as a REIT). This test is known as the “5/50 test.” Attribution rules in the Internal Revenue Code apply to determine if any individual or entity actually or constructively owns our capital stock for purposes of this requirement. Additionally, at least 100 persons must beneficially own our capital stock during at least 335 days of each taxable year (other than our first year as a REIT). To help ensure that we meet these tests, our charter restricts the acquisition and ownership of shares of our capital stock. Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and provides that, unless exempted by our Board of Directors, no person may own more than 9.9%5.0% in value of the outstanding shares of our capital stock. The ownership limit contained in our charter could delay or prevent a transaction or a change in control of our company under circumstances that otherwise could provide our stockholders with the opportunity to realize a premium over the then current market price for our common stock or would otherwise be in the best interests of our stockholders.
Our Board of Directors may grant an exemption from that ownership limit in its sole discretion, subject to such conditions, representations and undertakings as it may determine. In November 2008, our Board of Directors granted an exemption from the ownership limit to permit Joseph A. Jolson, the Chairman and Chief Executive Officer of JMP Group, Inc., to beneficially own up to 25% of the aggregate value of our outstanding capital stock. Because all other individuals who own our stock are permitted to own up to 9.9% in value of the outstanding shares of our capital stock, it is possible that four other individuals acquired between November 2008 and December 31, 2008, or could acquire during the last half of a taxable year, a sufficient amount of our stock to cause us to violate the 5/50 rule. In connection with the ownership waiver granted by us to Mr. Jolson, we intend to submit a proposal to our stockholders to amend our charter to reduce the 9.9% ownership limit to a percentage that will allow us to satisfy the 5/50 test with no uncertainty while also accommodating the exemption applicable to Mr. Jolson. Although we believe that we satisfy and will continue to satisfy the 5/50 test, there can be no assurance that our stockholders will approve an amendment to the charter reducing the 9.9% ownership limit prior to July 1, 2009 or that, absent such approval, we will continue to satisfy the 5/50 test on and after July 1, 2009.
Certain provisions of Maryland law and our charter and bylaws could hinder, delay or prevent a change in control which could have an adverse effect on the value of our securities.
Certain provisions of Maryland law, our charter and our bylaws may have the effect of delaying, deferring or preventing transactions that involve an actual or threatened change in control. These provisions include the following, among others:
| · | our charter provides that, subject to the rights of one or more classes or series of preferred stock to elect one or more directors, a director may be removed with or without cause only by the affirmative vote of holders of at least two-thirds of all votes entitled to be cast by our stockholders generally in the election of directors; |
| · | our bylaws provide that only our Board of Directors shall have the authority to amend our bylaws; |
| · | · | under our charter, our Board of Directors has authority to issue preferred stock from time to time, in one or more series and to establish the terms, preferences and rights of any such series, all without the approval of our stockholders; |
| · | the Maryland Business Combination Act; and |
| · | the Maryland Control Share Acquisition Act. |
Although our Board of Directors has adopted a resolution exempting us from application of the Maryland Business Combination Act and our bylaws provide that we are not subject to the Maryland Control Share Acquisition Act, our Board of Directors may elect to make the “business combination” statute and “control share” statute applicable to us at any time and may do so without stockholder approval.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
We have conducted and intend to continue to conduct our operations so as not to become regulated as an investment company under the Investment Company Act. We believe that there are a number of exemptionsexclusions under the Investment Company Act that are applicable to us. To maintain the exemption,exclusion, the assets that we acquire are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the Investment Company Act. In addition,On August 31, 2011, the SEC published a concept release entitled “Companies Engaged in the Business of Acquiring Mortgages and Mortgage Related Instruments” (Investment Company Act Rel. No. 29778). This release suggests that the SEC may modify the exemption relied upon by companies similar to us that invest in mortgage loans and mortgage-backed securities. If the SEC acts to narrow the availability of, or if we otherwise fail to qualify for, our exclusion, we could, among other things, be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could have ana material adverse effect on our operations and the market price forof our securities.common stock.
Tax Risks Related to Our Structure
Failure to qualify as a REIT would adversely affect our operations and ability to make distributions.
We have operated and intend to continue to operate so to qualify as a REIT for federal income tax purposes. Our continued qualification as a REIT will depend on our ability to meet various requirements concerning, among other things, the ownership of our outstanding stock, the nature of our assets, the sources of our income, and the amount of our distributions to our stockholders. In order to satisfy these requirements, we might have to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our investment performance. Moreover, while we intend to continue to operate so to qualify as a REIT for federal income tax purposes, given the highly complex nature of the rules governing REITs, there can be no assurance that we will so qualify in any taxable year.
If we fail to qualify as a REIT in any taxable year and we do not qualify for certain statutory relief provisions, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. We might be required to borrow funds or liquidate some investments in order to pay the applicable tax. Our payment of income tax would reduce our net earnings available for investment or distribution to stockholders. Furthermore, if we fail to qualify as a REIT and do not qualify for certain statutory relief provisions, we would no longer be required to make distributions to stockholders. Unless our failure to qualify as a REIT were excused under the federal income tax laws, we generally would be disqualified from treatment as a REIT for the four taxable years following the year in which we lost our REIT status.
REIT distribution requirements could adversely affect our liquidity.
In order to qualify as a REIT, we generally are required each year to distribute to our stockholders at least 90% of our REIT taxable income, excluding any net capital gain. To the extent that we distribute at least 90%, but less than 100% of our REIT taxable income, we will be subject to corporate income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of (i) 85% of our ordinary REIT income for that year, (ii) 95% of our REIT capital gain net income for that year, and (iii) 100% of our undistributed REIT taxable income from prior years.
We have made and intend to continue to make distributions to our stockholders to comply with the 90% distribution requirement and to avoid corporate income tax and the nondeductible excise tax. However, differences in timing between the recognition of REIT taxable income and the actual receipt of cash could require us to sell assets or to borrow funds on a short-term basis to meet the 90% distribution requirement and to avoid corporate income tax and the nondeductible excise tax.
Certain of our assets may generate substantial mismatches between REIT taxable income and available cash. Such assets could include mortgage-backed securities we hold that have been issued at a discount and require the accrual of taxable income in advance of the receipt of cash. As a result, our taxable income may exceed our cash available for distribution and the requirement to distribute a substantial portion of our net taxable income could cause us to:
| | · | sell assets in adverse market conditions, |
| | · | borrow on unfavorable terms or |
| | · | distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt in order to comply with the REIT distribution requirements. |
Further, our lenders could require us to enter into negative covenants, including restrictions on our ability to distribute funds or to employ leverage, which could inhibit our ability to satisfy the 90% distribution requirement.
Dividends payable by REITs do not qualify for the reduced tax rates on dividend income from regular corporations.
The maximum U.S. federal income tax rate for dividends payable to domestic shareholders that are individuals, trust and estates is 15% (through 2008)2012). Dividends payable by REITs, however, are generally not eligible for the reduced rates. Although the reduced U.S. federal income tax rate applicable to dividend income from regular corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rate applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common shares.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code substantially limit our ability to hedge the RMBS in our investment portfolio. Our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques or implement those hedges through a TRS. Any hedging income earned by a TRS would be subject to federal, state and local income tax at regular corporate rates. This could increase the cost of our hedging activities or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear.
A decline in the value of the real estate securing the mortgage loans that back RMBS could cause a portion of our income from such securities to be nonqualifying income for purposes of the REIT 75% gross income test, which could cause us to fail to qualify as a REIT.
Pools of mortgage loans back the RMBS that we hold in our investment portfolio and in which we invest. In general, the interest income from a mortgage loan is qualifying income for purposes of the 75% gross income test applicable to REITs to the extent that the mortgage loan is secured by real property. If a mortgage loan has a loan-to-value ratio greater than 100%, however, then only a proportionate part of the interest income is qualifying income for purposes of the 75% gross income test and only a proportionate part of the value of the loan is treated as a “real estate asset” for purposes of the 75% asset test applicable to REITs. This loan-to-value ratio is generally measured at the time that the REIT commits to acquire the loan. Although the IRS has ruled generally that the interest income from non-collateralized mortgage obligation (“CMO”)non-CMO RMBS is qualifying income for purposes of the 75% gross income test, it is not entirely clear how this guidance would apply if we purchase non-CMO RMBS in the secondary market at a time when the loan-to-value ratio of one or more of the mortgage loans backing the non-CMO RMBS is greater than 100%, and, accordingly, a portion of any income from such non-CMO RMBS may be treated as non-qualifying income for purposes of the 75% gross income test. In addition, that guidance does not apply to CMO RMBS. In the case of CMO MBS,RMBS, if less than 95% of the assets of the issuer of the CMO RMBS constitute “real estate assets,” then only a proportionate part of our income derived from the CMO RMBS will qualify for purposes of the 75% gross income test. Although the law is not clear, the IRS may take the position that the determination of the loan-to-value ratio for mortgage loans that back CMO RMBS is to be made on a quarterly basis. A decline in the value of the real estate securing the mortgage loans that back our CMO RMBS could cause a portion of the interest income from those RMBS to be treated as non-qualifying income for purposes of the 75% gross income test. If such non-qualifying income caused us to fail the 75% gross income test and we did not qualify for certain statutory relief provisions, we would fail to qualify as a REIT.
Our ability to invest in and dispose of “to be announced” securities could be limited by our REIT status, and we could lose our REIT status as a result of these investments.
Until such time as we seek and receive a favorable private letter ruling from the IRS, or we are advised by counsel that TBAs should be treated as qualifying assets for purposes of the 75% asset test, we will limit our investment in TBAs and any non-qualifying assets to no more than 25% of our assets at the end of any calendar quarter. Further, until such time as we seek and receive a favorable private letter ruling from the IRS or we are advised by counsel that income and gains from the disposition of TBAs should be treated as qualifying income for purposes of the 75% gross income test, we will limit our gains from dispositions of TBAs and any non-qualifying income to no more than 25% of our gross income for each calendar year. Accordingly, our ability to purchase Agency RMBS through TBAs and to dispose of TBAs, through dollar roll transactions or otherwise, could be limited.
Moreover, even if we are advised by counsel that TBAs should be treated as qualifying assets or that income and gains from dispositions of TBAs should be treated as qualifying income, it is possible that the IRS could successfully take the position that such assets are not qualifying assets and such income is not qualifying income. In that event, we could be subject to a penalty tax or we could fail to qualify as a REIT if (i) the value of our TBAs, together with our non-qualifying assets for the 75% asset test, exceeded 25% of our gross assets at the end of any calendar quarter or (ii) our income and gains from the disposition of TBAs, together with our non-qualifying income for the 75% gross income test, exceeded 25% of our gross income for any taxable year.
None.
Other than real estate owned, acquired through, or in lieu of, foreclosures on mortgage loans, the Company does not own any properties. As of December 31, 2008,2011, our principal executive and administrative offices are located in leased space at 52 Vanderbilt Avenue, Suite 403, New York, New York 1001710017.
The Company isWe are at times subject to various legal proceedings arising in the ordinary course of our business. As of the date of this report, the Company doeswe do not believe that any of itsour current legal proceedings, individually or in the aggregate, will have a material adverse effect on itsour operations, financial condition or cash flows.
On December 13, 2006, Steven B. Yang and Christopher Daubiere (the “Plaintiffs”), filed suit in the United States District Court for the Southern District of New York against HC and the Company, alleging that HC failed to pay them, and similarly situated employees, overtime in violation of the Fair Labor Standards Act (“FLSA”) and New York State law. The Plaintiffs, each of whom were former employees in the Company's discontinued mortgage lending business, purported to bring a FLSA “collective action” on behalf of similarly situated loan officers of HC and sought unspecified amounts for alleged unpaid overtime wages, liquidated damages, attorney’s fees and costs.
On December 30, 2007, the Company entered into an agreement in principle with the Plaintiffs to settle this suit and on June 2, 2008, the court granted preliminary approval of the settlement. Upon completion of a fairness hearing on September 18, 2008, the court certified the class and approved the settlement, excluding Plaintiffs' counsel's application for attorney fees, which remained subject to final approval by the court. As part of the preliminary settlement, the Company funded the settlement in the amount of $1.35 million into an escrow account for the Plaintiffs. Plaintiffs’ counsel's fee was determined by the court and final approval for distributions of the settlement amount and Plaintiffs’ counsel's fees was granted on November 7, 2008. The Company previously reserved and expensed this amount in the year ended December 31, 2007. In December 2008, amounts held in the escrow account were disbursed in satisfaction of the settlement amounts and fees owed to Plaintiffs’ counsel, thereby resulting in the termination of this suit.
NoneNot applicable.
PART II
Market Price of and Dividends on the Registrant’s Common Equity and Related Stockholder Matters
Our common stock is traded on the NASDAQ Capital Market under the trading symbol “NYMT”. As of December 31, 2008,2011, we had 9,320,09413,938,273 shares of common stock outstanding and as of March 1, 2009,8, 2012, there were approximately 3868 holders of record of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name. We completed a one-for-two reverse stock split of our common stock in May 2008, which provided stockholders of record as of May 29, 2008 with one share of common stock for every two shares owned. In October 2007, we completed a one-for-five reverse stock split of our common stock, which provided stockholders of record as of October 9, 2007 with one share of common stock for every five shares owned.
The following table sets forth, for the periods indicated, the high, low and quarter end closing sales prices per share of our common stock and the cash dividends paid or payable on our common stock on a per share basis.
| | Common Stock Prices | | | Cash Dividends | |
| | | | | | | | | | | | | | | |
| | High | | Low | | Close | | | Declared | | | Paid or Payable | | Amount Per Share | |
| Year Ended December 31, 2011 | | | | | | | | | | | | | | |
| Fourth quarter | | $ | 7.36 | | | $ | 6.22 | | | $ | 7.21 | | | | 12/15/11 | | | | 01/25/12 | | | $ | 0.35 | |
| Third quarter | | | 7.50 | | | | 6.59 | | | | 6.97 | | | 09/20/11 | | | 10/25/11 | | | | 0.25 | |
| Second quarter | | | 7.93 | | | | 6.49 | | | | 7.45 | | | 05/31/11 | | | 06/27/11 | | | | 0.22 | |
| First quarter | | | 7.43 | | | | 6.88 | | | | 7.07 | | | 03/18/11 | | | 04/26/11 | | | | 0.18 | |
| | Common Stock Prices | | | Cash Dividends | |
| | | | | | |
| | High | | Low | | Close | | | Declared | | | Paid or Payable | | Amount Per Share | |
| Year Ended December 31, 2010 | | | | | | | | | | | | | | |
| Fourth quarter | | $ | 6.96 | | | $ | 6.23 | | | $ | 6.96 | | | | 12/20/10 | | | | 01/25/11 | | | $ | 0.18 | |
| Third quarter | | | 6.52 | | | | 5.68 | | | | 6.26 | | | 10/04/10 | | | 10/25/10 | | | | 0.18 | |
| Second quarter | | | 7.77 | | | | 6.51 | | | | 6.62 | | | 06/16/10 | | | 07/26/10 | | | | 0.18 | |
| First quarter | | | 8.03 | | | | 6.54 | | | | 7.55 | | | 03/16/10 | | | 04/26/10 | | | | 0.25 | |
We intend to continue to pay quarterly dividends to holders of shares of common stock. All stock prices and dividends set forth immediately below reflect the Company’s reverse stock splits as if they had occurred on January 1, 2007. The data below has been sourced from http://www.bloomberg.com.
| | | Common Stock Prices (1) | | Cash Dividends | |
| | | High | | | Low | | | Close | | Declared | | Paid or Payable | | Amount per Share | |
| Year Ended December 31, 2008 | | | | | | | | | | | | | | | |
| Fourth quarter | | $ | 4.37 | | | $ | 1.51 | | | $ | 2.20 | | 12/23/08 | | 01/26/09 | | $ | 0.10 | |
| Third quarter | | | 5.99 | | | | 2.50 | | | | 3.17 | | 09/29/08 | | 10/27/08 | | | 0.16 | |
| Second quarter | | | 6.24 | | | | 4.00 | | | | 6.20 | | 06/30/08 | | 7/25/08 | | | 0.16 | |
| First quarter | | | 9.80 | | | | 4.40 | | | | 5.40 | | 04/21/08 | | 05/15/08 | | | 0.12 | |
| | | Common Stock Prices (2) | | Cash Dividends | |
| | | High | | | Low | | | Close | | Declared | | Paid or Payable | | | Amount per Share | |
| Year Ended December 31, 2007 | | | | | | | | | | | | | | | | |
| Fourth quarter | | $ | 10.00 | | | $ | 6.02 | | | $ | 8.60 | | | | | | | | |
| Third quarter | | | 19.26 | | | | 3.10 | | | | 8.40 | | | | | | | | |
| Second quarter | | | 29.60 | | | | 17.70 | | | | 19.10 | | | | | | | | |
| First quarter | | | 33.90 | | | | 23.40 | | | | 25.40 | | 3/14/07 | | 4/26/07 | | $ | 0.50 | |
| (1)
| Our common stock was reported on the OTCBB from January 1, 2008 through June 4, 2008. Our common stock has been listed on the NASDAQ since June 5, 2008.
|
| (2)
| Our common stock was listed on the NYSE from the date of our IPO until September 11, 2007, at which time our common stock was delisted from the NYSE. Our common stock was reported on the OTCBB beginning on September 11, 2007.
|
During 2008, dividend distributions for the Company’s common stock were $0.44 per share (as adjusted for the reverse stock splits). As of December 31, 2008, the Company’s common stock trades under the ticker symbol NYMT and was listed under CUSIP Nos. 649604501 and 649604600. For tax reporting purposes, 2008 taxable dividendFuture distributions will be classifiedat the discretion of the Board of Directors and will depend on our earnings and financial condition, maintenance of our REIT qualification, restrictions on making distributions under Maryland law and such other factors as follows: $0.2597 as ordinary income and $0.1803 as a returnour Board of capital. The following table contains this information on a quarterly basis.
| Declaration Date | | Record Date | | Payment Date | | Cash Distribution per share | | | Income Dividends | | | Short-term Capital Gain | | | Total Taxable Ordinary Dividend | | | Return of Capital | |
| | | | | | | | | | | | | | | | | | | | |
| 04/21/08 | | 04/30/08 | | 05/15/08 | | $ | 0.1200 | | | $ | 0.0941 | | | $ | 0.0000 | | | $ | 0.0941 | | | $ | 0.0259 | |
| 06/30/08 | | 07/10/08 | | 07/25/08 | | $ | 0.1600 | | | $ | 0.1600 | | | $ | 0.0000 | | | $ | 0.1600 | | | $ | 0.0000 | |
| 09/29/08 | | 10/10/08 | | 10/27/08 | | $ | 0.1600 | | | $ | 0.0056 | | | $ | 0.0000 | | | $ | 0.0056 | | | $ | 0.1544 | |
| Total 2008 Cash Distributions | | $ | 0.4400 | | | $ | 0.2597 | | | $ | 0.0000 | | | $ | 0.2597 | | | $ | 0.1803 | |
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The Company currently has a share repurchase program, which it previously announced in November 2005. At management’s discretion, the Company is authorized to repurchase shares of Company common stock in the open market or through privately negotiated transactions through December 31, 2015. The plan may be temporarily or permanently suspended or discontinued at any time. The Company has not repurchased any shares since March 2006.2006 and currently has no intention to recommence repurchases in the near-future.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of December 31, 20082011 with respect to compensation plans under which equity securities of the Company are authorized for issuance. The Company has no such plans that were not approved by security holders.
Plan Category
| Number of Securities to
be Issued upon Exercise
of Outstanding Options,
Warrants and Rights
| | Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
| | Number of Securities
Remaining Available for
Future Issuance under
Equity
Compensation Plans
|
Equity compensation plans approved by security holders | — | | $ | — | | 103,111 |
Plan Category | | Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights | | | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | | | Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans | |
| Equity compensation plans approved by security holders | | | — | | | $ | — | | | $ | 1,154,992 | |
Performance Graph
The following line graph sets forth, for the period from June 23, 2004, the date of our IPO, through December 31, 2008, a comparison of the percentage change in the cumulative total stockholder return on the Company's common stock compared to the cumulative total return of the NYSE Composite Index and the National Association of Real Estate Investment Trusts ("NAREIT") Mortgage REIT Index. The graph assumes that the value of the investment in the Company's common stock and each of the indices was $100 as of June 23, 2004.
*$100 invested on 6/24/04 in stock & index-including reinvestment of dividends.
Fiscal year ended December 31.
The foregoing graph and chart shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent we specifically incorporate this information by reference, and shall not otherwise be deemed filed under those acts.
Item 6.SELECTED FINANCIAL DATA
The following selected consolidated financial data is derived from our audited consolidated financial statementsWe are a smaller reporting company and, the notes thereto for the periods presented and should be read in conjunction with the more detailed information therein and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report. Operating resultstherefore, are not necessarily indicative of future performance.
| | | As of and For the Year Ended December 31, | |
| (Dollar amounts in thousands, except per Share Amounts) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| Operating Data: | | | | | | | | | | | | | | | |
| Revenues: | | | | | | | | | | | | | | | |
| Interest income | | $ | 44,123 | | | $ | 50,564 | | | $ | 64,881 | | | $ | 62,725 | | | $ | 20,394 | |
| Interest expense | | | 36,260 | | | | 50,087 | | | | 60,097 | | | | 49,852 | | | | 12,470 | |
| Net Interest Income | | | 7,863 | | | | 477 | | | | 4,784 | | | | 12,873 | | | | 7,924 | |
| Provision for loan losses | | | (1,462 | ) | | | (1,683 | ) | | | (57 | ) | | | — | | | | — | |
| (Loss) gain on sale of securities and related hedges | | | (19,977 | ) | | | (8,350 | ) | | | (529 | ) | | | 2,207 | | | | 167 | |
| Impairment loss on investment securities | | | (5,278 | ) | | | (8,480 | ) | | | — | | | | (7,440 | ) | | | — | |
| Total other expense | | | (26,717 | ) | | | (18,513 | ) | | | (586 | ) | | | (5,233 | ) | | | 167 | |
| Expenses: | | | | | | | | | | | | | | | | | | | | |
| Salaries and benefits | | | 1,869 | | | | 865 | | | | 714 | | | | 1,934 | | | | 382 | |
| General and administrative expenses | | | 5,041 | | | | 1,889 | | | | 1,318 | | | | 2,384 | | | | 810 | |
| Total expenses | | | 6,910 | | | | 2,754 | | | | 2,032 | | | | 4,318 | | | | 1,192 | |
| (Loss) income from continuing operations | | | (25,764 | ) | | | (20,790 | ) | | | 2,166 | | | | 3,322 | | | | 6,899 | |
| Income (loss) discontinued operations – net of tax (1) | | | 1,657 | | | | (34,478 | ) | | | (17,197 | ) | | | (8,662 | ) | | | (1,952 | ) |
| Net (loss) income (2) | | $ | (24,107 | ) | | $ | (55,268 | ) | | $ | (15,031 | ) | | $ | (5,340 | ) | | $ | 4,947 | |
| Basic and diluted (loss) income per common share from continuing operations | | $ | (3.11 | ) | | $ | (11.46 | ) | | $ | 1.20 | | | $ | 1.85 | | | $ | 3.85 | |
| Basic and diluted income (loss) per common share from discontinued operations | | $ | 0.20 | | | $ | (19.01 | ) | | $ | (9.53 | ) | | $ | (4.81 | ) | | $ | (1.09 | ) |
| Basic and diluted (loss) income per common share | | $ | (2.91 | ) | | $ | (30.47 | ) | | $ | (8.33 | ) | | $ | (2.96 | ) | | $ | 2.76 | |
| Dividends per common share | | $ | 0.54 | | | $ | 0.50 | | | $ | 4.70 | | | $ | 9.20 | | | $ | 4.00 | |
| Balance Sheet Data: | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 9,387 | | | $ | 5,508 | | | $ | 969 | | | $ | 9,056 | | | $ | 7,613 | |
| Investment securities available for sale | | | 477,416 | | | | 350,484 | | | | 488,962 | | | | 716,482 | | | | 1,204,745 | |
| Mortgage loans held in securitization trusts or held for investment (net) | | | 348,337 | | | | 430,715 | | | | 588,160 | | | | 780,670 | | | | 190,153 | |
| Assets related to discontinued operations | | | 5,854 | | | | 8,876 | | | | 212,805 | | | | 248,871 | | | | 201,034 | |
| Total assets | | | 853,300 | | | | 808,606 | | | | 1,321,979 | | | | 1,789,943 | | | | 1,614,762 | |
| Financing arrangements | | | 402,329 | | | | 315,714 | | | | 815,313 | | | | 1,166,499 | | | | 1,115,809 | |
| Collateralized debt obligations | | | 335,646 | | | | 417,027 | | | | 197,447 | | | | 228,226 | | | | — | |
| Subordinated debentures | | | 44,618 | | | | 44,345 | | | | 44,071 | | | | 43,650 | | | | — | |
| Convertible preferred debentures | | | 19,702 | | | | — | | | | — | | | | — | | | | — | |
| Liabilities related to discontinued operations | | | 3,566 | | | | 5,833 | | | | 187,705 | | | | 231,925 | | | | 189,095 | |
| Total liabilities | | | 814,052 | | | | 790,188 | | | | 1,250,407 | | | | 1,688,985 | | | | 1,495,280 | |
| Total stockholders’ equity | | $ | 39,248 | | | $ | 18,418 | | | $ | 71,572 | | | $ | 100,958 | | | $ | 119,482 | |
| (1) | In connection with the sale of the Company's wholesale mortgage origination platform assets on February 22, 2007 and the sale of its retail mortgage origination platform assets on March 31, 2007, the Company is required to classify its mortgage lending business as a discontinued operations in accordance with Statement of Financial Accounting Standards No. 144 (see note 8 in the notes to our consolidated financial statements). |
| (2) | The selected financial data as of and for the years ended December 31, 2008, December 31, 2007, December 31, 2006 and December 31, 2005, include the operations of NYMT and its consolidated subsidiaries. Included in the selected financial data for the year ended December 31, 2004 are the results of NYMT for the period beginning June 29, 2004 (the closing date of our IPO) and HC for the period January 1, 2004 to June 29, 2004. |
Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
New York Mortgage Trust, Inc., together with its consolidated subsidiaries (“NYMT”,We are a REIT in the “Company”, “we”, “our”,business of acquiring, investing in, financing and “us”), is a self-advised real estate investment trust, or REIT, that investsmanaging primarily in real estate-related assets, including residential adjustable-rate mortgage-backed securities, which includes collateralized mortgage obligation floating rate securities (“RMBS”), and prime credit quality residential adjustable-rate mortgage (“ARM”) loans (“prime ARM loans”),mortgage-related and, to a lesser extent, in certain alternative real estate-relatedfinancial assets. Our objective is to manage a portfolio of investments that will deliver stable distributions to our stockholders over diverse economic conditions. We intend to achieve this objective through a combination of net interest margin and financial assetsnet realized capital gains from our investment portfolio. Our portfolio includes investments sourced from distressed markets over the previous two years that present greatercreate the potential for capital gains as well as more traditional types of mortgage-related investments, such as Agency ARMs and Agency IOs, that generate interest income.
Since 2009, we have endeavored to build a diversified investment portfolio that includes elements of interest rate and credit risk, and lessas we believe a portfolio diversified among interest rate risk thanand credit risks are best suited to delivering stable cash flows over various economic cycles. In 2011, we refined our investment strategy from one focused on a broad range of alternative assets sourced by HCS to an investment strategy focused on residential and multi-family loans and securities. In connection with this focus, we entered into separate investment management agreements with Midway and RiverBanc to provide investment management services with respect to certain of our investment strategies, including our investments in Agency RMBS comprised of IOs, which we sometimes refer to as Agency IOs, and prime ARM loans. Our principal business objective is to generate net income for distribution to our stockholders resulting from the spread between the interest and other income we earnCMBS backed by commercial mortgage loans on our interest-earning assets and the interest expense we pay on the borrowings that we use to finance these assets,multi-family properties, which we refer to as our net interest income.
multi-family CMBS. Our investment strategy historically has focused on investments in RMBS issued or guaranteed by a U.S. government agency (such as the Government National Mortgage Association, or Ginnie Mae), or by a U.S. Government-sponsored entity (such as the Federal National Mortgage Association, or Fannie Mae, and the Federal Home Loan Mortgage Corporation, or Freddie Mac), prime ARM loans, and non-agency RMBS. We refer throughout this Annual Report on Form 10-K to RMBS issued by a U.S. government agency or U.S. Government-sponsored entity as “Agency RMBS”. Starting with the completion of our initial public offering in June 2004, we began building a leveraged investment portfolio comprised largely of RMBS purchased in the open market or through privately negotiated transactions, and prime ARM loans originated by us or purchased from third parties that we securitized and which are held in our securitization trusts. Since exiting the mortgage lending business on March 31, 2007, we have exclusively focused our resources and efforts on investing, on a leveraged basis, in RMBS and, since August 2007, we have employed a portfolio strategy that focuses on investments in Agency RMBS. We refer to our historic investment strategy throughout this Annual Report on Form 10-K as our “principal investment strategy.”
In January 2008, we formed a strategic relationship with JMP Group Inc., a full-service investment banking and asset management firm, and certain of its affiliates (collectively, the “JMP Group”), for the purpose of improving our capitalization and diversifying our investment strategyfocus having moved away from a strategy exclusively focused on investments in Agency RMBS, in part to achieve attractive risk-adjusted returns, and to potentially utilize all or part of a $64.0 million net operating loss carry-forward that resulted fromthe alternative assets sourced by HCS, our exit from the mortgage lending business in 2007. In connection with this strategic relationship, the JMP Group made a $20.0 million investment in our Series A Cumulative Convertible Redeemable Preferred Stock (the “Series A Preferred Stock)” in January 2008 and purchased approximately $4.5 million of our common stock in a private placement in February, 2008. In addition, in connection with the JMP Group’s strategic investment in us, James J. Fowler, a managing director of HCS (defined below), became our Non-Executive Chairman of the Board of Directors. As of December 31, 2008, JMP Group Inc. and its affiliates beneficially owned approximately 33.7% of our outstanding common stock. The 33.7% includes shares of Series A preferred stock which may be converted into common stock.
In an effortDirectors determined to diversify our investment strategy, we entered into anterminate the advisory agreement with Harvest Capital Strategies LLC (“HCS”), formerly knownHCS on December 30, 2011, resulting in a one-time charge of approximately $2.2 million.
We believe we are well positioned heading into 2012 with seasoned investment managers, a focused residential strategy and an investment pipeline that we expect will produce long-term stable returns. Our targeted assets currently include:
| · | Agency RMBS consisting of adjustable-rate and hybrid adjustable-rate RMBS, which we sometimes refer to as Agency ARMs, and Agency IOs; and |
We have elected to be taxed as JMP Asset Management LLC, concurrenta REIT and have complied, and intend to continue to comply, with the issuanceprovisions of our Series A Preferred Stockthe Internal Revenue Code, with respect thereto. Accordingly, we do not expect to the JMP Group, pursuantbe subject to which HCS will implement and manage our investments in alternative real estate-related and financial assets. Pursuant to the advisory agreement, HCS is responsible for managing investments made by two of our wholly-owned subsidiaries, Hypotheca Capital, LLC (“HC,” also formerly known as The New York Mortgage Company, LLC), and New York Mortgage Funding, LLC, as well as any additional subsidiaries acquired or formed in the future to hold investments madefederal income tax on our behalf by HCS. We refer to these subsidiaries in our periodic reports filed with the Securities and Exchange Commission (“SEC”) as the “Managed Subsidiaries.” Due to market conditions and other factors in 2008, including the significant disruptions in the credit markets,REIT taxable income that we elected to forgo making investments in alternative real estate-related and financial assets and instead, exclusively focused our resources and efforts on preserving capital and investing in Agency RMBS. However, we expect to begin the diversification of our investment strategy in 2009 by opportunistically investing in certain alternative real estate-related and financial assets, or equity interests therein, including, without limitation, certain non-Agency RMBS and other non-rated mortgage assets, commercial mortgage-backed securities, commercial real estate loans, collateralized loan obligations and other investments. We refer throughout this Annual Report on Form 10-Kcurrently distribute to our investment in alternative real estate-relatedstockholders if certain asset, income and financial assets, other than Agency RMBS, prime ARM loansownership tests and non-Agency RMBS thatrecordkeeping requirements are already held in our investment portfolio, as our “alternative investment strategy” and such assets as our “alternative assets.” Generally,fulfilled. Even if we expect that our investment in alternative assets will be made on a non-levered basis, will be conducted through the Managed Subsidiaries and will be managed by HCS. Currently, we have established for our alternative assets a targeted range of 5% to 10% of our total assets, subject to market conditions, credit requirements and the availability of appropriate market opportunities.
We expect to benefit from the JMP Group’s and HCS’ investment expertise, infrastructure, deal flow, extensive relationships in the financial community and financial and capital structuring skills. Moreover, as a result of the JMP Group’s and HCS’ investment expertise and knowledge of investment opportunities in multiple asset classes, we believe we have preferred access to a unique source of investment opportunities that may be in discounted or distressed positions, many of which may not be available to other companies that we compete with. We intend to be selective in our investments in alternative assets, seeking out co-investment opportunities with the JMP Group where available, conducting substantial due diligence on the alternative assets we seek to acquire and any loans underlying those assets, and limiting our exposure to losses by investing in alternative assets on a non-levered basis. By diversifying our investment strategy, we intend to construct an investment portfolio that, when combined with our current assets, will achieve attractive risk-adjusted returns and that is structured to allow us to maintain our qualification as a REIT, we expect to be subject to some federal, state and the requirements for exclusion from regulation under the Investment Company Act of 1940, as amended, or Investment Company Act.local taxes on our income generated in our TRSs.
Because we intend to continue to qualify as a REIT for federal income tax purposes and to operate our business so as to be exempt from regulation under the Investment Company Act, we will be required to invest a substantial majority of our assets in qualifying real estate assets, such as agency RMBS, mortgage loans and other liens on and interests in real estate. Therefore, the percentage of our assets we may invest in corporate investments and other types of instruments is limited, unless those investments comply with various federal income tax requirements for REIT qualification and the requirements for exclusion from Investment Company Act regulation.
Factors that Affect our Results of Operations and Financial Condition
Our results of operations and financial condition are affected by various factors, including, among other things:
| · | changes in interest rates; |
| · | rates of prepayment, default and defaultrecovery on our assets or the mortgages or loans that underlieunderlying such assets; assets; |
| · | general economic and financial and credit market conditions; conditions; |
| · | our leverage, our access to funding and our borrowing costs; |
| · | changes in the credit quality or ratings of the loans, securities, and other assets we own; |
| · | changes in the market value of our investments; |
| | |
| · | liabilities related to our discontinued operations, including repurchase obligations on the sales allocation of mortgage loans; and
capital between various asset classes; |
| · | liabilities related to our discontinued operation; |
| |
| · | the performance of our external managers; |
| |
| · | legislative or regulatory changes, as well as actions taken by the U.S. Federal Reserve and the U.S. Government; and |
| |
| · | requirements to maintain REIT status and to qualify for an exemption from registration under the Investment Company Act. |
We earn income and generate cash through our investments. Our income is generated primarily from the net spread, which we refer to as net interest income, which is the difference between the interest and other income we earn on assets in our investment portfolio and the cost of our borrowings and hedging activities. Our net interest income will vary based upon, among other things, the difference between the interest rates earned on our interest-earning assets and the borrowing costs of the liabilities used to finance those investments, prepayment speeds and default and recovery rates on the assets or the loans underlying such assets. Because changes in interest rates may significantly affect our activities, our operating results depend, in large part, upon our ability to manage interest rate risks and prepayment risks effectively while maintaining our status as a REIT.
We anticipate that, for any period during which changes in the interest rates earned on our assets do not coincide with interest rate changes on our borrowings, such assets will reprice more slowly than the corresponding liabilities. Consequently, changes in interest rates, particularly short-term interest rates, may significantly influence our net interest income. BecauseWith the maturities of our assets generally haveof longer termsduration than those of our liabilities, interest rate increases will tend to decrease ourthe net interest income we derive from, and the market value of our interest rate sensitive assets (and therefore our book value). Such rate increases could possibly result in operating losses or adversely affect our ability to make distributions to our stockholders.
The yield on our assets may be affected by a difference between the actual prepayment rates and our projections. Prepayment rates, as reflected by the rate of principal paydown, and interest rates vary according to the current interest rate environment, the type of investment, conditions in the economy and financial markets, government action, competition and other factors, none of which can be predicted with any certainty. To the extent we have acquired assets at a premium or discount to par, or face value, changes in prepayment rates may impact our anticipated yield. In periods of declining interest rates, prepayments on our mortgage-related assets will likely increase. If we are unable to reinvest the proceeds of such prepayments at comparable yields, our net interest income will be negatively impacted. The current climate of government intervention in the mortgage markets significantly increases the risk associated with prepayments.
While we historically have used, and intend to use in the future, hedging to mitigate some of our interest rate risk, we do not hedge all of our exposure to changes in interest rates, and prepayment rates, as there are practical limitations on our ability to insulate our portfolio from all potential negative consequences associated with changes in short-term interest rates in a manner that will allow us to seek or maintain attractive net spreads on our assets.
In addition, our returns will be affected by the credit performance and market risks of our non-agencymore credit-sensitive assets, such as our non-Agency RMBS, CMBS, equity investment in a pool of mortgage loans and CLOs. These investments and certain of our targeted assets, as well as other investments. Ifassets that we may acquire from time-to-time, expose us to credit risk and various market risks. To mitigate the credit risks associated with these assets, we may acquire more senior pieces of the capital structure, purchase the assets at discounted prices or hedge with credit sensitive derivative instruments. Nevertheless, if credit losses on our investments, loans, or the loans underlying our investments increase,exceed our expectations or our ability to adequately hedge against these losses, it may have an adverse effect on our performance.performance and our earnings.
As it relatesIn addition to loans sold previously under certain loan sale agreements bythe impact of credit risk, our discontinued mortgage lending business, wereturns may be required to repurchase some of those loans or indemnify the loan purchaser for damages causedimpacted by a breach of the loan sale agreement. Whilechanges in the past we complied with the repurchase demands by repurchasing the loan with cash and reselling it atmarket values of these assets. Market values of these investments may decline for a loss, thus reducing our cash position; more recently we have addressed these requests by negotiating a net cash settlement based on thenumber of reasons, such as actual or assumed loss onperceived increases in defaults or prepayment experience, or the loan in lieuwidening of repurchasingcredit spreads. If the loans. Asmarket values of December 31, 2008, the amount of repurchase requests outstanding was approximately $1.8 million, against which we had a reserve of approximately $0.4 million. We cannot assure you that we willour investments were to decline for any reason, our book value would likely be successful in settling the remaining repurchase demands on favorable terms, or at all. If we are unable to continue to resolve our current repurchase demands through negotiated net cash settlements, our liquidity could be adversely affected. In addition, we may be subject to new repurchase requests from investors with whom we have not settled or with respect to repurchase obligations not covered under the settlement.negatively impacted.
For more information regarding the factors and risks that affect our operations and performance, see “Item 1A. Risk Factors” above and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” below.
Current Market Conditions and Known Material Trends
General. The well publicized disruptions in the credit markets that began in 2007 escalated throughout 2008 and spread to the financial markets and the greater economy. During the year, global financial markets came under increased stress as problems in the U.S. real estate and residential mortgage market spread to the broader economy and the global financial sector. In addition, fears of a global recession increased and were exacerbated by further declines in the housing and credit markets in the U.S. and Europe, which heightened concerns over the creditworthiness of some financial institutions. As a result, most sectors of the financial markets experienced significant declines during the year, including international equity and credit markets, driven, in part, by deleveraging and difficulty pricing risk in the market that has been affecting investors all over the world.
In response, various initiatives by the U.S. Government have been implemented to address credit and liquidity issues. Among other things, in September 2008, Fannie Mae and Freddie Mac were placed under conservatorship by the FHFA and the U.S. Treasury Department (“the Treasury”) announced it would purchase senior preferred stock in Fannie Mae or Freddie Mac, if needed, to a maximum of $100.0 billion per company in order that each maintains a positive net worth. In October 2008, the U.S. Treasury created the “capital purchase program” as part of the $700.0 billion Troubled Asset Relief Program, allocating $350.0 billion to invest in U.S. financial institutions to help stabilize and strengthen the U.S. financial system. In November 2008, the Federal Reserve Bank of New York (“the Federal Reserve”) announced that it would buy up to $500.0 billion of Agency RMBS from Fannie Mae, Freddie Mac and Ginnie Mae, and in January 2009, the Federal Reserve began to purchase Agency RMBS in accordance with this initiative. In March 2009, the Federal Reserve announced that it was increasing its purchase commitment for Agency RMBS by up to an additional $750 billion. We believe that the stronger backing for the guarantors of Agency RMBS, resulting from the conservatorship of Fannie Mae and Freddie Mac and the U.S. Treasury’s commitment to purchase senior preferred stock in these companies has, and are expected to continue to, positively impact the value of our Agency RMBS. Although the U.S. government has committed capital to Fannie Mae and Freddie Mac, there can be no assurance that the credit facilities and other capital infusions will be adequate for their needs. If the financial support is inadequate, these companies could continue to suffer losses and could fail to honor their guarantees and other obligations.
On February 18, 2009, the President of the United States announced the Homeowner Affordability and Stability Plan, or HASP, which is intended to stabilize the housing market by providing relief to distressed homeowners in an effort to reduce or forestall home foreclosures. Among other things, the HASP is designed to (i) enable responsible homeowners to refinance in certain instances where their home value has fallen below the amount outstanding on the homeowner’s mortgage, (ii) address certain “at-risk” homeowners by providing cash incentives to lenders to refinance the homeowner’s mortgage to a lower interest rate and subsidizing in part a reduction in the outstanding mortgage principal, (iii) provide for an amendment of the bankruptcy laws to permit the modification of mortgage loans in bankruptcy proceedings and (iv) support lower mortgage interest rates by increasing the U.S. Treasury’s preferred stock investment in each of Fannie Mae and Freddie Mac to $200 billion, increasing the size of the companies’ retained mortgage portfolios to $900 billion each and reaffirming its commitment to continue purchasing Fannie Mae and Freddie Mac issued RMBS. This new U.S. government program, as well as future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may adversely affect the value of, and the returns on, the Agency RMBS in which we invest.
On March 23, 2009, the U.S. Treasury announced the creation of a public–private investment program designed to attract private capital to purchase eligible legacy loans from participating banks and eligible legacy securities in the secondary market through FDIC debt guarantees equity co-investment by the U.S. Treasury and government-supported term asset-backed loan facilities, as applicable.
The outcome of these events remain highly uncertain and we cannot predict whether or when such actions may occur or what impact, if any, such actions could have on our business, results of operations and financial condition.
Mortgage asset valuesCurrent Market Conditions and Commentar. Investors’ appetite fory
General. Despite some positive momentum and optimism in early 2011 with respect to an acceleration of the U.S. mortgage assets remained weak throughout 2008. Due to liquidations of large investment portfolios of mortgage assets in connection with forcedeconomic recovery, the economy and voluntary de-leveragingmarkets generally exhibited continued lackluster economic growth in the mortgage asset industryU.S. in March 2008, along with decreased2011 due to a lack of job growth and significant volatility in the financial markets, which was primarily due to concerns regarding Euro zone sovereign debt and the U.S. federal deficit and debt ceiling debates. It remains unclear what impact these events may have on the global economy in 2012. Additionally, despite recent labor reports from the U.S. Department of Labor that suggest that labor market conditions are improving and recent data suggesting the U.S. economic outlook is improving, inflation and wage pressure expectations remain low and the U.S. housing market continues to face significant headwinds. In August 2011 and again in November 2011, the Federal Reserve announced that it intends to keep the Federal Funds Target Rate near zero through mid-2014, thereby suggesting, in our view, that the Federal Reserve expects sluggish growth again in 2012. This environment has fostered continued strong demand for these assets among investors mortgage asset prices declined significantlyAgency RMBS backed by ARMs and fixed-rate mortgages while also helping to keep the costs of financing and hedging at or near historical lows.
On August 5, 2011, Standard & Poor’s lowered its long term sovereign credit rating of the U.S. from AAA to AA+. The downgrade reflected Standard & Poor’s view that the fiscal consolidation plan of the U.S. Congress at that time fell short of what would be necessary to stabilize the U.S. government’s medium term debt dynamics. In addition, many economists and financial analysts continue to believe that other rating agencies may lower their long term sovereign credit ratings of the U.S. in March 2008. Prices improved during the second quarter of 2008 asnear future. Because the guarantees provided by Fannie Mae and Freddie Mac increased buying of Agency securities for their portfolio. However, duringare perceived by investors to be guaranteed by the third quarter pricesU.S. government, if the U.S.’s credit rating were negatively impactedfurther downgraded or downgraded by events involvingother ratings agencies, it would likely impact the conservatorship of Fannie Mae and Freddie Mac and the bankruptcy of Lehman Brothers Holdings Inc. More recently, the Federal Reserve’s announcement on January 9, 2009 that it had begun to buycredit risk associated with Agency RMBS resulted in an increase inand, therefore, decrease the value of the Agency RMBS. We believe thatRMBS in our portfolio. Moreover, any further downgrade of the stronger backingU.S.’s credit rating may create broader financial turmoil and uncertainty, which could have significant consequences for the guarantors of Agency RMBS, resulting from the conservatorship of Fannie Maeglobal banking system and Freddie Mac, along with the U.S. Treasury’s commitment to purchase senior preferred stock in these companies and the Federal Reserve’s Agency RMBS purchase program has, and are expected to continue to, positively impact the value of our Agency RMBS.credit markets generally.
Financing marketsRecent Government Actions. Many political and liquidity - -economic analysts believe that there is little likelihood of any significant legislation being passed by the U.S. Congress prior to the 2012 presidential election, including meaningful deficit reduction legislation. In connection withrecent years, the U.S. Government and the Federal Reserve and other governmental regulatory bodies have, however, taken numerous actions to stabilize or improve market disruption of March 2008, many financial institutions withdrew or reduced financing and liquidity that they typically offered clients as part of their daily business operations. Significant eventseconomic conditions in the financial marketsU.S. or to assist homeowners and may in the second halffuture take additional significant actions that may impact our portfolio and our business. A description of 2008 caused further tightening of lending standardsrecent government actions that we believe are most relevant to our operations and reduced overall market liquidity. In March 2008, the market experienced extreme liquidity dislocations as a result of a major broker dealer failure and several large hedge fund liquidations. As a result of these events the secured borrowing terms changed significantly, increased haircuts along with reduced credit availability caused most leveraged investors to significantly reduce their portfolio leverage. The Company’s average haircut increased to approximately 8.8% at March 31, 2008 from 5.6% at December 31, 2007. As of December 31, 2008, the Company’s average haircut was 9.2%.business is included below:
Financing costs and interest rates - - The overall credit market deterioration since August 2007 has also affected prevailing interest rates. For example, interest rates have been unusually volatile since the third quarter of 2007. Since September 18, 2007, the U.S. Federal Reserve has lowered the target for the Federal Funds Rate from 5.25% to a range between 0% and 0.25%. Historically, the 30-day London Interbank Offered Rate, or LIBOR, has closely tracked movements in the Federal Funds Rate. Our funding costs under repurchase agreements have traditionally tracked 30 day LIBOR. The spread between LIBOR and the Fed Funds Rate was unusually volatile during 2008, but narrowed considerably toward the end of 2008. As of December 31, 2008, 30-day LIBOR was 0.44% while the Fed Funds Rate was 0.25%. Because of continued uncertainty in the credit markets and U.S. economic conditions, we expect that interest rates are likely to experience continued volatility. | · | On September 21, 2011, the U.S. Federal Reserve announced the maturity extension program where it intends to sell $400 billion of shorter-term U.S. Treasury securities by the end of June 2012 and use the proceeds to buy longer-term U.S. Treasury securities. This program is intended to extend the average maturity of the securities in the Federal Reserve’s portfolio. By reducing the supply of longer-term U.S. Treasury securities in the market, this action should put downward pressure on longer-term interest rates, including rates on financial assets that investors consider to be close substitutes for longer-term U.S. Treasury securities, like certain types of Agency RMBS. The reduction in longer-term interest rates, in turn, may contribute to a broad easing in financial market conditions that the Federal Reserve hopes will provide additional stimulus to support the economic recovery. |
Prepayment rates. As a result of various government initiatives, rates on conforming mortgages have declined, nearing historical lows. Hybrid and adjustable-rate mortgage originations have declined substantially, as rates on these types of mortgages are comparable with rates available on 30-year fixed-rate mortgages. While such significant decreases in mortgage rates would typically foster mortgage refinancing, such activity has not occurred. We believe that the decline in home values, increases in the jobless rate and the resulting deterioration in borrowers creditworthiness have limited refinance activity to date. The recent creation of the HASP is aimed to further assist homeowners in refinancing and to reduce potential foreclosures. Although we expect that the constant prepayment rate, or CPR, will trend upward during 2009 based on current market interest rates, future CPRs will be affected by the success of HASP and the timing and purpose of any future legislation, if any, and the resulting impact on borrowers’ ability to refinance, mortgage interest rates in the market and home values. | · | On October 24, 2011, the FHFA, along with Fannie Mae and Freddie Mac, announced several changes to be made to HARP. Among those changes to HARP that are now part of HARP II are (1) the reduction or elimination in certain cases, of many risk based fees charged to borrowers when refinancing, (2) the expansion of the previous 125% loan-to-value ceiling to allow all underwater borrowers (those borrowers who owe more on their mortgages than the value of their homes) to participate in the program, regardless of the size of their loan versus the value of their home and (3) the removal of certain representations and warranties made on behalf of lenders for loans owned or guaranteed by Fannie Mae or Freddie Mac, among other changes. These refinancing opportunities will only be available to borrowers with loans originated prior to June 1, 2009 that are owned or guaranteed by Fannie Mae or Freddie Mac and, aside from the expansion of HARP as described above, are subject to the restrictions originally put in place for the program. Although it is not yet possible to gauge the ultimate success of HARP II and the expansion announcement, the FHFA’s actions present the opportunity for many borrowers, who previously could not, to take advantage of the ability to refinance their mortgages into lower interest rates, possibly resulting in higher prepayment speeds in the future. This could negatively impact our Agency RMBS, particularly the performance of our Agency IOs; however, it is unknown at this time what the ultimate impact will be on our portfolio. Moreover, in his annual State of the Union Address on January 24, 2012, President Obama announced his desire for the U.S. Congress to pass legislation that would extend this policy to non-Agency borrowers with standard (non-Jumbo) loans who are current with their mortgage payments. However, as discussed above, many political analysts believe that such legislation is unlikely to be passed by the U.S. Congress prior to the 2012 presidential election. |
Significant Events | · | On August 31, 2011, the SEC published a concept release (No. IC-29778; File No. SW7-34-11, Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related Instruments) pursuant to which it is reviewing whether certain companies that invest in mortgage-backed securities and rely on the exemption from registration under Section 3(c)(5)(C) of the Investment Company Act should continue to be allowed to rely on such exemption from registration. This release suggests that the SEC may modify the exemption relied upon by companies similar to us that invest in mortgage loans and mortgage-backed securities. |
Developments at Fannie Mae and Freddie Mac. Payments on the Agency RMBS in 2008
Strategic Relationship Established With JMP Group Inc.which we invest are guaranteed by Fannie Mae and Freddie Mac. As broadly publicized, Fannie Mae and Freddie Mac have experienced significant losses in recent years, and are presently under federal conservatorship as the U.S. Government continues to evaluate the futures of these entities and what role the U.S. Government should continue to play in the housing markets in the future. The scope and nature of the actions that the U.S. Government will ultimately undertake with respect to the future of Fannie Mae and Freddie Mac are unknown and will continue to evolve. New regulations and programs related to Fannie Mae and Freddie Mac may adversely affect the pricing, supply, liquidity and value of RMBS and otherwise materially harm our business and operations.
On January 18, 2008, we issued 1.0 million sharesCredit Spreads. Over the past few years, the credit markets generally experienced tightening credit spreads (specifically, spreads between U.S. Treasury securities and other securities) mainly due to the strong demand for lending opportunities. However, during the past three months, the credit markets experienced significant spread widening due to a series of our Series A Preferred Stockfactors, including concerns related to JMP Group Inc.a possible global economic slowdown, the European sovereign debt crisis and continued concern with respect to certain of its affiliates for an aggregate purchase price of $20.0 million. Concurrent with our issuance of the Series A Preferred Stock, we entered into an advisory agreement with HCS, which is an affiliate of JMP Group Inc., to manage investments made by the Managed Subsidiaries. We expectU.S. domestic economic policies. Additionally, HARP II has created a perception that HCSprepayment speeds will assist us with the implementation of our alternative investment strategy, and once implemented, will manage our alternative investment strategy, as described more fully in Item 1 of this Annual Report on Form 10-K. In acting as our advisor, HCS will play a key rolerise in the sourcingnear future, thereby placing additional pressure on credit spreads. Finally, during the third quarter of our alternative investment opportunities. As2011 the 10 year U.S treasury note reached a yield of 1.72%, a historic low and increased only marginally during the datefourth quarter of this report, HCS had yet2011. All of these factors have contributed to manage anysignificant widening of our assets. For more information regarding the terms of the advisory agreement, see “Our Relationship with HCScredit spreads, which typically has a negative impact on credit-sensitive assets such as CLOs and the Advisory Agreement” in Item 1 of this Annual Report on Form 10-K and the advisory agreement itself, which is filed an exhibit to this Annual Report on Form 10-K.multi-family CMBS, as well as Agency IOs.
Financing markets and liquidity. The Series A Preferred Stock entitles the holders to receive a cumulative dividendavailability of 10% per year, subject torepurchase agreement financing is stable with interest rates between 0.30% and 0.60% for 30-90 day repurchase agreements. The 30-day London Interbank Offered Rate (“LIBOR”) was 0.30% at December 30, 2011, marking an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. The Series A Preferred Stock matures on December 31, 2010, has a redemption value of $20.00 per share, and is convertible into shares of the Company's common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock.
Completion of $60.0 Million Offering of Common Stock
On February 21, 2008, the Company completed the issuance and sale of 7.5 million shares of its common stock to certain accredited investors (as such term is defined in Rule 501 of Regulation D of the Securities Act of 1933, as amended, or Securities Act) at a price of $8.00 per share. This private offering of the Company's common stock generated gross proceeds to the Company of $60.0 million, and net proceeds to the Company of approximately $56.6 million. Pursuant6 basis points from September 30, 2011, and an increase of 4 basis points from the previous year end. While we expect interest rates to a registration rights agreement,rise over the Company filed a resale shelf registration statement registeringlonger term, we believe that interest rates, and thus our short-term financing costs, are likely to remain at these historically low levels until such time as the resaleeconomic data begin to confirm an acceleration of the shares sold in this offering, which became effective in April 2008. Pursuant to the registration rights agreement, we paid $0.7 million in liquidated damages in 2008 to the investors in the offering for not filing a resale shelf registration statement by the date required in the registration rights agreement and not obtaining NASDAQ listing for our common stock on or prior to the effective date of the resale shelf registration statement. We do not expect to incur future penalty fees under the registration rights agreement.overall economic recovery.
In accordance with our investment plan, we promptly deployed the net proceeds from our January and February 2008 equity offerings by purchasing an aggregate of approximately $714.1 million of Agency hybrid RMBS during January and February 2008. These acquisitions were financed in part with repurchase agreements and hedged with interest rate swaps.Prepayment rates
March 2008 Credit Market Disruption
During March 2008, news of potential and actual security liquidations negatively impacted market values for, and available liquidity to finance, certain mortgage securities, including some of our Agency RMBS and AAA-rated non-Agency RMBS, resulting in a significant deleveraging event for a relatively broad range of leveraged public and private companies with investment and financing strategies similar to ours. In response to these significantly changed conditions, we undertook a number of strategic actions to reduce leverage and increase liquidity in our portfolio of Agency RMBS. During March 2008, the Company sold, in aggregate, approximately $592.8 million of Agency RMBS from its investment portfolio that was comprised of $516.4 million of Agency hybrid ARM RMBS and $76.4 million of Agency CMO floating rate securities (“CMO Floaters”), resulting in a loss of $15.0 million.. As a result of various government initiatives and the reduction in intermediate and longer-term treasury yields, rates on conforming mortgages have reached and remained at historical lows during the second half of 2011 and into early 2012. While these salestrends have historically resulted in higher rates of RMBS,refinancing and thus higher prepayment speeds, we also terminated associatedcontinue to experience relatively low prepayment rates for the current interest rate swaps that were used to hedge our liability costs with a notional balance of $297.7 million at a cost of $2.0 million. We believe these proactive steps taken by our management team to reduce leverage and increase liquidity enabled our company to successfully navigate the extremely difficult operating and credit conditions facing companies with investment and financing strategies similar to ours.environment.
Subsequent Events – March 2009
Restructuring of Principal Investment Portfolio. As of December 31, 2008, our principal investment portfolio included approximately $197.7 million of collateralized mortgage obligation floating rate securities issued by an Agency, which we refer to as Agency CMO Floaters. Following a review of our principal investment portfolio, we determined in March 2009 that the Agency CMO Floaters held in our portfolio were no longer producing acceptable returns, and as a result, we decided to initiate a program to dispose of these securities on an opportunistic basis. As of March 25, 2009, the Company had sold approximately $149.8 million in current par value of Agency CMO Floaters under this program resulting in a net gain of approximately $0.2 million. As a result of these sales and our intent to sell the remaining Agency CMO Floaters in our principal investment portfolio, we concluded the reduction in value at December 31, 2008 was other-than-temporary and recorded an impairment charge of $4.1 million for the quarter and year ended December 31, 2008.
In addition, we also determined that $6.1 million in current par value of non-agency RMBS, which includes $2.5 million in current par value of retained residual interest, had suffered an other-than-temporary impairment and, accordingly, recorded an impairment charge of $1.2 million for the quarter and year ended December 31, 2008.
Note Regarding Discontinued OperationsOperation
In connection with the sale of our wholesale mortgage lending platform assets on February 22, 2007 and the sale of our retail mortgage lending platform assets to Indymac Bank, F.S.B. (“Indymac”) on March 31,in 2007, during the fourth quarter of 2006, we classified our mortgage lending business as a discontinued operations in accordance with the provisions of SFAS No. 144.operation. As a result, we have reported revenues and expenses related to the mortgage lending business as a discontinued operationsoperation and the related assets and liabilities as assets and liabilities related to a discontinued operationsoperation for all periods presented in the accompanying consolidated financial statements. Certain assets and liabilities, such as theour deferred tax asset and certain liabilities, such asour subordinated debt, and liabilities related to leased facilities not assigned to Indymac are part of our ongoing operations and accordingly, we have not been classified as a discontinued operations in accordance with the provisions of SFAS No. 144. See note 8 in the notes to our consolidated financial statements.
Until March 31, 2007, our discontinued mortgage lending operation contributed to our then current period financial results. Subsequent to March 31, 2007, our discontinued mortgage lending operation has impacted our financial results due to liabilities remaining after the sale of the operation’s assets.operation. As of December 31, 2008,2011 and 2010, discontinued operations consist of $5.9$4.0 million in assets (including $3.8 million in loans held for sale) and $0.5 million in liabilities, and $4.0 million in assets and $3.6$0.6 million in liabilities, down from $8.9 millionrespectively, and are included in receivables and other assets and $5.8accrued expenses and other liabilities in the consolidated balance sheets included in this Annual Report.
The discontinued operations had net income of $0.1 million in liabilities as ofand $1.1 million for the years ended December 31, 2007.
Prior2011 and 2010, respectively. We continue to March 31, 2007, we originated a wide rangewind down the discontinued operations and anticipate to be substantially complete with such winding down by the end of residential mortgage loan products including prime, alternative-A, and to a lesser extent sub-prime loans, home equity lines of credit, second mortgages, and bridge loans. We originated $0.4 billion in mortgage loans during three months ended March 31, 2007. Our sale of the mortgage lending platform assets on March 31, 2007 marked our exit from the mortgage lending business.2012.
Financial Condition
TableAs of ContentsDecember 31, 2011, we had approximately $682.7 million of total assets, as compared to approximately $374.3 million of total assets as of December 31, 2010. The increase in total assets is primarily a function of more fully investing our available capital on a levered basis and our increased capital base, which resulted from raising additional capital during the year.
Investment Allocation
The following table sets forth our allocated equity by investment type at December 31, 2011:
| (dollar amounts in thousands) | | Agency ARMs | | | Agency IOs | | | Multi- Family CMBS | | | Securitized Loans | | | Other (1) | | | Total | |
| | | | | | | | | | | | | | | | | | | | |
| Carrying value | | $ | 68,776 | | | $ | 63,681 | | | $ | 41,185 | | | $ | 206,920 | | | $ | 44,301 | | | $ | 424,863 | |
| Liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
Callable (2) | | | (56,913 | ) | | | (49,226 | ) | | | (21,531 | ) | | | - | | | | (6,535 | ) | | | (134,205 | ) |
Non callable | | | | | | | - | | | | - | | | | (199,762 | ) | | | (45,000 | ) | | | (244,762 | ) |
Hedges (Net) (3) | | | (304 | ) | | | 9,317 | | | | - | | | | - | | | | - | | | | 9,013 | |
| Cash | | | - | | | | 16,536 | | | | - | | | | - | | | | 16,586 | | | | 33,122 | |
| Other | | | - | | | | 1,333 | | | | - | | | | - | | | | (3,057 | ) | | | (1,724 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net equity allocated | | $ | 11,559 | | | $ | 41,641 | | | $ | 19,654 | | | $ | 7,158 | | | $ | 6,295 | | | $ | 86,307 | |
| (1) | Other includes CLOs, investment in limited partnership, loans held for investment and non-Agency RMBS. Other callable liabilities include a $6.5 million repurchase agreement on our CLO securities and other non-callable liabilities consist of $45.0 million in subordinated debentures. |
| (2) | Includes repurchase agreements and $21.5 million in payables for securities purchased related to our multi-family CMBS strategy. |
| (3) | Includes derivative assets, receivable for securities sold, derivative liabilities, payable for securities purchased and restricted cash posted as margin. |
Balance Sheet Analysis
Investment Securities - Available for Sale. OurAt December 31, 2011, our securities portfolio consists of Agency RMBS, or primarily AAA-rated residential RMBS.including Agency ARM pass-through certificates and Agency IOs, CMBS, non-Agency RMBS and CLOs. At December 31, 2008,2011, we had no investment securities in a single issuer or entity, other than Fannie Mae, or Freddie Mac, that had an aggregate book value in excess of 10% of our total assets. The following tables set forth the credit characteristicsbalances of our principal investment securities portfolioavailable for sale as of December 31, 20082011 and December 31, 2007:2010, respectively:
Credit CharacteristicsBalances of Our Investment Securities (dollar amounts in thousands):
| December 31, 2008 | | Sponsor or Rating | | Par Value | | | Carrying Value | | | % of Portfolio | | | Coupon | | | Yield | |
| Credit | | | | | | | | | | | | | | | | | |
| Agency Hybrid ARMs | | FNMA | | $ | 251,810 | | | $ | 258,196 | | | | 54 | % | | | 5.15 | % | | | 3.93 | % |
| Agency REMIC CMO Floating Rate | | FNMA/FHLMC | | | 203,638 | | | | 197,675 | | | | 41 | % | | | 1.83 | % | | | 8.54 | % |
| Private Label Floating Rate | | AAA | | | 23,289 | | | | 18,118 | | | | 4 | % | | | 1.27 | % | | | 15.85 | % |
| Private Label Floating Rate | | Aa | | | 3,648 | | | | 2,828 | | | | 1 | % | | | 2.30 | % | | | 4.08 | % |
| NYMT Retained Securities | | AAA-BBB | | | 609 | | | | 530 | | | | 0 | % | | | 5.80 | % | | | 8.56 | % |
| NYMT Retained Securities | | Below Investment Grade | | | 2,462 | | | | 69 | | | | 0 | % | | | 5.67 | % | | | 16.99 | % |
| Total/Weighted Average | | | | $ | 485,456 | | | $ | 477,416 | | | | 100 | % | | | 3.55 | % | | | 6.51 | % |
| December 31, 2011 | | Par Value | | | Carrying Value | | | % of Portfolio | |
| Agency RMBS: | | | | | | | | | |
| IOs | | $ | 537,032 | | | $ | 63,681 | | | | 31.8 | % |
| ARMs | | | 65,112 | | | | 68,776 | | | | 34.3 | % |
| CMBS: | | | | | | | | | | | | |
| IOs | | | 850,821 | | | | 6,258 | | | | 3.1 | % |
| POs | | | 138,386 | | | | 34,927 | | | | 17.5 | % |
| Non-Agency RMBS | | | 6,079 | | | | 3,945 | | | | 1.9 | % |
| Collateralized Loan Obligations | | | 35,550 | | | | 22,755 | | | | 11.4 | % |
| Total | | $ | 1,632,980 | | | $ | 200,342 | | | | 100.0 | % |
| December 31, 2010 | | Par Value | | | Carrying Value | | | % of Portfolio | |
| Agency RMBS | | $ | 45,042 | | | $ | 47,529 | | | | 55.3 | % |
| Non-Agency RMBS | | | 11,104 | | | | 8,985 | | | | 10.4 | % |
| Collateralized Loan Obligations | | | 45,950 | | | | 29,526 | | | | 34.3 | % |
| Total | | $ | 102,096 | | | $ | 86,040 | | | | 100.0 | % |
| December 31, 2007 | | Sponsor or Rating | | Par Value | | | Carrying Value | | | % of Portfolio | | | Coupon | | | Yield | |
| Credit | | | | | | | | | | | | | | | | | |
| Agency REMIC CMO Floating Rate | | FNMA/FHLMC/GNMA | | $ | 324,676 | | | $ | 318,689 | | | | 91 | % | | | 5.98 | % | | | 5.55 | % |
| Private Label Floating Rate | | AAA | | | 29,764 | | | | 28,401 | | | | 8 | % | | | 5.66 | % | | | 5.50 | % |
| NYMT Retained Securities | | AAA-BBB | | | 2,169 | | | | 2,165 | | | | 1 | % | | | 6.31 | % | | | 6.28 | % |
| NYMT Retained Securities | | Below Investment Grade | | | 2,756 | | | | 1,229 | | | | 0 | % | | | 5.68 | % | | | 12.99 | % |
| Total/Weighted Average | | | | $ | 359,365 | | | $ | 350,484 | | | | 100 | % | | | 5.95 | % | | | 5.61 | % |
CMBS Loan Characteristics
The following table sets forth the stated reset periods and weighted average yieldsdetails our CMBS loan characteristics (first loss securities) as of our investment securities at December 31, 2008 and December 31, 20072011 (dollar amounts in thousands):
| | | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months To 60 Months | | | Total | |
| December 31, 2008 | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | |
| Agency Hybrid ARMs | | $ | — | | | | — | % | | $ | 66,910 | | | | 3.69 | % | | $ | 191,286 | | | | 4.02 | % | | $ | 258,196 | | | | 3.93 | % |
| Agency REMIC CMO Floating Rate | | | 197,675 | | | | 8.54 | % | | | — | | | | — | % | | | — | | | | — | % | | | 197,675 | | | | 8.54 | % |
| Private Label Floating Rate | | | 20,946 | | | | 14.25 | % | | | — | | | | — | % | | | — | | | | — | % | | | 20,946 | | | | 14.25 | % |
| NYMT Retained Securities | | | 530 | | | | 8.56 | % | | | — | | | | — | % | | | 69 | | | | 16.99 | % | | | 599 | | | | 15.32 | % |
| Total/Weighted Average | | $ | 219,151 | | | | 9.21 | % | | $ | 66,910 | | | | 3.69 | % | | $ | 191,355 | | | | 4.19 | % | | $ | 477,416 | | | | 6.51 | % |
| | | December 31, 2011 | |
| Current balance of loans | | $ | 3,457,297 | |
| Number of loans | | | 234 | |
| Weighted average original LTV | | | 68.0 | % |
| Weighted average underwritten debt service coverage ratio | | | 1.52 | x |
| Current average loan size | | $ | 14,775 | |
| Weighted average original loan term (in months) | | | 117 | |
| Weighted average current remaining term (in months) | | | 101 | |
| Weighted average loan rate | | | 5.25 | % |
| First mortgages | | | 100 | % |
| Geographic state concentration (greater than 5.0%): | | | | |
| Texas | | | 14.3 | % |
| California | | | 9.3 | % |
| New York | | | 7.2 | % |
| Georgia | | | 6.7 | % |
| Washington | | | 6.3 | % |
| Florida | | | 5.5 | % |
Detailed Composition of Loans Securitizing Our CLOs
The following tables summarize the loans securitizing our CLOs grouped by range of outstanding balance and industry as of December 31, 2011 and 2010, respectively (dollar amounts in thousands).
| | | As of December 31, 2011 | | As of December 31, 2010 | |
| | | | | | | | | | | | | | |
Range of Outstanding Balance | | Number of Loans | | Maturity Date | | Total Principal | | Number of Loans | | Maturity Date | | Total Principal | |
| | | | | | | | | | | | | | | | |
| $0 - $500 | | 20 | | 8/2015 – 11/2018 | | $ | 8,583 | | 11 | | 11/2014 – 11/2017 | | $ | 5,404 | |
| $500 - $2,000 | | 103 | | 12/2012 – 12/2018 | | | 147,598 | | 72 | | 5/2013 – 12/2017 | | | 95,704 | |
| $2,000 - $5,000 | | 84 | | 4/2013 – 9/2019 | | | 250,010 | | 88 | | 8/2012 – 11/2017 | | | 276,265 | |
| $5,000 - $10,000 | | 6 | | 2/2013 – 3/2016 | | | 35,623 | | 11 | | 11/2011 – 3/2016 | | | 77,366 | |
| Total | | 213 | | | | $ | 441,814 | | 182 | | | | $ | 454,739 | |
| | | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months To 60 Months | | | Total | |
| December 31, 2007 | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Agency REMIC CMO Floating Rate | | $ | 318,689 | | | | 5.55 | % | | $ | — | | | | — | % | | $ | — | | | | — | % | | $ | 318,689 | | | | 5.55 | % |
| Private Label Floating Rate | | | 28,401 | | | | 5.50 | % | | | — | | | | — | % | | | — | | | | — | % | | | 28,401 | | | | 5.50 | % |
| NYMT Retained Securities | | | 2,165 | | | | 6.28 | % | | | — | | | | — | % | | | 1,229 | | | | 12.99 | % | | | 3,394 | | | | 10.03 | % |
| Total/Weighted Average | | $ | 349,255 | | | | 5.55 | % | | $ | — | | | | — | % | | $ | 1,229 | | | | 12.99 | % | | $ | 350,484 | | | | 5.61 | % |
Prepayment Experience. The constant prepayment rate (“CPR”) on our overall portfolio averaged approximately 12% during 2008 as compared to 19% during 2007. CPRs on our purchased portfolio of investment securities averaged approximately 9% while the CPRs on loans held in our securitization trusts averaged approximately 19% during 2008. When prepayment expectations over the remaining life of assets increase, we have to amortize premiums over a shorter time period resulting in a reduced yield to maturity on our investment assets. Conversely, if prepayment expectations decrease, the premium would be amortized over a longer period resulting in a higher yield to maturity. We monitor our prepayment experience on a monthly basis and adjust the amortization rate to reflect current market conditions.47
December 31, 2011
| Industry | Number of Loans | | Outstanding Balance | | | % of Outstanding Balance |
| | | | | | | |
| Healthcare, Education & Childcare | 24 | | $ | 61,543 | | | 13.9% |
| Retail Store | 14 | | | 35,704 | | | 8.1% |
| Electronics | 13 | | | 31,721 | | | 7.2% |
| Telecommunications | 13 | | | 27,638 | | | 6.3% |
| Chemicals, Plastics and Rubber | 12 | | | 25,336 | | | 5.7% |
| Diversified/Conglomerate Service | 15 | | | 22,320 | | | 5.1% |
| Beverage, Food & Tobacco | 10 | | | 20,274 | | | 4.6% |
| Leisure, Amusement, Motion Pictures & Entertainment | 8 | | | 18,904 | | | 4.3% |
| Personal & Non-Durable Consumer Products | 8 | | | 18,203 | | | 4.1% |
| Aerospace & Defense | 10 | | | 17,254 | | | 3.9% |
| Utilities | 5 | | | 16,723 | | | 3.8% |
| Hotels, Motels, Inns and Gaming | 5 | | | 15,914 | | | 3.6% |
| Personal, Food & Misc. Services | 12 | | | 14,598 | | | 3.3% |
| Containers, Packaging and Glass | 7 | | | 14,493 | | | 3.3% |
| Finance | 8 | | | 11,471 | | | 2.6% |
| Printing & Publishing | 4 | | | 11,404 | | | 2.6% |
| Automobile | 7 | | | 9,829 | | | 2.2% |
| Diversified/Conglomerate Mfg. | 6 | | | 9,643 | | | 2.2% |
| Banking | 3 | | | 8,777 | | | 2.0% |
| Broadcasting & Entertainment | 3 | | | 6,293 | | | 1.4% |
| Mining, Steel, Iron and Non-Precious Metals | 3 | | | 6,242 | | | 1.4% |
| Machinery (Non-Agriculture, Non-Construction & Non-Electronic) | 4 | | | 6,029 | | | 1.4% |
| Textiles & Leather | 5 | | | 5,281 | | | 1.2% |
| Personal Transportation | 2 | | | 4,969 | | | 1.1% |
| Grocery | 3 | | | 4,911 | | | 1.1% |
| Buildings and Real Estate | 2 | | | 4,887 | | | 1.1% |
| Insurance | 2 | | | 4,352 | | | 1.0% |
| Diversified Natural Resources, Precious Metals and Minerals | 1 | | | 2,227 | | | 0.5% |
| Ecological | 2 | | | 1,984 | | | 0.4% |
| Farming & Agriculture | 1 | | | 1,900 | | | 0.4% |
| Cargo Transport | 1 | | | 990 | | | 0.2% |
| | 213 | | $ | 441,814 | | | 100.0% |
December 31, 2010
| Industry | Number of Loans | | Outstanding Balance | | | % of Outstanding Balance |
| | | | | | | |
| Healthcare, Education & Childcare | 19 | | $ | 52,537 | | | 11.55% |
| Retail Store | 10 | | | 29,388 | | | 6.46% |
| Electronics | 10 | | | 29,148 | | | 6.41% |
| Telecommunications | 13 | | | 26,410 | | | 5.81% |
| Leisure , Amusement, Motion Pictures & Entertainment | 10 | | | 22,316 | | | 4.91% |
| Personal, Food & Misc Services | 10 | | | 21,179 | | | 4.66% |
| Chemicals, Plastics and Rubber | 9 | | | 20,962 | | | 4.61% |
| Beverage, Food & Tobacco | 9 | | | 18,666 | | | 4.10% |
| Utilities | 5 | | | 17,035 | | | 3.75% |
| Aerospace & Defense | 7 | | | 16,468 | | | 3.62% |
| Insurance | 3 | | | 16,245 | | | 3.57% |
| Hotels, Motels, Inns and Gaming | 5 | | | 15,389 | | | 3.38% |
| Farming & Agriculture | 5 | | | 14,983 | | | 3.29% |
| Cargo Transport | 3 | | | 14,372 | | | 3.16% |
| Diversified/Conglomerate Mfg | 6 | | | 13,914 | | | 3.06% |
| Personal & Non-Durable Consumer Products | 5 | | | 13,774 | | | 3.03% |
| Printing & Publishing | 4 | | | 11,944 | | | 2.63% |
| Diversified/Conglomerate Service | 5 | | | 10,841 | | | 2.38% |
| Broadcasting & Entertainment | 4 | | | 10,037 | | | 2.21% |
| Ecological | 4 | | | 8,763 | | | 1.93% |
| Finance | 3 | | | 7,803 | | | 1.72% |
| Containers, Packaging and Glass | 4 | | | 7,635 | | | 1.68% |
| Machinery (Non-Agriculture, Non-Construction & Non-Electronic) | 4 | | | 7,482 | | | 1.65% |
| Personal Transportation | 3 | | | 7,306 | | | 1.61% |
| Buildings and Real Estate | 3 | | | 6,970 | | | 1.53% |
| Banking | 2 | | | 6,750 | | | 1.48% |
| Automobile | 5 | | | 6,544 | | | 1.44% |
| Mining, Steel, Iron and Non-Precious Metals | 3 | | | 5,466 | | | 1.20% |
| Textiles & Leather | 3 | | | 4,359 | | | 0.96% |
| Oil & Gas | 2 | | | 3,994 | | | 0.88% |
| Grocery | 3 | | | 3,808 | | | 0.84% |
| Diversified Natural Resources, Precious Metals and Minerals | 1 | | | 2,251 | | | 0.49% |
| | 182 | | $ | 454,739 | | | 100.00% |
Mortgage Loans Held in Securitization Trusts. Included in our portfolio are prime ARM loans that we originated or purchased in bulk from third parties that met our investment criteria and portfolio requirements. The Companyrequirements and that we subsequently securitized. We have completed four securitizations; three were classified as financings per SFAS No. 140 and one, New York Mortgage Trust 2006-1, qualified as a sale, under SFAS No. 140, which resulted in the recording of residual assets and mortgage servicing rights. The residual assets carrying value total $0.1 million and are included in investment securities available for sale.
The following table detailsAt December 31, 2011, mortgage loans held in securitization trusts totaled approximately $206.9 million, or 30.3% of our total assets. The Company has a net equity investment of approximately $7.6 million in the three securitization trusts at December 31, 2008 and December 31, 2007 (dollar amounts in thousands):
| | | Par Value | | | Coupon | | | Carrying Value | | | Yield | |
| December 31, 2008 | | $ | 347,546 | | | | 5.56 | % | | $ | 348,337 | | | | 3.96 | % |
| December 31, 2007 | | $ | 429,629 | | | | 5.74 | % | | $ | 430,715 | | | | 5.36 | % |
At December 31, 20082011. Of the mortgage loans held in securitizationsecuritized trusts, represented approximately 41% of our total assets. Of this mortgage loan investment portfolio 100% are traditional ARMs or hybrid ARMs, and 79%81.7% of which are ARM loans that are interest only. On our hybrid ARMs, interest rate reset periods are predominately five years or less and the interest-only/amortizationinterest-only period is typically 10 years, which mitigates the “payment shock” at the time of interest rate reset. No loans in our investment portfolioNone of the mortgage loans held in securitization trusts are payment option-ARMs or ARMs with negative amortization.
The following table details mortgage loans held in securitization trusts at December 31, 2011 and 2010, respectively (dollar amounts in thousands):
| | | # of Loans | | | Par Value | | | Coupon | | | Carrying Value | |
| December 31, 2011 | | | 512 | | | $ | 208,934 | | | | 2.82 | % | | $ | 206,920 | |
| December 31, 2010 | | | 556 | | | $ | 229,323 | | | | 3.16 | % | | $ | 228,185 | |
Characteristics of Our Mortgage Loans Held in Securitization Trusts and Retained Interest in Securitization:
The following table sets forth the composition of our loans held in securitization trusts and loans backing the retained interests from our REMIC securitization as of December 31, 20082011 (dollar amounts in thousands):
| | | # of Loans | | | Par Value | | | Carrying Value | |
| Loan Characteristics: | | | | | | | | | |
| Mortgage loans held in securitization trusts | | | 793 | | | $ | 347,546 | | | $ | 348,337 | |
| Retained interest in REMIC securitization (included in Investment securities available for sale) | | | 337 | | | | 177,442 | | | | 599 | |
| Total Loans Held | | | 1,130 | | | $ | 524,988 | | | $ | 348,936 | |
| | | Average | | | High | | | Low | |
| General Loan Characteristics: | | | | | | | | | |
| Original Loan Balance (dollar amounts in thousands) | | $ | 445 | | | $ | 2,950 | | | $ | 48 | |
| Current Coupon Rate | | | 2.82 | % | | | 7.25 | % | | | 1.38 | % |
| Gross Margin | | | 2.37 | % | | | 4.13 | % | | | 1.13 | % |
| Lifetime Cap | | | 11.29 | % | | | 13.25 | % | | | 9.13 | % |
| Original Term (Months) | | | 360 | | | | 360 | | | | 360 | |
| Remaining Term (Months) | | | 280 | | | | 288 | | | | 247 | |
| Average Months to Reset | | | 4 | | | | 11 | | | | 1 | |
| Original Average FICO Score | | | 729 | | | | 818 | | | | 593 | |
| Original Average LTV | | | 70.41 | % | | | 95.00 | % | | | 13.94 | % |
| | | % of Outstanding Loan Balance | | | Weighted Average Gross Margin (%) | |
| Index Type/Gross Margin: | | | | | | |
| One Month LIBOR | | | 2.8 | % | | | 1.69 | % |
| Six Month LIBOR | | | 72.9 | % | | | 2.40 | % |
| One Year LIBOR | | | 16.4 | % | | | 2.26 | % |
| One Year Constant Maturity Treasury | | | 7.9 | % | | | 2.64 | % |
| Total | | | 100.0 | % | | | 2.38 | % |
| | | Average | | | High | | | Low | |
| General Loan Characteristics: | | | | | | | | | |
| Original Loan Balance | | $ | 491 | | | $ | 3,500 | | | $ | 48 | |
| Current Coupon Rate | | | 5.67 | % | | | 8.13 | % | | | 4.00 | % |
| Gross Margin | | | 2.34 | % | | | 5.00 | % | | | 1.13 | % |
| Lifetime Cap | | | 11.19 | % | | | 13.38 | % | | | 9.13 | % |
| Original Term (Months) | | | 360 | | | | 360 | | | | 360 | |
| Remaining Term (Months) | | | 319 | | | | 327 | | | | 283 | |
The following table sets forth the composition of our loans held in securitization trusts and loans backing the retained interests from our REMIC securitization as of December 31, 20072010 (dollar amounts in thousands):
| | | # of Loans | | | Par Value | | | Carrying Value | |
| Loan Characteristics: | | | | | | | | | |
| Mortgage loans held in securitization trusts | | | 972 | | | $ | 429,629 | | | $ | 430,715 | |
| Retained interest in securitization (included in Investment securities available for sale) | | | 391 | | | | 209,455 | | | | 3,394 | |
| Total Loans Held | | | 1,363 | | | $ | 639,084 | | | $ | 434,109 | |
| | | Average | | | High | | | Low | |
| General Loan Characteristics: | | | | | | | | | |
| Original Loan Balance (dollar amounts in thousands) | | $ | 443 | | | $ | 2,950 | | | $ | 48 | |
| Current Coupon Rate | | | 3.16 | % | | | 7.25 | % | | | 1.38 | % |
| Gross Margin | | | 2.36 | % | | | 4.13 | % | | | 1.13 | % |
| Lifetime Cap | | | 11.28 | % | | | 13.25 | % | | | 9.13 | % |
| Original Term (Months) | | | 360 | | | | 360 | | | | 360 | |
| Remaining Term (Months) | | | 292 | | | | 300 | | | | 259 | |
| Average Months to Reset | | | 4 | | | | 11 | | | | 1 | |
| Original Average FICO Score | | | 729 | | | | 818 | | | | 593 | |
| Original Average LTV | | | 70.48 | % | | | 95.00 | % | | | 13.94 | % |
| | | % of Outstanding Loan Balance | | | Weighted Average Gross Margin (%) | |
| Index Type/Gross Margin: | | | | | | |
| One Month LIBOR | | | 2.6 | % | | | 1.69 | % |
| Six Month LIBOR | | | 72.9 | % | | | 2.40 | % |
| One Year LIBOR | | | 16.6 | % | | | 2.26 | % |
| One Year Constant Maturity Treasury | | | 7.9 | % | | | 2.65 | % |
| Total | | | 100.0 | % | | | 2.36 | % |
| | | Average | | | High | | | Low | |
| General Loan Characteristics: | | | | | | | | | |
| Original Loan Balance | | $ | 490 | | | $ | 3,500 | | | $ | 48 | |
| Current Coupon Rate | | | 5.79 | % | | | 9.93 | % | | | 4.00 | % |
| Gross Margin | | | 2.34 | % | | | 6.50 | % | | | 1.13 | % |
| Lifetime Cap | | | 11.19 | % | | | 13.75 | % | | | 9.00 | % |
| Original Term (Months) | | | 360 | | | | 360 | | | | 360 | |
| Remaining Term (Months) | | | 330 | | | | 339 | | | | 295 | |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Arm Loan Type | | | | | | |
| Traditional ARMs | | | 2.2 | % | | | 2.3 | % |
| 2/1 Hybrid ARMs | | | 1.1 | % | | | 1.6 | % |
| 3/1 Hybrid ARMs | | | 7.8 | % | | | 10.2 | % |
| 5/1 Hybrid ARMs | | | 86.3 | % | | | 83.4 | % |
| 7/1 Hybrid ARMs | | | 2.6 | % | | | 2.5 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| Percent of ARM loans that are Interest Only | | | 78.6 | % | | | 77.3 | % |
| Weighted average length of interest only period | | 8.3 years | | | 8.3 years | |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Traditional ARMs - Periodic Caps | | | | | | |
| None | | | 79.4 | % | | | 72.9 | % |
| 1% | | | 1.2 | % | | | 1.4 | % |
| Over 1% | | | 19.4 | % | | | 25.7 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Hybrid ARMs - Initial Cap | | | | | | |
| 3.00% or less | | | 6.7 | % | | | 8.3 | % |
| 3.01%-4.00% | | | 4.0 | % | | | 5.1 | % |
| 4.01%-5.00% | | | 88.2 | % | | | 85.6 | % |
| 5.01%-6.00% | | | 1.1 | % | | | 1.0 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Original FICO Scores | | | | | | |
| 650 or less | | | 4.4 | % | | | 3.9 | % |
| 651 to 700 | | | 18.0 | % | | | 17.0 | % |
| 701 to 750 | | | 32.7 | % | | | 32.4 | % |
| 751 to 800 | | | 40.9 | % | | | 42.5 | % |
| 801 and over | | | 4.0 | % | | | 4.2 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| Average FICO Score | | | 736 | | | | 738 | |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Original Loan to Value (LTV) | | | | | | |
| 50% or less | | | 9.7 | % | | | 9.5 | % |
| 50.01%-60.00% | | | 8.2 | % | | | 8.9 | % |
| 60.01%-70.00% | | | 25.8 | % | | | 27.3 | % |
| 70.01%-80.00% | | | 54.4 | % | | | 52.2 | % |
| 80.01% and over | | | 1.9 | % | | | 2.1 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| Average LTV | | | 69.9 | % | | | 69.7 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Property Type | | | | | | |
| Single Family | | | 51.4 | % | | | 51.3 | % |
| Condominium | | | 23.3 | % | | | 22.8 | % |
| Cooperative | | | 9.8 | % | | | 9.8 | % |
| Planned Unit Development | | | 12.8 | % | | | 13.0 | % |
| Two to Four Family | | | 2.7 | % | | | 3.1 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Occupancy Status | | | | | | |
| Primary | | | 85.1 | % | | | 84.4 | % |
| Secondary | | | 11.0 | % | | | 12.0 | % |
| Investor | | | 3.9 | % | | | 3.6 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Documentation Type | | | | | | |
| Full Documentation | | | 72.7 | % | | | 72.0 | % |
| Stated Income | | | 19.6 | % | | | 19.7 | % |
| Stated Income/ Stated Assets | | | 6.3 | % | | | 6.8 | % |
| No Documentation | | | 1.0 | % | | | 1.0 | % |
| No Ratio | | | 0.4 | % | | | 0.5 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Loan Purpose | | | | | | |
| Purchase | | | 58.0 | % | | | 57.8 | % |
| Cash out refinance | | | 16.1 | % | | | 15.9 | % |
| Rate & term refinance | | | 25.9 | % | | | 26.3 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
| | | December 31, 2008 Percentage | | | December 31, 2007 Percentage | |
| Geographic Distribution: 5% or more in any one state | | | | | | |
| NY | | | 30.7 | % | | | 31.2 | % |
| MA | | | 17.2 | % | | | 17.4 | % |
| FL | | | 7.8 | % | | | 8.3 | % |
| CA | | | 7.2 | % | | | 7.2 | % |
| NJ | | | 6.0 | % | | | 5.7 | % |
| Other (less than 5% individually) | | | 31.1 | % | | | 30.2 | % |
| Total | | | 100.0 | % | | | 100.0 | % |
The following table details loan summary information for loans held in securitization trusttrusts at December 31, 2008 (all2011 (dollar amounts in thousands):
| Description | | | Interest Rate | | | Final Maturity | | | Periodic Payment | | | | Original Amount | | | Current Amount | | | Principal Amount of Loans | |
| Balance | | | | | Max | | | Min | | | Avg | | | Min | | | Max | | | | | | | | | | | | | | |
| Single | <= $100 | | | 14 | | | | 3.00 | | | | 2.50 | | | | 2.88 | | | 09/01/34 | | | 11/01/35 | | | | 360 | | NA | | $ | 1,658 | | | $ | 1,055 | | | $ | - | |
| FAMILY | <= $250 | | | 71 | | | | 4.50 | | | | 2.50 | | | | 2.96 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 16,299 | | | | 13,107 | | | | 956 | |
| | <= $500 | | | 89 | | | | 3.75 | | | | 2.50 | | | | 2.87 | | | 07/01/33 | | | 01/01/36 | | | | 360 | | NA | | | 33,896 | | | | 31,056 | | | | 6,135 | |
| | <=$1,000 | | | 34 | | | | 3.50 | | | | 1.50 | | | | 2.77 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 27,122 | | | | 25,368 | | | | 3,411 | |
| | >$1,000 | | | 21 | | | | 3.25 | | | | 2.63 | | | | 2.81 | | | 01/01/35 | | | 11/01/35 | | | | 360 | | NA | | | 37,357 | | | | 36,811 | | | | 9,047 | |
| | Summary | | | 229 | | | | 4.50 | | | | 1.50 | | | | 2.88 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 116,332 | | | $ | 107,397 | | | $ | 19,549 | |
| 2-4 | <= $100 | | | 2 | | | | 3.63 | | | | 3.00 | | | | 3.31 | | | 02/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 212 | | | $ | 168 | | | $ | 75 | |
| FAMILY | <= $250 | | | 6 | | | | 3.63 | | | | 2.63 | | | | 3.02 | | | 12/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 1,283 | | | | 1,094 | | | | - | |
| | <= $500 | | | 15 | | | | 7.25 | | | | 2.13 | | | | 3.10 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 5,554 | | | | 5,134 | | | | 254 | |
| | <=$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| | >$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| | Summary | | | 23 | | | | 7.25 | | | | 2.13 | | | | 3.10 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | $ | 7,049 | | | $ | 6,396 | | | $ | 329 | |
| Condo | <= $100 | | | 13 | | | | 3.25 | | | | 2.63 | | | | 2.81 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | $ | 1,640 | | | $ | 844 | | | $ | - | |
| | <= $250 | | | 72 | | | | 3.50 | | | | 1.50 | | | | 2.93 | | | 02/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 14,297 | | | | 12,415 | | | | 468 | |
| | <= $500 | | | 58 | | | | 3.75 | | | | 2.38 | | | | 2.84 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 20,942 | | | | 18,891 | | | | - | |
| | <=$1,000 | | | 14 | | | | 3.88 | | | | 1.63 | | | | 2.76 | | | 08/01/33 | | | 09/01/35 | | | | 360 | | NA | | | 10,339 | | | | 9,996 | | | | - | |
| | > $1,000 | | | 10 | | | | 2.88 | | | | 2.63 | | | | 2.73 | | | 01/01/35 | | | 09/01/35 | | | | 360 | | NA | | | 14,914 | | | | 14,559 | | | | - | |
| | Summary | | | 167 | | | | 3.88 | | | | 1.50 | | | | 2.86 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 62,132 | | | $ | 56,705 | | | $ | 468 | |
| CO-OP | <= $100 | | | 4 | | | | 2.88 | | | | 2.50 | | | | 2.69 | | | 10/01/34 | | | 08/01/35 | | | | 360 | | NA | | $ | 443 | | | $ | 306 | | | $ | - | |
| | <= $250 | | | 15 | | | | 3.38 | | | | 2.25 | | | | 2.78 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 3,423 | | | | 2,573 | | | | 212 | |
| | <= $500 | | | 23 | | | | 3.50 | | | | 1.38 | | | | 2.78 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 9,537 | | | | 8,233 | | | | - | |
| | <=$1,000 | | | 11 | | | | 2.88 | | | | 2.63 | | | | 2.69 | | | 12/01/34 | | | 10/01/35 | | | | 360 | | NA | | | 8,563 | | | | 8,321 | | | | - | |
| | > $1,000 | | | 4 | | | | 2.75 | | | | 2.25 | | | | 2.59 | | | 11/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,659 | | | | 5,232 | | | | - | |
| | Summary | | | 57 | | | | 3.50 | | | | 1.38 | | | | 2.72 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 27,625 | | | $ | 24,665 | | | $ | 212 | |
| PUD | <= $100 | | | 1 | | | | 2.63 | | | | 2.63 | | | | 2.63 | | | 07/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 100 | | | $ | 89 | | | $ | - | |
| | <= $250 | | | 18 | | | | 3.13 | | | | 2.50 | | | | 2.87 | | | 08/01/35 | | | 12/01/35 | | | | 360 | | NA | | | 3,958 | | | | 3,656 | | | | 160 | |
| | <= $500 | | | 10 | | | | 3.00 | | | | 2.63 | | | | 2.88 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 3,665 | | | | 3,422 | | | | 315 | |
| | <=$1,000 | | | 4 | | | | 3.25 | | | | 2.75 | | | | 2.99 | | | 05/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 2,832 | | | | 2,593 | | | | - | |
| | > $1,000 | | | 3 | | | | 2.88 | | | | 2.75 | | | | 2.83 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 4,148 | | | | 4,011 | | | | - | |
| | Summary | | | 36 | | | | 3.25 | | | | 2.50 | | | | 2.87 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | $ | 14,703 | | | $ | 13,771 | | | $ | 475 | |
| Summary | <= $100 | | | 34 | | | | 3.63 | | | | 2.50 | | | | 2.85 | | | 09/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 4,053 | | | $ | 2,462 | | | $ | 75 | |
| | <= $250 | | | 182 | | | | 4.50 | | | | 1.50 | | | | 2.93 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 39,260 | | | | 32,845 | | | | 1,796 | |
| | <= $500 | | | 195 | | | | 7.25 | | | | 1.38 | | | | 2.87 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 73,594 | | | | 66,736 | | | | 6,704 | |
| | <=$1,000 | | | 63 | | | | 3.88 | | | | 1.50 | | | | 2.77 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 48,856 | | | | 46,278 | | | | 3,411 | |
| | > $1,000 | | | 38 | | | | 3.25 | | | | 2.25 | | | | 2.77 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 62,078 | | | | 60,613 | | | | 9,047 | |
| | Grand Total | | | 512 | | | | 7.25 | | | | 1.38 | | | | 2.82 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 227,841 | | | $ | 208,934 | | | $ | 21,033 | |
| | | | | | | | | | | | | | | | | | | | | | | | | Principal Amount of Loans | |
| | | | | | | | | | | | | | | | | | | | | | | | | Subject to | |
| | | | | | | | | | | | | | | | | Periodic | | | | | | | | Delinquent | |
Description | | Interest Rate | | Final Maturity | | Payment | | | | Original | | Current | | Principal | |
| Property | | | | Loan | | | | | | | | | | | | Term | | Prior | | Amount of | | Amount of | | or | |
Type | | Balance | | Count | | Max | | Min | | Avg | | Min | | Max | | (months) | | Liens | | Principal | | Principal | | Interest | |
| Single | | | <= $100,000 | | | 12 | | | 7.75 | | | 4.75 | | | 5.44 | | | 12/01/34 | | | 11/01/35 | | | 360 | | | NA | | $ | 1,595 | | $ | 853 | | $ | 69 | |
| Family | | | <= $250,000 | | | 93 | | | 8.13 | | | 4.75 | | | 5.63 | | | 09/01/32 | | | 12/01/35 | | | 360 | | | NA | | | 18,680 | | | 16,740 | | | 249 | |
| | | | <= $500,000 | | | 139 | | | 7.13 | | | 4.25 | | | 5.54 | | | 09/01/32 | | | 01/01/36 | | | 360 | | | NA | | | 51,158 | | | 48,545 | | | 1,257 | |
| | | | <=$1,000,000 | | | 65 | | | 7.38 | | | 4.38 | | | 5.56 | | | 07/01/33 | | | 12/01/35 | | | 360 | | | NA | | | 47,889 | | | 45,919 | | | 3,645 | |
| | | | > $1,000,000 | | | 33 | | | 6.75 | | | 5.00 | | | 5.64 | | | 01/01/35 | | | 01/01/36 | | | 360 | | | NA | | | 57,977 | | | 56,407 | | | - | |
| | | | Summary | | | 342 | | | 8.13 | | | 4.25 | | | 5.58 | | | 09/01/32 | | | 01/01/36 | | | 360 | | | NA | | $ | 177,299 | | $ | 168,464 | | $ | 5,220 | |
| 2-4 | | | <= $100,000 | | | 1 | | | 6.63 | | | 6.63 | | | 6.63 | | | 02/01/35 | | | 02/01/35 | | | 360 | | | NA | | $ | 80 | | $ | 76 | | $ | - | |
| FAMILY | | | <= $250,000 | | | 6 | | | 6.75 | | | 4.38 | | | 5.75 | | | 12/01/34 | | | 07/01/35 | | | 360 | | | NA | | | 1,115 | | | 1,015 | | | - | |
| | | | <= $500,000 | | | 21 | | | 7.25 | | | 5.00 | | | 5.82 | | | 09/01/34 | | | 01/01/36 | | | 360 | | | NA | | | 7,764 | | | 7,568 | | | 513 | |
| | | | <=$1,000,000 | | | 4 | | | 6.88 | | | 5.38 | | | 6.06 | | | 12/01/34 | | | 08/01/35 | | | 360 | | | NA | | | 3,068 | | | 3,047 | | | - | |
| | | | >$1,000,000 | | | 0 | | | - | | | - | | | - | | | - | | | - | | | 360 | | | NA | | | - | | | - | | | - | |
| | | | Summary | | | 32 | | | 7.25 | | | 4.38 | | | 5.86 | | | 09/01/34 | | | 01/01/36 | | | 360 | | | NA | | $ | 12,027 | | $ | 11,706 | | $ | 513 | |
| Condo | | | <= $100,000 | | | 16 | | | 6.63 | | | 4.38 | | | 5.79 | | | 01/01/35 | | | 12/01/35 | | | 360 | | | NA | | $ | 1,938 | | $ | 1,133 | | $ | - | |
| | | | <= $250,000 | | | 94 | | | 6.88 | | | 4.50 | | | 5.65 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | | 18,643 | | | 16,953 | | | 230 | |
| | | | <= $500,000 | | | 91 | | | 6.88 | | | 4.50 | | | 5.45 | | | 09/01/32 | | | 12/01/35 | | | 360 | | | NA | | | 31,915 | | | 30,853 | | | 917 | |
| | | | <=$1,000,000 | | | 36 | | | 6.13 | | | 4.50 | | | 5.36 | | | 08/01/33 | | | 11/01/35 | | | 360 | | | NA | | | 26,589 | | | 24,751 | | | - | |
| | | | > $1,000,000 | | | 15 | | | 6.13 | | | 5.13 | | | 5.61 | | | 07/01/34 | | | 09/01/35 | | | 360 | | | NA | | | 24,568 | | | 22,061 | | | - | |
| | | | Summary | | | 252 | | | 6.88 | | | 4.38 | | | 5.55 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | $ | 103,653 | | $ | 95,751 | | $ | 1,147 | |
| CO-OP | | | <= $100,000 | | | 5 | | | 6.25 | | | 4.75 | | | 5.60 | | | 09/01/34 | | | 06/01/35 | | | 360 | | | NA | | $ | 842 | | $ | 247 | | $ | - | |
| | | | <= $250,000 | | | 24 | | | 6.25 | | | 4.00 | | | 5.45 | | | 10/01/34 | | | 12/01/35 | | | 360 | | | NA | | | 4,710 | | | 4,319 | | | - | |
| | | | <= $500,000 | | | 41 | | | 6.38 | | | 4.75 | | | 5.45 | | | 08/01/34 | | | 12/01/35 | | | 360 | | | NA | | | 16,829 | | | 15,401 | | | - | |
| | | | <=$1,000,000 | | | 29 | | | 6.75 | | | 4.75 | | | 5.35 | | | 11/01/34 | | | 11/01/35 | | | 360 | | | NA | | | 21,454 | | | 20,435 | | | - | |
| | | | > $1,000,000 | | | 6 | | | 6.00 | | | 4.88 | | | 5.44 | | | 11/01/34 | | | 12/01/35 | | | 360 | | | NA | | | 8,664 | | | 8,164 | | | - | |
| | | | Summary | | | 105 | | | 6.75 | | | 4.00 | | | 5.42 | | | 08/01/34 | | | 12/01/35 | | | 360 | | | NA | | $ | 52,499 | | $ | 48,566 | | $ | - | |
| PUD | | | <= $100,000 | | | 3 | | | 5.63 | | | 5.25 | | | 5.38 | | | 07/01/35 | | | 08/01/35 | | | 360 | | | NA | | $ | 938 | | $ | 244 | | $ | - | |
| | | | <= $250,000 | | | 25 | | | 6.75 | | | 4.38 | | | 5.61 | | | 01/01/35 | | | 12/01/35 | | | 360 | | | NA | | | 5,275 | | | 4,665 | | | - | |
| | | | <= $500,000 | | | 22 | | | 7.88 | | | 4.38 | | | 5.70 | | | 08/01/32 | | | 12/01/35 | | | 360 | | | NA | | | 7,799 | | | 7,474 | | | 480 | |
| | | | <=$1,000,000 | | | 8 | | | 5.88 | | | 4.75 | | | 5.36 | | | 09/01/33 | | | 12/01/35 | | | 360 | | | NA | | | 5,637 | | | 5,474 | | | - | |
| | | | > $1,000,000 | | | 4 | | | 6.13 | | | 5.22 | | | 5.71 | | | 04/01/34 | | | 12/01/35 | | | 360 | | | NA | | | 5,233 | | | 5,202 | | | - | |
| | | | Summary | | | 62 | | | 7.88 | | | 4.38 | | | 5.60 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | $ | 24,882 | | $ | 23,059 | | $ | 480 | |
| Summary | | | <= $100,000 | | | 37 | | | 7.75 | | | 4.38 | | | 5.64 | | | 09/01/34 | | | 12/01/35 | | | 360 | | | NA | | $ | 5,393 | | $ | 2,553 | | $ | 69 | |
| | | | <= $250,000 | | | 242 | | | 8.13 | | | 4.00 | | | 5.62 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | | 48,423 | | | 43,692 | | | 479 | |
| | | | <= $500,000 | | | 314 | | | 7.88 | | | 4.25 | | | 5.54 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | | 115,465 | | | 109,841 | | | 3,167 | |
| | | | <=$1,000,000 | | | 142 | | | 7.38 | | | 4.38 | | | 5.47 | | | 07/01/33 | | | 12/01/35 | | | 360 | | | NA | | | 104,637 | | | 99,626 | | | 3,645 | |
| | | | > $1,000,000 | | | 58 | | | 6.75 | | | 4.88 | | | 5.62 | | | 04/01/34 | | | 01/01/36 | | | 360 | | | NA | | | 96,442 | | | 91,834 | | | - | |
| | | | Grand Total | | | 793 | | | 8.13 | | | 4.00 | | | 5.56 | | | 08/01/32 | | | 01/01/36 | | | 360 | | | NA | | $ | 370,360 | | $ | 347,546 | | $ | 7,360 | |
The following table details loan summary information for loans held in securitization trusts at December 31, 2010 (dollar amounts in thousands):
| Description | | | Interest Rate | | | Final Maturity | | | Periodic Payment | | | | Original Amount | | | Current Amount | | | Principal Amount of Loans | |
| Balance | | | | | Max | | | Min | | | Avg | | | Min | | | Max | | | | | | | of Principal | | | of Principal | | | | |
| Single | <= $100 | | | 12 | | | | 3.88 | | | | 2.63 | | | | 3.21 | | | 12/01/34 | | | 11/01/35 | | | | 360 | | NA | | $ | 1,508 | | | $ | 914 | | | $ | - | |
| FAMILY | <= $250 | | | 70 | | | | 6.25 | | | | 2.63 | | | | 3.40 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 14,580 | | | | 12,615 | | | | 417 | |
| | <= $500 | | | 103 | | | | 6.50 | | | | 2.63 | | | | 3.23 | | | 10/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 39,299 | | | | 35,981 | | | | 7,606 | |
| | <=$1,000 | | | 39 | | | | 5.75 | | | | 1.50 | | | | 3.01 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 31,128 | | | | 29,236 | | | | 3,411 | |
| | >$1,000 | | | 21 | | | | 3.25 | | | | 2.75 | | | | 2.97 | | | 01/01/35 | | | 11/01/35 | | | | 360 | | NA | | | 37,357 | | | | 36,857 | | | | 10,162 | |
| | Summary | | | 245 | | | | 6.50 | | | | 1.50 | | | | 3.22 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 123,872 | | | $ | 115,603 | | | $ | 21,596 | |
| 2-4 | <= $100 | | | 1 | | | | 3.88 | | | | 3.88 | | | | 3.88 | | | 02/01/35 | | | 02/01/35 | | | | 360 | | NA | | $ | 80 | | | $ | 73 | | | $ | 75 | |
| FAMILY | <= $250 | | | 7 | | | | 4.00 | | | | 2.75 | | | | 3.25 | | | 12/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 1,415 | | | | 1,221 | | | | 191 | |
| | <= $500 | | | 15 | | | | 7.25 | | | | 2.13 | | | | 3.53 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 5,554 | | | | 5,259 | | | | 254 | |
| | <=$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| | >$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| | Summary | | | 23 | | | | 7.25 | | | | 2.13 | | | | 3.46 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | $ | 7,049 | | | $ | 6,553 | | | $ | 520 | |
| Condo | <= $100 | | | 15 | | | | 3.50 | | | | 2.75 | | | | 3.04 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | $ | 1,912 | | | $ | 938 | | | $ | 55 | |
| | <= $250 | | | 74 | | | | 6.38 | | | | 2.75 | | | | 3.35 | | | 02/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 14,512 | | | | 13,036 | | | | 444 | |
| | <= $500 | | | 64 | | | | 6.25 | | | | 1.50 | | | | 3.20 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 21,957 | | | | 20,844 | | | | 272 | |
| | <=$1,000 | | | 21 | | | | 4.00 | | | | 1.63 | | | | 2.96 | | | 08/01/33 | | | 10/01/35 | | | | 360 | | NA | | | 15,489 | | | | 14,558 | | | | - | |
| | > $1,000 | | | 10 | | | | 3.25 | | | | 2.75 | | | | 2.96 | | | 01/01/35 | | | 09/01/35 | | | | 360 | | NA | | | 14,914 | | | | 14,654 | | | | - | |
| | Summary | | | 184 | | | | 6.38 | | | | 1.50 | | | | 3.21 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 68,784 | | | $ | 64,030 | | | $ | 771 | |
| CO-OP | <= $100 | | | 4 | | | | 3.00 | | | | 2.63 | | | | 2.84 | | | 10/01/34 | | | 08/01/35 | | | | 360 | | NA | | $ | 443 | | | $ | 331 | | | $ | - | |
| | <= $250 | | | 19 | | | | 6.13 | | | | 2.25 | | | | 3.16 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 4,135 | | | | 3,399 | | | | 212 | |
| | <= $500 | | | 26 | | | | 6.38 | | | | 1.38 | | | | 3.16 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 10,724 | | | | 9,533 | | | | - | |
| | <=$1,000 | | | 12 | | | | 3.25 | | �� | | 2.75 | | | | 2.91 | | | 12/01/34 | | | 10/01/35 | | | | 360 | | NA | | | 9,089 | | | | 8,896 | | | | - | |
| | > $1,000 | | | 4 | | | | 6.00 | | | | 2.25 | | | | 3.44 | | | 11/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,659 | | | | 5,339 | | | | - | |
| | Summary | | | 65 | | | | 6.38 | | | | 1.38 | | | | 3.16 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 30,050 | | | $ | 27,498 | | | $ | 212 | |
| PUD | <= $100 | | | 1 | | | | 3.00 | | | | 3.00 | | | | 3.00 | | | 07/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 100 | | | $ | 92 | | | $ | - | |
| | <= $250 | | | 16 | | | | 6.50 | | | | 2.63 | | | | 3.66 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | | 3,260 | | | | 3,092 | | | | 113 | |
| | <= $500 | | | 14 | | | | 6.13 | | | | 2.63 | | | | 3.37 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 4,969 | | | | 4,671 | | | | 770 | |
| | <=$1,000 | | | 4 | | | | 3.50 | | | | 2.75 | | | | 3.19 | | | 05/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 2,832 | | | | 2,650 | | | | - | |
| | > $1,000 | | | 4 | | | | 6.13 | | | | 2.75 | | | | 3.66 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,233 | | | | 5,134 | | | | 1,085 | |
| | Summary | | | 39 | | | | 6.50 | | | | 2.63 | | | | 3.49 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | $ | 16,394 | | | $ | 15,639 | | | $ | 1,968 | |
| Summary | <= $100 | | | 33 | | | | 3.88 | | | | 2.63 | | | | 3.10 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 4,043 | | | $ | 2,348 | | | $ | 130 | |
| | <= $250 | | | 186 | | | | 6.50 | | | | 2.25 | | | | 3.38 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 37,902 | | | | 33,363 | | | | 1,377 | |
| | <= $500 | | | 222 | | | | 7.25 | | | | 1.38 | | | | 3.23 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 82,503 | | | | 76,288 | | | | 8,902 | |
| | <=$1,000 | | | 76 | | | | 5.75 | | | | 1.50 | | | | 2.99 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 58,538 | | | | 55,340 | | | | 3,411 | |
| | > $1,000 | | | 39 | | | | 6.13 | | | | 2.25 | | | | 3.09 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 63,163 | | | | 61,984 | | | | 11,247 | |
| | Grand Total | | | 556 | | | | 7.25 | | | | 1.38 | | | | 3.16 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 246,149 | | | $ | 229,323 | | | $ | 25,067 | |
The following table details activity for loans held in securitization trusttrusts (net) for the year ended December 31, 2008.2011 (dollar amounts in thousands):
| | | Principal | | | Premium | | | Allowance for Loan Losses | | | Net Carrying Value | |
| Balance, December 31, 2007 | | $ | 429,629 | | | $ | 2,733 | | | $ | (1,647 | ) | | $ | 430,715 | |
| Additions | | | - | | | | - | | | | - | | | | - | |
| Principal repayments | | | (82,083 | ) | | | - | | | | - | | | | (82,083 | ) |
| Provision for loan loss | | | - | | | | - | | | | (1,433 | ) | | | (1,433 | ) |
| Charge-Offs | | | | | | | | | | | 1,674 | | | | 1,674 | |
| Amortization for premium | | | - | | | | (536 | ) | | | - | | | | (536 | ) |
| Balance, December 31, 2008 | | $ | 347,546 | | | $ | 2,197 | | | $ | (1,406 | ) | | $ | 348,337 | |
| | | Principal | | | Premium | | | Allowance for Loan Losses | | | Net Carrying Value | |
| Balance, January 1, 2011 | | $ | 229,323 | | | $ | 1,451 | | | $ | (2,589 | ) | | $ | 228,185 | |
| Principal repayments | | | (19,674 | ) | | | — | | | | — | | | | (19,674 | ) |
| Provision for loan loss | | | — | | | | — | | | | (1,380 | ) | | | (1,380 | ) |
| Transfer to real estate owned | | | (890 | ) | | | — | | | | 192 | | | | (698 | ) |
| Charge-Offs | | | 175 | | | | — | | | | 446 | | | | 621 | |
| Amortization for premium | | | — | | | | (134 | ) | | | — | | | | (134 | ) |
| Balance, December 31, 2011 | | $ | 208,934 | | | $ | 1,317 | | | $ | (3,331 | ) | | $ | 206,920 | |
51
The following table details activity for loans held in securitization trusts (net) for the year ended December 31, 2010 (dollar amounts in thousands)| | | Principal | | | Premium | | | Allowance for Loan Losses | | | Net Carrying Value | |
| Balance, January 1, 2010 | | $ | 277,007 | | | $ | 1,750 | | | $ | (2,581 | ) | | $ | 276,176 | |
| Principal repayments | | | (45,721 | ) | | | — | | | | — | | | | (45,721 | ) |
| Provision for loan loss | | | — | | | | — | | | | (1,560 | ) | | | (1,560 | ) |
| Transfer to real estate owned | | | (1,963 | ) | | | — | | | | 564 | | | | (1,399 | ) |
| Charge-Offs | | | — | | | | — | | | | 988 | | | | 988 | |
| Amortization for premium | | | — | | | | (299 | ) | | | — | | | | (299 | ) |
| Balance, December 31, 2010 | | $ | 229,323 | | | $ | 1,451 | | | $ | (2,589 | ) | | $ | 228,185 | |
Delinquency Status
As of December 31, 2008, we had 17 delinquent loans totaling approximately $7.4 million categorized asOur Mortgage Loans Held in Securitization Trusts. In additionTrusts (Net). As of December 31, 2011, we had four REO properties38 delinquent loans totaling approximately $1.9 million.$21.0 million categorized as mortgage loans held in securitization trusts (net). Of the $21.0 million in delinquent loans, $18.0 million, or 86%, were currently under some form of modified payment plan at December 31, 2011. A substantial number of the loans reflected in the tables below at each of December 31, 2011 and 2010 are the same loans as the foreclosure process can take multiple years to be completed, particularly in certain states, including New York, Massachusetts and New Jersey. Loans originated in judicial states are required to go through the supervision of a court for foreclosure resolution. The table below shows delinquencies in our loan portfolio of loans held in securitization trusts as of December 31, 20082011 (dollar amounts in thousands):
| Days Late | | Number of Delinquent Loans | | | Total Dollar Amount | | | % of Loan Portfolio | |
| 30-60 | | | 2 | | | $ | 517 | | | | 0.25 | % |
| 61-90 | | | 1 | | | $ | 378 | | | | 0.18 | % |
| 90+ | | | 35 | | | $ | 20,138 | | | | 9.61 | % |
| Real Estate Owned (REO) | | | 3 | | | $ | 656 | | | | 0.31 | % |
Days Late | | Number of Delinquent Loans | | | Total Dollar Amount | | | % of Loan Portfolio | |
| 30-60 | | | 3 | | | $ | 1,363 | | | | 0.39 | % |
| 61-90 | | | 1 | | | $ | 263 | | | | 0.08 | % |
| 90+ | | | 13 | | | $ | 5,734 | | | | 1.65 | % |
| Real Estate Owned (REO) | | | 4 | | | $ | 1,927 | | | | 0.55 | % |
As of December 31, 2007,2010, we had 1446 delinquent loans totaling approximately $8.8$25.1 million categorized as Mortgage Loans Heldmortgage loans held in Securitization Trusts.securitization trusts (net). Of the $25.1 million in delinquent loans, $17.8 million, or 71%, were under some form of modified payment plan at December 31, 2010. The table below shows delinquencies in our loan portfolio of loans held in securitization trusts as of December 31, 20072010 (dollar amounts in thousands):
| Days Late | | Number of Delinquent Loans | | | Total Dollar Amount | | | % of Loan Portfolio | |
| 30-60 | | | 7 | | | $ | 2,515 | | | | 1.09 | % |
| 61-90 | | | 4 | | | $ | 4,362 | | | | 1.89 | % |
| 90+ | | | 35 | | | $ | 18,191 | | | | 7.90 | % |
| Real Estate Owned (REO) | | | 3 | | | $ | 894 | | | | 0.39 | % |
Days Late | | Number of Delinquent Loans | | | Total Dollar Amount | | | % of Loan Portfolio | |
| 30-60 | | | - | | | $ | - | | | | - | |
| 61-90 | | | 2 | | | $ | 1,859 | | | | 0.43 | % |
| 90+ | | | 12 | | | $ | 6,910 | | | | 1.61 | % |
| Real Estate Owned (REO) | | | 4 | | | $ | 4,145 | | | | 0.96 | % |
Interest is recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectible. The accrual of interest on loans is discontinued when, in management’s opinion, the interest is not collectible in the normal course of business, but in no case beyond when payment on a loan becomes 90 days delinquent. Interest collected on loans for which accrual has been discontinued is recognized as income upon receipt.
Cash and Cash Equivalents.Equity Investment in Limited Partnership. We had unrestricted cash and cash equivalents of $9.4 million at December 31, 2008.
Restricted Cash. Restricted cash totaled $8.0 millionThe following table details loan summary information for loans held in the limited partnership in which we have an equity interest as of December 31, 2008. Included2011 and 2010, respectively, which is accounted for under the equity method (dollar amounts in restricted cash was $4.2 million related to amounts deposited to meet margin calls on interest rate swaps and $3.2 million for amounts posted to meet repurchase agreement margin calls.thousands):
Prepaid and Other Assets. Prepaid and other assets totaled $1.2 million as of December 31, 2008. Prepaid and other assets consist mainly of $0.4 million in escrow advances related to loans held in securitization trust and $0.2 million of capitalized servicing costs.| Loan Summary | | December 31, 2011 | |
| Number of Loans | | | 64 | |
| Aggregate Current Loan Balance | | $ | 9,654 | |
| Average Current Loan Balance | | $ | 151 | |
| Weighted Average Original Term (Months) | | | 375 | |
| Weighted Average Remaining Term (Months) | | | 311 | |
| Weighted Average Gross Coupon (%) | | | 7.02% | |
| Weighted Average Original Loan-to-Value of Loan (%) | | | 85.69% | |
| Average Cost-to-Principal of Asset at Funding (%) | | | 70.81% | |
| Fixed Rate Mortgages (%) | | | 55.55% | |
| Adjustable Rate Mortgages (%) | | | 44.45% | |
| First Lien Mortgages (%) | | | 100.00% | |
| Loan Summary | | December 31, 2010 | |
| Number of Loans | | | 159 | |
| Aggregate Current Loan Balance | | $ | 26,953 | |
| Average Current Loan Balance | | $ | 170 | |
| Weighted Average Original Term (Months) | | | 377 | |
| Weighted Average Remaining Term (Months) | | | 326 | |
| Weighted Average Gross Coupon (%) | | | 6.80% | |
| Weighted Average Original Loan-to-Value of Loan (%) | | | 86.60% | |
| Average Cost-to-Principal of Asset at Funding (%) | | | 66.99% | |
| Fixed Rate Mortgages (%) | | | 69.63% | |
| Adjustable Rate Mortgages (%) | | | 30.37% | |
| First Lien Mortgages (%) | | | 100.00% | |
Financing Arrangements, Portfolio Investments. As of December 31, 2008,2011, there were approximately $402.3$112.7 million of repurchase agreement borrowings outstanding. Our repurchase agreements typically have terms of 30 days.days or less. As of December 31, 2008,2011, the current weighted average borrowing rate on these financing facilities was 2.62%0.71%. For the year ended December 31, 2011, the ending balance, yearly average and maximum balance at any month-end for our repurchase agreement borrowings were $112.7 million, $85.6 million and $123.8 million, respectively.
Collateralized Debt Obligations. As of December 31, 2008,2011, we had $335.6$199.8 million of collateralized debt obligations, or CDOs, outstanding with ana weighted average interest rate of 0.85%0.68%.
Subordinated Debentures. As of December 31, 2008,2011, one of our wholly owned subsidiary, HC,subsidiaries had trust preferred securities outstanding of $44.6 million net of deferred bond issuance costs of $0.4$45.0 million with ana weighted average interest rate of 6.61%4.35%. The securities are fully guaranteed by the Companyus with respect to distributions and amounts payable upon liquidation, redemption or repayment. These securities are classified as subordinated debentures in the liability section of the Company’sour consolidated balance sheet.sheet included in this Annual Report.
$25.0 million of ourOur subordinated debentures in the amount of $25 million have a floating interest rate equal to three-month LIBOR plus 3.75%, resetting quarterly, (5.22%quarterly; the interest rate on these subordinated debentures was 4.33% at December 31, 2008).2011. These securities mature on March 15, 2035 and may be called at par by the Companyus any time after March 15, 2010. HCThe subsidiary that issued these securities entered into an interest rate cap agreement to limit the maximum interest rate cost of thethese trust preferred securities to 7.5% through March 15, 2010. The term of2010, at which point the interest rate cap agreement is five years and resets quarterly in conjunction with the reset periods of the trust preferred securities.expired.
$20 million of ourOur subordinated debentures havein the amount of $20 million had a fixed interest rate equal to 8.35% up to and including July 30, 2010, at which point the interest rate is converted to a floating rate equal to one-month LIBOR plus 3.95% until maturity.maturity; the interest rate on these subordinated debentures was 4.38% at December 31, 2011. The securities mature on October 30, 2035 and may be called at par by the Companyus any time after October 30, 2010.
Convertible Preferred Debentures. At December 31, 2008 we had $19.7The Company issued $20.0 million of convertible preferred debentures outstanding net of $0.3 million of deferred debt issuance cost. We issued these shares ofin Series A Convertible Preferred Stock to JMP Group Inc. and certain of its affiliates for an aggregate purchase price of $20.0 million. The Series A Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. The Series A Preferred Stock is convertible into shares of the Company's common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. The Series A Preferred Stock maturesthat matured on December 31, 2010. Pursuant to SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, because of this mandatory redemption feature,The outstanding shares were redeemed by the Company classifies these securities as a liabilityat the $20.00 per share liquidation preference plus accrued dividends on its balance sheet.December 31, 2010.
Derivative Assets and LiabilitiesLiabilities. .We generally hedge the riskrisks related to changes in the benchmark interest rate used in the variable rate index, usually LIBOR.rates related to our borrowings as well as market values of our overall portfolio.
In order to reduce these risks,our interest rate risk related to our borrowings, we enter intomay utilize various hedging instruments, such as interest rate swap agreementsagreement contracts whereby we receive floating rate payments in exchange for fixed rate payments, effectively converting our short term repurchase agreement borrowingborrowings or CDOs to a fixed rate. We alsoAt December 31, 2011, the Company had $24.8 million of notional amount of interest rate swaps outstanding with a fair market liability value of $0.3 million. The interest rate swaps qualify as cash flow hedges for financial reporting purposes.
In addition to utilizing interest rate swaps, we may purchase or sell short U.S. Treasury securities or enter into Eurodollar or other futures contracts or options to help mitigate the potential impact of changes in interest rates on the performance of our Agency IOs. We may borrow securities to cover short sales of U.S. Treasury securities under reverse repurchase agreements. We account for the securities borrowing transactions as reverse repurchase agreements on our consolidated balance sheet. Short sales of U.S. Treasury securities are accounted for as securities sold short, at fair value. Realized and unrealized gains and losses associated with purchases and short sales of U.S. Treasury securities and Eurodollar or other futures are recognized through earnings in the consolidated statements of operations.
The Company uses TBAs, U.S. Treasury securities and U.S. Treasury futures and options to hedge interest rate cap agreements whereby,risk, as well as spread risk associated with its investments in exchangeAgency IOs. For example, we may utilize TBAs to hedge the interest rate or yield spread risk inherent in our long Agency RMBS by taking short positions in TBAs that are similar in character. In a TBA transaction, we would agree to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. The Company typically does not take delivery of TBAs, but rather settles with its trading counterparties on a premium,net basis. TBAs are liquid and have quoted market prices and represent the most actively traded class of RMBS. For TBA contracts that we have entered into, we have not asserted that physical settlement is probable. Because we have not designated these forward commitments associated with our Agency IOs as hedging instruments, realized and unrealized gains and losses associated with these TBAs, U.S. Treasury securities and U.S. Treasury futures and options are reimbursed for interest paidrecognized through earnings in excessthe consolidated statements of operations.
The use of TBAs exposes the Company to market value risk, as the market value of the securities that the Company is required to purchase pursuant to a contractually specified capped rate.TBA transaction may decline below the agreed-upon purchase price. Conversely, the market value of the securities that the Company is required to sell pursuant to a TBA transaction may increase above the agreed upon sale price. The use of TBAs associated with our Agency IO investments creates significant short term payables (and/or receivables) on our balance sheet. For more information regarding our use of TBAs please see Note 6 - “Derivative Instruments and Hedging Activities”included in Item 8 of this Annual Report on Form 10-K.
Derivative financial instruments may contain credit risk to the extent that the institutional counterparties may be unable to meet the terms of the agreements. We attempted to minimize this risk by limiting our counterparties to major financial institutions with good credit ratings. In addition, we regularly monitor the potential risk of loss with any one party resulting from this type of credit risk. Accordingly, we do not expect any material losses as a result of default by other parties, but can provide no assurance thatcannot guarantee we will avoid counter partydo not have counterparty failures.
We enter into derivative transactions solely for risk management purposes. The decision of whether or not a given transaction, or a portion thereof, is hedged is made on a case-by-case basis, based on the risks involved and other factors as determined by senior management, including the financial impact on income and asset valuations and the restrictions imposed on REIT hedging activities by the Internal Revenue Code, among others. In determining whether to hedge a risk, we may consider whether other assets, liabilities, firm commitments and anticipated transactions already offset or reduce the risk. All transactions undertaken as a hedge are entered into with a view towards minimizing the potential for economic losses that could be incurred by us. Generally, all derivatives entered into are intended to qualify as cash flow hedges in accordance with GAAP, unless specifically precluded under SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities. To this end, terms of the hedges are matched closely to the terms of hedged items.
The following table summarizespresents the estimated fair value of derivative assetsinstruments designated as hedging instruments and liabilities as oftheir location in the Company’s consolidated balance sheets at December 31, 20082011 and December 31, 20072010, respectively (dollar amounts in thousands):
| Derivatives Designated as Hedging Instruments | | Balance Sheet Location | | December 31, 2011 | | | December 31, 2010 | |
| Interest Rate Swaps | | Derivative liabilities | | $ | 304 | | | $ | 1,087 | |
At December 31, 2011, we had $24.8 million in notional interest rate swaps outstanding. Should market rates for similar term interest rate swaps drop below the fixed rates we have agreed to on our interest rate swaps, we will be required to post additional margin to the swap counterparty, reducing available liquidity. At December 31, 2011, the Company pledged $0.6 million in cash margin to cover decreased valuations for our interest rate swaps. The weighted average maturity of the swaps was 0.6 years at December 31, 2011.
| | | December 31, 2008 | | | December 31, 2007 | |
| Derivative assets: | | | | | | |
| Interest rate caps | | $ | 22 | | | $ | 416 | |
| Total derivative assets | | $ | 22 | | | $ | 416 | |
| | | | | | | | | |
| Derivative liabilities: | | | | | | | | |
| Interest rate swaps | | $ | 4,194 | | | $ | 3,517 | |
| Total derivative liabilities | | $ | 4,194 | | | $ | 3,517 | |
Our investment in Agency IOs involves several types of derivative instruments used to hedge the overall risk profile of our investments in Agency IOs. This hedging technique is dynamic in nature and requires frequent adjustments, which accordingly makes it very difficult to qualify for hedge accounting treatment. Hedge accounting treatment requires specific identification of a risk or group of risks and then requires that we designate a particular trade to that risk with no minimal ability to adjust over the life of the transaction. Because we and our external manager are frequently adjusting these derivative instruments in response to current market conditions, we have determined to account for all the derivative instruments related to our Agency IO investments as derivatives not designated as hedging instruments. The following table presents the fair value of derivative instruments related to our Agency IO investments that were not designated as hedging instruments and their location in the Company’s consolidated balance sheets at December 31, 2011 and 2010, respectively (dollar amounts in thousands):
Derivatives Not Designated as Hedging Instruments | | Balance Sheet Location | | December 31, 2011 | | December 31, 2010 |
| TBA securities | | Derivative assets | | $ | 207,891 | | $ | — |
| Options on U.S. Treasury futures | | Derivative assets | | | 327 | | | — |
| U.S. Treasury futures | | Derivative liabilities | | | 566 | | | — |
| Eurodollar futures | | Derivative liabilities | | | 1,749 | | | — |
For the year ended December 31, 2011, we recorded net realized gains of $2.9 million and unrealized gains of $1.4 million in connection with TBA transactions. There were no realized or unrealized gains or losses from TBAs for the same period in 2010. As of December 31, 2011, the fair value of our TBAs totaled $207.9 million with a corresponding liability of $206.8 million included in payable for securities purchased.
For the year ended December 31, 2011, we recorded net realized losses of $0.2 million and net unrealized losses of $0.7 million from U.S. Treasury futures and options. There were no realized or unrealized gains or losses from U.S. Treasury securities, U.S. Treasury futures or options for the same period in 2010.
For the year ended December 31, 2011, we recorded net realized losses of $2.0 million and net unrealized losses of $1.7 million on our Eurodollar futures contracts. The Eurodollar futures consist of 2,422 contracts with expiration dates ranging between March 2012 and September 2014. There were no realized or unrealized gains or losses from Eurodollars for the same period in 2010. Our Eurodollar futures swap equivalents are accounted for at fair value with both realized and unrealized gains and losses included in other income (expense) in our consolidated statements of operations.
Balance Sheet Analysis - Stockholders’ Equity
Stockholders’ equity at December 31, 20082011 was $39.2$85.3 million and included $8.5$11.3 million of netaccumulated other comprehensive income. The accumulated other comprehensive income consisted of $12.8 million in unrealized gains primarily related to our CLOs, $1.2 million in unrealized losses $5.6related to our CMBS and $0.3 million in unrealized derivative losses related to cash flow hedgeshedges. Stockholders’ equity at December 31, 2010 was $68.5 million and $2.9included $17.7 million of accumulated other comprehensive income. The accumulated other comprehensive income consisted of $18.8 million in unrealized gains primarily related to our CLOs and $1.1 million in unrealized derivative losses related to availablecash flow hedges.
Analysis of Changes in Book Value
The following table analyzes the changes in book value for sale securities presented as accumulated other comprehensive income.
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the quarter and year ended December 31, 2011 (amounts in thousands, except per share):
Table of Contents| | | Quarter Ended December 31, 2011 | | | Year ended December 31, 2011 | |
| | | Amount | | | Shares | | | Per Share(1) | | | Amount | | | Shares(1) | | | Per Share | |
| Beginning Balance | | $ | 75,437 | | | | 11,178 | | | $ | 6.75 | | | $ | 68,487 | | | | 9,425 | | | $ | 7.27 | |
Stock issuance(2) | | | 17,773 | | | | 2,760 | | | | 6.44 | | | | 29,697 | | | | 4,485 | | | | 6.62 | |
| Restricted shares | | | | | | | | | | | | | | | 210 | | | | 28 | | | | 7.54 | |
| Balance after share issuance activity | | | 93,210 | | | | 13,938 | | | | 6.69 | | | | 98,394 | | | | 13,938 | | | | 7.06 | |
| Dividends declared | | | (4,878 | ) | | | | | | | (0.35 | ) | | | (11,452 | ) | | | | | | | (0.82 | ) |
Net change AOCI:(3) | | | | | | | | | | | | | | | | | | | | | | | | |
| Hedges | | | 180 | | | | | | | | 0.01 | | | | 783 | | | | | | | | 0.06 | |
| RMBS | | | 284 | | | | | | | | 0.02 | | | | (440 | ) | | | | | | | (0.03 | ) |
| CMBS | | | (1,036 | ) | | | | | | | (0.08 | ) | | | (1,036 | ) | | | | | | | (0.08 | ) |
| CLOs | | | (590 | ) | | | | | | | (0.04 | ) | | | (5,747 | ) | | | | | | | (0.41 | ) |
| Net income excluding unrealized gains and losses on Agency IOs and related hedges | | | (997 | ) | | | | | | | (0.07 | ) | | | 14,433 | | | | | | | | 1.03 | |
| Unrealized gains and losses on Agency IOs and related hedges | | | (895 | ) | | | | | | | (0.06 | ) | | | (9,657 | ) | | | | | | | (0.69 | ) |
| Ending Balance | | $ | 85,278 | | | | 13,938 | | | $ | 6.12 | | | $ | 85,278 | | | | 13,938 | | | $ | 6.12 | |
| (1) | Outstanding shares used to calculate book value per share for the quarter and year ended periods are based on outstanding shares as of December 31, 2011 of 13,938,273. |
| (2) | On June 28, 2011, we entered into an underwriting agreement relating to the offer and sale of 1,500,000 shares of our common stock at a public offering price of $7.50 per share, which shares were issued and proceeds received on July 1, 2011. On July 14, 2011, we issued an additional 225,000 shares of common stock to the underwriter pursuant to their exercise of an over-allotment option. On December 1, 2011, we entered into an underwriting agreement relating to the offer and sale of 2,400,000 shares of our common stock at a public offering price of $6.90 per share, which shares were issued and proceeds received on December 6, 2011. On December 16, 2011, we issued an additional 360,000 shares of common stock to the underwriter pursuant to their exercise of an over-allotment option. |
| (3) | Accumulated other comprehensive income (“AOCI”). |
ResultsStatement of Operations Analysis
The following is a brief description of key terms from our consolidated financial statements:statements of operations:
RevenuesNet Interest income. Our primary source of income is net interest income on our portfolio of assets. Net interest income is the difference between interest income, which is the income that we earn on our assets, which for 2008 was RMBS and loans in securitization trusts, and interest expense, which is the interestexpense we pay on our portfolio borrowings, subordinated debt and convertible preferred debentures. Prior to our exit from the mortgage lending business in March 2007, net interest income was also earned on the loan originations by HC for the period of time commencing upon the closing of a loan and ending upon the sale of such loan to a third party.
Other Expenses.income (expense). Other expenseincome (expense) includes a provision for estimated loan losses for costs incurred with respect to, the disposition of non-performing or early payment default loans we have originated or purchased from third parties or from losses incurred on non-performing loans held in securitization trusts. In addition, other expense includestrusts, impairment losses on investment securities, net lossesrealized gains from the sale of investments securities or the early termination of interest rate swaps and related hedges, net unrealized losses from impairments on investment securities.securities and related hedges associated with our Agency IOs and income from our investment in a limited partnership and limited liability company.
General, administrative and other expenses.Expenses. Non-interest expenses we incur in operating our business consist primarily of salary and employee benefits, fees payable to HCS, Midway and RiverBanc pursuant to the advisory and management agreements, professional fees, insurance management fees and other general and administrative expenses. Other general and administrative expenses include expenses for office rents,rent, supplies and equipment, rentals, office supplies, postagecomputer and shipping,software, telephone, travel and entertainment, outsourced accounting services and other miscellaneous operating expenses. In 2008, other expenses included the penalty payments paid to investors pursuant to a registration rights agreement we entered into in connection with our February 2008 common equity offering.
Income (loss) from discontinued operations:operation. LossIncome from discontinued operations includes all revenues and expenses related to our discontinued mortgage lending business excluding those costs that will be retained by us, which arebusiness.
Executive Summary Of Operating Results and Stockholders' Equity for Quarter and Year Ended December 31, 2011
For the quarter ended December 31, 2011, the Company reported consolidated net loss attributable to common stockholders of $1.9 million, or $0.16 per common share, as compared to consolidated net income attributable to common stockholders of $1.0 million, or $0.11 per common share, for the quarter ended December 31, 2010. The decline in net income for the fourth quarter of 2011 was primarily expensesdue to realized and unrealized losses on investment securities and related hedges associated with the Company's Agency IO strategy of $2.3 million and $0.9 million, respectively, during the fourth quarter of 2011, as compared to realized and unrealized gains on investment securities and related hedges associated with Agency IOs of $1.4 million and $0, respectively, during the fourth quarter of 2010. In addition, the Company took a one time charge of $2.2 million related to rent expensethe termination of its advisory agreement with HCS, which negatively impacted net income for leased locations not assignedthe 2011 fourth quarter.
Although the realized and unrealized losses contributed to the Company’s decline in net income for the 2011 fourth quarter, the Company’s investment portfolio continued to post strong net interest income results, generating $5.4 million in net interest income in the 2011 fourth quarter, which represents a 176% improvement over net interest income for the same period of 2010. The increase in net interest income during the 2011 fourth quarter as partcompared to the same period in 2010, was primarily driven by a 320 basis point increase in net interest income which was mainly due to the performance of the dispositionCompany’s Agency IOs and its investments in the multi-family CMBS.
For the year ended December 31, 2011, the Company reported consolidated net income attributable to common stockholders of $4.8 million, or $0.46 per common share, as compared to $6.8 million, or $0.72 per common share, for the year ended December 31, 2010. The decrease in full year 2011 earnings as compared to the same period in 2010 was driven by a net unrealized loss of $9.7 million on investment securities and related hedges associated with the Company’s Agency IOs, partially offset by realized gains of $4.7 million on the sale of CLO notes during 2011. Because of the hedging strategy employed by the Company with respect to its Agency IOs, unrealized gains and losses are not designated for hedge accounting treatment, and therefore are directly run through the Company’s income statement. Similar to the fourth quarter of 2011, full year 2011 net income was also impacted by the one-time charge of $2.2 million related to the termination of the advisory agreement with HCS.
For full year 2011, the Company’s net interest income reached record levels at $19.5 million, an increase of $9.2 million, which represents an 89% improvement over net interest income from the previous year. The increase in net interest income for the 2011 year as compared to the same period in 2010 was primarily driven by a 281 basis point increase in net interest income spread which was mainly due to the performance of the Company’s Agency IOs and multi-family CMBS, as well as the repayment of $20.0 million of convertible preferred debentures on December 31, 2010 which had an interest rate of 10%.
As of December 31, 2011, the Company’s book value per common share was $6.12, down from $6.75 at September 30, 2011 and $7.27 at December 31, 2010. The decrease since September 30, 2011 is due in part to the unrealized losses in our mortgage lending businesscredit sensitive securities of approximately $0.12 per share, the net loss for the fourth quarter of $0.16 per share and certain allocated payroll expenses for employees remaining with us. Our discontinued operations were profitabledividends of $0.35 per share. The decline in 2008book value since December 31, 2010 is due in part to unrealized losses on CLO notes of approximately $0.41 per share and unrealized losses on multi-family CMBS of approximately $0.07 per share, each due primarily to widening credit spreads, and unrealized losses associated with our Agency IOs and related hedges of approximately $0.69 per share. Unrealized gains and losses on the rent reimbursement from Indymac stemming from Indymac’s useCompany’s CLOs are run through the balance sheet and as a result, directly impact stockholders’ equity and book value per share. As of December 31, 2011, since the inception of our former corporate headquartersinvestment in these securities, our CLOs have generated realized gains of $4.7 million and unrealized gains of $12.5 million. While unrealized losses associated with the Company’s Agency IOs and related hedges are run through the endincome statement, they do impact the Company’s book value per share through retained earnings.
The realized and unrealized losses discussed above, that contributed to lower net income and book value per common share as of July 2008. Seeand for the year and quarter ended December 31, 2011, were negatively impacted as a result of a confluence of several factors, including (i) a historical rally in U.S. Treasuries during the year leading to the lowest yield ever on the 10-year Treasury note, 8which contributed to perceived higher future prepayment experience for the Company’s IOs, (ii) continued uncertainty and concerns of systemic risk related to the European sovereign debt crisis, and (iii) uncertainty resulting from the implementation of HARP II, with the intent of increasing significantly the number of homeowners eligible to refinance their mortgage under this program and thus, further elevating fears of higher prepayment speeds. Each of these factors contributed to a significant widening of credit spreads and global market uncertainty during the second half of 2011, which in turn, negatively impacted the pricing of our consolidated financial statements includedCLOs, Agency IOs and multi-family CMBS at December 31, 2011. However, while the markets anticipated an escalation in this Annual Report on Form 10-K for more information regarding our discontinued operations.prepayment speeds, the Company’s actual prepayment experience during the last four months have not indicated significant increases in speeds, although management anticipates prepayment speeds increasing in the near term.
Results of Operations - Comparison of Years Ended December 31, 2008, 20072011 and 20062010
| (dollar amounts in thousands) | | For the Years Ended December 31, | |
| | | 2008 | | | 2007 | | | % Change | | | 2006 | | | % Change | |
| Net interest income | | $ | 7,863 | | | $ | 477 | | | | 1,548.4 | % | | $ | 4,784 | | | | (62.8 | )% |
| Other expenses | | $ | 26,717 | | | $ | 18,513 | | | | 44.3 | % | | $ | 586 | | | | 3,059.2 | % |
| Total expenses | | $ | 6,910 | | | $ | 2,754 | | | | 150.9 | % | | $ | 2,032 | | | | 52.9 | % |
| (Loss) income for continuing operations | | $ | (25,764 | ) | | $ | (20,790 | ) | | | (23.9 | )% | | $ | 2,166 | | | | (34.8 | )% |
| Income (loss) from discontinued operations | | $ | 1,657 | | | $ | (34,478 | ) | | | 104.8 | % | | $ | (17,197 | ) | | | (98.5 | )% |
| Net loss | | $ | (24,107 | ) | | $ | (55,268 | ) | | | 56.4 | % | | $ | (15,031 | ) | | | (181.5 | )% |
| Basic and diluted loss per share | | $ | (2.91 | ) | | $ | (30.47 | ) | | | 90.4 | % | | $ | (8.33 | ) | | | (179.9 | )% |
| (dollar amounts in thousands) | | For the Years Ended December 31, |
| | | 2011 | | | 2010 | | | % Change |
| Net interest income | | $ | 19,454 | | | $ | 10,288 | | | | 89.1 | % |
| Total other (expense) income | | $ | (3,693 | ) | | $ | 3,332 | | | | (210.8 | )% |
| Total general, administrative and other expenses | | $ | 10,518 | | | $ | 7,950 | | | | 32.3 | % |
| Income from continuing operations before income taxes | | $ | 5,243 | | | $ | 5,670 | | | | (7.5 | )% |
| Income tax expense | | $ | 433 | | | $ | — | | | | 100.0 | % |
| Income from continuing operations | | $ | 4,810 | | | $ | 5,670 | | | | (15.2 | )% |
| Income from discontinued operation - net of tax | | $ | 63 | | | $ | 1,135 | | | | (94.4 | )% |
| Net income | | $ | 4,873 | | | $ | 6,805 | | | | (28.4 | )% |
| Net income attributable to noncontrolling interest | | $ | 97 | | | $ | — | | | | 100.0 | % |
| Net income attributable to common stockholders | | $ | 4,776 | | | $ | 6,805 | | | | (29.8 | )% |
| Basic income per common share | | $ | 0.46 | | | $ | 0.72 | | | | (36.1 | )% |
| Diluted income per common share | | $ | 0.46 | | | $ | 0.72 | | | | (36.1 | )% |
For the year ended December 31, 2008,2011, we reported a net lossincome attributable to common stockholders of $24.1$4.8 million as compared to a net loss of $55.3$6.8 million for the year ended December 31, 2007 or a2010. The $2.0 million decrease of $31.2 million. The decreasein net income was due mainlyprimarily to the eliminationa $9.7 million increase in net unrealized loss on investment securities and related hedges, a one-time termination fee of non recurring charges that were$2.2 million recorded in 2007, including an $18.4 million charge to reserve 100%connection with the termination of the deferredHCS Advisory Agreement, a $1.1 million decrease in income from discontinued operations, a $0.4 million increase in general, administrative and other expenses, a $0.4 million increase in income tax asset related to the discontinued business,expense, partially offset by a $16.1$9.2 million operatingincrease in net interest margin on our investment portfolio and loans held in securitization trusts, a $1.7 million increase in income from investments in limited partnership and limited liability company, a $0.5 million decrease in provision for loan loss for the mortgage origination business that was soldloans held in March 2007. Additionally, thesecuritization trusts, and a $0.4 million increase in net realized gain on securities and related hedges. The increase in net interest marginincome for the twelve months ended December 31, 2008 increased by $7.4 million as compared to the same period in 2007 due to significant portfolio restructuring. The Company incurred a $5.3 million non cash impairment in the fourth quarter of 2008 as compared to an $8.5 million impairment charge in the fourth quarter of 2007.
For the year ended December 31, 2007, we reported a net loss of $55.3 million,2011 as compared to the year ended December 31, 2010 was primarily due to a 281 basis point increase in net interest income spread, which was mainly due to the performance of our Agency IOs and the maturity of our Series A Preferred Stock in 2010. The $7.0 million decrease in other (expense) income from 2010 to 2011 was due primarily to a $9.7 million increase in net unrealized loss on investment securities and related hedges primarily associated with our Agency IOs, partially offset by a $1.7 million increase in income from investments in limited partnership and limited liability company, a $0.5 decrease in provision for loan loss for the loans held in securitization trusts, and a $0.4 million increase in net realized gain on securities and related hedges. Included in our total realized gains of $15.0$5.7 million for the year ended December 31, 2006. The increase in net loss of $40.3 was due to2011 is a $4.7 million gain on the following factors: an $18.4 million charge to reserve 100% of the deferred tax asset, a decrease in net interest margin of $4.3 million, an $8.5 million non cash impairment related to the investment portfolio, an increase of $7.8 million related to losses on sale of securities and hedges and an increase in loan losses of $1.6 million related to loans held in securitization trust.CLOs.
Revenues
Comparative Net Interest Income
| | | For the years ended December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
thousands) | | Average Balance | | | Amount | | | Yield/ Rate | | | Average Balance | | | Amount | | | Yield/ Rate | | | Average Balance | | | Amount | | | Yield/ Rate | |
| | | ($ Millions) | | | | | | | | | ($ Millions) | | | | | | | | | ($ Millions) | | | | | | | |
| Interest Income: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Investment securities and loans held in the securitization trusts | | $ | 907.3 | | | | 44,778 | | | | 4.94 | % | | $ | 907.0 | | | $ | 52,180 | | | | 5.74 | % | | $ | 1,266.4 | | | $ | 66,973 | | | | 5.29 | % |
| Amortization of net premium | | | 1.4 | | | | (655 | ) | | | (0.08 | )% | | | 2.4 | | | | (1,616 | ) | | | (0.18 | )% | | | 5.9 | | | $ | (2,092 | ) | | | (0.16 | )% |
| Interest income | | $ | 908.7 | | | | 44,123 | | | | 4.86 | % | | $ | 909.4 | | | $ | 50,564 | | | | 5.56 | % | | $ | 1,272.3 | | | $ | 64,881 | | | | 5.13 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Investment securities and loans held in the securitization trusts | | $ | 820.5 | | | | 30,351 | | | | 3.65 | % | | $ | 864.7 | | | $ | 46,529 | | | | 5.31 | % | | $ | 1,201.2 | | | $ | 56,553 | | | | 4.64 | % |
| Subordinated debentures | | | 45.0 | | | | 3,760 | | | | 8.24 | % | | | 45.0 | | | | 3,558 | | | | 7.80 | % | | | 45.0 | | | | 3,544 | | | | 7.77 | % |
| Convertible preferred debentures | | | 20.0 | | | | 2,149 | | | | 10.60 | % | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest expense | | $ | 885.5 | | | | 36,260 | | | | 4.09 | % | | $ | 909.7 | | | $ | 50,087 | | | | 5.43 | % | | $ | 1,246.2 | | | $ | 60,097 | | | | 4.76 | % |
| Net interest income | | $ | 23.2 | | | | 7,863 | | | | 0.77 | % | | $ | (0.3 | ) | | $ | 477 | | | | 0.13 | % | | $ | 26.1 | | | $ | 4,784 | | | | 0.37 | % |
The operatingOur results of operations for our mortgageinvestment portfolio management business during a given period typically reflectreflects the net interest spreadincome earned on our investment portfolio of residential mortgageAgency and non-Agency RMBS, CMBS, prime ARM loans held in securitization trusts, loans held for investment, loans held for sale, CLOs, and U.S. Treasury securities and loans.(our “Interest Earning Assets”). The net interest spread is impacted by factors such as our cost of financing, the interest rate that our investments are earningbear and our interest rate hedging strategies. Furthermore, the cost of loans held in our portfolio, the amount of premium or discount paid on purchased portfolio investments and the prepayment rates on portfolio investments will impact the net interest spread as such factors will be amortized over the expected term of such investments. Realized and unrealized gains and losses on TBAs, Eurodollar and Treasury futures and other derivatives associated with our Agency IO investments, which do not utilize hedge accounting for financial reporting purposes, are included in other (expense) income in our statement of operations and therefore not reflected in the net interest income data set forth below. The following tables set forth the changes in net interest income, yields earned on our Interest Earning Assets and rates on financing arrangements for each of the years ended December 31, 2011 and 2010, respectively (dollar amounts in thousands, except as noted):
| | | For the Years Ended December 31, |
| | | 2011 | | | 2010 |
| | | Average Balance (1) | | | Amount | | | Yield/ Rate (2) | | | Average Balance (1) | | | Amount | | | Yield/ Rate (2) |
| | | ($Millions) | | | | | | | | | ($Millions) | | | | | | | |
| Interest Income: | | | | | | | | | | | | | | | | | | |
| Interest income | | $ | 348.6 | | | $ | 24,291 | | | | 6.97 | % | | $ | 370.8 | | | $ | 19,899 | | | | 5.37 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest Expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Investment securities and loans | | $ | 300.9 | | | $ | 2,946 | | | | 0.98 | % | | $ | 302.7 | | | $ | 4,864 | | | | 1.61 | % |
| Subordinated debentures | | | 45.0 | | | | 1,891 | | | | 4.20 | % | | | 45.0 | | | | 2,473 | | | | 5.49 | % |
| Convertible preferred debentures | | | - | | | | - | | | | - | % | | | 20.0 | | | | 2,274 | | | | 11.37 | % |
| Interest expense | | $ | 345.9 | | | $ | 4,837 | | | | 1.40 | % | | $ | 367.7 | | | $ | 9,611 | | | | 2.61 | % |
| Net interest income / Net yield | | | | | | $ | 19,454 | | | | 5.57 | % | | | | | | $ | 10,288 | | | | 2.76 | % |
| (1) | Our average balance of Interest Earning Assets is calculated each period as the daily average balance for the period of our Interest Earning Assets, excluding unrealized gains and losses. Our average balance of interest bearing liabilities is calculated each period as the daily average balance for the period of our financing arrangements (portfolio investments), CDOs, subordinated debentures and convertible preferred debentures. |
| (2) | Our net yield on Interest Earning Assets is calculated by dividing our interest income from our Interest Earning Assets for the period by our average Interest Earning Assets during the same period. Our interest expense rate is calculated by dividing our interest expense from our interest bearing liabilities for the period by our average interest bearing liabilities. The interest expense includes interest incurred on interest rate swaps. |
Comparative Net Interest Spread- Interest Earning Assets
The following table sets forth, among other things, the net interest spread for our portfolio of Interest Earning Assets by quarter for the eight most recently completed quarters, excluding the costs of our subordinated debentures and convertible preferred debentures.
| Quarter Ended | | Average Interest Earning Assets ($ millions) (1) | | | Weighted Average Coupon (2) | | | Weighted Average Cash Yield on Interest Earning Assets (3) | | | Cost of Funds (4) | | | Net Interest Spread (5) | | | Constant Prepayment Rate (CPR) (6) | |
| December 31, 2011 | | $ | 372.9 | | | | 4.43 | % | | | 7.17 | % | | | 0.97 | % | | | 6.20 | % | | | 15.8 | % |
| September 30, 2011 | | $ | 369.8 | | | | 4.47 | % | | | 8.04 | % | | | 0.89 | % | | | 7.15 | % | | | 10.8 | % |
| June 30, 2011 | | $ | 341.7 | | | | 4.28 | % | | | 7.59 | % | | | 0.94 | % | | | 6.65 | % | | | 8.8 | % |
| March 31, 2011 | | $ | 310.2 | | | | 3.19 | % | | | 4.76 | % | | | 1.08 | % | | | 3.68 | % | | | 9.6 | % |
| December 31, 2010 | | $ | 318.0 | | | | 3.24 | % | | | 4.98 | % | | | 1.45 | % | | | 3.53 | % | | | 13.8 | % |
| September 30, 2010 | | $ | 343.5 | | | | 3.76 | % | | | 5.29 | % | | | 1.66 | % | | | 3.63 | % | | | 21.1 | % |
| June 30, 2010 | | $ | 393.8 | | | | 4.22 | % | | | 5.28 | % | | | 1.58 | % | | | 3.70 | % | | | 20.5 | % |
| March 31, 2010 | | $ | 425.1 | | | | 4.50 | % | | | 5.85 | % | | | 1.60 | % | | | 4.25 | % | | | 18.6 | % |
| (1) | Our Average Interest Earning Assets is calculated each quarter as the daily average balance of our Interest Earning Assets for the quarter, excluding unrealized gains and losses. |
| (2) | The Weighted Average Coupon reflects the weighted average rate of interest paid on our Interest Earning Assets for the quarter, net of fees paid. The percentages indicated in this column are the interest rates that will be effective through the interest rate reset date, where applicable, and have not been adjusted to reflect the purchase price we paid for the face amount of the security. |
| (3) | Our Weighted Average Cash Yield on Interest Earning Assets was calculated by dividing our annualized interest income from Interest Earning Assets for the quarter by our average Interest Earning Assets for the quarter. |
| (4) | Our Cost of Funds was calculated by dividing our annualized interest expense from our Interest Earning Assets for the quarter by our average financing arrangements, portfolio investments and CDOs for the quarter. |
| (5) | Net Interest Spread is the difference between our Weighted Average Cash Yield on Interest Earning Assets and our Cost of Funds. |
| (6) | Our Constant Prepayment Rate, or CPR, is the proportion of principal of our pool of loans that were paid off during each quarter. |
ForPrepayment Experience. The constant prepayment rate (“CPR”) on our overall portfolio averaged approximately 11% and 19% during 2011 and 2010, respectively. CPRs on our purchased portfolio of investment securities averaged approximately 14% while the CPRs on mortgage loans held for investments and loans held in our securitization trusts averaged approximately 8% during 2011, as compared to 25% and 16%, respectively, during 2010. When prepayment expectations over the remaining life of assets increase, we have to amortize premiums over a shorter time period resulting in a reduced yield to maturity on our net interest spread as well as average Constant investment assets. Conversely, if prepayment expectations decrease, the premium would be amortized over a longer period resulting in a higher yield to maturity. In addition, the market values and cash flows from our Agency IOs can be materially adversely affected during periods of elevated prepayments. We monitor our prepayment experience on a monthly basis and adjust the amortization rate to reflect current market conditions.
The following table sets forth the constant prepayment rates for selected asset classes, by quarter:
| Quarter Ended | | Agency RMBS | | | Non-Agency RMBS | | | Securitizations | | | Total Investment Portfolio | |
| December 31, 2011 | | | 19.2 | % | | | 12.6 | % | | | 5.2 | % | | | 15.8 | % |
| September 30, 2011 | | | 10.8 | % | | | 14.7 | % | | | 10.2 | % | | | 10.8 | % |
| June 30, 2011 | | | 9.0 | % | | | 11.2 | % | | | 8.4 | % | | | 8.8 | % |
| March 31, 2011 | | | 12.0 | % | | | 20.8 | % | | | 7.0 | % | | | 9.6 | % |
| December 31, 2010 | | | — | % | | | 18.4 | % | | | 11.5 | % | | | 13.8 | % |
| September 30, 2010 | | | — | % | | | 15.5 | % | | | 18.7 | % | | | 21.1 | % |
| June 30, 2010 | | | — | % | | | 13.5 | % | | | 11.9 | % | | | 20.5 | % |
| March 31, 2010 | | | — | % | | | 18.0 | % | | | 20.9 | % | | | 18.6 | % |
Prepayment Rate (“CPR”) by quarter since we beganHistory Agency RMBS Portfolio
| | | | Quarterly Averages | | Monthly Averages |
| | Carrying Value 12/31/2011 | | 9/30/2011 | | 12/31/2011 | | 12/31/2011 | | 01/31/2012 | | 02/28/2012 |
| Agency Arms | $ 68,776 | | 16.6% | | 16.9% | | 21.0% | | 23.3% | | 23.1% |
| Agency IOs | $ 63,681 | | 10.1% | | 19.5% | | 20.6% | | 20.2% | | 20.3% |
Federal Housing Finance Agency HARP II Program
In November, the U.S. Government announced details of HARP II, which is a program designed to assist borrowers who are current with their mortgage payments but are unable to refinance due to property valuation ratios. HARP II will target homeowners who did not participate in the original version of HARP and whose mortgages were originated prior to May 31, 2009. The following table summarizes the Agency RMBS in our portfolio investment activities follows:that contain mortgages which are eligible for refinancing and thus may be prepaid under HARP II given the parameters of the program.
| Quarter Ended | | Average Interest Earning Assets ($ millions) | | | Weighted Average Coupon | | | Weighted Average Cash Yield on Interest Earning Assets | | | Cost of Funds | | | Net Interest Spread | | | CPR | |
| December 31, 2008 | | $ | 841.7 | | | | 4.77 | % | | | 4.65 | % | | | 3.34 | % | | | 1.31 | % | | | 9.2 | % |
| September 30, 2008 | | $ | 874.5 | | | | 4.81 | % | | | 4.72 | % | | | 3.36 | % | | | 1.36 | % | | | 13.8 | % |
| June 30, 2008 | | $ | 899.3 | | | | 4.86 | % | | | 4.78 | % | | | 3.35 | % | | | 1.43 | % | | | 14.0 | % |
| March 31, 2008 | | $ | 1,019.2 | | | | 5.24 | % | | | 5.20 | % | | | 4.35 | % | | | 0.85 | % | | | 13.0 | % |
| December 31, 2007 | | $ | 799.2 | | | | 5.90 | % | | | 5.79 | % | | | 5.33 | % | | | 0.46 | % | | | 19.0 | % |
| September 30, 2007 | | $ | 865.7 | | | | 5.93 | % | | | 5.72 | % | | | 5.38 | % | | | 0.34 | % | | | 21.0 | % |
| June 30, 2007 | | $ | 948.6 | | | | 5.66 | % | | | 5.55 | % | | | 5.43 | % | | | 0.12 | % | | | 21.0 | % |
| March 31, 2007 | | $ | 1,022.7 | | | | 5.59 | % | | | 5.36 | % | | | 5.34 | % | | | 0.02 | % | | | 19.2 | % |
| December 31, 2006 | | $ | 1,111.0 | | | | 5.53 | % | | | 5.35 | % | | | 5.26 | % | | | 0.09 | % | | | 17.2 | % |
| September 30, 2006 | | $ | 1,287.6 | | | | 5.50 | % | | | 5.28 | % | | | 5.12 | % | | | 0.16 | % | | | 20.7 | % |
| June 30, 2006 | | $ | 1,217.9 | | | | 5.29 | % | | | 5.08 | % | | | 4.30 | % | | | 0.78 | % | | | 19.8 | % |
| March 31, 2006 | | $ | 1,478.6 | | | | 4.85 | % | | | 4.75 | % | | | 4.04 | % | | | 0.71 | % | | | 18.7 | % |
| December 31, 2005 | | $ | 1,499.0 | | | | 4.84 | % | | | 4.43 | % | | | 3.81 | % | | | 0.62 | % | | | 26.9 | % |
| September 30, 2005 | | $ | 1,494.0 | | | | 4.69 | % | | | 4.08 | % | | | 3.38 | % | | | 0.70 | % | | | 29.7 | % |
| June 30, 2005 | | $ | 1,590.0 | | | | 4.50 | % | | | 4.06 | % | | | 3.06 | % | | | 1.00 | % | | | 30.5 | % |
| March 31, 2005 | | $ | 1,447.9 | | | | 4.39 | % | | | 4.01 | % | | | 2.86 | % | | | 1.15 | % | | | 29.2 | % |
| December 31, 2004 | | $ | 1,325.7 | | | | 4.29 | % | | | 3.84 | % | | | 2.58 | % | | | 1.26 | % | | | 23.7 | % |
| September 30, 2004 | | $ | 776.5 | | | | 4.04 | % | | | 3.86 | % | | | 2.45 | % | | | 1.41 | % | | | 16.0 | % |
| | Weighted Average Coupon (“WAC”) of Underlying Loans |
| | < 4.0% | < 4.5% | < 5.0% | < 5.5% | > 5.5% |
| Agency Arms | $ 21,556 | - | - | - | $ 15,006 |
| Agency IOs | - | - | - | $ 4,261 | $ 11,211 |
The Company does not believe securities backed by loans with WAC’s less than 4.0% are at risk to the HARP II program as the borrower has minimal rate incentive. In addition, the Agency ARMs with coupons greater than 5.5% have an average coupon reset period of 12 months where the projected new coupon would be approximately 3.4%.
ExpensesNon-GAAP Financial Measures
In addition to disclosing financial results calculated in accordance with United States generally accepted accounting principals (GAAP), we also present non-GAAP financial measures that exclude certain items. These measures include "Net Interest Spread―Core Interest Earning Assets" and net income excluding management contract termination and unrealized gains and losses associated with Agency IO investments. These non-GAAP financial measures are provided to enhance the user’s overall understanding of our financial performance. Specifically, management believes the non-GAAP financial measures provide useful information to investors by excluding or adjusting certain items affecting reported operating results that were unusual or not indicative of our core operating results. The non-GAAP financial measures presented by the Company should not be considered a substitute for, or superior to, the financial measures calculated in accordance with GAAP. Moreover, these non-GAAP financial measures may not be comparable to similarly titled measures reported by other companies. The non-GAAP financial measures included in this filing have been reconciled to the nearest GAAP measure.
Comparative ExpensesNet Interest Spread―Core Interest Earning Assets, a Non GAAP Financial Measure
Net Interest Spread―Core Interest Earning Assets is a non-GAAP financial measure and is defined as GAAP net interest spread plus unconsolidated investments in interest earning assets, such as our investments in a limited partnership and limited liability company. Our investment in limited partnership represents our equity investment in a limited partnership that owns a pool of residential whole mortgage loans and from which we receive distributions equal to principal and interest payments and sales net of certain administrative expenses. Our investment in a limited liability company includes interest income from our share of two tranches of securitized debt net of certain administrative costs. Because the income we receive from our investments in a limited partnership and limited liability company include interest from pools of mortgage loans, management considers the investment to be a functional equivalent to its Interest Earning Assets under GAAP. In order to evaluate the effective Net Interest Income of our investments, management uses Net Interest Spread―Core Interest Earning Assets to reflect the net interest spread of our investments as adjusted to reflect the addition of unconsolidated investments in interest earning assets. Management believes that Net Interest Spread―Core Interest Earning Assets provides useful information to investors as the income stream from this unconsolidated investment is similar to the net interest spread for our Interest Earning Assets. Net Interest Spread–Core Interest Earning Assets should not be considered a substitute for our GAAP-based calculation of net interest spread.
The following tables reconcile our GAAP Net Interest Spread for our portfolio of Interest Earning Assets for the years ended December 31, 2011 and 2010, respectively, to our non-GAAP measure of Net Interest Spread―Core Interest Earning Assets. We acquired our unconsolidated investment in a limited partnership during the third and fourth quarters of 2010 and our investment in a limited liability company during the second quarter of 2011. The limited liability company was dissolved and its assets distributed to the partners, including RBCM, on December 30, 2011.
| | | For the Year Ended December 31, | |
(dollar amounts in thousands) | | 2008 | | | 2007 | | | % Change | | | 2006 | | | % Change | |
| Salaries and benefits | | $ | 1,869 | | | $ | 865 | | | | 116.1 | % | | $ | 714 | | | | 21.1 | % |
| Professional fees | | | 1,212 | | | | 612 | | | | 98.0 | % | | | 598 | | | | 2.3 | % |
| Insurance | | | 948 | | | | 474 | | | | 100.0 | % | | | 204 | | | | 132.4 | % |
| Management fees | | | 665 | | | | — | | | | 100.0 | % | | | — | | | | — | |
| Other | | | 2,216 | | | | 803 | | | | 176.0 | % | | | 516 | | | | 55.6 | % |
| Total Expenses | | $ | 6,910 | | | $ | 2,754 | | | | 150.9 | % | | $ | 2,032 | | | | 35.5 | % |
| Year Ended December 31, 2011 | | Average Interest Earning Assets $ millions) (1) | | | Weighted Average Coupon (2) | | | Weighted Average Cash Yield on Interest Earning Assets (3) | | | Cost of Funds (4) | | | Net Interest Spread (5) | |
| Net Interest Spread –Interest Earning Assets | | $ | 348.6 | | | | 4.24 | % | | | 6.97 | % | | | 0.98 | % | | | 5.99 | % |
| Investment in Limited Partnership | | $ | 12.3 | | | | 6.82 | % | | | 10.29 | % | | | — | % | | | 10.29 | % |
| Investment in Limited Liability Company | | $ | 4.3 | | | | 4.58 | % | | | 8.76 | % | | | — | % | | | 8.76 | % |
| Net Interest Spread –Core Interest Earning Assets | | $ | 365.2 | | | | 4.34 | % | | | 7.15 | % | | | 0.98 | % | | | 6.17 | % |
The $4.2 million increase in total expenses in 2008 as compared to 2007 was to due to the following:| Year Ended December 31, 2010 | | Average Interest Earning Assets ($ millions) (1) | | | Weighted Average Coupon (2) | | | Weighted Average Cash Yield on Interest Earning Assets (3) | | | Cost of Funds (4) | | | Net Interest Spread (5) | |
| Net Interest Spread –Interest Earning Assets | | $ | 370.8 | | | | 3.98 | % | | | 5.37 | % | | | 1.61 | % | | | 3.76 | % |
| Investment in Limited Partnership | | $ | 9.1 | | | | 7.56 | % | | | 13.50 | % | | | — | % | | | 13.50 | % |
| Net Interest Spread –Core Interest Earning Assets | | $ | 379.9 | | | | 4.03 | % | | | 5.44 | % | | | 1.61 | % | | | 3.83 | % |
| | ·(1) | $1.0 million or 116.1% increase in salariesOur Average Interest Earning Assets is calculated each period as the daily average balance of our Interest Earning Assets for the period, excluding unrealized gains and benefits due mainly to the elimination of allocating salaries between our continuing and discontinued operations.losses. |
| | ·(2) | $0.6 millionThe Weighted Average Coupon reflects the weighted average rate of interest paid on our Interest Earning Assets or 98.0% increaseCore Interest Earning Assets, as applicable, for the period, net of fees paid. The percentages indicated in professional feesthis column are the interest rates that will be effective through the interest rate reset date, where applicable, and have not been adjusted to reflect the purchase price we paid for the face amount of the security. |
| (3) | Our Weighted Average Cash Yield on Interest Earning Assets was due to increased legal fees defending nuisance lawsuits related tocalculated by dividing our discontinued operationsannualized interest income from Interest Earning Assets or Core Interest Earning Assets, as applicable, for the period by our average Interest Earning Assets or Core Interest Earning Assets, as applicable. |
| (4) | Our Cost of Funds was calculated by dividing our annualized interest expense from our Interest Earning Assets for the period by our average financing arrangements, portfolio investments and CDOs. |
| (5) | Net Interest Spread is the elimination of allocating auditdifference between our continuingWeighted Average Cash Yield on Interest Earning Assets or Core Interest Earning Assets, as applicable, and discontinued operations.our Cost of Funds. |
| · | $0.7 million in management fees paid to HCS pursuant the advisory agreement entered into in January 2008. |
| | |
| · | $1.4 million increase in other expenses includes $0.7 million non-recurring penalty fees paid in 2008 pursuant to a registration rights agreement, $0.2 million write-off of capitalized legal costs related to discontinued securitization shelf registration statement and $0.2 million related to rent. |
62
Net Income Excluding Management Contract Termination and Unrealized Gains and Losses Associated with Agency IO Investments
During the quarter and year ended December 31, 2011, we incurred a one-time $2.2 million termination fee in connection with our termination of the HCS Advisory Agreement and experienced unusually excessive market volatility that impacted unrealized gains and losses on our Agency IOs and related hedges. A reconciliation between net income excluding the one-time fee for the management contract termination and unrealized gains and losses related to our investments in Agency IOs and related hedges and GAAP net income attributable to common stockholders for the years and quarters ended December 31, 2011 and 2010, respectively, is presented below (dollar amounts in thousands, except per share amounts):
| | | For the Year Ended December 31, 2011 | | | For the Year Ended December 31, 2010 | |
| | | Amounts | | | Per Share | | | Amounts | | | Per Share | |
| | | | | | | | | | | | | |
| Net Income Attributable to Common Stockholders - GAAP | | $ | 4,776 | | | $ | 0.46 | | | $ | 6,805 | | | $ | 0.72 | |
| Adjustments | | | | | | | | | | | | | | | | |
| Unrealized gains and losses on investment securities and related hedges associated with Agency IO investments | | | 9,657 | | | | 0.91 | | | | - | | | | - | |
| Termination of management contract | | | 2,195 | | | | 0.21 | | | | - | | | | - | |
| Net income excluding termination of management contract and unrealized gains and losses | | $ | 16,628 | | | $ | 1.58 | | | $ | 6,805 | | | $ | 0.72 | |
| | | For the Quarter Ended December 31, 2011 | | | For the Quarter Ended December 31, 2010 | |
| | | Amounts | | | Per Share | | | Amounts | | | Per Share | |
| | | | | | | | | | | | | |
| Net (Loss) Income Attributable to Common Stockholders - GAAP | | $ | (1,892 | ) | | $ | (0.16 | ) | | $ | 1,018 | | | $ | 0.11 | |
| Adjustments | | | | | | | | | | | | | | | | |
| Unrealized gains and losses on investment securities and related hedges associated with Agency IO investments | | | 895 | | | | 0.08 | | | | - | | | | - | |
| Termination of management contract | | | 2,195 | | | | 0.18 | | | | - | | | | - | |
| Net income excluding termination of management contract and unrealized gains and losses | | $ | 1,198 | | | $ | 0.10 | | | $ | 1,018 | | | $ | 0.11 | |
Comparative Expenses (dollar amounts in thousands)
| | | For the Year Ended December 31, |
| General, administrative and other expenses: | | 2011 | | | 2010 | | | % Change | |
| Salaries and benefits | | $ | 1,518 | | | $ | 1,780 | | | | (14.7 | )% |
| Professional fees | | | 1,521 | | | | 1,199 | | | | 26.9 | % |
| Management fees | | | 3,250 | | | | 2,852 | | | | 14.0 | % |
| Termination of management contract | | | 2,195 | | | | — | | | | 100.0 | % |
| Other | | | 2,034 | | | | 2,119 | | | | (4.0 | )% |
| Total | | $ | 10,518 | | | $ | 7,950 | | | | 32.3 | % |
The majorityincrease in general, administrative and other expenses of all expense increases from$2.6 million for the year ended December 31, 20062011, as compared to the year ended December 31, 20072010 was primarily due primarily to the increased allocation$2.2 million termination fee related to the termination of expensesthe HCS Advisory Agreement, a $0.4 million increase in management fees due to NYMT from the discontinued operations.
It should be noted that certain expenses are sharedRiverBanc and Midway, a $0.3 million increase in professional fees, offset by the Companya $0.3 million decrease in salaries and are included asbenefits, and a discontinued operations for this presentation.$0.1 million decrease in other expenses.
Discontinued Operations (dollar amounts in thousands) | Discontinued Operations | | | | | | | | | | | | | | | |
| | | For the Year Ended December 31, | |
| (dollar amounts in thousands) | | 2008 | | | 2007 | | | % Change | | | 2006 | | | % Change | |
| Revenues: | | | | | | | | | | | | | | | |
| Net interest income | | $ | 419 | | | $ | 1,070 | | | | (60.8 | )% | | $ | 3,524 | | | | (69.6 | )% |
| Gain on sale of mortgage loans | | | 46 | | | | 2,561 | | | | (98.2 | )% | | | 17,987 | | | | (85.8 | )% |
| Loan losses | | | (433 | ) | | | (8,874 | ) | | | (95.1 | )% | | | (8,228 | ) | | | 7.9 | % |
| Brokered loan fees | | | — | | | | 2,318 | | | | (100.0 | )% | | | 10,937 | | | | (78.8 | )% |
| Gain on sale of retail lending segment | | | — | | | | 4,368 | | | | (100.0 | )% | | | — | | | | 100.0 | |
| Other income (expense) | | | 1,463 | | | | (67 | ) | | | 2,284 | % | | | (294 | ) | | | (77.2 | )% |
| Total net revenues | | | 1,495 | | | | 1,376 | | | | 8.6 | % | | | 23,926 | | | | (94.2 | )% |
| | | | | | | | | | | | | | | | | | | | | |
| Expenses: | | | | | | | | | | | | | | | | | | | | |
| Salaries, commissions and benefits | | | 63 | | | | 7,209 | | | | (99.1 | )% | | | 21,711 | | | | (66.8 | )% |
| Brokered loan expenses | | | — | | | | 1,731 | | | | (100.0 | )% | | | 8,277 | | | | (79.1 | )% |
| Occupancy and equipment | | | (559 | ) | | | 1,819 | | | | (130.7 | )% | | | 5,077 | | | | (64.2 | )% |
| General and administrative | | | 334 | | | | 6,743 | | | | (95.0 | )% | | | 14,552 | | | | (53.7 | )% |
| Total expenses | | | (162 | ) | | | 17,502 | | | | (100.9 | )% | | | 49,617 | | | | (64.7 | )% |
| Income (loss) before income tax (provision) benefit | | | 1,657 | | | | (16,126 | ) | | | 110.3 | % | | | (25,691 | ) | | | (37.2 | )% |
| Income tax (provision) benefit | | | — | | | | (18,352 | ) | | | (100.0 | )% | | | 8,494 | | | | (316.1 | )% |
| Loss from discontinued operations – net of tax | | $ | 1,657 | | | $ | (34,478 | ) | | | 104.8 | % | | $ | (17,197 | ) | | | (100.5 | )% |
| | | For the Year Ended December 31, | |
| | | 2011 | | | 2010 | | | % Change | |
| Revenues: | | | | | | | | | |
| Net interest income | | $ | 176 | | | $ | 220 | | | | (20.0 | )% |
| Other income (net) | | | 27 | | | | 1,183 | | | | (97.7 | )% |
| Total net revenues | | | 203 | | | | 1,403 | | | | (85.5 | )% |
| | | | | | | | | | | | | |
| Expenses: | | | | | | | | | | | | |
| General and administrative | | | 140 | | | | 268 | | | | (47.8 | )% |
| Total expenses | | | 140 | | | | 268 | | | | (47.8 | )% |
| Income from discontinued operations – net of tax | | $ | 63 | | | $ | 1,135 | | | | (94.4 | )% |
The decrease in income from discontinued operations – net of tax is primarily a function of our continued winding down of assets and liabilities classified as discontinued operations.
Portfolio Asset Yields for the Quarter Ended December 31, 2011
The following table summarizes the Company’s significant interest earning assets at December 31, 2011, classified by relevant categories (dollar amount in thousands, except as noted):
| | | Current Par Value | | | Carrying Value | | | Coupons(1) | | | Yield(1) | | | CPR(1) | | |
| Agency RMBS | | $ | 65,112 | | | $ | 68,776 | | | | 3.73 | % | | | 2.97 | % | | | 16.9 | % |
| Agency IOs | | $ | 537,032 | | | $ | 63,681 | | | | 5.21 | % | | | 18.06 | % | | | 19.5 | % |
| CMBS | | $ | 989,207 | | | $ | 41,185 | | | | 5.02 | % | | | 11.09 | % | | | N/A | |
| Securitized Loans | | $ | 208,934 | | | $ | 206,920 | | | | 2.71 | % | | | 2.66 | % | | | 5.2 | % |
Other (2) | | $ | 60,453 | | | $ | 44,301 | | | | 4.96 | % | | | 22.49 | % | | | N/A | |
| (1) | Coupons, yields and CPRs are based on fourth quarter 2011 average balances. |
| (2) | Other includes CLOs, investment in limited partnership, loans held for investment and non-Agency RMBS. |
Off-Balance Sheet Arrangements
Since inception, we have not maintained any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities. Accordingly, we are not materially exposed to any market, credit, liquidity or financing risk that could arise if we had engaged in such relationships.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, comply with margin requirements, fund our operations, pay management, incentive and consulting fees, pay dividends to our stockholders and other general business needs. We recognize the need to have funds available for our operating businesses and meet these potential cash requirements. Our investments and assets generate liquidity on an ongoing basis through mortgage principal and interest payments, prepayments, and net earnings heldretained prior to payment of dividends.dividends and distributions from unconsolidated investments. In addition, depending on market conditions, the sale of investment securities or capital market transactions may provide additional liquidity. We intendHowever, our intention is to meet our liquidity needs through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds. In connection with the March 2008 market disruption
We fund our investments and the anticipated increase in collateral requirements byoperations through a balanced and diverse funding mix, which includes short-term repurchase agreement borrowings, short-term structured debt and longer term debt, such as our lenders as a result of the decrease in the market value oftrust preferred debentures and, prior to their redemption, our investment securities, we elected to increase our liquidity by reducing our leverage through the sale of an aggregate of approximately $592.8 million of Agency RMBS in March 2008, which resulted in an aggregate loss of approximately $17.1 million, including losses related to the termination of interest rate swaps.convertible preferred debentures. At December 31, 2008,2011, we had cash balances of $9.4$16.6 million. The reduction in cash and cash equivalents from $19.4 million $20.9 million in unencumbered securities and borrowings of $402.3 million under outstanding repurchase agreements. At December 31, 2008, we also had longer-term capital resources, including CDOs outstanding of $335.6 million and subordinated debt of $44.6 million. In addition, the Company received net proceeds of $19.6 million and $56.5 million from private offerings of its Series A Preferred Stock and common stock, respectively, in January and February 2008. The Series A Preferred Stock matures onat December 31, 2010 at which time any outstanding shares must be redeemed by us atreflects the $20.00 per share liquidation preference. Based onuse of additional capital in 2011 to acquire our current investment portfolio, leverage ratio and available borrowing arrangements, we believe our existing cash balances, funds available under our current repurchase agreements and cash flows from operations will meet our liquidity requirements for at least the next 12 months. However, should further volatility and deterioration in the broader credit, residential mortgage and MBS markets occur in the future, we cannot assure you that our existing sources of liquidity will be sufficient to meet our liquidity requirements during the next 12 months.
To finance our RMBS investment portfolio, we generally seek to borrow between seven and nine times the amount of our equity. At December 31, 2008 our leverage ratio for our RMBS investment portfolio, which we define as our outstanding indebtedness under repurchase agreements divided by the sum of total stockholders’ equity and the convertible preferred debentures, was 6.8:1. This definition of the leverage ratio is consistent with the manner in which the credit providers under our repurchase agreements calculate our leverage.targeted assets.
We hadrely primarily on repurchase agreements to finance the mortgage-backed securities in our investment portfolio. As of December 31, 2011, we have outstanding repurchase agreements, a form of collateralized short-term borrowing, with sixfive different financial institutions as of December 31, 2008.institutions. These agreements are secured by certain of our mortgage-backedinvestment securities and bear interest rates that have historically moved in close relationship to LIBOR. Our borrowings under repurchase agreements are based on the fair value of our mortgage backedinvestment securities portfolio. Interest rate changes and increased prepayment activity can have a negative impact on the valuation of these securities, reducing the amount we can borrow under these agreements. Moreover, our repurchase agreements allow the counterparties to determine a new market value of the collateral to reflect current market conditions and because these lines of financing are not committed, the counterparty can call the loan at any time. If a counterparty determines that the value of the collateral has decreased, the counterparty may initiate a margin call and require us to either post additional collateral to cover such decrease or repay a portion of the outstanding borrowing in cash, on minimal notice. Moreover, Inin the event an existing counterparty elected to not resetrenew the outstanding balance at its maturity into a new repurchase agreement, we would be required to repay the outstanding balance with cash or proceeds received from a new counterparty or to surrender the mortgage-backed securities that serve as collateral for the outstanding balance, or any combination thereof. If we are unable to secure financing from a new counterparty and had to surrender the collateral, we would expect to incur a significant loss. In addition, in the event one of our lenders under the repurchase agreement defaults on its obligation to “re-sell” or return to us the securities that are securing the borrowings at the end of the term of the repurchase agreement, we would incur a loss on the transaction equal to the amount of “haircut” associated with the repurchase agreement.
At December 31, 2011, the Company had short term borrowings or repurchase agreements of $112.7 million as compared to $35.6 million as of December 31, 2010. The increase of $77.1 million is primarily due to our investment in Agency IOs in 2011. In addition to our excess cash, the Company has $48.9 million in unencumbered securities, including $17.0 million of RMBS, of which $13.0 million are Agency RMBS. There is $16.5 million in restricted cash available to meet additional margin calls as it relates to the repurchase agreements secured by our Agency IOs. At December 31, 2011, we also had longer-term debt, including CDOs outstanding of $199.8 million and subordinated debt of $45.0 million. The CDOs are collateralized by the mortgage loans held in securitization trusts. Based on our current investment portfolio, new investment initiatives, leverage ratio and available and future possible borrowing arrangements, we believe our existing cash balances, funds available under our current repurchase agreements and cash flows from operations will meet our liquidity requirements for at least the next 12 months.
Our leverage ratio for our investment portfolio, which we define as our outstanding indebtedness under repurchase agreements divided by stockholders’ equity, was 1.3 to 1 at December 31, 2011. We have continued to utilize significantly less leverage than our previously targeted leverage due to the ongoing repositioning of our investment portfolio to a more diversified portfolio that includes elements of credit risk with reduced leverage.
As of December 31, 2011, we have provided invested capital of $39.5 million towards our Agency IO strategy and $22.1 million to RBCM in connection with our multi-family CMBS investments. We also purchased an additional $21.5 million of CMBS through RBCM that settled in the first quarter of 2012. We funded these investments primarily with proceeds from our December 2011 capital raise, excess working capital and short-term borrowings. We anticipate continuing to contribute additional capital toward the acquisition of these assets in the future from either working capital liquidity or proceeds from capital market transactions or a combination thereof.
Certain of our hedging instruments may also impact our liquidity. We use Eurodollar or other futures contracts to hedge interest rate risk associated with our investments in Agency IOs. With respect to futures contracts, initial margin deposits will be made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking to market on a daily basis to reflect the market value of the contract at the end of each day’s trading. We may be required to satisfy variation margin payments periodically, depending upon whether unrealized gains or losses are incurred.
We also use TBAs to hedge interest rate risk and spread risk associated with our investments in Agency IOs. Since delivery for these securities extends beyond the typical settlement dates for most non-derivative investments, these transactions are more prone to market fluctuations between the trade date and the ultimate settlement date, and thereby are more vulnerable, especially in the absence of margin arrangements with respect to these transactions, to increasing amounts at risk with the applicable counterparties.
In connection with the dramatic declines in the housing market and significant asset write-downs by financial institutions, many investors and financial institutions that lend in the mortgage securities repurchase markets (including some of the lenders under our repurchase agreements) significantly tightened their lending standards and, in some cases, have ceased to provide funding to borrowers, including other financial institutions. In our case, during March 2008, we experienced increases in the amount of “haircut,” which is the difference between the value of the collateral and the loan amount, required to obtain financing for both our Agency RMBS and non-Agency RMBS. As of December 31, 2008, our RMBS securities portfolio consisted of approximately $455.9 million of Agency RMBS and $21.5 million of non-Agency RMBS, which was financed with approximately $402.3 million of repurchase agreement borrowing with an average haircut of 9%. Although average haircuts have remained stable since the second quarter, any increase in haircuts by our lenders would materially adversely affect our profitability and liquidity. Moreover, in the event the conditions that have recently caused global credit and other financial markets to experience substantial volatility and disruption persist or worsen, certain financial institutions may become insolvent or further tighten their lending standards, which could make it more difficult for us to obtain financing on favorable terms or at all. Our profitability may be adversely affected if we are unable to obtain cost-effective financing for our investments.
We enter intoalso use U.S. Treasury securities and U.S. Treasury futures and options to hedge interest rate swap agreements to extend the maturity ofrisk associated with our repurchaseinvestments in Agency IOs and interest rate swap agreements as a mechanism to reduce the interest rate risk of the securities portfolio. At December 31, 2008, we had $137.3our Agency ARMs and mortgage loans held in securitization trusts.
We also own approximately $3.8 million of loans held for sale, which are included in notional interest rate swaps outstanding. Should market rates for similar term interest rate swaps drop below the minimum rates we have agreed to on our interest rate swaps, we will be required to post additional margin to the swap counterparty, reducing available liquidity. At December 31, 2008 the Company pledged $4.2 million in cash margin to cover decreased valuation of the interest rate swaps. The weighted average maturity of the swaps was 3.6 years at December 31, 2008.
discontinued operations. Our inability to sell approximately $5.4 million, net of lower of costthese loans at all or market adjustment, of mortgage loans we ownon favorable terms could adversely affect our profitability as any sale for less than the current valuationreserved balance would result in a loss. Currently, these loans are not financed or pledged.
As it relates to loans sold previously under certain loan sale agreements by our discontinued mortgage lending business, we may be required to repurchase some of those loans or indemnify the loan purchaser for damages caused by a breach of the loan sale agreement. While in the past we complied with the repurchase demands by repurchasing the loan with cash and reselling it at a loss, thus reducing our cash position; more recently weWe have addressed these requests by negotiating a net cash settlement based on the actual or assumed loss on the loan in lieu of repurchasing the loans. The Company periodically receives repurchase requests, each of which management reviews to determine, based on management’s experience, whether such request may reasonably be deemed to have merit. As of December 31, 2008, we had a total of $1.8 million of unresolved repurchase requests that management concluded may reasonably be deemed to have merit, against which we had a reserve of approximately $0.4$0.3 million. In addition, we may be subject to new repurchase requests from investors with whom we have not settled or with respect to repurchase obligations not covered under the settlement.
We paid quarterly cash dividends of $0.12, $0.16$0.18, $0.18, $0.22 and $0.16$0.25 per common share in May, July,January, April, June, and October 2008,2011, respectively. On December 23, 2008,15, 2011, we declared a 2011 fourth quarter cash dividend of $0.25 per common share and a special cash dividend of $0.10 per common shareshare. The dividend was paid on January 25, 2012 to common stockholders of record January 5, 2009, which was paid on January 26, 2009. On January 30, 2009, we paid a $0.50 per share cash dividend, or approximately $0.5 million in the aggregate, on shares of our Series A Preferred Stock to holders of record as of December 31, 2008. We also paid a $0.50 per share cash dividend on shares of our Series A Preferred Stock during each of the first, second and third quarters of 2008.27, 2011. Each of these dividends was paid out of our working capital. We expect to continue to pay quarterly cash dividends on our common stock during the Company’s working capital and recorded as interest expense in the Company’s consolidated statementnear term. However, our Board of operations as the Series A Preferred Stock is reported as debt per SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. WeDirectors will continue to evaluate our dividend policy each quarter and will make adjustments as necessary, based on a variety of factors, including, among other things, the need to maintain our REIT status, our financial condition, liquidity, earnings projections and business prospects. Our dividend policy does not constitute an obligation to pay dividends, which only occurs when our Board of Directors declares a dividend.
On June 28, 2011, we entered into an underwriting agreement relating to the offer and sale of 1,500,000 shares of our common stock at a public offering price of $7.50 per share, which shares were issued and proceeds received on July 1, 2011. On July 14, 2011, we issued an additional 225,000 shares of common stock to the underwriter pursuant to their exercise of an over-allotment option. We received total net proceeds of $11.9 million from the issuance of the 1,725,000 shares.
On December 1, 2011, we entered into an underwriting agreement relating to the offer and sale of 2,400,000 shares of our common stock at a public offering price of $6.90 per share, which shares were issued and proceeds received on December 6, 2011. On December 16, 2011, we issued an additional 360,000 shares of common stock to the underwriter pursuant to their exercise of an over-allotment option. We received total net proceeds of $17.9 million from the issuance of the 2,760,000 shares.
We intend to make distributions to our stockholders to comply with the various requirements to maintain our REIT status and to minimize or avoid corporate income tax and the nondeductible excise tax. However, differences in timing between the recognition of REIT taxable income and the actual receipt of cash could require us to sell assets or to borrow funds on a short-term basis to meet the REIT distribution requirements and to minimize or avoid corporate income tax and the nondeductible excise tax. At December 31, 2011, Hypotheca Capital, LLC, one of our TRSs, had approximately $59 million of net operating loss carryforwards that will expire in 2024 through 2029. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carryforwards that can be utilized if certain changes in the Company’s ownership occur. The Company has undergone an ownership change within the meaning of IRC section 382 that will limit the net loss carryforwards to be used to offset future taxable income to $660,000 per year. Hypotheca Capital, LLC, one of our TRSs, is presently undergoing an IRS examination for the taxable years ended December 31, 2010 and 2009.
Exposure to European financial counterparties
We finance the acquisition of a significant portion of our mortgage-backed securities with repurchase agreements. 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 financing with the extent of over-collateralization ranging from 6% of the amount borrowed (in the case of Agency ARM collateral) to up to 35% (in the case of CLO collateral). While our repurchase agreement financing results in us recording a liability to the counterparty in our consolidated balance sheet, 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.
Several large European banks have experienced financial difficulty and have been either rescued by government assistance or by other large European banks. Some of these banks have U.S. banking subsidiaries which have provided repurchase agreement financing or interest rate swap agreements to us in connection with the acquisition of various investments, including mortgage-backed securities investments. We have entered into repurchase agreements with Credit Suisse First Boston LLC (a subsidiary of Credit Suisse Group AG, which is domiciled in Switzerland) in the amount of $11.1 million at December 31, 2011. We have outstanding interest rate swap agreements with Barclays Bank PLC (domiciled in the United Kingdom) as a counterparty in the amount of $24.8 million notional with a net exposure of $0.3 million. In addition, certain of our U.S. based counterparties may have significant exposure to European sovereign debt which could impact their future lending activities or cause them to default under agreements with us. Any counterparty defaults could result in a material adverse effect on our operating results. We refer you to Note 7, Financing Arrangements, Portfolio Investments, included in Item 8 of this Annual Report on Form 10-K.
Certain of our assets may generate substantial mismatches between REIT taxable income and available cash. These assets could include mortgage-backed securities we hold that have been issued at a discount and require the accrual of taxable income in advance of the receipt of cash. As a result, our REIT taxable income may exceed our cash available for distribution and the requirement to distribute a substantial portion of our net taxable income could cause us to:
| · | sell assets in adverse market conditions; |
| · | borrow on unfavorable terms; |
| · | distribute amounts that would otherwise be invested in assets or repayment of debt, in order to comply with the REIT distribution requirements. |
Inflation
For the periods presented herein, inflation has been relatively low and we believe that inflation has not had a material effect on our results of operations. The impact of inflation is primarily reflected in the increased costs of our operations. Virtually all our assets and liabilities are financial in nature. Our consolidated financial statements and corresponding notes thereto have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. As a result, interest rates and other factors influence our performance far more than inflation. Inflation affects our operations primarily through its effect on interest rates, since interest rates typically increase during periods of high inflation and decrease during periods of low inflation. During periods of increasing interest rates, demand for mortgages and a borrower’s ability to qualify for mortgage financing in a purchase transaction may be adversely affected. During periods of decreasing interest rates, borrowers may prepay their mortgages, which in turn may adversely affect our yield and subsequently the value of our portfolio of mortgage assets.
Contractual Obligations and Commitments
The Company had the following contractual obligations at December 31, 2008:2011 (dollar amounts in thousands):
| ($ amounts in thousands) | | Total | | | Less than 1 year | | | 1 to 3 years | | | 4 to 5 years | | | after 5 years | |
| Operating leases | | $ | 867 | | | $ | 219 | | | $ | 383 | | | $ | 265 | | | $ | — | |
| Repurchase agreements (1) | | | 403,627 | | | | 403,627 | | | | — | | | | — | | | | — | |
| Collateralized debt obligations (1)(2) | | | 350,923 | | | | 46,407 | | | | 102,563 | | | | 68,631 | | | | 133,322 | |
| Subordinated debentures (1) | | | 110,168 | | | | 3,016 | | | | 5,187 | | | | 4,849 | | | | 97,116 | |
| Convertible preferred debentures (1) | | | 24,000 | | | | 2,000 | | | | 22,000 | | | | — | | | | — | |
| Interest rate swaps (1) | | | 7,402 | | | | 3,348 | | | | 3,519 | | | | 535 | | | | — | |
| Management fees (4) | | | 1,476 | | | | 738 | | | | 738 | | | | — | | | | — | |
| Employment agreements (3) | | | 200 | | | | 200 | | | | — | | | | — | | | | — | |
| | | $ | 898,663 | | | $ | 459,555 | | | $ | 134,390 | | | $ | 74,280 | | | $ | 230,438 | |
| | | Total | | | Less than 1 year | | | 1 to 3 years | | | 3 to 5 years | | | More than 5 years | |
| Operating leases | | $ | 265 | | | $ | 198 | | | $ | 67 | | | $ | — | | | $ | — | |
| Repurchase agreements | | | 112,674 | | | | 112,674 | | | | — | | | | — | | | | — | |
| CDOs (1)(2) | | | 213,527 | | | | 17,767 | | | | 33,494 | | | | 32,823 | | | | 129,443 | |
| Subordinated debentures (1) | | | 89,464 | | | | 1,895 | | | | 3,779 | | | | 3,784 | | | | 80,006 | |
| Management fees (3) | | | 1,290 | | | | 1,290 | | | | — | | | | — | | | | — | |
| Employment agreements | | | 300 | | | | 300 | | | | — | | | | — | | | | — | |
| Interest rate swaps (1) | | | 564 | | | | 526 | | | | 38 | | | | — | | | | — | |
| Total contractual obligations | | $ | 418,084 | | | $ | 134,650 | | | $ | 37,378 | | | $ | 36,607 | | | $ | 209,449 | |
| (1) | Amounts include projected interest paidpayments during the period. Interest based on interest rates in effect on December 31, 2008.2011. |
| (2) | Maturities of our CDOs are dependent upon cash flows received from the underlying loans receivable. Our estimate of their repayment is based on scheduled principal payments and estimated principal prepayments based on our internal prepayment model on the underlying loans receivable. This estimate will differ from actual amounts to the extent prepayments and/or loan losses are experienced. |
| (3) | RepresentsWe terminated the HCS Advisory Agreement on December 30, 2011. Amounts include the base cash compensation under contract of the Company’s Chief Executive Officer, Steven R. Mumma. |
(4) | Amounts due with respect to the advisory fee are subject to adjustmentfees for Midway and RiverBanc based on the equitycurrent invested capital, of the Managed Subsidiaries and any incentive compensation due pursuantremaining base management fees to the advisory agreement between the Managed Subsidiaries and HCS. See “Item 1. Business - Our Relationship withbe paid to HCS and the Advisory Agreement - Advisory Agreement” above for a summary of the material terms of the advisory agreement.
excludes incentive fees which are based on future performance. |
Advisory and Management Agreements
During the 2011 fiscal year, the Company was a party to management or advisory agreements with HCS, Midway and RiverBanc. We terminated the HCS Advisory Agreement effective December 31, 2011. See “Item 1. Business –Recent Developments –Termination of Advisory Agreement.” In connection with our continuing management agreements with RiverBanc and Midway, we have agreed to pay the applicable external manager that is a party to those agreements certain fees for the performance of certain services thereunder. See “Item 1. Business” for a description of the fees and expenses payable by us under these agreements.
For the years ended December 31, 2011 and 2010, HCS earned aggregate base advisory and consulting fees of approximately $1.1 million and $0.9 million, respectively, and an incentive fee of approximately $1.7 million and $2.0 million, respectively. As of December 31, 2011 and 2010, approximately $34.0 million and $48.2 million, respectively, of the Company’s assets were being managed under the HCS Advisory Agreement. As of December 31, 2011 and 2010, the Company had a management fee payable totaling $0.8 million and $0.7 million, respectively, included in accrued expenses and other liabilities.
For the year ended December 31, 2011, Midway earned base management and incentive fees of approximately $420,000 and $0, respectively.
For the year ended December 31, 2011, RiverBanc earned base management fees of approximately $96,000.
Off-Balance Sheet Arrangements
We did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities.
Advisory Agreement
On January 18, 2008, we entered into an advisory agreement with HCS, pursuant to which HCS will advise, manage and make investments on behalf of two of our wholly-owned subsidiaries. Pursuant to the Advisory Agreement, HCS is entitled to receive the following compensation:
| · | base advisory fee equal to 1.50% per annum of the “equity capital” (as defined in Item 1 of this Annual Report) of the Managed Subsidiaries is payable by us to HCS in cash, quarterly in arrears; and |
| · | incentive compensation equal to 25% of the GAAP net income of the Managed Subsidiaries attributable to the investments that are managed by HCS that exceed a hurdle rate equal to the greater of (a) 8.00% and (b) 2.00% plus the ten year treasury rate for such fiscal year will be payable by us to HCS in cash, quarterly in arrears; provided, however, that a portion of the incentive compensation may be paid in shares of our common stock.
|
If we terminate the advisory agreement (other than for cause) or elect not to renew it, we will be required to pay HCS a cash termination fee equal to the sum of (i) the average annual base advisory fee and (ii) the average annual incentive compensation earned during the 24-month period immediately preceding the date of termination.
Significance ofSignificant Estimates and Critical Accounting Policies
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, orU.S. GAAP, many of which requirerequires the use of estimates, judgments and assumptions that affect reported amounts. These estimates are based, in part, on our judgment and assumptions regarding various economic conditions that we believe are reasonable based on facts and circumstances existing at the time of reporting. The results of these estimates affect reported amounts of assets, liabilities and accumulated other comprehensive income at the date of the consolidated financial statements and the reported amounts of income, expenses and other comprehensive income during the periods presented.
Changes in the estimates and assumptions could have a material effect on these financial statements. Accounting policies and estimates related to specific components of our consolidated financial statements are disclosed in the notes to our consolidated financial statements. In accordance with SEC guidance, those material accounting policies and estimates that we believe are most critical to an investor’s understanding of our financial results and condition and which require complex management judgment are discussed below.
Revenue Recognition. Interest income on our residential mortgage loans and mortgage-backed securities is a combination of the interest earned based on the outstanding principal balance of the underlying loan/security, the contractual terms of the assets and the amortization of yield adjustments, principally premiums and discounts, using generally accepted interest methods. The net GAAP cost over the par balance of self-originated loans held for investment and premium and discount associated with the purchase of mortgage-backed securities and loans are amortized into interest income over the lives of the underlying assets using the effective yield method as adjustedmethod. Adjustments to amortization are made for the effects of estimated prepayments.actual prepayment activity. Estimating prepayments and the remaining term of our interest yield investments require management judgment, which involves, among other things, consideration of possible future interest rate environments and an estimate of how borrowers will react to those environments, historical trends and performance. The actual prepayment speed and actual lives could be more or less than the amount estimated by management at the time of origination or purchase of the assets or at each financial reporting period.
With respect to derivative instruments that have not been designated as hedges, any fluctuations in the fair value will be recognized in current earnings.
Fair value.The Company adopted SFAS No.157, Fair Value Measurements, effective January 1, 2008, and accordingly all assets and liabilities measured at fair value will utilize valuation methodologies in accordance with the statement. The Company has established and documented processes for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, then fair value is based upon internally developed models that primarily use inputs that are market-based or independently-sourced market parameters, including interest rate yield curves.
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 established by FAS 157 are defined as follows:
Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 - Such inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following describesCompany’s IOs and POs are considered to be the valuation methodologies used for the Company’s financial instruments measured atmost significant of its fair value as well as the general classification of such instruments pursuant to the valuation hierarchy.
a. Investment Securities Available for Sale - Fair value is generally based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will incorporate common market pricing methods, including a spread measurement to the Treasury curve or Interest Rate Swap Cure as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. If the fair value of a security is not reasonably available from a dealer, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and based on available market information. Management reviews all prices used in determining valuation to ensure they represent current market conditions. This review includes surveying similar market transactions, comparisons to interest pricing models as well as offerings of like securities by dealers. The Company’s investment securities are valued based upon readily observable market parameters and are classified as Level 2 fair values.estimates.
Impairment of and Basis Adjustments on Securitized Financial AssetsMortgage Loans Held in Securitization Trusts – Impaired Loans (net). - As previously described herein, during 2005 and early 2006, we regularly securitized ourImpaired mortgage loans and retainedheld in the beneficial interests created by such securitization. Such assetssecuritization trusts are evaluated for impairment on a quarterly basis or, if events or changes in circumstances indicate that these assets or the underlying collateral may be impaired, on a more frequent basis. We evaluate whether these assets are considered impaired, whether the impairment is other-than-temporary and, if the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the asset’srecorded at amortized cost basis and its fair value. These evaluations require management to make estimates and judgmentsless specific loan loss reserves. Impaired loan value is based on changes inmanagement’s estimate of the net realizable value taking into consideration local market interest rates, credit ratings, creditconditions of the distressed property, updated appraisal values of the property and delinquency data and other informationestimated expenses required to determine whether unrealized losses are reflective of credit deterioration and our ability and intent to holdremediate the investment to maturity or recovery. This other-than-temporary impairment analysis requires significant management judgment and we deem this to be a critical accounting estimate.
As of December 31, 2008, our principal investment portfolio included approximately $197.7 million of Agency CMO Floaters. Following a review of our principal investment portfolio, we determined in March 2009 that the Agency CMO Floaters held in our portfolio were no longer producing acceptable returns and initiated a program to dispose of these securities on an opportunistic basis. As of March 25, 2009, the Company had sold approximately $149.8 million in current par value of Agency CMO Floaters under this program resulting in a net gain of approximately $0.2 million. As a result of these sales and our intent to sell the remaining Agency CMO Floaters in our principal investment portfolio, we concluded the reduction in value at December 31, 2008 was other-than-temporary and recorded an impairment charge of $4.1 million for the quarter and year ended December 31, 2008.
In addition, we also determined that $6.1 million in current par value of non-agency RMBS, which includes $2.5 million in current par value of retained residual interest, had suffered an other-than-temporary impairment and, accordingly, recorded an impairment charge of $1.2 million for the quarter and year ended December 31, 2008.
b. Interest Rate Swaps and Caps - The fair value of interest rate swaps and caps are based on using market accepted financial models as well as dealer quotes. The model utilizes readily observable market parameters, including treasury rates, interest rate swap spreads and swaption volatility curves. The Company’s interest rate caps and swaps are classified as Level 2 fair values.impaired loan.
The Company’s valuation methodologies are described in Note 14 – Fair Value of Financial Instruments included in Item 8 of this Annual Report on Form 10-K
c. Mortgage Loans Held for Sale (Net) Variable Interest Entities– An entity is referred to as a variable interest entity (“VIE”) if it meets at least one of the following criteria: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (2) as a group, the holders of the equity investment at risk lack (a) the power to direct the activities of an entity that most significantly impact the entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual returns; or (3) have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionally few voting rights.
The Company consolidates a VIE when it has 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. The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.
Fair Value Option – The fair value of mortgage loans held for sale (net) are estimated by the Company based on the priceoption provides an election that would be received if the loans were sold as whole loans taking into consideration the aggregated characteristics of the loans such as, but not limitedallows companies to collateral type, index, interest rate, margin, length of fixed interest rate period, life cap, periodic cap, underwriting standards, age and credit. As there are not readily available quoted prices for identical or similar loans are classified as Level 3 fair values.
New Accounting Pronouncements - - On January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, which definesirrevocably elect fair value establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements.
The changes to previous practice resulting from the application of SFAS No.157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. The definition of fair value retains the exchange price notion used in earlier definitions of fair value. SFAS No.157 clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. SFAS No.157 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, SFAS No.157 provides a framework for measuring fair value, and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date The Company has disclosed the required elements of SFAS No. 157 herein at Note 11.
On January 1, 2008, the Company adopted SFAS No.159, The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities on an instrument-by-instrument basis at fair value.
The objective of SFAS No. 159 is to reduce both complexityinitial recognition. Changes in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 establishes presentation and disclosure requirements and requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company's choice to use fair value on its earnings. SFAS No. 159 also requires entities to display the fair value of thosefor assets and liabilities for which the Company has chosen to use fair valueelection is made will be recognized in earnings as they occur.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements and the possible effects on the face of the balance sheet. The Company’s adoption of SFAS No. 159 did not have a material impact on the consolidatedour financial statements as the Company did not elect the fair value option for anyis included in Note 1 — Summary of its existing financial assets or liabilities asSignificant Accounting Policies included in Item 8 of January 1, 2008.
In June 2007, the Emerging Issues Task Force (“EITF”) reached consensusthis Annual Report on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards . EITF Issue No. 06-11 requires that the tax benefit related to dividend equivalents paid on restricted stock units, which are expected to vest, be recorded as an increase to additional paid-in capital. The Company currently accounts for this tax benefit as a reduction to income tax expense. EITF Issue No. 06-11 is to be applied prospectively for tax benefits on dividends declared in fiscal years beginning after December 15, 2008, and the Company expects to adopt the provisions of EITF Issue No. 06-11 beginning in the first quarter of 2009. The Company does not expect the adoption of EITF Issue No. 06-11 to have a material effect on its financial condition, results of operations or cash flows.
In December 2007, the FASB issued SFAS No. 141, Business Combinations and issued SFAS No. 141(R) Business Combinations. SFAS No. 141(R) broadens the guidance of SFAS No. 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses. It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations; and it stipulates that acquisition related costs be generally expensed rather than included as part of the basis of the acquisition. SFAS No. 141(R) expands required disclosures to improve the ability to evaluate the nature and financial effects of business combinations. SFAS No. 141(R) is effective for all transactions the Company closes, on or after January 1, 2009. Adoption of SFAS No. 141(R) will impact the Company’s acquisitions subsequent to January 1, 2009.Form 10-K.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. SFAS No.160 requires a noncontrolling interest in a subsidiary to be reported as equity and the amount of consolidated net income specifically attributable to the noncontrolling interest to be identified in the consolidated financial statements. SFAS No. 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS No.160 is effective for the Company on January 1, 2009 and most of its provisions will apply prospectively. We are currently evaluating the impact SFAS No.160 will have on our consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position (“FSP”) No. 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions. SFAS No.140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 140”) unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. FSP No. 140-3 is effective for the Company’s fiscal years beginning after November 15, 2008, and will be applied to new transactions entered into after the date of adoption. Early adoption is prohibited. The Company is currently evaluating the impact of adopting FSP No.140-3 on its financial condition and cash flows. Adoption of FSP No.140-3 will have no effect on the Company’s results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133. SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, and is effective for financial statements the Company issues for fiscal years beginning after November 15, 2008, with early application encouraged. The Company will adopt SFAS No. 161 in the first quarter of 2009. Because SFAS No. 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS No. 161 will not affect the Company’s financial condition, results of operations or cash flows.
In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement. The adoption of this FSP would affect the accounting for our convertible preferred debentures. The FSP requires the initial proceeds from the sale of our convertible preferred debentures to be allocated between a liability component and an equity component. The resulting discount would be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The FSP would be effective for our fiscal year beginning on January 1, 2009 and requires retroactive application. We are currently evaluating the impact of the FSP on our financial statements.
On October 10, 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP No.157-3 clarifies the application of SFAS No.157 in a market that is not active and provides an example to illustrate key consideration in determining the fair value of a financial asset when the market for that financial asset is not active. The issuance of FSP 157-3 did not have any impact on the Company’s determination of fair value for its financial assets.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). FSP FAS 140-4 and FIN 46(R)-8 amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and FIN No. 46(R), “Consolidation of Variable Interest Entities (revised December 2003) – an interpretation of Accounting Research Bulletin No. 51” to require additional disclosures regarding transfers of financial assets and interest in variable interest entities and is effective for interim or annual reporting periods ending after December 15, 2008. The adoption of FSP SFAS 140-4 and FIN 46(R)-8 did not have a material impact on the Company’s financial statements.
On January 12, 2009, the FASB issued EITF No. 99-20-1, “Amendments to the Impairment Guidance of EITF 99-20” to achieve more consistent determination of whether an other-than-temporary impairment has occurred for all beneficial interest within the scope of EITF 99-20. EITF 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008, on a prospective basis. EITF 99-20-1 eliminates the requirement that a holder’s best estimate of cash flows be based upon those that “a market participant” would use and instead requires that an other–than–temporary impairment be recognized as a realized loss through earnings when it its “probable” there has been an adverse change in the holder’s estimated cash flows from cash flows previously projected. This change is consistent with the impairment models contained in SFAS No. 115. EITF No. 99-20-1 emphasizes that the holder must consider all available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of future cash flows. Such information generally should include the remaining payment terms of the security, prepayments speeds, financial condition of the issuer, expected defaults, and the value of any underlying collateral. The holder should also consider industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. The Company’s adoption of EITF 99-20-1 at December 31, 2008 did not have a material impact on the Company’s consolidated financial statements.
We seekMarket risk is the exposure to manage our risks related toloss resulting from changes in interest rates, liquidity, prepayment speeds, credit qualityspreads and equity prices. All of our market risk sensitive assets, liabilities and the market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive total returns through ownership of our capital stock. While we do not seek to avoid risk, we seek to: assume risk that can be quantified from historical experience, and actively manage such risk; earn sufficient returns to justify the taking of such risks; and maintain capital levels consistent with the risks that we undertake.
Werelated derivative positions are not subject to foreign currency exchange because we are invested solely in U.S. dollar denominated instruments, primarily residential mortgage assets, and our borrowings are also domestic and U.S. dollar denominated risk.
for non-trading purposes only. Management recognizes the following primary risks associated with our business and the industry in which we conduct business:
| | · | Market (fair value)Fair value risk |
The following analysis includes forward-looking statements that assume that certain market conditions occur. Actual results may differ materially from these projected results due to changes in our portfolio assets and borrowings mix and due to developments in the domestic and global financial and real estate markets. Developments in the financial markets include the likelihood of changing interest rates and the relationship of various interest rates and their impact on our portfolio yield, cost of funds and cash flows. The analytical methods that we use to assess and mitigate these market risks should not be considered projections of future events or operating performance.
Interest Rate Risk
Interest rates are sensitive to many factors, including governmental, monetary, tax policies, domestic and international economic conditions, and political or regulatory matters beyond our control. Changes in interest rates affect the value of our RMBS and ARM loansthe financial assets we manage and hold in our investment portfolio, the variable-rate borrowings we use to finance our portfolio, and the interest rate swaps and caps, Eurodollar and other futures, TBAs and other securities or instruments we use to hedge our portfolio. All of our portfolio interest market risk sensitive assets, liabilities and related derivative positions are managed withAs a long term perspective and are not for trading purposes.
Interest rate risk is measured by the sensitivity of our current and future earnings to interest rate volatility, variability of spread relationships, the difference in re-pricing intervals between our assets and liabilities and the effect that interest rates may have on our cash flows, especially the speed at which prepayments occur on our residential mortgage related assets. Changes in interest rates can affectresult, our net interest income which is the difference between theparticularly affected by changes in interest income earned on assets and our interest expense incurred in connection with our borrowings.rates.
Our CMO floater assetsFor example, we hold RMBS some of which may have interest ratescoupons that adjust monthly, at a margin over LIBOR, as do the repurchase agreement liabilities that we use to finance those CMO assets.
Our adjustable-rate hybrid ARM assets reset on various dates that are not matched to the reset dates on our repurchase agreements. In general, the repricingre-pricing of our repurchase agreements occurs more quickly than the repricingre-pricing of our assets. First,Thus, it is likely that our floating rate borrowings may react to changes in interest rates before our adjustable rate assetsRMBS because the weighted average next re-pricing dates on the related borrowings may have shorter time periods than that of the adjustable rate assets. Second,RMBS. In addition, the interest rates on adjustable rate assetsour Agency ARMs backed by hybrid ARMs may be limited to a “periodic cap” or an increase of typically 1% or 2% per adjustment period, while our borrowings do not have comparable limitations. Third,Changes in interest rates can directly impact prepayment speeds, thereby affecting our adjustable rate assets typically lag changes in the applicablenet return on RMBS. During a declining interest rate indicesenvironment, the prepayment of RMBS may accelerate (as borrowers may opt to refinance at a lower rate) causing the amount of liabilities that have been extended by 45 days duethe use of interest rate swaps to increase relative to the notice period providedamount of RMBS, possibly resulting in a decline in our net return on RMBS as replacement RMBS may have a lower yield than those being prepaid. Conversely, during an increasing interest rate environment, RMBS may prepay slower than expected, requiring us to adjustable rate borrowersfinance a higher amount of RMBS than originally forecast and at a time when the interest rates may be higher, resulting in a decline in our net return on their loans are scheduled to change.RMBS. Accordingly, each of these scenarios can negatively impact our net interest income.
We seek to manage interest rate risk in the portfolio by utilizing interest rate swaps, caps, Eurodollar and Eurodollarother futures, options and U.S. Treasury securities with the goal of optimizing the earnings potential while seeking to maintain long term stable portfolio values. We continually monitor the duration of our mortgage assets and have a policy to hedge the financing such that the net duration of the assets, our borrowed funds related to such assets, and related hedging instruments, are less than one year.
Interest rates can also affect In addition, we utilize TBAs to mitigate the risks on our net return on hybrid ARM securities and loans net of the cost of financing hybrid ARMs. We continually monitor and estimate the duration oflong Agency RMBS positions associated with our hybrid ARMs and have a policy to hedge the financing of the hybrid ARMs such that the net duration of the hybrid ARMs, our borrowed funds related to such assets, and related hedging instruments are less than one year. During a declining interest rate environment, the prepayment of hybrid ARMs may accelerate (as borrowers may opt to refinance at a lower rate) causing the amount of liabilities that have been extended by the use of interest rate swaps to increase relative to the amount of hybrid ARMs, possibly resultinginvestments in a decline in our net return on hybrid ARMs as replacement hybrid ARMs may have a lower yield than those being prepaid. Conversely, during an increasing interest rate environment, hybrid ARMs may prepay slower than expected, requiring us to finance a higher amount of hybrid ARMs than originally forecast and at a time when interest rates may be higher, resulting in a decline in our net return on hybrid ARMs. Our exposure to changes in the prepayment speed of hybrid ARMs is mitigated by regular monitoring of the outstanding balance of hybrid ARMs, and adjusting the amounts anticipated to be outstanding in future periods and, on a regular basis, making adjustments to the amount of our fixed-rate borrowing obligations for future periods.Agency IOs.
We utilize a model basedmodel-based risk analysis system to assist in projecting portfolio performances over a scenario of different interest rates. The model incorporates shifts in interest rates, changes in prepayments and other factors impacting the valuations of our financial securities and instruments, including mortgage-backed securities, repurchase agreements, interest rate swaps and interest rate caps.caps, TBAs and Eurodollar futures
Based on the results of the model, as of December 31, 2008,instantaneous changes in interest rates would have had the following effect on net interest income:income for the next 12 months based on our assets and liabilities as of December 31, 2011 (dollar amounts in thousands):
| Changes in Net Interest Income |
| Changes in Interest Rates | | Changes in Net Interest Income |
| +200 | | $ | 6,107 | |
| +100 | | $ | 5,081 | |
| -100 | | $ | (7,822 | ) |
| Changes in Net Interest Income | |
| Changes in Interest Rates | | Changes in Net Interest Income | |
| +200 | | $ | (4,162 | ) |
| +100 | | $ | (2,508 | ) |
| -100 | | $ | (6,347 | ) |
Interest rate changes may also impact our net book value as our mortgage assets and related hedge derivatives are marked-to-market each quarter. Generally, as interest rates increase, the value of our mortgage assets, other than IOs, decreases, and conversely, as interest rates decrease, the value of such investments will increase. The value of an IO will likely be negatively affected in a declining interest rate environment due to the risk of increasing prepayment rates because the IOs value is wholly contingent on the underlying mortgage loans having an outstanding balance. In general, we would expect however that, over time, decreases in value of our portfolio attributable to interest rate changes will be offset, to the degree we are hedged, by increases in value of our interest rate swaps or other financial instruments used for hedging purposes, and vice versa. However, the relationship between spreads on securities and spreads on swapsour hedging instruments may vary from time to time, resulting in a net aggregate book value increase or decline. However,That said, unless there is a material impairment in value that would result in a payment not being received on a security or loan, changes in the book value of our portfolio will not directly affect our recurring earnings or our ability to make a distribution to our stockholders.
Liquidity Risk
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain investments, pay dividends to our stockholders and other general business needs. We recognize the need to have funds available to operate our business. It is our policy to have adequate liquidity at all times. We plan to meet liquidity through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds.
Our principal sources of liquidity are the repurchase agreements on our RMBS,mortgage-backed securities, the CDOs we have issued to finance our loans held in securitization trust,trusts, the principal and interest payments from mortgageour assets and cash proceeds from the issuance of equity securities.securities (as market and other conditions permit). We believe our existing cash balances and cash flows from operations will be sufficient for our liquidity requirements for at least the next 12 months.
As it relates to our investment portfolio, derivative financial instruments we use to hedge interest rate risk subject us to “margin call” risk. If the value of our pledged assets decrease, due to a change in interest rates, credit characteristics, or other pricing factors, we may be required to post additional cash or asset collateral, or reduce the amount we are able to borrower“borrow” versus the collateral. UnderFor example, under our interest rate swaps typically we pay a fixed rate to the counterparties while they pay us a floating rate. If interest rates drop below the fixed rate we are paying on an interest rate swap, we may be required to post cash margin.
Prepayment Risk
When borrowers repay the principal on their mortgage loans before maturity or faster than their scheduled amortization, the effect is to shorten the period over which interest is earned, and therefore, reduce the yield for mortgage assets purchased at a premium to their then current balance, as with the majority of our assets. Conversely, mortgage assets purchased for less than their then current balance exhibit higher yields due to faster prepayments. Furthermore, prepayment speeds exceeding or lower than our modeled prepayment speeds impact the effectiveness of any hedges we have in place to mitigate financing and/or fair value risk. Generally, when market interest rates decline, borrowers have a tendency to refinance their mortgages, thereby increasing prepayments. The impact of increasing prepayment rates, whether as a result of declining interest rates, government intervention in the mortgage markets or otherwise, is particularly acute with respect to our Agency IOs. Because the value of an IO security is wholly contingent on the underlying mortgage loans having an outstanding principal balance, an unexpected increase in prepayment rates on the pool of mortgage loans underlying the IOs could significantly negatively impact the performance of our Agency IOs.
Our prepayment modelmodeled prepayments will help determine the amount of hedging we use to off-set changes in interest rates. If actual prepayment rates are higher than modeled, the yield will be less than modeled in cases where we paid a premium for the particular mortgage asset. Conversely, when we have paid a premium, if actual prepayment rates experienced are slower than modeled, we would amortize the premium over a longer time period, resulting in a higher yield to maturity.
In an increasing prepayment environment, the timing difference between the actual cash receipt of principal paydowns and the announcement of the principal paydown may result in additional margin requirements from our repurchase agreement counterparties.
We mitigate prepayment risk by constantly evaluating our mortgage assets relative to prepayment speeds observed for assets with a similar structure, quality and characteristics. Furthermore, we stress-test the portfolio as to prepayment speeds and interest rate risk in order to further develop or make modifications to our hedge balances. Historically, we have not hedged 100% of our liability costs due to prepayment risk.
Credit Risk
Credit risk is the risk that we will not fully collect the principal we have invested in mortgage loans or securitiesother assets, such as non-Agency RMBS, CMBS, and CLOs, due to either borrower defaults, or a counterparty failure.defaults. Our portfolio of loans held in securitization trusts as of December 31, 20082011 consisted of approximately $348.3$208.9 million of securitized first liens originated in 2005 and earlier, approximately $455.9 million of Agency RMBS backed by the credit of Fannie Mae or Freddie Mac, approximately $18.1 million of non-Agency floating rate securities rated AAA by both Standard and Poor’s and Moody’s. In addition we own approximately $5.4 million of loans held for sale in HC, net of lower or cost or market (“LOCOM”) adjustment.
earlier. The securitized first liens were principally originated in 2005 by one of our subsidiary HCsubsidiaries prior to our exit from the mortgage lending business. These are predominately high-quality loans with an average loan-to-value (“LTV”) ratio at origination of approximately 69.5%70.4%, and average borrower creditFICO score of approximately 736.729. In addition, approximately 70.0%64.4% of these loans were originated with full income and asset verification. While we feel that our origination and underwriting of these loans will help to mitigate the risk of significant borrower defaults,default on these loans, we cannot assure you that all borrowers will continue to satisfy their payment obligations under these loans and thereby avoidingavoid default.
The $348.3 million of mortgage loans held in securitization trusts are permanently financed with $335.6 million of collateralized debt obligations leaving the Company with a net exposure of $12.7 million of credit exposure, which represents the Company's equity interest in the CDO's.
Market (Fair Value)As of December 31, 2011 the Company owns $34.9 million of first loss CMBS comprised of POs that are backed by commercial mortgage loans on multi-family properties at a weighted average amortized purchase price of approximately 26.1% of current par. The overall return of these securities will be dependent on the performance of the underlying loans and accordingly, management has taken an appropriate credit reserve when determining the amount of discount to accrete into income over time. In addition, we owned approximately $3.9 million on non-Agency RMBS senior securities. The non-Agency RMBS has a weighted average amortized purchase price of approximately 84.8% of current par value. Management believes the purchase price discount coupled with the credit support within the bond structure protects us from principal loss under most stress scenarios for these non-Agency RMBS. As of December 31, 2011, we own approximately $22.8 million of notes issued by a CLO at a discounted purchase price equal to 28.9% of par. The securities are backed by a portfolio of middle market corporate loans.
Fair Value Risk
Changes in interest rates also expose us to market risk that the market value (fair) value(fair value) fluctuation on our assets, may decline. For certainliabilities and hedges. While the fair value of the financial instrumentsmajority of our assets that are measured on a recurring basis are determined using Level 2 fair values, we own certain assets, such as our CMBS, for which fair values willmay not be readily available sinceif there are no active trading markets for these instruments as characterized by current exchanges between willing parties. Accordingly,the instruments. In such cases, fair values canwould only be derived or estimated for these investments using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved. However, the determination of estimated future cash flows is inherently subjective and imprecise. Minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values. TheseOur fair value estimates and assumptions are indicative of the interest rate environments as of December 31, 2008,2011, and do not take into consideration the effects of subsequent interest rate fluctuations.
We note that the values of our investments in mortgage-backed securities and in derivative instruments, primarily interest rate hedges on our debt, will be sensitive to changes in market interest rates, interest rate spreads, credit spreads and other market factors. The value of these investments can vary and has varied materially from period to period. Historically, the values of our mortgage loan portfolio have tended to vary inversely with those of its derivative instruments.
The following describes the methods and assumptions we use in estimating fair values of our financial instruments:
Fair value estimates are made as of a specific point in time based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and the judgments made regarding risk characteristics of various financial instruments, discount rates, estimate of future cashflows,cash flows, future expected loss experience and other factors.
Changes in assumptions could significantly affect these estimates and the resulting fair values. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in an immediate sale of the instrument. Also, because of differences in methodologies and assumptions used to estimate fair values, the fair values used by us should not be compared to those of other companies.
The fair values of the Company's residential mortgage-backed securitiesRMBS and CDOs are generally based on market prices provided by five to seven dealers who make markets in these financial instruments. If the fair value of a security is not reasonably available from a dealer, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and on available market information.
The fair value of mortgage loans held for in securitization trusts are determined byis estimated using pricing models and taking into consideration the loan pricing sheet whichaggregated characteristics of groups of loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed-rate period, life cap, periodic cap, underwriting standards, age and credit estimated using the estimated market prices for similar types of loans.
The fair value of our CMBS is based third party loan origination entitieson management’s estimates using pricing models and inputs from current market conditions including recent transactions. Our CMBS investments were acquired in private transactions and are not actively traded in the secondary markets. However similar products and markets.assets are issued on a periodic basis that allows management to assess current market conditions when formulating a model evaluation.
The market risk management discussion and the amounts estimated from the analysis that follows are forward-looking statements that assume that certain market conditions occur. Actual results may differ materially from these projected results due to changes in our portfolio assets and borrowings mix and due to developments in the domestic and global financial and real estate markets. Developments in the financial markets include the likelihood of changing interest rates and the relationship of various interest rates and their impact on our portfolio yield, cost of funds and cash flows. The analytical methods that we use to assess and mitigate these market risks should not be considered projections of future events or operating performance.
As a financial institution that has only invested in U.S.-dollar denominated instruments, primarily residential mortgage instruments, and has only borrowed money in the domestic market, we are not subject to foreign currency exchange or commodity price risk. Rather, our market risk exposure is largely due to interest rate risk. Interest rate risk impacts our interest income, interest expense and the market value on a large portion of our assets and liabilities. The management of interest rate risk attempts to maximize earnings and to preserve capital by minimizing the negative impacts of changing market rates, asset and liability mix, and prepayment activity.
The table below presents the sensitivity of the market value and net duration changes of our portfolio as of December 31, 2008,2011, using a discounted cash flow simulation model.model assuming an instantaneous interest rate shift. Application of this method results in an estimation of the fair market value change of our assets, liabilities and hedging instruments per 100 basis point (“bp”) shift in interest rates.
The use of hedging instruments is a critical part of our interest rate risk management strategies, and the effects of these hedging instruments on the market value of the portfolio are reflected in the model's output. This analysis also takes into consideration the value of options embedded in our mortgage assets including constraints on the re-pricing of the interest rate of assets resulting from periodic and lifetime cap features, as well as prepayment options. Assets and liabilities that are not interest rate-sensitive such as cash, payment receivables, prepaid expenses, payables and accrued expenses are excluded.
Changes in assumptions including, but not limited to, volatility, mortgage and financing spreads, prepayment behavior, defaults, as well as the timing and level of interest rate changes will affect the results of the model. Therefore, actual results are likely to vary from modeled results.
| Market Value Changes | | | | | | | | |
Changes in Interest Rates | | Changes in Market Value | | Net Duration | | Changes in Market Value | | | Net Duration |
| | | (Amount in thousands) | | | | (Amounts in thousands) | | | |
| +200 | | $ | (16,381 | ) | 0.88 years | | $ | (13,092) | | | 2.73 years |
| +100 | | $ | (6,149 | ) | 0.52 years | | $ | (6,579) | | | 1.92 years |
| Base | | $ | — | | 0.41 years | | | — | | | 0.70 years |
| -100 | | $ | 4,595 | | 0.15 years | | $ | 602 | | | (0.69) years |
It should be noted that the model is used as a tool to identify potential risk in a changing interest rate environment but does not include any changes in portfolio composition, financing strategies, market spreads or changes in overall market liquidity.
Based on the assumptions used, the model output suggests a very low degree of portfolio price change given increases in interest rates, which implies that our cash flow and earning characteristics should be relatively stable for comparable changes in interest rates.
Although market value sensitivity analysis is widely accepted in identifying interest rate risk, it does not take into consideration changes that may occur such as, but not limited to, changes in investment and financing strategies, changes in market spreads and changes in business volumes. Accordingly, we make extensive use of an earnings simulation model to further analyze our level of interest rate risk.
There are a number of key assumptions in our earnings simulation model. These key assumptions include changes in market conditions that affect interest rates, the pricing of ARM products, the availability of investment assets and the availability and the cost of financing for portfolio assets. Other key assumptions made in using the simulation model include prepayment speeds and management's investment, financing and hedging strategies, and the issuance of new equity. We typically run the simulation model under a variety of hypothetical business scenarios that may include different interest rate scenarios, different investment strategies, different prepayment possibilities and other scenarios that provide us with a range of possible earnings outcomes in order to assess potential interest rate risk. The assumptions used represent our estimate of the likely effect of changes in interest rates and do not necessarily reflect actual results. The earnings simulation model takes into account periodic and lifetime caps embedded in our assets in determining the earnings at risk.
TheOur financial statements of the Company and the related notes, and schedules to the financial statements, together with the Report of Independent Registered Public Accounting Firm thereon, as required by this Item 8, are set forth beginning on page F-1 of this annual reportAnnual Report on Form 10-K and are incorporated herein by reference.
None.
Evaluation of Disclosure Controls and Procedures.Procedures As of the end of the period covered by this report, we carried out an evaluation, under the supervision of and with the participation of our management, including Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our- We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of December 31, 2008that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management timely.as appropriate to allow timely decisions regarding required disclosures. An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2011. Based upon that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2008.2011.
Management’s Report on Internal Control Over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control system was designed to provide reasonable assurance to our management and Board of Directors regarding the reliability, preparation and fair presentation of published financial statements in accordance with generally accepted accounting principles. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control - Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).Commission. Based on our evaluation under the framework inInternal Control -IntegratedIntegrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2008.2011.
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to the rules of the SEC that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting. There have been no changes in the our internal control over financial reporting during the quarter ended December 31, 20082011 that have materially affected, or are reasonably likely to materially affect, the our internal control over financial reporting.
None.The information set forth in Item 1 of this Annual Report on Form 10-K related to the Midway Amendment and the Midway Management Agreement are incorporated by reference herein. A copy of the Midway Amendment is filed as Exhibit 10.[_] to this Annual Report on Form 10-K.
Information on our directors and executive officers and the audit committee of our Board of DirectorsThe information required by this item is incorporated by reference fromincluded in our Proxy Statement (under the headings “Proposal 1: Election of Directors,” “Information on Our Board of Directors and its Committees,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Executive Officers”) to be filed with respect tofor our 2012 Annual Meeting of Stockholders to be held June 9, 2009filed with the SEC within 120 days after the end of the fiscal year ended December 31, 2011 (the “2009“2012 Proxy Statement”). and is incorporated herein by reference.
In addition, we have filed, as exhibits to this Annual Report on Form 10-K, the certifications of our principal executive officer and principal financial officer required under Sections 302 and 906 of the Sarbanes Oxley Act of 2002.
The information presented underrequired by this item is included in the headings “Compensation of Directors”, “Executive Compensation”, “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report” in our 20092012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
The
Except as set forth below, the information presented underrequired by this item is included in the headings “Share Ownership of Directors and Executive Officers” and “Share Ownership by Certain Beneficial Owners” in our 20092012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
The information presented under the heading “Market for the Registrant’s Common Equity and Related Stockholder Matters — Securities Authorized for Issuance Under Equity Compensation Plans” in Item 5 of Part II of this Form 10-K is incorporated herein by reference.
The information presented underrequired by this item is included in the heading “Certain Relationships and Related Transactions” and “Information on Our Board of Directors and its Committees” in our 20092012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
The information presented underrequired by this item is included in the heading “Relationship with Independent Registered Public Accounting Firm” in our 20092012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
| | (a) | Financial Statements and Schedules. The following financial statements and schedules are included in this report: |
| | Page |
FINANCIAL STATEMENTS: | | |
| | |
| - Grant Thornton LLP | F-2 |
| | | |
| Consolidated Balance Sheets | F-3 |
| | | |
| Consolidated Statements of Operations | F-4 |
| | | |
| Consolidated Statements of Stockholders’/Members’ EquityComprehensive Income | F-5 |
| | | |
| Consolidated Statements of Cash FlowsEquity | F-6 |
| | | |
| Consolidated Statements of Cash Flows | F-7 |
| | |
| Notes to Consolidated Financial Statements | F-7 F-8 |
The information set forth under “Exhibit Index” below is incorporated herein by reference.
Pursuant to the requirements of Section 13 or 15(d) 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.
| | |
| | NEW YORK MORTGAGE TRUST, INC. |
| | | |
Date: March 31, 200912, 2012 | By: | /s/ Steven R. Mumma |
| | Name: Steven R. Mumma |
| | Title: Chief Executive Officer and President |
| (Principal Executive Officer) |
| | |
| Date: March 12, 2012 | By: | /s/ Fredric S. Starker |
| Fredric S. Starker |
| Chief Financial Officer |
| (Principal Financial and Accounting Officer) |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature | | Title | | Date |
| | | | | |
| /s/ Steven R. Mumma | | President, Chief Executive Officer, President and Director | | March 31, 200912, 2012 |
| Steven R. Mumma | | Chief Financial Officer(Principal Executive Officer) | | |
| | | | | |
| /s/ Fredric S. Starker | | Chief Financial Officer | | March 12, 2012 |
| Frederic S. Starker | | (Principal Executive OfficerFinancial and Principal FinancialAccounting Officer) | | |
| | | | | |
| /s/ James J. Fowler | | Chairman of the Board | | March 31, 200912, 2012 |
| James J. Fowler | | | | |
| | | | |
/s/ David R. Bock | | Director | | March 31, 2009 |
David R. Bock | | | | |
| | | | | |
| /s/ Alan L. Hainey | | Director | | March 31, 200912, 2012 |
| Alan L. Hainey | | | | |
| | | | | |
| /s/ Steven G. Norcutt | | Director | | March 31, 200912, 2012 |
| Steven G. Norcutt | | | | |
| | | | | |
/s/ Steven M. AbreuDavid R. Bock | | Director | | March 31, 200912, 2012 |
Steven M. AbreuDavid R. Bock | | | | |
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND
REPORTSREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
For Inclusion in Form 10-K
Filed with
United States Securities and Exchange Commission
December 31, 20082011
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
| | | Page | |
| FINANCIAL STATEMENTS: | | | | |
| | | | | |
| - Grant Thornton LLP | | | F-2 | |
| | | | | |
| | | F-3 | |
| | | | | |
| | | F-4 | |
| | | | | |
| Comprehensive Income | | | F-5 | |
| | | | | |
| Equity | | | F-6 | |
| | | | | |
| | | F-7 | |
| | | | |
| Notes to Consolidated Financial Statements | | | F-7F-8 | |
To the
Board of Directors and Stockholders ofShareholders
New York Mortgage Trust, Inc.
New York, New York
We have audited the accompanying consolidated balance sheets of New York Mortgage Trust, Inc. (a Maryland corporation) and subsidiaries (the "Company"“Company”) as of December 31, 20082011 and 2007,2010, and the related consolidated statements of operations, stockholders'comprehensive income, equity, and cash flows for each of the threetwo years in the period ended December 31, 2008.2011. These consolidated financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on the consolidatedthese financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our auditsaudit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company'sCompany’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, suchthe consolidated financial statements referred to above present fairly, in all material respects, the financial position of New York Mortgage Trust, Inc. and subsidiaries as of December 31, 20082011 and 2007,2010, and the results of theirits operations and theirits cash flows for each of the threetwo years in the period ended December 31, 2008,2011 in conformity with accounting principles generally accepted in the United States of America.
/s/ DELOITTE & TOUCHEGrant Thornton LLP
New York, New York
March 31, 200912, 2012
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
| | | | | | | |
| ASSETS | | | | | | |
| | | | | | | |
Investment securities available for sale, at fair value (including pledged securities of $129,942 and $38,475, respectively) | | $ | 200,342 | | | $ | 86,040 | |
| Mortgage loans held in securitization trusts (net) | | | 206,920 | | | | 228,185 | |
| Mortgage loans held for investment | | | 5,118 | | | | 7,460 | |
| Investment in limited partnership | | | 8,703 | | | | 18,665 | |
| Cash and cash equivalents | | | 16,586 | | | | 19,375 | |
| Receivable for securities sold | | | 1,133 | | | | 5,653 | |
| Derivative assets | | | 208,218 | | | | - | |
| Receivables and other assets | | | 35,685 | | | | 8,916 | |
| Total Assets | | $ | 682,705 | | | $ | 374,294 | |
| | | | | | | | | |
| LIABILITIES AND EQUITY | | | | | | | | |
| Liabilities: | | | | | | | | |
| Financing arrangements, portfolio investments | | $ | 112,674 | | | $ | 35,632 | |
| Collateralized debt obligations | | | 199,762 | | | | 219,993 | |
| Derivative liabilities | | | 2,619 | | | | 1,087 | |
| Payable for securities purchased | | | 228,300 | | | | - | |
| Accrued expenses and other liabilities | | | 8,043 | | | | 4,095 | |
| Subordinated debentures | | | 45,000 | | | | 45,000 | |
| Total liabilities | | | 596,398 | | | | 305,807 | |
| Commitments and Contingencies | | | | | | | | |
| Equity: | | | | | | | | |
| Stockholders' equity | | | | | | | | |
Common stock, $0.01 par value, 400,000,000 authorized, 13,938,273 and 9,425,442, shares issued and outstanding, respectively | | | 139 | | | | 94 | |
| Additional paid-in capital | | | 153,710 | | | | 135,300 | |
| Accumulated other comprehensive income | | | 11,292 | | | | 17,732 | |
| Accumulated deficit | | | (79,863 | ) | | | (84,639 | ) |
| Total stockholders' equity | | | 85,278 | | | | 68,487 | |
| Noncontrolling interest | | | 1,029 | | | | - | |
| Total equity | | | 86,307 | | | | 68,487 | |
| Total Liabilities and Equity | | $ | 682,705 | | | $ | 374,294 | |
| | | December 31, 2008 | | | December 31, 2007 | |
| ASSETS | | | | | | |
| Cash and cash equivalents | | $ | 9,387 | | | $ | 5,508 | |
| Restricted cash | | | 7,959 | | | | 7,515 | |
| Investment securities available for sale, at fair value (including pledged assets of $456,506 and $337,356 at December 31, 2008 and 2007, respectively) | | | 477,416 | | | | 350,484 | |
| Accounts and accrued interest receivable | | | 3,095 | | | | 3,485 | |
| Mortgage loans held in securitization trusts (net) | | | 348,337 | | | | 430,715 | |
| Prepaid and other assets | | | 1,191 | | | | 1,545 | |
| Derivative assets | | | 22 | | | | 416 | |
| Property and equipment (net) | | | 39 | | | | 62 | |
| Assets related to discontinued operations | | | 5,854 | | | | 8,876 | |
| Total Assets | | $ | 853,300 | | | $ | 808,606 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | | | | | |
| Liabilities: | | | | | | | | |
| Financing arrangements, portfolio investments | | $ | 402,329 | | | $ | 315,714 | |
| Collateralized debt obligations | | | 335,646 | | | | 417,027 | |
| Derivative liabilities | | | 4,194 | | | | 3,517 | |
| Accounts payable and accrued expenses | | | 3,997 | | | | 3,752 | |
| Subordinated debentures (net) | | | 44,618 | | | | 44,345 | |
| Convertible preferred debentures (net) | | | 19,702 | | | | — | |
| Liabilities related to discontinued operations | | | 3,566 | | | | 5,833 | |
| Total liabilities | | | 814,052 | | | | 790,188 | |
| | | | | | | | | |
| Commitments and Contingencies | | | | | | | | |
| | | | | | | | | |
| Stockholders’ Equity: | | | | | | | | |
| Common stock, $0.01 par value, 400,000,000 shares authorized 9,320,094 shares issued and outstanding at December 31, 2008 and 1,817,927 shares issued and outstanding at December 31, 2007 | | | 93 | | | | 18 | |
| Additional paid-in capital | | | 150,790 | | | | 99,357 | |
| Accumulated other comprehensive loss | | | (8,521 | ) | | | (1,950 | ) |
| Accumulated deficit | | | (103,114 | ) | | | (79,007 | ) |
| Total stockholders’ equity | | | 39,248 | | | | 18,418 | |
| Total Liabilities and Stockholders’ Equity | | $ | 853,300 | | | $ | 808,606 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except per share amounts)data)
| | | For the Years Ended December 31, | |
| | | 2011 | | | 2010 | |
| | | | | | | |
| | | | | | | |
| INTEREST INCOME | | $ | 24,291 | | | $ | 19,899 | |
| | | | | | | | | |
| INTEREST EXPENSE: | | | | | | | | |
| Investment securities and loans held in securitization trusts | | | 2,946 | | | | 4,864 | |
| Subordinated debentures | | | 1,891 | | | | 2,473 | |
| Convertible preferred debentures | | | - | | | | 2,274 | |
| Total interest expense | | | 4,837 | | | | 9,611 | |
| | | | | | | | | |
| NET INTEREST INCOME | | | 19,454 | | | | 10,288 | |
| | | | | | | | | |
| OTHER (EXPENSE) INCOME: | | | | | | | | |
| Provision for loan losses | | | (1,693 | ) | | | (2,230 | ) |
| Impairment loss on investment securities | | | (250 | ) | | | (296 | ) |
Income from investments in limited partnership and limited liability company | | | 2,167 | | | | 496 | |
Realized gain on investment securities and related hedges, net | | | 5,740 | | | | 5,362 | |
Unrealized loss on investment securities and related hedges, net | | | (9,657 | ) | | | - | |
| Total other (expense) income | | | (3,693 | ) | | | 3,332 | |
| | | | | | | | | |
| General, administrative and other expenses | | | 8,323 | | | | 7,950 | |
| Termination of management contract | | | 2,195 | | | | - | |
| Total general, administrative and other expenses | | | 10,518 | | | | 7,950 | |
| | | | | | | | | |
| INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES | | | 5,243 | | | | 5,670 | |
| Income tax expense | | | 433 | | | | - | |
| INCOME FROM CONTINUING OPERATIONS | | | 4,810 | | | | 5,670 | |
| Income from discontinued operation - net of tax | | | 63 | | | | 1,135 | |
| NET INCOME | | | 4,873 | | | | 6,805 | |
| Net income attributable to noncontrolling interest | | | 97 | | | | - | |
| NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS | | $ | 4,776 | | | $ | 6,805 | |
| | | | | | | | | |
| Basic income per common share | | $ | 0.46 | | | $ | 0.72 | |
| Diluted income per common share | | $ | 0.46 | | | $ | 0.72 | |
| Dividends declared per common share | | $ | 1.00 | | | $ | 0.79 | |
| Weighted average shares outstanding-basic | | | 10,495 | | | | 9,422 | |
| Weighted average shares outstanding-diluted | | | 10,495 | | | | 9,422 | |
| | | For the Year Ended December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
| REVENUES: | | | | | | | | | |
| Interest income - Investment securities and loans held in securitization trusts | | $ | 44,123 | | | $ | 50,564 | | | $ | 64,881 | |
| Interest expense - Investment securities and loans held in securitization trusts | | | 30,351 | | | | 46,529 | | | | 56,553 | |
| Net interest income from investment securities and loans held in securitization trusts | | | 13,772 | | | | 4,035 | | | | 8,328 | |
| Interest expense - subordinated debentures | | | (3,760 | ) | | | (3,558 | ) | | | (3,544 | ) |
| Interest expense - convertible preferred debentures | | | (2,149 | ) | | | — | | | | — | |
| Net interest income | | | 7,863 | | | | 477 | | | | 4,784 | |
| OTHER EXPENSE: | | | | | | | | | | | | |
| Provision for loan losses | | | (1,462 | ) | | | (1,683 | ) | | | (57 | ) |
| Realized losses on securities and related hedges | | | (19,977 | ) | | | (8,350 | ) | | | (529 | ) |
| Impairment loss on investment securities | | | (5,278 | ) | | | (8,480 | ) | | | — | |
| Total other expense | | | (26,717 | ) | | | (18,513 | ) | | | (586 | ) |
| EXPENSES: | | | | | | | | | | | | |
| Salaries and benefits | | | 1,869 | | | | 865 | | | | 714 | |
| Professional fees | | | 1,212 | | | | 612 | | | | 598 | |
| Insurance | | | 948 | | | | 474 | | | | 204 | |
| Management fees | | | 665 | | | | — | | | | — | |
| Other | | | 2,216 | | | | 803 | | | | 516 | |
| Total expenses | | | 6,910 | | | | 2,754 | | | | 2,032 | |
| (LOSS) INCOME FROM CONTINUING OPERATIONS | | | (25,764 | ) | | | (20,790 | ) | | | 2,166 | |
| Income (loss) from discontinued operations - net of tax | | | 1,657 | | | | (34,478 | ) | | | (17,197 | ) |
| NET LOSS | | $ | (24,107 | ) | | $ | (55,268 | ) | | $ | (15,031 | ) |
| Basic and diluted loss per common share | | $ | (2.91 | ) | | $ | (30.47 | ) | | $ | (8.33 | ) |
| Dividends declared per common share | | $ | 0.54 | | | $ | 0.50 | | | $ | 4.70 | |
| Weighted average common shares outstanding-basic and diluted | | | 8,272 | | | | 1,814 | | | | 1,804 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2008, 2007 and 2006COMPREHENSIVE INCOME
(Dollar amounts in thousands)
| | | | | | Additional Paid-In Capital | | | | | | Accumulated Other Comprehensive Income (Loss) | | | Comprehensive Income (Loss) | | | Total | |
| BALANCE, JANUARY 1, 2006 | | $ | 18 | | | $ | 107,738 | | | $ | (8,708 | ) | | $ | 1,910 | | | | | | $ | 100,958 | |
| Net loss | | | — | | | | — | | | | (15,031 | ) | | | — | | | $ | (15,031 | ) | | | (15,031 | ) |
| Dividends declared | | | — | | | | (8,595 | ) | | | — | | | | — | | | | — | | | | (8,595 | ) |
| Repurchase of common stock | | | (1 | ) | | | (299 | ) | | | — | | | | — | | | | — | | | | (300 | ) |
| Restricted stock | | | 1 | | | | 819 | | | | — | | | | — | | | | — | | | | 820 | |
| Performance shares | | | — | | | | 8 | | | | — | | | | — | | | | — | | | | 8 | |
| Stock options exercised | | | — | | | | 3 | | | | — | | | | — | | | | — | | | | 3 | |
| Decrease in net unrealized gain on investment available for sale securities | | | — | | | | — | | | | — | | | | (879 | ) | | | (879 | ) | | | (879 | ) |
| Decrease in derivative instruments utilized for cash flow hedge | | | — | | | | — | | | | — | | | | (5,412 | ) | | | (5,412 | ) | | | (5,412 | ) |
| Comprehensive loss | | | — | | | | — | | | | — | | | | — | | | $ | (21,322 | ) | | | | |
| BALANCE, DECEMBER 31, 2006 | | | 18 | | | | 99,674 | | | | (23,739 | ) | | | (4,381 | ) | | | | | | | 71,572 | |
| Net loss | | | — | | | | — | | | | (55,268 | ) | | | — | | | $ | (55,268 | ) | | | (55,268 | ) |
| Dividends declared | | | — | | | | (909 | ) | | | — | | | | — | | | | — | | | | (909 | ) |
| Restricted stock | | | — | | | | 592 | | | | — | | | | — | | | | — | | | | 592 | |
Reclassification adjustment for net loss included in net income | | | — | | | | — | | | | — | | | | 3,192 | | | | 3,192 | | | | 3,192 | |
| Decrease in derivative instruments utilized for cash flow hedge | | | — | | | | — | | | | — | | | | (761 | ) | | | (761 | ) | | | (761 | ) |
| Comprehensive loss | | | — | | | | — | | | | — | | | | — | | | $ | (52,837 | ) | | | | |
| BALANCE, DECEMBER 31, 2007 | | | 18 | | | | 99,357 | | | | (79,007 | ) | | | (1,950 | ) | | | | | | | 18,418 | |
| Net loss | | | | | | | | | | | (24,107 | ) | | | | | | $ | (24,107 | ) | | | (24,107 | ) |
| Dividends declared | | | — | | | | (5,033 | ) | | | — | | | | — | | | | — | | | | (5,033 | ) |
| Common stock issuance | | | 75 | | | | 56,466 | | | | — | | | | — | | | | — | | | | 56,541 | |
| Increase in net unrealized loss on investment available for sale securities | | | — | | | | — | | | | — | | | | (2,961 | ) | | | (2,961 | ) | | | (2,961 | ) |
| Decrease in derivative instruments utilized for cash flow hedge | | | — | | | | — | | | | — | | | | (3,610 | ) | | | (3,610 | ) | | | (3,610 | ) |
| Comprehensive loss | | | — | | | | — | | | | — | | | | — | | | $ | (30,678 | ) | | | | |
| BALANCE, DECEMBER 31, 2008 | | $ | 93 | | | $ | 150,790 | | | $ | (103,114 | ) | | $ | (8,521 | ) | | | | | | $ | 39,248 | |
| | | For the Years | |
| | | Ended December 31, | |
| | | 2011 | | | 2010 | |
| | | | | | | |
| | | | | | | |
| NET INCOME | | $ | 4,873 | | | $ | 6,805 | |
| | | | | | | | | |
| OTHER COMPREHENSIVE (LOSS) INCOME | | | | | | | | |
| | | | | | | | | |
| (Decrease) increase in net unrealized gain on available for sale securities | | | (3,337 | ) | | | 9,106 | |
| Reclassification adjustment for net gain included in net income | | | (3,886 | ) | | | (5,011 | ) |
| Increase in fair value of derivative instruments utilized for cash flow hedges | | | 783 | | | | 1,819 | |
| | | | | | | | | |
| OTHER COMPREHENSIVE (LOSS) INCOME | | | (6,440 | ) | | | 5,914 | |
| | | | | | | | | |
| COMPREHENSIVE (LOSS) INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS | | $ | (1,567 | ) | | $ | 12,719 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWSEQUITY
For the Years Ended December 31, 2011 and 2010
(Dollar amounts in thousands)
| | | | | | | | | | | | | | | | | | Total | |
| Balance, January 1, 2010 | | $ | 94 | | | $ | 142,519 | | | $ | (91,444 | ) | | $ | 11,818 | | | $ | - | | | $ | 62,987 | |
| Net income | | | - | | | | - | | | | 6,805 | | | | - | | | | - | | | | 6,805 | |
| Stock issuance | | | - | | | | 225 | | | | - | | | | - | | | | - | | | | 225 | |
| Dividends declared | | | - | | | | (7,444 | ) | | | - | | | | - | | | | - | | | | (7,444 | ) |
Reclassification adjustment for net gain included in net income | | | - | | | | - | | | | - | | | | (5,011 | ) | | | - | | | | (5,011 | ) |
Increase in net unrealized gain on available for sale securities | | | - | | | | - | | | | - | | | | 9,106 | | | | - | | | | 9,106 | |
Increase in fair value of derivative instruments utilized for cash flow hedges | | | - | | | | - | | | | - | | | | 1,819 | | | | - | | | | 1,819 | |
| Balance, December 31, 2010 | | | 94 | | | | 135,300 | | | | (84,639 | ) | | | 17,732 | | | | - | | | | 68,487 | |
| Net income | | | - | | | | - | | | | 4,776 | | | | - | | | | 97 | | | | 4,873 | |
| Stock issuance | | | 45 | | | | 30,548 | | | | - | | | | - | | | | - | | | | 30,593 | |
Costs associated with issuance of common stock | | | - | | | | (686 | ) | | | - | | | | - | | | | - | | | | (686 | ) |
| Dividends declared | | | - | | | | (11,452 | ) | | | - | | | | - | | | | - | | | | (11,452 | ) |
Increase in non-controlling interests related to consolidation of interest in a limited liability company | | | - | | | | - | | | | - | | | | - | | | | 932 | | | | 932 | |
Reclassification adjustment for net gain included in net income | | | - | | | | - | | | | - | | | | (3,886 | ) | | | - | | | | (3,886 | ) |
Decrease in net unrealized gain on available for sale securities | | | - | | | | - | | | | - | | | | (3,337 | ) | | | - | | | | (3,337 | ) |
Increase in fair value of derivative instruments utilized for cash flow hedges | | | - | | | | - | | | | - | | | | 783 | | | | - | | | | 783 | |
| Balance, December 31, 2011 | | $ | 139 | | | $ | 153,710 | | | $ | (79,863 | ) | | $ | 11,292 | | | $ | 1,029 | | | $ | 86,307 | |
| | | For the Years Ended December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
| CASH FLOWS FROM OPERATING ACTIVITIES: | | | | | | | | | |
| Net loss | | $ | (24,107 | ) | | $ | (55,268 | ) | | $ | (15,031 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in) operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 1,423 | | | | 765 | | | | 2,106 | |
| Amortization of premium on investment securities and mortgage loans | | | 997 | | | | 1,616 | | | | 2,483 | |
| Loss on sale of securities, loans and related hedges | | | 19,977 | | | | 8,350 | | | | 1,276 | |
| Impairment loss on investment securities | | | 5,278 | | | | 8,480 | | | | — | |
| Purchase of mortgage loans held for investment | | | — | | | | — | | | | (222,907 | ) |
| Origination of mortgage loans held for sale | | | — | | | | (300,863 | ) | | | (1,841,011 | ) |
| Proceeds from sales of mortgage loans | | | 2,746 | | | | 398,678 | | | | 2,059,981 | |
| Allowance for deferred tax asset / tax (benefit) | | | — | | | | 18,352 | | | | (8,494 | ) |
| Gain on sale of retail lending platform | | | — | | | | (4,368 | ) | | | — | |
| Change in value of derivatives | | | — | | | | 785 | | | | 289 | |
| Provision for loan losses | | | 1,520 | | | | 2,546 | | | | 6,800 | |
| Other | | | — | | | | 1,111 | | | | 806 | |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Due from loan purchasers | | | — | | | | 88,351 | | | | 33,462 | |
| Escrow deposits-pending loan closings | | | — | | | | 3,814 | | | | (2,380 | ) |
| Accounts and accrued interest receivable | | | 415 | | | | 4,141 | | | | 7,188 | |
| Prepaid and other assets | | | 642 | | | | 2,903 | | | | (1,586 | ) |
| Due to loan purchasers | | | 138 | | | | (7,115 | ) | | | 4,209 | |
| Accounts payable and accrued expenses | | | (2,767 | ) | | | (5,009 | ) | | | (7,957 | ) |
| Other liabilities | | | — | | | | (131 | ) | | | (453 | ) |
| Net cash provided by operating activities | | | 6,262 | | | | 167,138 | | | | 18,781 | |
| CASH FLOWS FROM INVESTING ACTIVITIES: | | | | | | | | | | | | |
| Increase in restricted cash | | | (444 | ) | | | (4,364 | ) | | | 2,317 | |
| Purchases of investment securities | | | (850,609 | ) | | | (231,932 | ) | | | (292,513 | ) |
| Proceeds from sale of investment securities | | | 625,986 | | | | 246,874 | | | | 356,895 | |
| Principal repayments received on loans held in securitization trust | | | 79,951 | | | | 154,729 | | | | 191,673 | |
| Proceeds from sale of retail lending platform | | | — | | | | 12,936 | | | | — | |
| Principal paydown on investment securities | | | 74,172 | | | | 113,490 | | | | 162,185 | |
| Purchases of property and equipment | | | — | | | | (396 | ) | | | (1,464 | ) |
| Proceeds from sale of fixed asset and real estate owned property | | | 10 | | | | 880 | | | | — | |
| Net cash (used in) provided by investing activities | | | (70,934 | ) | | | 292,217 | | | | 419,093 | |
| CASH FLOWS FROM FINANCING ACTIVITIES: | | | | | | | | | | | | |
| Repurchase of common stock | | | — | | | | — | | | | (300 | ) |
| Increase (decrease) in financing arrangements, portfolio investments | | | 86,615 | | | | (672,570 | ) | | | (403,400 | ) |
| Collateralized debt obligation borrowings | | | — | | | | 337,431 | | | | — | |
| Collateralized debt obligation paydowns | | | (81,725 | ) | | | (117,851 | ) | | | (30,779 | ) |
| Dividends paid | | | (4,100 | ) | | | (1,826 | ) | | | (11,524 | ) |
| Capital contributions from minority interest member | | | — | | | | — | | | | 42 | |
| Payments made for termination of swaps | | | (8,333 | ) | | | — | | | | — | |
| Proceeds from common stock issued (net) | | | 56,541 | | | | — | | | | — | |
| Proceeds from convertible preferred debentures (net) | | | 19,553 | | | | — | | | | — | |
| Net cash provided by (used in) financing activities | | | 68,551 | | | | (454,816 | ) | | | (445,961 | ) |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | | | 3,879 | | | | 4,539 | | | | (8,087 | ) |
| CASH AND CASH EQUIVALENTS — Beginning | | | 5,508 | | | | 969 | | | | 9,056 | |
| CASH AND CASH EQUIVALENTS — End | | $ | 9,387 | | | $ | 5,508 | | | $ | 969 | |
| SUPPLEMENTAL DISCLOSURE | | | | | | | | | | | | |
| Cash paid for interest | | $ | 31,479 | | | $ | 41,338 | | | $ | 76,905 | |
| NON CASH FINANCING ACTIVITIES | | | | | | | | | | | | |
| Dividends declared to be paid in subsequent period | | $ | 932 | | | $ | — | | | $ | 905 | |
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
| | | For the Years Ended December 31, | |
| | | 2011 | | | 2010 | |
| Cash Flows from Operating Activities: | | | | | | |
| Net income | | $ | 4,873 | | | $ | 6,805 | |
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: | | | | | | | | |
| Depreciation and amortization | | | 126 | | | | 669 | |
Net accretion on investment securities and mortgage loans held in securitization trusts | | | 5,558 | | | | (3,248 | ) |
| Realized gain on securities and related hedges, net | | | (5,740 | ) | | | (5,362 | ) |
| Unrealized loss on securities and related hedges, net | | | 9,657 | | | | - | |
| Impairment loss on investment securities | | | 250 | | | | 296 | |
| Net decrease in loans held for sale | | | 31 | | | | 32 | |
| Provision for loan losses | | | 1,693 | | | | 2,230 | |
| Income from investments in limited partnership and limited liability company | | | (2,167 | ) | | | (496 | ) |
| Interest distributions from investments in limited partnership and limited liability company | | | 1,079 | | | | 234 | |
| Stock issuance | | | 210 | | | | 225 | |
| Changes in operating assets and liabilities: | | | | | | | | |
| Receivables and other assets | | | (2,923 | ) | | | 269 | |
| Accrued expenses and other liabilities | | | 767 | | | | (1,959 | ) |
| Net cash provided by (used in) operating activities | | | 13,414 | | | | (305 | ) |
| | | | | | | | | |
| Cash Flows from Investing Activities: | | | | | | | | |
| Restricted cash | | | (24,326 | ) | | | 1,610 | |
| Purchases of investment securities | | | (291,211 | ) | | | (5 | ) |
| Proceeds from sales of investment securities | | | 167,805 | | | | 46,024 | |
| Issuance of mortgage loans held for investment | | | (2,520 | ) | | | (7,460 | ) |
| Proceeds from mortgage loans held for investment | | | 5,004 | | | | - | |
| Purchase of investments in limited partnership and limited liability company | | | (5,322 | ) | | | (19,359 | ) |
| Proceeds from investments in limited partnership | | | 10,909 | | | | 956 | |
| Net proceeds on other derivative instruments not designated as qualifying hedges | | | 4,961 | | | | - | |
| Principal repayments received on mortgage loans held in securitization trusts | | | 19,950 | | | | 45,744 | |
| Principal paydowns on investment securities - available for sale | | | 19,459 | | | | 52,174 | |
| Net cash (used in) provided by investing activities | | | (95,291 | ) | | | 119,684 | |
| | | | | | | | | |
| Cash Flows from Financing Activities: | | | | | | | | |
| Proceeds from (payments of) financing arrangements | | | 77,042 | | | | (49,474 | ) |
| Stock issuance | | | 30,382 | | | | - | |
| Costs associated with stock issuance | | | (686 | ) | | | - | |
| Dividends paid | | | (8,270 | ) | | | (8,102 | ) |
| Redemption of convertible preferred debentures | | | - | | | | (20,000 | ) |
| Payments made on collateralized debt obligations | | | (20,312 | ) | | | (46,950 | ) |
| Capital contributed by noncontrolling interest | | | 932 | | | | - | |
| Net cash provided by (used in) financing activities | | | 79,088 | | | | (124,526 | ) |
| Net Decrease in Cash and Cash Equivalents | | | (2,789 | ) | | | (5,147 | ) |
| Cash and Cash Equivalents - Beginning of Year | | | 19,375 | | | | 24,522 | |
| Cash and Cash Equivalents - End of Year | | $ | 16,586 | | | $ | 19,375 | |
| | | | | | | | | |
| Supplemental Disclosure: | | | | | | | | |
| Cash paid for interest | | $ | 4,669 | | | $ | 9,730 | |
| | | | | | | | | |
| Non-Cash Investment Activities: | | | | | | | | |
| Sale of investment securities not yet settled | | $ | 1,133 | | | $ | 5,653 | |
| Purchase of investment securities not yet settled | | $ | 228,300 | | | $ | - | |
| Transfer of investment securities from investment in limited liability company | | $ | 5,463 | | | $ | - | |
| | | | | | | | | |
| Non-Cash Financing Activities: | | | | | | | | |
| Dividends declared to be paid in subsequent period | | $ | 4,878 | | | $ | 1,697 | |
See notes to consolidated financial statements.
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollar amounts in thousands unless otherwise indicated)
| 1. | Summary of Significant Accounting Policies |
Organization -– New York Mortgage Trust, Inc., together with its consolidated subsidiaries (“NYMT”,NYMT,” the “Company”, “we”,“Company,” “we,” “our”, and “us”), is a self-advised real estate investment trust, or REIT, that investsin the business of acquiring, investing in, financing and managing primarily in real estate-related assets, including residential adjustable rate mortgage-backed securities (including collateralized mortgage obligation floating rate securities) issued by a United States government-sponsored enterprise (“GSE” or “Agency”), such as the Federal National Mortgage Association (“Fannie Mae”), or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), prime credit quality residential adjustable-rate mortgage (“ARM”) loans, or prime ARM loans, and non-agency mortgage-backed securities. We refer to residential adjustable rate mortgage-backed securities throughout this Annual Report on Form 10-K as “RMBS” and RMBS issued by a GSE as “Agency MBS”. We also may invest, although to a lesser extent, in certain alternative real-estate-related and financial assets that present greater credit risk and less interest rate risk than our investments our current investments RMBS and prime ARM loans. We refer to our investment in these alternative assets as our “alternative investment strategy.” We seek attractive long-term investment returns by investing our equity capital and borrowed funds in such securities.mortgage-related assets. Our principal business objective is to generate net income for distribution to our stockholders resulting from the spread between the interest and other income we earn on our interest-earning assets and the interest expense we pay on the borrowings that we use to finance theseour leveraged assets whichand our operating costs. We also may opportunistically acquire and manage various other types of mortgage-related and financial assets that we refer to as our net interest income.believe will compensate us appropriately for the risks associated with them.
The Company conducts its business through the parent company, NYMT, and several subsidiaries, including special purpose subsidiaries established for loan securitization purposes, a taxable REIT subsidiarysubsidiaries ("TRS"TRSs") and a qualified REIT subsidiarysubsidiaries ("QRS"QRSs"). The Company will conductconducts certain of its portfolio investment operations related to its alternative investment strategy through one of its wholly-owned TRS,TRSs, Hypotheca Capital, LLC (“HC”), in order to utilize, some or allto the extent permitted by law, a portion of a net operating loss carry-forward held in HC that resulted from the Company's exit from the mortgage lending business. Prior to March 31, 2007, the Company conducted substantially all of its mortgage lending business through HC. The Company'sCompany utilizes one of its wholly-owned QRS,QRSs, RB Commercial Mortgage LLC (“RBCM”), for its investments in multi-family CMBS assets, and, to a lesser extent, other commercial real estate-related debt investments. The Company utilizes another of its wholly-owned QRSs, NYMT-Midway LLC, and one of its wholly-owned TRSs, New York Mortgage Funding, LLC (“NYMF”), currently holds certain mortgage-related assets under our principal investment strategy for regulatory compliance purposes. The Company also may conduct certain of our operations related to our alternative investment strategy through NYMF. As of December 31, 2008, the Company had not acquired any investments under its alternative investment strategy.Agency IO portfolio managed by Midway. The Company consolidates all of its subsidiaries under Generally Accepted Accounting Principlesgenerally accepted accounting principles in the United States of America (“GAAP”).
The Company is organized and conducts its operations to qualify as a REIT for federal income tax purposes. As such, the Company will generally not be subject to federal income tax on that portion of its income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by the due date of its federal income tax return and complies with various other requirements.
Basis of Presentation -– The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. All inter-company accounts and transactions are eliminated in consolidation. Prior period amounts has been reclassified to conform to current period classifications, including $0.7 million of deferred debt issuance cost included in prepaid and other assets to an offset to subordinated debentures (net).
As used herein, references to the “Company,” “NYMT,” “we,” “our” and “us” refer to New York Mortgage Trust, Inc., collectively with its subsidiaries.
The Board of Directors declared a one for five reverse stock split of our common stock, as of October 9, 2007 and a one for two reverse stock split of our common stock, as of May 27, 2008, decreasing the number of common shares then outstanding to approximately 9.3 million. Prior and current period share amounts and earnings per share disclosures have been restated to reflectprepared on the reverse stock split. In addition, the termsaccrual basis of our Series A Preferred Stock provide that the conversion rate for the Series A Preferred Stock be appropriately adjusted to reflect any reverse stock split. As a result, the description of our Series A Preferred Stock reflects the May 2008 reverse stock split (see note 15)accounting in accordance with U.S. generally accepted accounting principles (“GAAP”).
Use of Estimates - The preparation of consolidated financial statements in conformity with GAAP requires management to 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 period. The Company’s estimates and assumptions primarily ariseActual results could differ from risks and uncertainties associated with interest rate volatility, prepayment volatility and credit exposure. Although management is not currently aware of any factors that would significantly change its estimates and assumptions in the near term, future changes in market conditions may occur which could cause actual results to differ materially.those estimates.
The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.
CashVariable Interest Entities – An entity is referred to as a variable interest entity (“VIE”) if it meets at least one of the following criteria: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (2) as a group, the holders of the equity investment at risk lack (a) the power to direct the activities of an entity that most significantly impact the entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual returns; or (3) have disproportional voting rights and Cash Equivalents - Cash and cash equivalents include cashthe entity’s activities are conducted on hand, amounts due from banks and overnight deposits. behalf of the investor that has disproportionally few voting rights.
The Company maintains its cashconsolidates a VIE when it has both the power to direct the activities that most significantly impact the economic performance of the VIE and cash equivalents in highly rated financial institutions, and at times these balances exceed insurable amounts.
Restricted Cash - Restricted cash includes approximately $7.9 million held by counterparties as collateral for hedging instruments and approximately $0.1 million held as collateral for one lettera right to receive benefits or absorb losses of credit relatedthe entity that could be potentially significant to the Company’s leaseVIE. The Company is required to reconsider its evaluation of it corporate headquarters.whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.
Investment Securities Available for Sale -– The Company's investment securities, are residential mortgage-backed securities comprised of Fannie Mae, Freddie Macwhere the fair value option has not been elected and “AAA”- rated adjustable-rate securities, including adjustable-rate securities that have an initial fixed-rate period. Investment securities are classified as available for sale securities andwhich are reported at fair value with unrealized gains and losses reported in other comprehensive lossincome (“OCI”), include residential mortgage-backed securities (“RMBS”) that are issued by government sponsored enterprises (“GSE”), which, together with RMBS issued or guaranteed by other GSEs or government agencies, is referred to as “Agency RMBS,” non-Agency RMBS, collateralized loan obligations (“CLOs”) and multi-family commercial mortgage-backed securities (“CMBS”). The fair valuesOur investment securities are classified as available for all securities in this classification are based on unadjusted price quotes for similar securities in active markets obtained from independent dealers.sale securities. Realized gains and losses recorded on the sale of investment securities available for sale are based on the specific identification method and included in realized gain (loss) on sale of securities and related hedges.hedges in the consolidated statements of operations. Purchase premiums or discounts on investment securities are amortized or accreted to interest income over the estimated life of the investment securities using the interesteffective yield method. Investment securities may be subjectAdjustments to interest rate, credit and/oramortization are made for actual prepayment risk.activity.
When the fair value of an available for saleinvestment security is less than its amortized cost management considers whether thereat the balance sheet date, the security is considered impaired. The Company assesses its impaired securities on at least a quarterly basis, and designates such impairments as either “temporary” or “other-than-temporary.” If the Company intends to sell an impaired security, or it is more likely than not that it will be required to sell the impaired security before its anticipated recovery, then it must recognize an other-than-temporary impairment inthrough earnings equal to the entire difference between the investment’s amortized cost and its fair value at the balance sheet date. If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the security (e.g., whetherother-than-temporary impairment related to credit losses is recognized through earnings with the security will be sold prior toremainder recognized as a component of other comprehensive income (loss) on the recoveryconsolidated balance sheet. Impairments recognized through other comprehensive income (loss) do not impact earnings. Following the recognition of fair value). Management considers at a minimum the following factors that, both individually or in combination, could indicate the decline is “other-than-temporary:” 1) the length of time and extent to which the fair value has been less than book value; 2) the financial condition and near-term prospects of the issuer; or 3) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery in market value. If, in management's judgment, an other-than-temporary impairment exists,through earnings, a new cost basis is established for the security, which may not be adjusted for subsequent recoveries in fair value through earnings. However, other-than-temporary impairments recognized through earnings may be accreted back to the amortized cost basis of the security on a prospective basis through interest income. The determination as to whether an other-than-temporary impairment exists and, if so, the amount considered other-than-temporarily impaired is written downsubjective, as such determinations are based on both factual and subjective information available at the time of assessment. As a result, the timing and amount of other-than-temporary impairments constitute material estimates that are susceptible to the then-current fair value, and the unrealized loss is transferred from accumulated other comprehensive income as an immediate reduction of current earnings (i.e., as if the loss had been realized in the period of impairment). Even though no credit concerns exist with respect to ansignificant change.
The Company’s investment securities available for sale security, an other-than-temporary impairment may be evident if management determinesalso includes its investment in a wholly owned account referred to as our Agency IO portfolio. These investments primarily include interest only and inverse interest only securities (collectively referred to as “IOs”) that are guaranteed or issued by a GSE or government agency. The Agency IO portfolio investments include derivative investments not designated as hedging instruments for accounting purposes, with unrealized gains and losses recognized through earnings in the consolidated statements of operations. The Company has elected the fair value option for these investment securities which also measures unrealized gains and losses through earnings in the consolidated statements of operations, as the Company does not have the intentbelieves this accounting treatment more accurately and ability to hold an investment until a forecasted recoveryconsistently reflects their results of the value of the investment. (see note 2)
Impairment of and Basis Adjustments on Securitized Financial Assets - As previously described herein, during 2005 and early 2006, we regularly securitized our mortgage loans and retained the beneficial interests created by such securitization. Such assets are evaluated for impairment on a quarterly basis or, if events or changes in circumstances indicate that these assets or the underlying collateral may be impaired, on a more frequent basis. We evaluate whether these assets are considered impaired, whether the impairment is other-than-temporary and, if the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the asset’s amortized cost basis and its fair value. These evaluations require management to make estimates and judgments based on changes in market interest rates, credit ratings, credit and delinquency data and other information to determine whether unrealized losses are reflective of credit deterioration and our ability and intent to hold the investment to maturity or recovery. This other-than-temporary impairment analysis requires significant management judgment and we deem this to be a critical accounting estimate.
As of December 31, 2008, our principal investment portfolio included approximately $197.7 million of Agency CMO Floaters. Following a review of our principal investment portfolio, we determined in March 2009 that the Agency CMO Floaters held in our portfolio were no longer producing acceptable returns and initiated a program to dispose of these securities on an opportunistic basis. As of March 25, 2009, the Company had sold approximately $149.8 million in current par value of Agency CMO Floaters under this program resulting in a net gain of approximately $0.2 million. As a result of these sales and our intent to sell the remaining Agency CMO Floaters in our principal investment portfolio, we concluded the reduction in value at December 31, 2008 was other-than-temporary and recorded an impairment charge of $4.1 million for the quarter and year ended December 31, 2008.operations.
In addition, we also determined that $6.1 million in current par value of non-agency RMBS, which includes $2.5 million in current par value of retained residual interest, had suffered an other-than-temporary impairment and, accordingly, recorded an impairment charge of $1.2 million for the year ended December 31, 2008.
Accounts and Accrued Interest Receivable - Accounts and accrued receivable includes interest receivable for investment securities and mortgage loans held in securitization trusts.
Mortgage Loans Held in Securitization Trusts (net) -– Mortgage loans held in securitization trusts are certain Adjustable Rate Mortgageadjustable rate mortgage ("ARM") loans transferred to New York Mortgage Trust 2005-1, New York Mortgage Trust 2005-2 and New York Mortgage Trust 2005-3 that have been securitized into sequentially rated classes of beneficial interests. The Company accounted for these securitization trusts as financings which are consolidated into the financial statements. Mortgage loans held in securitization trusts are carried at their unpaid principal balances, net of unamortized premium or discount, unamortized loan origination costs and allowance for loan losses. In accordance with Statement of Financial Accounting Standards (“SFAS”) SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, securitized ARM loans and ARM loans collateralizing debt are accounted for as loans and are not considered investments subject to classification under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (see note 3 and note 6). See Collateralized Debt Obligations below for further description.
Interest income is accrued and recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectible. The accrual of interest on loans is discontinued when, in management’s opinion, the interest is not collectible in the normal course of business, but in no case when payment becomes greater than 90 days delinquent. Loans return to accrual status when principal and interest become current and are anticipated to be fully collectible.
Allowance for Loan Losses on Mortgage Loans Held in Securitization Trusts—Trusts – We establish an allowance for loan losses based on management's judgment and estimate of credit losses inherent in our portfolio of mortgage loans held in securitization trusts.
Estimation involves the consideration of various credit-related factors including but not limited to, macro-economic conditions, the current housing market conditions, loan-to-value ratios, delinquency status, historical credit loss severity rates, purchased mortgage insurance, the borrower's creditcurrent economic condition and other factors deemed to warrant consideration. Additionally, we look at the balance of any delinquent loan and compare that to the current value of the collateralizing property. We utilize various home valuation methodologies including appraisals, broker pricing opinions (“BPOs”), internet-based property data services to review comparable properties in the same area or consult with a realtor in the property's area.
Comparing the current loan balance to the property value determines the current loan-to-value (“LTV”) ratio of the loan. Generally, we estimate that a first lien loan on a property that goes into a foreclosure process and becomes real estate owned (“REO”), results in the property being disposed of at approximately 68%84% of the property's originalcurrent value. This estimate is based on management's long term experience. During 2008,experience as a resultwell as realized severity rates since issuance of the significant deterioration in the housing market, we revised our policy to estimate recovery values based on current home valuations less expected costs to dispose. These costs typically approximate 15% of the current home value. It is possible given today's deteriorating market conditions, we may realize less than that return in certain cases. Thus, for a first lien loan that is delinquent, we will adjust the property value down to approximately 85% of the current property value and compare that to the current balance of the loan. The difference determines the base provision for the loan loss taken for that loan.securitizations. This base provision for a particular loan may be adjusted if we are aware of specific circumstances that may affect the outcome of the loss mitigation process for that loan. Predominately, however,However, we predominantly use the base reserve number for our reserve. If real estate markets continue to decline, we may adjust our anticipated realization percentage.
The allowanceMortgage Loans Held for Investment – Mortgage loans held for investment are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, net of valuation allowances. Interest income is accrued on the principal amount of the loan lossesbased on the loan’s contractual interest rate. Amortization of premiums and discounts is recorded using the effective yield method. Interest income, amortization of premiums and discounts and prepayment fees are reported in interest income. Loans are considered to be impaired when it is probable that, based upon current information and events, the Company will be maintained through ongoing provisions chargedunable to operating incomecollect all amounts due under the contractual terms of the loan agreement. Based on the facts and will be reducedcircumstances of the individual loans being impaired, loan specific valuation allowances are established for the excess carrying value of the loan over either: (i) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (ii) the estimated fair value of the loan’s underlying collateral if the loan is in the process of foreclosure or otherwise collateral dependent, or (iii) the loan’s observable market price.
Investment in Limited Partnership – The Company has an equity investment in a limited partnership. In circumstances where the Company has a non-controlling interest but either owns a significant interest or is able to exert influence over the affairs of the enterprise, the Company utilizes the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity’s earnings and decreased for cash distributions and a proportionate share of the entity’s losses.
Management periodically reviews its investments for impairment based on projected cash flows from the entity over the holding period. When any impairment is identified, the investments are written down to recoverable amounts.
Cash and Cash Equivalents – Cash and cash equivalents include cash on hand, amounts due from banks and overnight deposits. The Company maintains its cash and cash equivalents in highly rated financial institutions, and at times these balances exceed insurable amounts.
Receivables and Other Assets – Receivables and other assets include restricted cash held by loans that are charged off. Asthird parties of December 31, 2008 the allowance for loan losses$25.8 million which includes $16.5 million held in securitization trusts totaled $1.4 million. The allowanceour Agency IO portfolio to be used for loan losses was $1.6trading purposes and $9.1 million held by counterparties as collateral for hedging instruments at December 31, 2007.2011.
Financing Arrangements, Portfolio Investments — Portfolio investments– Investment securities available for sale are typically financed with repurchase agreements, a form of collateralized borrowing which is secured by portfoliothe securities on the balance sheet. Such financings are recorded at their outstanding principal balance with any accrued interest due recorded as an accrued expense (see note 5).expense.
Collateralized Debt Obligations (“CDO”CDOs”) -– We use CDOs to permanently finance our loans held in securitization trusts. For financial reporting purposes, the ARM loans and restricted cash held as collateral are carriedrecorded as assets of the Company and the CDO is carriedrecorded as the Company’s debt. The transaction includes interest rate caps which are held by the securitization trust and recorded as a derivative asset or liability of the Company.
The Company, as transferor, securitizes mortgage loans and securities by transferring the loans or securities to entities (“Transferees”) which generally qualify under GAAP as “qualifying special purpose entities” (“QSPE's”) as defined under SFAS No. 140. The QSPEs issue investment grade and non-investment grade securities. Generally, the investment grade securities are sold to third party investors, and the Company retains the non-investment grade securities. If a transaction meets the requirements for sale recognition under GAAP, and the Transferee meets the requirements to be a QSPE, the assets transferred to the QSPE are considered sold, and gain or loss is recognized. The gain or loss is based on the price of the securities sold and the estimated fair value of any securities and servicing rights retained over the cost basis of the assets transferred net of transaction costs. If subsequently the Transferee fails to continue to qualify as a QSPE, or the Company obtains the right to purchase assets out of the Transferee, then the Company may have to include in its financial statements such assets, or potentially, all the assets of such Transferee. The Company has completed four securitizations since inception, the first three were accounted for as a permanent financing (see note 6) and the fourth was accounted for as a sale.sale and accordingly, not included in the Company’s financial statements.
Subordinated Debentures (net) - -– Subordinated debentures are trust preferred securities that are fully guaranteed by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. These securities are classified as subordinated debentures in the liability section of the Company’s consolidated balance sheet and are presented net of the debt issurance costs (see note 7).sheet.
Convertible Preferred Debentures (net) - The Company issued $20.0 million in Series A Convertible Preferred Stock maturing on December 31, 2010, at which time any outstanding shares must be redeemed by the Company at the $20.00 per share liquidation preference. Pursuant to SFAS No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, because of this mandatory redemption feature, the Company classifies these securities as a liability on its balance sheet and are presented net of the debt issurance costs (see note 15).
Derivative Financial Instruments -– The Company has developed risk management programs and processes, which include investments in derivative financial instruments designed to manage marketinterest rate and prepayment risk associated with its mortgage banking and its mortgage-backed securities investment activities.
Derivative instruments contain an element of risk in the event that the counterparties may be unable to meet the terms of such agreements. The Company minimizes its risk exposure by limiting the counterparties with which it enters into contracts to banks and investment banks and certain private investors who meet established credit and capital guidelines. Management does not expect any counterparty to default on its obligations and, therefore, does not expect to incur any loss due to counterparty default. In addition, all outstanding interest rate swap agreements have bi-lateral margin call provisions that has the effect of minimizing the net exposure to either counterparty.
Interest Rate Risk - The Company hedges the aggregate risk of interest rate fluctuations with respect to its borrowings, regardless of the form of such borrowings, which require payments based on a variable interest rate index. The Company generally intends to hedge only the risk related to changes in the benchmark interest rate (London Interbank Offered Rate (“LIBOR”) or a Treasury rate). The Company applies hedge accounting utilizing the cash flow hedge criteria in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.
In order to reduce such risks, the Company enters into swap agreements whereby the Company receives floating rate payments in exchange for fixed rate payments, effectively converting the borrowing to a fixed rate. The Company also enters into cap agreements whereby, in exchange for a premium, the Company is reimbursed for interest paid in excess of a certain capped rate.
To qualify for cash flow hedge accounting, interest rate swaps and caps must meet certain criteria, including:
| · | the items to be hedged expose the Company to interest rate risk; and |
| · | the interest rate swaps or caps are expected to be and continue to be highly effective in reducing the Company's exposure to interest rate risk. |
The fair valuesCompany invests in To-Be-Announced securities (“TBAs”) through its Agency IO portfolio. TBAs are forward-settling purchases and sales of Agency RMBS where the Company's interest rate swap agreementsunderlying pools of mortgage loans are “To-Be-Announced.” Pursuant to these TBA transactions, we agree to purchase or sell, for future settlement, Agency RMBS with certain principal and interest rate cap agreementsterms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. For TBA contracts that we have entered into, we have not asserted that physical settlement is probable, therefore we have not designated these forward commitments as hedging instruments. Realized and unrealized gains and losses associated with these TBAs are based on values provided by dealers who are familiar with the terms of these instruments. Effectiveness is periodically assessed at least monthly based upon a comparison of the relative terms, changesrecognized through earnings in the fair values or cash flowsconsolidated statements of the interest rate swaps and caps and the items being hedged.operations.
For derivative instruments that are designated and qualify as a cash flow hedge, (i.e. hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instruments areinstrument is reported as a component of OCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instruments in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change.
With respect to interest rate swapsFor instruments that are not designated or qualify as a cash flow hedge, such as our use of U.S. Treasury securities or Eurodollar futures contracts, any realized and caps that have not been designated as hedges, any net payments under, or fluctuationsunrealized gains and losses associated with these instruments are recognized through earnings in the fair valueconsolidated statement of such swaps and caps, will be recognized in current earnings.operations.
Termination of Hedging Relationships -– The Company employs a number of risk management monitoring procedures to ensure that the designated hedging relationships are demonstrating, and are expected to continue to demonstrate, a high level of effectiveness. Hedge accounting is discontinued on a prospective basis if it is determined that the hedging relationship is no longer highly effective or expected to be highly effective in offsetting changes in fair value of the hedged item.
Additionally, the Company may elect to un-designate a hedge relationship during an interim period and re-designate upon the rebalancing of a hedge profile and the corresponding hedge relationship. When hedge accounting is discontinued, the Company continues to carry the derivative instruments at fair value with changes recorded in current earnings.
Revenue Recognition. Interest income on our residential mortgage loans and mortgage-backed securities is a combination of the interest earned based on the outstanding principal balance of the underlying loan/security, the contractual terms of the assets and the amortization of yield adjustments, principally premiums and discounts, using generally accepted interest methods. The net GAAP cost over the par balance of self-originated loans held for investment and premium and discount associated with the purchase of mortgage-backed securities and loans are amortized into interest income over the lives of the underlying assets using the effective yield method as adjusted for the effects of estimated prepayments. Estimating prepayments and the remaining term of our interest yield investments require management judgment, which involves, among other things, consideration of possible future interest rate environments and an estimate of how borrowers will react to those environments, historical trends and performance. The actual prepayment speed and actual lives could be more or less than the amount estimated by management at the time of origination or purchase of the assets or at each financial reporting period.
Accumulative Revenue Recognition – Interest income on our investment securities and on our mortgage loans is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with investment securities and mortgage loans at the time of purchase or origination are amortized into interest income over the life of such securities using the effective yield method. Adjustments to premium amortization are made for actual prepayment activity.
Interest income on our credit sensitive securities, such as our non-Agency RMBS and certain of our CMBS that were purchased at a discount to par value, is recognized based on the security’s effective interest rate. The effective interest rate on these securities is based on management’s estimate from each security of the projected cash flows, which are estimated based on the Company’s assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, 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 these securities.
Based on the projected cash flows from the Company’s first loss CMBS POs purchased at a discount to par value, a portion of the purchase discount is designated as non-accretable purchase discount or credit reserve, which effectively mitigates the Company’s risk of loss on the mortgages collateralizing such CMBS and is not expected to be accreted into interest income. The amount designated as a credit reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit reserve is more favorable than forecasted, a portion of the amount designated as credit reserve may be accreted into interest income over time. Conversely, if the performance of a security with a credit reserve is less favorable than forecasted, the amount designated as credit reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.
With respect to interest rate swaps and caps that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such swaps and caps will be recognized in current earnings.
Other Comprehensive Income (Loss) -– Other comprehensive income (loss) is comprised primarily of income (loss) from changes in value of the Company’s available for sale securities, and the impact of deferred gains or losses on changes in the fair value of derivative contracts hedging future cash flows.
Employee Benefits Plans -– The Company sponsors a defined contribution plan (the “Plan”) for all eligible domestic employees. The Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Plan, participating employees may defer up to 15% of their pre-tax earnings, subject to the annual Internal Revenue Code contribution limit. The Company may match contributions up to a maximum of 25% of the first 5% of salary. Employees vest immediately in their contribution and vest in the Company’s contribution at a rate of 25% after two full years and then an incremental 25% per full year of service until fully vested at 100% after five full years of service. The Company’s totalmade no contributions to the Plan were $0.0, $18,495 and $0.3 million for the years ended December 31, 2008, 20072011 and 2006, respectively.2010.
Stock Based Compensation - The Company accounts– Compensation expense for its stock options and restricted stock grants in accordance withequity based awards is recognized over the SFAS No. 123 R, Share-Based Payment , (“SFAS No. 123 R”) which requires all companies to measure compensation for all share-based payments, including employee stock options, atvesting period of such awards, based upon the fair value (see note 16).of the stock at the grant date.
Income Taxes -– The Company operates so as to qualify as a REIT under the requirements of the Internal Revenue Code. Requirements for qualification as a REIT include various restrictions on ownership of the Company’s stock, requirements concerning distribution of taxable income and certain restrictions on the nature of assets and sources of income. A REIT must distribute at least 90% of its taxable income to its stockholders of which 85% plus any undistributed amounts from the prior year must be distributed within the taxable year in order to avoid the imposition of an excise tax. TheDistribution of the remaining balance may extend until timely filing of the Company’s tax return in the subsequent taxable year. Qualifying distributions of taxable income are deductible by a REIT in computing taxable income.
HC is a taxable REIT subsidiaryand NYMF are TRSs and therefore subject to corporate Federalfederal and state income taxes. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base upon the change in tax status. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Accounting Standards Codification Topic 740 Accounting for Income Taxes (“ASC 740”) provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. In situations involving uncertain tax positions related to income tax matters, we do not recognize benefits unless it is more likely than not that they will be sustained. ASC 740 was applied to all open taxable years as of the effective date. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date (see note 12).based on factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. The Company will recognize interest and penalties, if any, related to uncertain tax positions as income tax expense.
Earnings Per Share -– Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.
Discontinued Operations - In connection with the sale of the assets of our wholesale mortgage origination platform assets on February 22, 2007 and the sale of the assets of our retail mortgage lending platform on March 31, 2007, during the fourth quarter of 2006, we classified our mortgage lending business as a discontinued operations in accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. As a result, we have reported revenues and expenses related to the mortgage lending business as a discontinued operations and the related assets and liabilities as assets and liabilities related to the discontinued operations for all periods presented in the accompanying consolidated financial statements. Certain assets and liabilities, not assigned to the sales will become part of the ongoing operations of NYMT and accordingly, have not been classified as a discontinued operations in accordance with the provisions of SFAS No. 144 (See note 8).
Allowance for Loan Loss on Repurchase Requests and Mortgage Under Indemnification Agreements- We establish a reserve when we have been requested to repurchase from investors and for loans subject to indemnification agreements. Generally loans wherein the borrowers do not make each of all the first three payments to the new investor once the loan has been sold, require us, under the terms of purchase and sale agreement entered into with the investor, to repurchase the loan.
For the twelve months ended December 31, 2008 no loans were repurchased. For the twelve months ended December 31, 2007, we repurchased a total of approximately $6.7 million of mortgage loans that were originated in 2005, 2006 or 2007, the majority of which were due to early payment defaults. We had pending repurchase requests totaling approximately $1.8 million and $4.4 million as of December 31, 2008 and 2007, respectively, against which the Company has taken a provision of approximately $0.4 million and $0.5 million, respectively. The allowance for loan losses is based on historical settlement rates, property value securing the loan in question and specific settlement discussion with third parties. The Company intends to address all outstanding repurchase requests by attempting to enter into net settlement agreements.
NewA Summary of Recent Accounting Pronouncements - -Follows:
Receivables (ASC 310)
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. On January 1, 2008,ASU 2011-02 clarifies whether loan modifications constitute troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the Company adopted SFASfollowing exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The adoption of ASU 2011-02 did not have an effect on our financial condition, results of operations and disclosures.
Transfers and Servicing (ASC 860)
In April 2011, the FASB issued ASU No. 157,2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. ASU 2011-03 is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. FASB Accounting Standards Codification (“Codification”) Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. We do not expect the adoption of ASU 2011-03 to have an effect on our financial condition, results of operations and disclosures.
Fair Value Measurements (ASC 820)
In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and International Financial Reporting Standards (“, which definesIFRS”). ASU 2011-04 represents the converged guidance of the FASB and the IASB (the “Boards”) on fair value establishes a frameworkmeasurements. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with GAAP and expands disclosures about fair value measurements.
IFRS. The changesamendments in this ASU are required to previous practice resulting frombe applied prospectively, and are effective for interim and annual periods beginning after December 15, 2011. We do not expect the applicationadoption of SFAS No.157 relateASU 2011-04 to the definitionhave a significant effect on our financial condition, results of fair value, the methods used to measure fair value,operations and the expanded disclosures about fair value measurements. The definition of fair value retains the exchange price notion used in earlier definitions of fair value. SFAS No.157 clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. SFAS No.157 provides a consistent definition of fair value which focuses on exit price and prioritizes, within a measurement of fair value, the use of market-based inputs over entity-specific inputs. In addition, SFAS No.157 provides a framework for measuring fair value, and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The Company has disclosed the required elements of SFAS No. 157 herein at Note 11.disclosures.
On January 1, 2008, the Company adopted SFAS No.159, The Fair Value Option for Financial Assets and Financial Liabilities, which provides companies with an option to report selected financial assets and liabilities at fair value. The objective of SFAS No. 159 is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS No. 159 establishes presentation and disclosure requirements and requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company's choice to use fair value on its earnings. SFAS No. 159 also requires entities to display the fair value of those assets and liabilities for which the Company has chosen to use fair value on the face of the balance sheet. The Company’s adoption of SFAS No. 159 did not have a material impact on the consolidated financial statements as the Company did not elect the fair value option for any of its existing financial assets or liabilities as of January 1, 2008.Comprehensive Income (ASC 220)
In June 2007,2011, the Emerging Issues Task Force (“EITF”) reached consensusFASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which amends current comprehensive income guidance. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of shareholders’ equity. Instead, the Company must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. However, in December 2011, the FASB issued ASU No. 2011-12, Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, which deferred the guidance on Issue No. 06-11, Accountingwhether to require entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement where net income is presented and the statement where other comprehensive income is presented for Income Tax Benefitsboth interim and annual financial statements. ASU 2011-12 reinstated the requirements for the presentation of Dividends on Share-Based Payment Awards . EITF Issue No. 06-11 requiresreclassifications that were in place prior to the tax benefit related to dividend equivalents paid on restricted stock units, whichissuance of ASU 2011-05 and did not change the effective date for ASU 2011-05. The amendments in ASU 2011-05 and ASU 2011-12 are expected to vest, be recorded as an increase to additional paid-in capital. The Company currently accountseffective for this tax benefit as a reduction to income tax expense. EITF Issue No. 06-11 is tofiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied prospectively for the Company’s tax benefits on dividends declared as of January 1, 2009.retrospectively. The Company does not expect theearly adoption of EITF Issue No. 06-11 tothis guidance during 2011 did not have a material effectsignificant impact on itsour financial condition,position, results of operations or cash flows.and disclosures as it only required a change in the format of the current presentation.
Balance Sheet (ASC 210)
In December 2007,2011, the FASB issued SFASASU No. 141(R)2011-11, Business CombinationsDisclosures about Offsetting Assets and Liabilities. SFAS No. 141(R) broadens the guidance of SFAS No. 141, extending its applicability to all transactionsThe update requires new disclosures about balance sheet offsetting and other events in which one entity obtains control over one or more other businesses. It broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations; and it stipulates that acquisition related costs be generally expensed rather than included as part of the basis of the acquisition. SFAS No. 141(R) expands required disclosures to improve the ability to evaluate the naturearrangements. For derivatives and financial effectsassets and liabilities, the amendments require disclosure of business combinations. SFAS No. 141(R)gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the balance sheet. The guidance is effective for all transactions the Company closes, on or after January 1, 2009. Adoption of SFAS No. 141(R) will impact the Company’s acquisitions subsequent to January 1, 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. SFAS No.160 requires a noncontrolling interest in a subsidiary2013 and is to be reported as equity and the amountapplied retrospectively. The adoption of consolidated net income specifically attributable to the noncontrolling interest to be identified in the consolidated financial statements. SFAS No. 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS No.160 is effective for the Company on January 1, 2009 and most of its provisions will apply prospectively. We are currently evaluating the impact SFAS No.160ASU 2011-11 will have an effect on our consolidateddisclosures but we do not expect the adoption to have an effect on our financial statements.condition or results of operations.
In February 2008, the FASB issued FASB Staff Position (“FSP”) No. 140-3, Accounting for Transfers of Financial Assets and Repurchase Financing Transactions. SFAS No.140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously or in contemplation of the initial transfer to be evaluated as a linked transaction under SFAS No.140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS No. 140”) unless certain criteria are met, including that the transferred asset must be readily obtainable in the marketplace. FSP No. 140-3 is effective for the Company on January 1, 2009, and will be applied to new transactions entered into after the date of adoption.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133. SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities, and is effective for financial statements the Company issues for fiscal years after January 1, 2009, with early application encouraged. The Company will adopt SFAS No. 161 in the first quarter of 2009. Because SFAS No. 161 requires only additional disclosures concerning derivatives and hedging activities, adoption of SFAS No. 161 will not effect the Company’s financial condition, results of operations or cash flows.
In May 2008, the FASB issued FSP No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement. The adoption of this FSP would affect the accounting for our convertible preferred debentures. The FSP requires the initial proceeds from the sale of our convertible preferred debentures to be allocated between a liability component and an equity component. The resulting discount would be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The FSP would be effective for our fiscal year beginning on January 1, 2009 and requires retroactive application. We are currently evaluating the impact of the FSP on our consolidated financial statements.
On October 10, 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP No.157-3 clarifies the application of SFAS No.157 in a market that is not active and provides an example to illustrate key consideration in determining the fair value of a financial asset when the market for that financial asset is not active. The issuance of FSP No. 157-3 did not have any impact on the Company’s determination of fair value for its financial assets.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities (“FSP FAS 140-4 and FIN 46(R)-8”). FSP FAS 140-4 and FIN 46(R)-8 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and FIN No. 46(R), Consolidation of Variable Interest Entities (revised December 2003) – an interpretation of Accounting Research Bulletin No. 51 to require additional disclosures regarding transfers of financial assets and interest in variable interest entities and is effective for interim or annual reporting periods ending after December 15, 2008. The adoption of FSP SFAS 140-4 and FIN 46(R)-8 did not have a material impact on the Company’s financial statements.
On January 12, 2009, the FASB issued EITF No. 99-20-1, Amendments to the Impairment Guidance of EITF 99-20 to achieve more consistent determination of whether an other-than-temporary impairment has occurred for all beneficial interest within the scope of EITF 99-20, Recognition of Interest Income and Imairmant on Purchased Beneficial Interests and Beneficial Interests that Continue to Be Held by a Transferor in Securitized Financial Assets. EITF 99-20-1 is effective for interim and annual reporting periods ending after December 15, 2008, on a prospective basis. EITF No. 99-20-1 eliminates the requirement that a holder’s best estimate of cash flows be based upon those that “a market participant” would use and instead requires that an other–than–temporary impairment be recognized as a realized loss through earnings when it its “probable” there has been an adverse change in the holder’s estimated cash flows from cash flows previously projected. This change is consistent with the impairment models contained in SFAS No. 115. EITF No. 99-20-1 emphasizes that the holder must consider all available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of future cash flows. Such information generally should include the remaining payment terms of the security, prepayments speeds, financial condition of the issuer, expected defaults, and the value of any underlying collateral. The holder should also consider industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. The Company’s adoption of EITF No. 99-20-1 at December 31, 2008 did not have a material impact on the Company’s consolidated financial statements.
2. | 2. Investment Securities Available For Sale
|
Investment securities available for sale consist of the following as of December 31, 20082011 (dollar amounts in thousands):
| | | Amortized Costs | | | Unrealized Gains | | | Unrealized Losses | | | Carrying Value | |
| Agency RMBS | | $ | 139,639 | | | $ | 2,327 | | | $ | (9,509) | | | $ | 132,457 | |
| CMBS | | | 42,221 | | | | 128 | | | | (1,164) | | | | 41,185 | |
| Non Agency RMBS | | | 5,156 | | | | — | | | | (1,211) | | | | 3,945 | |
| CLOs | | | 10,262 | | | | 12,493 | | | | — | | | | 22,755 | |
| Total | | $ | 197,278 | | | $ | 14,948 | | | $ | (11,884) | | | $ | 200,342 | |
| | | Amortized Cost | | | Unrealized Gains | | | Unrealized Losses | | | Carrying Value | |
| Agency Hybrid Arm Securities | | $ | 256,978 | | | $ | 1,316 | | | $ | (98 | ) | | $ | 258,196 | |
| Agency REMIC CMO Floaters | | | 197,675 | | | | — | | | | — | | | | 197,675 | |
| Private Label Floaters | | | 25,047 | | | | — | | | | (4,101 | ) | | | 20,946 | |
| NYMT Retained Securities | | | 677 | | | | — | | | | (78 | ) | | | 599 | |
| Total/Weighted Average | | $ | 480,377 | | | $ | 1,316 | | | $ | (4,277 | ) | | $ | 477,416 | |
Securities included in investment securities available for sale as part of our Agency IO portfolio that are measured at fair value through earnings consist of the following as of December 31, 2011 (dollar amounts in thousands):
| | | Amortized Costs | | | Unrealized Gains | | | Unrealized Losses | | | Carrying Value | |
| Interest only securities included in Agency RMBS: | | | | | | | | | | | | | | | | |
| Federal National Mortgage Association (“Fannie Mae”) | | $ | 31,079 | | | $ | 490 | | | $ | (3,908) | | | $ | 27,661 | |
| Federal Home Loan Mortgage Corporation (“Freddie Mac”) | | | 19,477 | | | | 142 | | | | (2,554) | | | | 17,065 | |
| Government National Mortgage Association (“Ginnie Mae”) | | | 21,656 | | | | 304 | | | | (3,004) | | | | 18,956 | |
| Total | | $ | 72,212 | | | $ | 936 | | | $ | (9,466) | | | $ | 63,682 | |
Investment securities available for sale consist of the following as of December 31, 20072010 (dollar amounts in thousands):
| | | Amortized Cost | | | Unrealized Gains | | | Unrealized Losses | | | Carrying Value | |
| Agency Hybrid Arm Securities | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| Agency REMIC CMO Floaters | | | 318,689 | | | | — | | | | — | | | | 318,689 | |
| Private Label Floaters | | | 28,401 | | | | — | | | | — | | | | 28,401 | |
| NYMT Retained Securities | | | 3,394 | | | | — | | | | — | | | | 3,394 | |
| Total/Weighted Average | | $ | 350,484 | | | $ | — | | | $ | — | | | $ | 350,484 | |
| | | Amortized Costs | | | Unrealized Gains | | | Unrealized Losses | | | Carrying Value | |
| Agency RMBS (1) | | $ | 45,865 | | | $ | 1,664 | | | $ | — | | | $ | 47,529 | |
| Non Agency RMBS | | | 10,071 | | | | 80 | | | | (1,166) | | | | 8,985 | |
| CLOs | | | 11,286 | | | | 18,240 | | | | — | | | | 29,526 | |
| Total | | $ | 67,222 | | | $ | 19,984 | | | $ | (1,166) | | | $ | 86,040 | |
| (1) | Agency RMBS includes only Fannie Mae issued securities at December 31, 2010. |
During the year ended December 31, 2011, the Company received total proceeds of approximately $20.8 million, realizing approximately $5.0 million of profit before incentive fee, from the sale of certain CLO investments, certain Agency RMBS and U.S. Treasury securities. During the year ended December 31, 2010, the Company received total proceeds of approximately $46.0 million, realizing approximately $5.0 million of profit before incentive fee, from the sale of certain Agency RMBS and non-Agency RMBS.
Actual maturities of our available for sale securities are generally shorter than stated contractual maturities (which range up to 36.0 years), as they are affected by the contractual lives of the underlying mortgages, periodic payments and prepayments of principal. As of December 31, 2008, our principal investment2011 and 2010, the weighted average life of the Company’s available for sale securities portfolio includedis approximately $197.7 million of Agency CMO Floaters. Following a review of our principal investment portfolio, we determined in March 2009 that the Agency CMO floaters held in our portfolio were no longer producing acceptable returns and initiated a program where we wanted to dispose of these securities on an opportunistic basis. As of March 25, 2009, the Company had sold approximately $149.8 million in current par value of Agency CMO floaters under this program resulting in a net gain of approximately $0.2 million. As a result of these sales and our intent to sell the remaining Agency CMO floaters in our principal investment portfolio, we concluded the reduction in value at December 31, 2008 was other-than-temporary due to our intent to sell such securities and recorded an impairment charge of $4.1 million for the quarter and year ended December 31, 2008. In addition, we also determined that $6.1 million in current par value of non-agency RMBS, which includes $2.5 million in current par value of retained residual interest, had suffered an other-than-temporary impairment and, accordingly, recorded an impairment charge of $1.2 million for the quarter and year ended December 31, 2008.5.24 years.
The following tables set forth the stated reset periods of security liquidations increased the volatility of many financial assets, including those held in our portfolio. The significant liquidation of RMBS by several large financial institutions in early March 2008 caused a significant decline in the fair market value of our RMBS portfolio, including Agency ARM RMBS and CMO Floaters that we pledge as collateral for borrowings under our repurchase agreements. As a result of the combination of lower fair values on our Agency securities and rising haircut requirements to finance those securities, we elected to improve our liquidity position by selling approximately $592.8 million of Agency RMBS securities, including $516.4 million of Agency ARM RMBS and $76.4 million of CMO Floaters from our portfolio in March 2008. The sales resulted in a realized loss of approximately $15.0 million.
As a result of the timing of these sales occurring prior to the release of our December 31, 2007 results, the Company determined that the unrealized losses on our entire RMBS securities portfolio were considered to be other than temporarily impaired as of December 31, 2007 and incurred an $8.5 million impairment charge for the quarter ended December 31, 2007.
As of December 31, 2008 and the date of this filing, we have the intent, and believe we have the ability, to hold remaining non impaired portfolio of securities which are currently in unrealized loss positions until recovery of their amortized cost, which may be until maturity. In making the determination management considered the severity and duration of the loss, as well as management’s intent an ability to hold the security until the recoverability or maturity. Given the uncertain state of the financial markets, should conditions change that would require us to sell securities at a loss, we may no longer be able to assert that we have the ability to hold our remaining securities until recovery, and we would then be required to record impairment charges related to these securities. Substantially all of the Company's investment securities available for sale are pledged as collateral for borrowings under financing arrangements (see note 5).
The Company had pledged approximately $456.5 million and $337.4 million in securities at December 31, 2008 and 2007, respectively, as collateral for repurchase agreements (see note 5). The Company had unencumbered securities totaling approximately $20.9 million and $13.1 million at December 31, 2008 and 2007, respectively.
All securities held in Investment Securities Available for Sale, including Agency, investment and non-investment grade securities, are based on unadjusted price quotes for similar securities in active markets and are categorized as Level 2 per SFAS No.157 (see note 11).
The following table sets forth the stated reset periods and weighted average yields of our investment securities at December 31, 20082011 (dollar amounts in thousands):
| | | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months | | | Total | |
| | | Carrying Value | | | Carrying Value | | | Carrying Value | | | Carrying Value | |
| Agency RMBS | | $ | 74,983 | | | $ | 29,210 | | | $ | 28,264 | | | $ | 132,457 | |
| CMBS | | | — | | | | — | | | | 41,185 | | | | 41,185 | |
| Non-Agency RMBS | | | 3,945 | | | | — | | | | — | | | | 3,945 | |
| CLO | | | 22,755 | | | | — | | | | — | | | | 22,755 | |
| Total | | $ | 101,683 | | | $ | 29,210 | | | $ | 69,449 | | | $ | 200,342 | |
| | | Less than 6 Months | | More than 6 Months To 24 Months | | More than 24 Months to 60 Months | | Total |
| | | Carrying Value | | Weighted Average Yield | | Carrying Value | | Weighted Average Yield | | Carrying Value | | Weighted Average Yield | | Carrying Value | | Weighted Average Yield |
| Agency Hybrid Arm Securities | | $ | — | | — | | $ | 66,910 | | 3.69% | | $ | 191,286 | | 4.02% | | $ | 258,196 | | 3.93% |
| Agency REMIC CMO Floaters | | | 197,675 | | 8.54% | | | — | | — | | | — | | — | | | 197,675 | | 8.54% |
| Private Label Floaters | | | 20,946 | | 14.25% | | | — | | — | | | — | | — | | | 20,946 | | 14.25% |
| NYMT Retained Securities (1) | | | 530 | | 8.56% | | | — | | — | | | 69 | | 16.99% | | | 599 | | 15.32% |
| Total/Weighted Average | | $ | 219,151 | | 9.21% | | $ | 66,910 | | 3.69% | | $ | 191,355 | | 4.19% | | $ | 477,416 | | 6.51% |
(1) The NYMT retained securities includes $0.1 million of residual interests related to the NYMT 2006-1 transaction.
The following table setstables set forth the stated reset periods and weighted average yields of our investment securities available for sale at December 31, 20072010 (dollar amounts in thousands):
| | | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months To 60 Months | | | Total | |
| | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | | | Carrying Value | | | Weighted Average Yield | |
| Agency REMIC CMO Floaters | | $ | 318,689 | | | | 5.55 | % | | $ | — | | | | — | | | $ | — | | | | — | | | $ | 318,689 | | | | 5.55 | % |
| Private Label Floaters | | | 28,401 | | | | 5.50 | % | | | — | | | | — | | | | — | | | | — | | | | 28,401 | | | | 5.50 | % |
| NYMT Retained Securities (1) | | | 2,165 | | | | 6.28 | % | | | — | | | | — | | | | 1,229 | | | | 12.99 | % | | | 3,394 | | | | 10.03 | % |
| Total/Weighted Average | | $ | 349,255 | | | | 5.55 | % | | $ | — | | | | — | | | $ | 1,229 | | | | 12.99 | % | | $ | 350,484 | | | | 5.61 | % |
| | | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months | | | Total | |
| | | Carrying Value | | | Carrying Value | | | Carrying Value | | | Carrying Value | |
| Agency RMBS | | $ | 25,816 | | | $ | 5,313 | | | $ | 16,400 | | | $ | 47,529 | |
| Non-Agency RMBS | | | 8,985 | | | | — | | | | — | | | | 8,985 | |
| CLO | | | 29,526 | | | | — | | | | — | | | | 29,526 | |
| Total | | $ | 64,327 | | | $ | 5,313 | | | $ | 16,400 | | | $ | 86,040 | |
(1) The NYMT retained securities includes $1.2 million of residual interests related to the NYMT 2006-1 transaction.
The following table presents the Company's investment securities available for sale in an unrealized loss position reported through OCI, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2008. There were no unrealized positions for Agency REMIC CMO Floaters2011 and the NYMT retained residual interests at December 31, 2008 as the Company incurred approximately $5.3 million impairment charge. There were no unrealized positions twelve months or more or as of December 31, 2007 as the Company incurred approximately $8.5 million impairment charge for unrealized loss positions2010, respectively (dollar amounts in thousands):
| December 31, 2011 | | Less than 12 Months | | | Greater than 12 months | | | Total | |
| | | Carrying Value | | | Gross Unrealized Losses | | | Carrying Value | | | Gross Unrealized Losses | | | Carrying Value | | | Gross Unrealized Losses | |
| Agency RMBS | | $ | 13,718 | | | $ | 43 | | | $ | — | | | $ | — | | | $ | 13,718 | | | $ | 43 | |
| CMBS | | | 13,396 | | | | 1,164 | | | | — | | | | — | | | | 13,396 | | | | 1,164 | |
| Non-Agency RMBS | | | — | | | | — | | | | 3,944 | | | | 1,211 | | | | 3,944 | | | | 1,211 | |
| Total | | $ | 27,114 | | | $ | 1,207 | | | $ | 3,944 | | | $ | 1,211 | | | $ | 31,058 | | | $ | 2,418 | |
| December 31, 2008 | | Less than 12 Months | | | Total | |
| | | Carrying Value | | | Gross Unrealized Losses | | | Carrying Value | | | Gross Unrealized Losses | |
| Agency Hybrid Arm Securities | | $ | 9,406 | | | $ | 98 | | | $ | 9,406 | | | $ | 98 | |
| Non-Agency floaters | | | 18,119 | | | | 4,101 | | | | 18,119 | | | | 4,101 | |
| NYMT retained security | | | 530 | | | | 78 | | | | 530 | | | | 78 | |
| Total | | $ | 28,055 | | | $ | 4,277 | | | $ | 28,055 | | | $ | 4,277 | |
| December 31, 2010 | | Less than 12 Months | | | Greater than 12 months | | | Total | |
| | | Carrying Value | | | Gross Unrealized Losses | | | Carrying Value | | | Gross Unrealized Losses | | | Carrying Value | | | Gross Unrealized Losses | |
| Non-Agency RMBS | | $ | — | | | $ | — | | | $ | 6,436 | | | $ | 1,166 | | | $ | 6,436 | | | $ | 1,166 | |
| Total | | $ | — | | | $ | — | | | $ | 6,436 | | | $ | 1,166 | | | $ | 6,436 | | | $ | 1,166 | |
As of December 31, 2011, the Company recognized a $0.3 million other-than-temporary impairment through earnings. As of December 31, 2010, the Company did not have unrealized losses in investment securities that were deemed other-than-temporary.
3. Mortgage Loans Held in Securitization Trusts (net)| 3. | Mortgage Loans Held in Securitization Trusts and Real Estate Owned |
Mortgage loans held in securitization trusts (net) consist of the following at December 31, 20082011 and December 31, 20072010, respectively (dollar amounts in thousands):
| | | | December 31, | |
| | | December 31, 2008 | | | December 31, 2007 | | | 2011 | | 2010 | |
| Mortgage loans principal amount | | $ | 347,546 | | | $ | 429,629 | | | $ | 208,934 | | | $ | 229,323 | |
| Deferred origination costs – net | | | 2,197 | | | | 2,733 | | | | 1,317 | | | | 1,451 | |
| Allowance for loan losses | | | (1,406 | ) | | | (1,647 | ) | |
| Total mortgage loans held in securitization trusts (net) | | $ | 348,337 | | | $ | 430,715 | | |
| Reserve for loan losses | | | | (3,331) | | | | (2,589) | |
| Total | | | $ | 206,920 | | | $ | 228,185 | |
Allowance for Loan losses - The following table presents the activity in the Company's allowance for loan losses on mortgage loans held in securitization trusts for the yearyears ended December 31, 20082011 and 20072010, respectively (dollar amounts in thousands).:
| | | December 31, | | | Years ended December 31, | |
| | | 2008 | | | 2007 | | | 2010 | | 2010 | |
| Balance at beginning of period | | $ | 1,647 | | | $ | — | | | $ | 2,589 | | | $ | 2,581 | |
| Provisions for loan losses | | | 1,433 | | | | 1,655 | | | | 1,380 | | | | 1,560 | |
| Transfer to real estate owned | | | | (192) | | | | (564) | |
| Charge-offs | | | (1,674 | ) | | | (8 | ) | | | (446) | | | | (988) | |
| Balance of the end of period | | $ | 1,406 | | | $ | 1,647 | | |
| Balance at the end of period | | | $ | 3,331 | | | $ | 2,589 | |
On an ongoing basis, the Company evaluates the adequacy of its allowance for loan losses. The Company’s allowance for loan losses at December 31, 2011 was $3.3 million, representing 159 basis points of the outstanding principal balance of loans held in securitization trusts as of December 31, 2011, as compared to 113 basis points as of December 31, 2010. As part of the Company’s allowance for loan adequacy analysis, management will assess an overall level of allowances while also assessing credit losses inherent in each non-performing mortgage loan held in securitization trusts. These estimates involve the consideration of various credit related factors, including but not limited to, current housing market conditions, current loan to value ratios, delinquency status, borrower’s current economic and credit status and other relevant factors.
Real Estate Owned – The following table presents the activity in the Company’s real estate owned held in securitization trusts for the years ended December 31, 2011 and 2010, respectively (dollar amounts in thousands):
| | | December 31, | |
| | | 2011 | | | 2010 | |
| Balance at beginning of period | | $ | 740 | | | $ | 546 | |
| Write downs | | | (87) | | | | (193 | ) |
| Transfer from mortgage loans held in securitization trusts | | | 698 | | | | 1,398 | |
| Disposal | | | (897) | | | | (1,011 | ) |
| Balance at the end of period | | $ | 454 | | | $ | 740 | |
Real estate owned held in securitization trusts are included in receivables and other assets on the balance sheet and write downs are included in provision for loan losses in the statement of operations for reporting purposes.
All of the Company’s mortgage loans and real estate owned held in securitization trusts are pledged as collateral for the CDOs (see note 6). Theissued by the Company. As of December 31, 2011 and 2010, the Company’s net investment in the mortgage loans held in securitization trusts, orwhich is the maximum amount of the Company’s investment that is at risk to loss and represents the difference between the carrying amount of the loans and real estate owned held in securitization trusts and the amount of CDOs outstanding, was $12.7$7.6 million and $13.7$8.9 million, against which the Company had a $1.4 million and $1.6 million allowance for loan losses asrespectively.
Delinquency Status of Our Mortgage Loans Held in Securitization Trusts
As of December 31, 2008 and 2007, respectively.
The following sets forth2011, we had 38 delinquent loans with an aggregate principal amount outstanding of approximately $21.0 million categorized as Mortgage Loans Held in Securitization Trusts (net). Of the $21.0 million in delinquent loans, $18.0 million, or 86%, are currently under some form of modified payment plan. The table below shows delinquencies in our portfolio of loans held in securitization trusts, including real estate owned through foreclosure (REO) in our portfolio, as of December 31, 2008 and December 31, 20072011 (dollar amounts in thousands):
December 31, 20082011
| Days Late | | Number of Delinquent Loans | | Total Dollar Amount | | % of Loan Portfolio | |
| 30-60 | | 2 | | $ | 517 | | 0.25 | % |
| 61-90 | | 1 | | $ | 378 | | 0.18 | % |
| 90+ | | 35 | | $ | 20,138 | | 9.61 | % |
| Real estate owned through foreclosure | | 3 | | $ | 656 | | 0.31 | % |
As of December 31, 2010, we had 46 delinquent loans with an aggregate principal amount outstanding of approximately $25.1 million categorized as Mortgage Loans Held in Securitization Trusts (net). Of the $25.1 million in delinquent loans, $17.8 million, or 71%, are currently under some form of modified payment plan. The table below shows delinquencies in our portfolio of loans held in securitization trusts, including real estate owned through foreclosure (REO), as of December 31, 2010 (dollar amounts in thousands):
December 31, 2010
| Days Late | | Number of Delinquent Loans | | Total Dollar Amount | | % of Loan Portfolio | |
| 30-60 | | 7 | | $ | 2,515 | | 1.09 | % |
| 61-90 | | 4 | | $ | 4,362 | | 1.89 | % |
| 90+ | | 35 | | $ | 18,191 | | 7.90 | % |
| Real estate owned through foreclosure | | 3 | | $ | 894 | | 0.39 | % |
| Days Late | | Number of Delinquent Loans | | Total Dollar Amount | | % of Loan Portfolio | |
| 30-60 | | 3 | | $ | 1,363 | | 0.39 | % |
| 61-90 | | 1 | | $ | 263 | | 0.08 | % |
| 90+ | | 13 | | $ | 5,734 | | 1.65 | % |
| REO | | 4 | | $ | 1,927 | | 0.55 | % |
December 31, 2007| 4. | Variable Interest Entities |
The Company has evaluated its real estate debt investments to determine whether they are a VIE. As of December 31, 2011, the Company identified interests in four entities which were determined to be VIEs. Based on management’s analysis, the Company is not the primary beneficiary of three of the identified VIEs since it (i) does not have the power to direct the activities that most significantly impact the VIE’s economic performance; and (ii) does not have the obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Accordingly, these VIEs are not consolidated into the Company’s financial statements as of December 31, 2011. | Days Late | | Number of Delinquent Loans | | | Total Dollar Amount | | | % of Loan Portfolio | |
| 30-60 | | | — | | | $ | — | | | | — | % |
| 61-90 | | | 2 | | | $ | 1,859 | | | | 0.43 | % |
| 90+ | | | 12 | | | $ | 6,910 | | | | 1.61 | % |
| REO | | | 4 | | | $ | 4,145 | | | | 0.96 | % |
The Company’s three identified variable interests in a VIE that are not consolidated are investment securities with a fair value of $41.2 million, which is our maximum exposure to loss. The Company has accounted for these three investment securities as available for sale securities at fair value, with unrealized gains and losses reported in OCI. The investment securities consist of first loss principal only strips from Freddie Mac Multi-Family K-Series CMBS securitizations.
The Company has identified one entity that it has determined that it has a variable interest in a VIE and for which it is the primary beneficiary and has a controlling financial interest. The entity is an investment in a limited liability company that has provided a loan to a borrower that is secured by commercial property. The loan is for $2.5 million and the limited liability company has been consolidated into the Company’s financial statements.
| 5. | Investment in Limited Partnership |
4. The Company has a non-controlling, unconsolidated limited partnership interest in an entity that is accounted for using the equity method of accounting. Capital contributions, distributions, and profits and losses of the entity are allocated in accordance with the terms of the limited partnership agreement. The Company owns 100% of the equity of the limited partnership, but has no decision-making powers, and therefore does not consolidate the limited partnership. Our maximum exposure to loss in this variable interest entity is $8.5 million and $18.7 million at December 31, 2011 and 2010, respectively. During the third and fourth quarters of 2010, HC invested, in exchange for limited partnership interests, $19.4 million in this limited partnership that was formed for the purpose of acquiring, servicing, selling or otherwise disposing of first-lien residential mortgage loans. The pool of mortgage loans was acquired by the partnership at a significant discount to the loans’ unpaid principal balance.
At December 31, 2011 and 2010, the Company had an investment in this limited partnership of $8.5 million and $18.7 million, respectively. For the years ended December 31, 2011 and 2010, the Company recognized income from the investment in limited partnership of $1.8 million and $0.5 million, respectively. For the years ended December 31, 2011 and 2010, the Company received distributions from the investment in limited partnership of $11.8 million and $1.2 million, respectively.
The balance sheet of the investment in limited partnership at December 31, 2011 and 2010, respectively, is as follows (dollar amounts in thousands):
| | | December 31, | |
| Assets | | 2011 | | | 2010 | |
| Cash | | $ | 1,154 | | | $ | 152 | |
| Mortgage loans held for sale (net) | | | 6,918 | | | | 18,072 | |
| Other assets | | | 661 | | | | 478 | |
| Total Assets | | $ | 8,733 | | | $ | 18,702 | |
| | | | | | | | | |
| Liabilities & Partners’ Equity | | | | | | | | |
| Other liabilities | | $ | 206 | | | $ | 37 | |
| Partners’ equity | | | 8,527 | | | | 18,665 | |
| Total Liabilities & Partners’ Equity | | $ | 8,733 | | | $ | 18,702 | |
The statement of operations of the investment in limited partnership for the years ended December 31, 2011 and 2010, respectively, is as follows (dollar amounts in thousands):
| | | Years ended December 31, | |
| Statement of Operations | | 2011 | | | 2010 | |
| Interest income | | $ | 1,267 | | | $ | 489 | |
| Realized gain | | | 1,107 | | | | 164 | |
| Total Income | | | 2,374 | | | | 653 | |
| Other expenses | | | (536 | ) | | | (157 | ) |
| Net Income | | $ | 1,838 | | | $ | 496 | |
During the second quarter of 2011, RBCM invested $5.3 million in a limited liability company that was formed for the purpose of investing in two tranches of securities. For the year ended December 31, 2011, the Company recognized income from the investment in limited liability company of $0.3 million, which was accounted for using the equity method of accounting. For the year ended December 31, 2011, the Company received distributions from the investment in this limited liability company of $0.2 million. The limited liability company was dissolved on December 30, 2011 and the two tranches of securities transferred to the Company at carrying value as directly owned securities accounted for as investment securities available for sale.
| 6. | Derivative Instruments and Hedging Activities |
The Company enters into derivative transactionsinstruments to manage its interest rate risk exposure. These derivativesderivative instruments include interest rate swaps, caps and caps, which had the effect to modify the interest rate repricing characteristics to mitigate the effectsfutures. The Company may also purchase or short TBAs and U.S. Treasury securities, purchase put or call options on U.S. Treasury futures or invest in other types of interest rate changes on net investment spread.
During the twelve months ended December 31, 2008, the Company paid a total of $8.3 million to terminate a total of $517.7 million of notional interest rate swaps resulting in a realized loss of $4.8 million and recorded as realized loss on securities and related hedges.mortgage derivative securities.
The following table summarizespresents the estimated fair value of derivative assetsinstruments held in our Agency IO portfolio that were not designated as hedging instruments and liabilities as oftheir location in the Company’s consolidated balance sheets at December 31, 20082011 and December 31, 20072010, respectively (dollar amounts in thousands):
Derivatives Not Designated as Hedging Instruments | | Balance Sheet Location | | December 31, 2011 | | | December 31, 2010 | |
| TBA securities | | Derivative assets | | $ | 207,891 | | | $ | — | |
| Options on U.S. Treasury futures | | Derivative assets | | | 327 | | | | — | |
| U.S. Treasury futures | | Derivative liabilities | | | 566 | | | | — | |
| Eurodollar futures | | Derivative liabilities | | | 1,749 | | | | — | |
The tables below summarize the activity of derivative instruments not designated as hedges for the year ended December 31, 2011 (dollar amounts in thousands). There were no derivative instruments not designated as hedges for the same period in 2010.
| | | For the Year Ended December 31, 2011 | |
Derivatives Not Designated as Hedging Instruments | | Notional Amount as of December 31, 2010 | | | Additions | | | Settlement, Expiration or Exercise | | | Notional Amount as of December 31, 2011 | |
| TBA securities | | $ | — | | | $ | 1,017,000 | | | $ | (815,000 | ) | | $ | 202,000 | |
| U.S. Treasury futures | | | — | | | | 566,600 | | | | (659,400 | ) | | | (92,800 | ) |
| Short sales of Eurodollar futures | | | — | | | | 1,938,000 | | | | (4,360,000 | ) | | | (2,422,000 | ) |
| Options on U.S. Treasury futures | | | — | | | | 795,000 | | | | (595,500 | ) | | | 199,500 | |
The TBAs in our Agency IO portfolio are accounted for at fair value with both realized and unrealized gains and losses included in other income (expense) in our consolidated statements of operations. The use of TBAs exposes the Company to market value risk, as the market value of the securities that the Company is required to purchase pursuant to a TBA transaction may decline below the agreed-upon purchase price. Conversely, the market value of the securities that the Company is required to sell pursuant to a TBA transaction may increase above the agreed upon sale price. For the year ended December 31, 2011, we recorded net realized gains of $2.9 million and unrealized gains of $1.4 million. There were no realized or unrealized gains or losses from TBAs for the same period in 2010. At December 31, 2011 our consolidated balance sheet includes TBA-related liabilities of $206.8 million included in payable for securities purchased. Open TBA purchases and sales involving the same counterparty, same underlying deliverable and the same settlement date are reflected in our consolidated financial statements on a net basis.
The Eurodollar futures in our Agency IO portfolio are accounted for at fair value with both realized and unrealized gains and losses included in other income (expense) in our consolidated statements of operations. For the year ended December 31, 2011, we recorded net realized losses of $2.0 million and net unrealized losses of $1.7 million in our Eurodollar futures contracts. The Eurodollar futures consist of 2,422 contracts with expiration dates ranging between March 2012 and September 2014. There were no realized or unrealized gains or losses from Eurodollars for the same period in 2010.
The U.S. Treasury futures and options in our Agency IO portfolio are accounted for at fair value with both realized and unrealized gains and losses included in other income (expense) in our consolidated statements of operations. For the year ended December 31, 2011, we recorded net realized losses of $0.2 million and net unrealized losses of $0.7 million. There were no realized or unrealized gains or losses from U.S. Treasury futures and options for the same period in 2010.
| | | December 31, 2008 | | | December 31, 2007 | |
| Derivative assets: | | | | | | |
| Interest rate caps | | $ | 22 | | | $ | 416 | |
| Total derivative assets | | $ | 22 | | | $ | 416 | |
| | | | | | | | | |
| Derivative liabilities: | | | | | | | | |
| Interest rate swaps | | $ | 4,194 | | | $ | 3,517 | |
| Total derivative liabilities | | $ | 4,194 | | | $ | 3,517 | |
The following table presents the fair value of derivative instruments designated as hedging instruments and their location in the Company’s consolidated balance sheets at December 31, 2011 and 2010, respectively (dollar amounts in thousands):
Derivatives Designated as Hedging Instruments | | Balance Sheet Location | | December 31, 2011 | | | December 31, 2010 | |
| Interest Rate Swaps | | Derivative liabilities | | $ | 304 | | | $ | 1,087 | |
The following table presents the impact of the Company’s derivative instruments on the Company’s accumulated other comprehensive income (loss) for the years ended December 31, 2011 and 2010, respectively (dollar amounts in thousands):
| | | Years Ended December 31, | |
| Derivatives Designated as Hedging Instruments | | 2011 | | 2010 | |
| Accumulated other comprehensive income (loss) for derivative instruments: | | | | | |
| Balance at beginning of the period | | $ | (1,087 | ) | | $ | (2,904 | ) |
| Unrealized gain on interest rate caps | | | — | | | | 394 | |
| Unrealized gain on interest rate swaps | | | 783 | | | | 1,423 | |
| Balance at end of the period | | $ | (304 | ) | | $ | (1,087 | ) |
The Company had $4.2estimates that over the next 12 months, approximately $0.3 million of restricted cash related to margin posted forthe net unrealized losses on the interest rate swaps as of December 31, 2008.will be reclassified from accumulated other comprehensive income (loss) into earnings.
The notional amountsfollowing table details the impact of the Company’s interest rate swaps and interest rate caps as ofincluded in interest expense for the years ended December 31, 20082011 and 2010, respectively (dollar amounts in thousands):
| | | Years Ended December 31, | |
| | | 2011 | | 2010 | |
| Interest Rate Caps: | | | | | |
| Interest expense-investment securities and loans held in securitization trusts | | $ | — | | | $ | 308 | |
| Interest expense-subordinated debentures | | | — | | | | 92 | |
| Interest Rate Swaps: | | | | | | | | |
| Interest expense-investment securities | | | 893 | | | | 2,515 | |
The Company’s interest rate swaps are designated as cash flow hedges against the benchmark interest rate risk associated with its short term repurchase agreements. There were $137.3 million,no costs incurred at the inception of our interest rate swaps, under which the Company agrees to pay a fixed rate of interest and $434.4 million, respectively.receive a variable interest rate based on one month LIBOR, on the notional amount of the interest rate swaps. The Company’s interest rate swap notional amounts are based on an amortizing schedule fixed at the start date of the transaction. The Company’s interest rate cap transactions are designated as cash flow hedges against the benchmark interest rate risk associated with the CDOs and the subordinated debentures. The interest rate cap transactions were initiated with an upfront premium that is being amortized over the life of the contract.
The notional amountsCompany documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities, and upon entering into hedging transactions, documents the relationship between the hedging instrument and the hedged liability contemporaneously. The Company assesses, both at inception of a hedge and on an on-going basis, whether or not the hedge is “highly effective” when using the matched term basis.
The Company discontinues hedge accounting on a prospective basis and recognizes changes in the fair value through earnings when: (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a hedge is no longer appropriate. The Company’s derivative instruments are carried on the Company’s balance sheet at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative. For the Company’s derivative instruments that are designated as “cash flow hedges,” changes in their fair value are recorded in accumulated other comprehensive income (loss), provided that the hedges are effective. A change in fair value for any ineffective amount of the Company’s derivative instruments would be recognized in earnings. The Company has not recognized any change in the value of its existing derivative instruments designated as cash flow hedges through earnings as a result of ineffectiveness of any of its hedges.
The following table presents information about the Company’s interest rate swaps and interest rate caps as of December 31, 20072011 and 2010, respectively (dollar amounts in thousands):
| | | December 31, 2011 | | | December 31, 2010 | |
Maturity (1) | | Notional Amount | | | Weighted Average Fixed Pay Interest Rate | | | Notional Amount | | | Weighted Average Fixed Pay Interest Rate | |
| Within 30 Days | | $ | 14,930 | | | | 3.02 | % | | $ | 24,080 | | | | 2.99 | % |
| Over 30 days to 3 months | | | 260 | | | | 2.93 | | | | 2,110 | | | | 3.03 | |
| Over 3 months to 6 months | | | 380 | | | | 2.93 | | | | 2,280 | | | | 3.03 | |
| Over 6 months to 12 months | | | 810 | | | | 2.93 | | | | 5,600 | | | | 3.03 | |
| Over 12 months to 24 months | | | 8,380 | | | | 2.93 | | | | 16,380 | | | | 3.01 | |
| Over 24 months to 36 months | | | — | | | | | | | | 8,380 | | | | 2.93 | |
| Total | | $ | 24,760 | | | | 2.99 | % | | $ | 58,830 | | | | 3.00 | % |
| (1) | The Company enters into scheduled amortizing interest rate swap transactions whereby the Company pays a fixed rate of interest and receives one month LIBOR. |
Interest Rate Caps – Interest rate caps were $220.0designated by the Company as cash flow hedges against interest rate risk associated with the Company’s CDOs and the subordinated debentures. The interest rate caps associated with the CDOs were amortizing contractual schedules determined at origination. The Company had $0 and $76.0 million of notional interest rate caps outstanding as of December 31, 2011 and 2010, respectively. These interest rate caps were utilized to cap the interest rate on the CDOs at a fixed-rate when one month LIBOR exceeds a predetermined rate. The interest rate caps expired on April 25, 2011.
Interest Rate Swaps, Futures Contracts and TBAs - The use of interest rate swaps “Swaps” exposes the Company to counterparty credit risks in the event of a default by a Swap counterparty. If a counterparty defaults under the applicable Swap agreement, the Company may be unable to collect payments to which it is entitled under its Swap agreements, and may have difficulty collecting the assets it pledged as collateral against such Swaps. The Company currently has in place with all outstanding Swap counterparties bi-lateral margin agreements thereby requiring a party to post collateral to the Company for any valuation deficit. This arrangement is intended to limit the Company’s exposure to losses in the event of a counterparty default.
The Company is required to pledge assets under a bi-lateral margin arrangement, including either cash or Agency RMBS, as collateral for its interest rate swaps, futures contracts and TBAs, whose collateral requirements vary by counterparty and change over time based on the market value, notional amount, and remaining term of the agreement. In the event the Company is unable to meet a margin call under one of its agreements, thereby causing an event of default or triggering an early termination event under one of its agreements, the counterparty to such agreement may have the option to terminate all of such counterparty’s outstanding transactions with the Company. In addition, under this scenario, any close-out amount due to the counterparty upon termination of the counterparty’s transactions would be immediately payable by the Company pursuant to the applicable agreement. The Company believes it was in compliance with all margin requirements under its agreements as of December 31, 2011 and 2010. The Company had $9.1 million and $749.6$1.2 million of restricted cash related to margin posted for its agreements as of December 31, 2011 and 2010, respectively. The restricted cash held by third parties is included in receivables and other assets in the accompanying consolidated balance sheets.
5. Financing Arrangements, Portfolio Investments| 7. | Financing Arrangements, Portfolio Investments |
The Company has entered into repurchase agreements with third party financial institutions to finance its mortgage-backed securitiesinvestment portfolio. The repurchase agreements are short-term borrowings that bear interest rates typically based on a spread to LIBOR, and are secured by the RMBSsecurities which they finance. At December 31, 2008,2011, the Company had repurchase agreements with an outstanding balance of $402.3$112.7 million and a weighted average interest rate of 2.62%0.71%. As of December 31, 2007,2010, the Company had repurchase agreements with an outstanding balance of $315.7$35.6 million and a weighted average interest rate of 5.02%0.39%. At December 31, 20082011 and December 31, 2007,2010, securities pledged by the Company as collateral for repurchase agreements had estimated fair values and carrying values of $456.5$129.9 million and $337.4$38.5 million, respectively. All outstanding borrowings under our repurchase agreements mature within 3230 days. As of December 31, 2008,2011 and 2010, the average days to maturity for all repurchase agreements are 17 days.is 19 days and 29 days, respectively.
The follow table summarizes outstanding repurchase agreement borrowings secured by portfolio investments as of December 31, 20082011 and December 31, 2007 (dollars2010, respectively (dollar amounts in thousands):
Repurchase Agreements by Counterparty
| Counterparty Name | | December 31, 2008 | | | December 31, 2007 | |
| AVM | | $ | 54,911 | | | $ | — | |
| Barclays Securities | | | — | | | | 101,297 | |
| Credit Suisse First Boston LLC | | | 97,781 | | | | 97,388 | |
| Enterprise Bank of Florida | | | 19,409 | | | | — | |
| Goldman, Sachs & Co. | | | — | | | | 66,432 | |
| HSBC | | | 42,120 | | | | 50,597 | |
| MF Global | | | 30,272 | | | | — | |
| RBS Greenwich Capital | | | 157,836 | | | | — | |
| Total Financing Arrangements, Portfolio Investments | | $ | 402,329 | | | $ | 315,714 | |
| Repurchase Agreements by Counterparty | |
| | | | | | | |
| Counterparty Name | | December 31, 2011 | | | December 31, 2010 | |
| Cantor Fitzgerald, L.P. | | $ | 9,225 | | | $ | 4,990 | |
| Credit Suisse First Boston LLC | | | 11,147 | | | | 12,080 | |
| Jefferies & Company, Inc. | | | 18,380 | | | | 9,476 | |
| JPMorgan Chase & Co. | | | 49,226 | | | | — | |
| South Street Securities LLC | | | 24,696 | | | | 9,086 | |
| Total Financing Arrangements, Portfolio Investments | | $ | 112,674 | | | $ | 35,632 | |
As of December 31, 2008,2011, the outstanding balance under our Agency ARM RMBS are financed with $233.3 million of repurchase agreement funding withagreements was funded at an advance rate of 94%84% that implies aan average haircut of 6%,16%. The weighted average “haircut” related to our Agency CMO floaters are financed with $154.6 million of repurchase agreement financing with an advance ratefor our Agency IOs, CLOs and other Agency RMBS was approximately 25%, 35% and 6%, respectively, for a total weighted average “haircut” of 87% that implies a haircut of 13%16%. The amount at risk for Credit Suisse First Boston LLC, South Street Securities LLC, Jefferies & Company, Inc., Cantor Fitzgerald, L.P., and the non-Agency CMO floater was financed with $14.4JPMorgan Chase & Co. are $0.9 million, of repurchase agreement funding with an advance rate of 80% that implies a 20% haircut. $1.9 million, $0.9 million, $4.2 million and $9.3 million, respectively.
In the event we are unable to obtain sufficient short-term financing through repurchase agreements or otherwise, or our lenders start to require additional collateral, we may have to liquidate our investment securities at a disadvantageous time, which could result in losses. Any losses resulting from the disposition of our investment securities in this manner could have a material adverse effect on our operating results and net profitability.
As of December 31, 2008,2011, the Company had $9.4$16.6 million in cash and $20.9$48.9 million in unencumbered investment securities including $16.3 million in Agency RMBS to meet additional haircut or market valuation requirements.requirements, including $17.0 million of RMBS, of which $13.0 million are Agency RMBS. The $16.6 million of cash and the $17.0 million in RMBS (which, collectively, represents 30% of our financing arrangements, portfolio investments) are liquid and could be monetized to pay down or collateralize the liability immediately. There is also an additional $16.5 million held in overnight deposits in our Agency IO portfolio included in restricted cash that is available to meet margin calls as it relates to our Agency IO portfolio repurchase agreements.
6.8. | Collateralized Debt Obligations |
The Company’s CDOs, which are recorded as liabilities on the Company’s balance sheet, are secured by ARM loans pledged as collateral, which are recorded as assets of the Company. As of December 31, 20082011 and December 31, 2007,2010, the Company had CDOs outstanding of $335.6$199.8 million and $417.0$220.0 million, respectively. As of December 31, 20082011 and December 31, 2007,2010, the current weighted average interest rate on these CDOs was 0.85%0.68% and 5.25%0.65%, respectively. The CDOs are collateralized by ARM loans with a principal balance of $347.5$208.9 million and $429.6$229.3 million at December 31, 20082011 and December 31, 2007,2010, respectively. The Company retained the owner trust certificates, or residual interest for three securitizations, and, as of December 31, 20082011 and December 31, 2007,2010, had a net investment in the securitizations trusts of $12.7$7.6 million and $13.7$8.9 million, respectively.
The CDO transactions includeincluded amortizing interest rate cap contracts with an aggregate notional amount of $204.3$0 and $76.0 million as of December 31, 20082011 and an aggregate notional amount of $286.9 million as of December 31, 2007,2010, respectively, which arewere recorded as an asset of the Company. The interest rate caps arewere carried at fair value and totaled $18,575$0 as of December 31, 20082011 and $0.1 million2010. The interest rate caps reduced interest rate exposure on the CDOs. The interest rate caps expired on April 25, 2011.
| 9. | Subordinated Debentures |
The follow table summarizes outstanding repurchase agreement borrowings secured by portfolio investments as of December 31, 2007, respectively. The interest rate caps reduce interest rate exposure on these transactions.
7. | Subordinated Debentures (net) |
Subordinated debentures consist of the following as of December 31, 20082011 and December 31, 2007 (dollars2010, respectively (dollar amounts in thousands):
| | | December 31, | |
| | | 2008 | | 2007 | |
| Subordinated debentures | | $ | 45,000 | | | $ | 45,000 | |
| Less: unamortized bond issuance costs | | | (382 | ) | | | (655 | ) |
| Subordinated debentures (net) | | $ | 44,618 | | | $ | 44,345 | |
| | | December 31, | |
| | | 2011 | | | 2010 | |
| Subordinated debentures | | $ | 45,000 | | | $ | 45,000 | |
On September 1, 2005 the Company closed a private placement of $20.0 million of trust preferred securities to Taberna Preferred Funding II, Ltd., a pooled investment vehicle. The securities were issued by NYM Preferred Trust II and are fully guaranteed by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. These securities havehad a fixed interest rate equal to 8.35% up to and including July 30, 2010, at which point the interest rate iswas converted to a floating rate equal to three-month LIBOR plus 3.95% until maturity.maturity (4.38% at December 31, 2011 and 4.24% at December 31, 2010). The securities mature on October 30, 2035 and may be called at par by the Company any time after October 30, 2010. In accordance with the guidelines of SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, the issuedThe preferred stock of NYM Preferred Trust II has been classified as subordinated debentures (net) in the liability section of the Company’s consolidated balance sheet.
On March 15, 2005 the Company closed a private placement of $25.0 million of trust preferred securities to Taberna Preferred Funding I, Ltd., a pooled investment vehicle. The securities were issued by NYM Preferred Trust I and are fully guaranteed by the Company with respect to distributions and amounts payable upon liquidation, redemption or repayment. These securities have a floating interest rate equal to three-month LIBOR plus 3.75%, resetting quarterly (5.22%(4.33% at December 31, 20082011 and 8.58%4.05% at December 31, 2007)2010). The securities mature on March 15, 2035 and may be called at par by the Company any time after March 15, 2010. HC entered into an interest rate cap agreement to limit the maximum interest rate cost of the trust preferred securities to 7.5%. The term of the interest rate cap agreement is five years and resets quarterly in conjunction with the reset periods of the trust preferred securities. The interest rate cap agreement is accounted for as a cash flow hedge transaction in accordance with SFAS No.133 “Accounting for Derivative Instruments and Hedging Activities”. In accordance with the guidelines of SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, the issued preferred stock of NYM Preferred Trust I has been classified as subordinated debentures (net) in the liability section of the Company’s consolidated balance sheet.
As of March 1, 2009,5, 2012, the Company has not been notified, and is not aware, of any event of default under the covenants for the subordinated debentures.
| 10. | Convertible Preferred Debentures (Net) |
The Company issued $20.0 million in Series A Cumulative Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) that matured on December 31, 2010. The outstanding shares were redeemed by the Company at the $20.00 per share liquidation preference plus accrued dividends on December 31, 2010.
8.11. | Discontinued OperationsOperation |
In connection with the sale of our wholesale mortgage origination platform assets on February 22, 2007 andduring the sale of our retail mortgage lending platform onquarter ended March 31, 2007, during the fourth quarter of 2006, we classified our mortgage lending businesssegment as a discontinued operations in accordance with the provisions of SFAS No. 144.operation. As a result, we have reported revenues and expenses related to the mortgage lending businesssegment as a discontinued operations and the related assets and liabilities as assets and liabilities related to a discontinued operationsoperation for all periods presented in the accompanying consolidated financial statements. Certain assets, such as the deferred tax asset, and certain liabilities, such as subordinated debtdebentures and liabilities related to leasedlease facilities not assigned to Indymac Bank,F.S.B. (“Indymac”), the acquirersold, are part of our retail mortgage origination assets, will become part of the ongoing operations of NYMT and accordingly, we have not included these items as part of the discontinued operationsoperation. Assets and liabilities related to the discontinued operation are $4.0 million and $0.5 million, respectively, at December 31, 2011, and $4.0 million and $0.6 million, respectively, at December 31, 2010, and are included in accordance withreceivables and other assets and accounts payable, accrued expenses and other liabilities in the provisions of SFAS No. 144.consolidated balance sheets.
Balance Sheet Data
The components of Assetsassets related to the discontinued operationsoperation as of December 31, 20082011 and 20072010, respectively, are as follows (dollar amounts in thousands):
| | | December 31, | | | December 31, | |
| | | 2008 | | | 2007 | | | 2011 | | 2010 | |
| Accounts and accrued interest receivable | | $ | 26 | | | $ | 51 | | | $ | 14 | | | $ | 18 | |
| Mortgage loans held for sale (net) | | | 5,377 | | | | 8,077 | | | | 3,780 | | | | 3,808 | |
| Prepaid and other assets | | | 451 | | | | 737 | | | | 249 | | | | 213 | |
| Property and equipment (net) | | | — | | | | 11 | | |
| Total assets | | $ | 5,854 | | | $ | 8,876 | | | $ | 4,043 | | | $ | 4,039 | |
The components of Liabilitiesliabilities related to the discontinued operationsoperation as of December 31, 20082011 and 20072010, respectively, are as follows (dollar amounts in thousands):
| | December 31, | | | December 31, | |
| | 2008 | | 2007 | | | 2011 | | | 2010 | |
| Due to loan purchasers | | $ | 708 | | | $ | 894 | | | $ | 342 | | | $ | 342 | |
| Accounts payable and accrued expenses | | | 2,858 | | | | 4,939 | | |
| Accrued expenses and other liabilities | | | | 147 | | | | 214 | |
| Total liabilities | | $ | 3,566 | | | $ | 5,833 | | | $ | 489 | | | $ | 556 | |
Mortgage Loans Held for Sale (net) - - Mortgage loans held for sale are recorded at lowerStatements of cost or market and consistOperations Data
The statements of operations of the following as of December 31, 2008 and December 31, 2007 (dollar amounts in thousands):
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Mortgage loans principal amount | | $ | 6,547 | | | $ | 9,636 | |
| Deferred origination costs – net | | | (34 | ) | | | (43 | ) |
| Lower of cost or market adjustments | | | (1,136 | ) | | | (1,516 | ) |
| Total mortgage loans held for sale (net) | | $ | 5,377 | | | $ | 8,077 | |
Lower of Cost or Market Adjustments - - The following table presents the activity in the Company's account for lower of cost or market adjustmentsdiscontinued operation for the years ended December 31, 20082011 and 2007 (dollar amounts in thousands).
| | | December 31, | |
| | | 2008 | | | 2007 | |
| Balance at beginning of year | | $ | 1,516 | | | $ | 4,042 | |
| Lower cost or market adjustments | | | (380 | ) | | | (2,526 | ) |
| Balance of the end of year | | $ | 1,136 | | | $ | 1,516 | |
The combined results of operations related to the discontinued operations2010, respectively, are as follows (dollar amounts in thousands):
| | | For the Year Ended December 31, | |
| | | 2011 | | | 2010 | |
| Revenues | | $ | 203 | | | $ | 1,403 | |
| Expenses | | | 140 | | | | 268 | |
| Income from discontinued operations – net of tax | | $ | 63 | | | $ | 1,135 | |
| | | For the Year Ended December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
| Revenues: | | | | | | | | | |
| Net interest income | | $ | 419 | | | $ | 1,070 | | | $ | 3,524 | |
| Gain on sale of mortgage loans | | | 46 | | | | 2,561 | | | | 17,987 | |
| Losses from lower of cost or market of loans | | | (433 | ) | | | (8,874 | ) | | | (8,228 | ) |
| Brokered loan fees | | | — | | | | 2,318 | | | | 10,937 | |
| Gain on retail lending segment | | | — | | | | 4,368 | | | | — | |
| Other income (expense) | | | 1,463 | | | | (67 | ) | | | (294 | ) |
| Total net revenues | | | 1,495 | | | | 1,376 | | | | 23,926 | |
| Expenses: | | | | | | | | | | | | |
| Salaries, commissions and benefits | | | 63 | | | | 7,209 | | | | 21,711 | |
| Brokered loan expenses | | | — | | | | 1,731 | | | | 8,277 | |
| Occupancy and equipment | | | (559 | ) | | | 1,819 | | | | 5,077 | |
| General and administrative | | | 334 | | | | 6,743 | | | | 14,552 | |
| Total expenses | | | (162 | ) | | | 17,502 | | | | 49,617 | |
| Income (loss) before income tax benefit | | | 1,657 | | | | (16,126 | ) | | | (25,691 | ) |
| Income tax (provision) benefit | | | — | | | | (18,352 | ) | | | 8,494 | |
| Income (loss) from discontinued operations – net of tax | | $ | 1,657 | | | $ | (34,478 | ) | | $ | (17,197 | ) |
9.12. | Commitments and Contingencies |
Loans Sold to Investors -Third Parties – The Company sold its discontinued mortgage lending business in March 2007. In the normal course of business, the Company is obligated to repurchase loans based on violations of representationrepresentations and warranties related to loans originated and sold by our discontinued mortgage origination business. in the loan sale agreements. The Company did not repurchase any loans during the yearyears ended December 31, 2008. The Company repurchased from investors $6.7 million of loans from investors for the year ended2011 and 2010. At December 31, 2007.
As of December 31, 2008 we had a total of $1.8 million of unresolved repurchase requests, against which2011, the Company hashad a reserve of approximately $0.4 million included in other liabilities of the discontinued operations.$0.3 million.
Outstanding Litigation – - The Company is at times subject to various legal proceedings arising in the ordinary course of business other than as described below,business. As of December 31, 2011, the Company does not believe that any of its current legal proceedings, individually or in the aggregate, will have a material adverse effect on its operations, financial condition or cash flows.
On December 13, 2006, Steven B. Yang and Christopher Daubiere (“Plaintiffs”), filed suit in the United States District Court for the Southern District of New York against HC and us, alleging that we failed to pay them, and similarly situated employees, overtime in violation of the Fair Labor Standards Act (“FLSA”) and New York State law. The Plaintiffs, each of whom were former employees in our discontinued mortgage lending business, purported to bring a FLSA “collective action” on behalf of similarly situated loan officers in our now discontinued mortgage lending business and sought unspecified amounts for alleged unpaid overtime wages, liquidated damages, attorney’s fee and costs.
On December 30, 2007 we entered into an agreement in principle with the Plaintiffs to settle this suit. On June 2, 2008 the court granted a preliminary approval of settlement and authorized to plaintiffs and held a fairness hearing on September 18, 2008. At the hearing, the court certified the class and approved the settlement, subject to a final motion to approve Plaintiffs’ counsel’s application for fees. As part of the preliminary settlement, the Company funded the settlement in the amount of $1.35 million into an escrow account for the Plaintiffs. The amount was previously reserved and expensed in the year ended December 31, 2007. The Plaintiffs’ counsel fee was determined by the court and final approval for distributions was made on November 7, 2008. The Plaintiffs’ counsel fee and Plaintiffs’ award distribution were made from the escrow account by the escrow agent during December 2008.
Leases – - The Company leases its corporate offices and certain office space related to our discontinued mortgage lending operation not assumed by IndyMac and equipment under a short-term lease agreementsagreement expiring at various dates through 2010. All such leases arein 2013. This lease is accounted for as an operating leases.lease. Total rental (income)property lease expense for property and equipment amounted to ($0.6)$0.2 million $1.5 million and $4.8 million for each of the years ended December 31, 2008, 20072011 and 2006, respectively.2010.
Pursuant to an Assignment and Assumption of Sublease and an Escrow Agreement (“the Agreements”), with Lehman Brothers Holding, Inc. (“Lehman”) (collectively, the “Agreement”), the Company assigned and Lehman assumed the sublease for the Company’s corporate headquarters at 1301 Avenue of the Americas. Pursuant to the Agreements, Lehman funded an escrow account, containing $3.0 million for the benefit of HC as consideration for the assignment of the lease to Lehman. The escrow amount was reduced by $0.2 million for each month the Company or IndyMac remained in the leased space between February 1, 2008 and July 31, 2008, for a total escrow reduction of $1.2 million, which amount was subsequently reimbursed to HC by IndyMac. The remaining $1.8 million in escrow was released to the Company by Lehman on August 18, 2008. IndyMac occupied the leased space at 1301 Avenue of the Americas until July 31, 2008 pursuant to contractual provisions related to the sale of the mortgage origination business. Pursuant to the provisions of the sale transaction with IndyMac, IndyMac paid rent equal to the Company’s cost, including any penalties and foregone bonuses resulting from the delay in vacating the leased premises.
As of December 31, 2008 obligations under non-cancelable operating leases that have an initial term of more than one year are as follows (dollar amounts in thousands):
| Year Ending December 31, | | Total | |
| 2009 | | $ | 219 | |
| 2010 | | | 189 | |
| 2011 | | | 194 | |
| 2012 | | | 198 | |
| 2013 | | | 67 | |
| Thereafter | | | — | |
| | | $ | 867 | |
Letters of Credit– The Company maintains a letter of credit in the amount of $178,200$0.2 million in lieu of a cash security deposit for its current corporate headquarters, located at 52 Vanderbilt Avenue in New York City, for its landlord, Vanderbilt Associates I, L.L.C, as beneficiary. This letter of credit is secured by cash deposited in a bank account maintained at JP Morgan Chase bank.
HC maintains a letterAs of creditDecember 31, 2011, obligations under non-cancelable operating leases that have an initial term of more than one year are as follows (dollar amounts in the amount of $100,000 in lieu of a cash security deposit for an office lease dated June 1998 for the Company's former headquarters located at 304 Park Avenue South in New York City. The sole beneficiary of this letter of credit is the owner of the building, 304 Park Avenue South LLC. This letter of credit is secured by cash deposited in a bank account maintained at JP Morgan Chase bank.thousands):
| Year Ending December 31, | | Total | |
| 2012 | | $ | 198 | |
| 2013 | | | 67 | |
| | | $ | 265 | |
10.13. | Concentrations of Credit Risk |
At December 31, 20082011 and December 31, 2007,2010, there were geographic concentrations of credit risk exceeding 5% of the total loan balances within mortgage loans held in the securitization trusts and retained interests in our REMIC securitization, NYMT 2006-1, as follows:
| | | December 31, | | | December 31, | |
| | | 2008 | | | 2007 | | |
| Mortgage loans held in securitization trusts and real estate owned held in securitization trusts: | | | 2011 | | 2010 | |
| New York | | | 30.7 | % | | 31.2 | % | | | 37.5 | % | | | 37.9 | % |
| Massachusetts | | | 17.2 | % | | 17.4 | % | | | 24.6 | % | | | 25.0 | % |
| New Jersey | | | | 9.2 | % | | | 8.7 | % |
| Florida | | | 7.8 | % | | 8.3 | % | | | 5.7 | % | | | 5.6 | % |
| California | | | 7.2 | % | | 7.2 | % | |
| New Jersey | | | 6.0 | % | | 5.7 | % | |
| Connecticut | | | 5.1 | % | | | 4.7 | % |
| | | December 31, | |
| CMBS investments: | | 2011 | | | 2010 | |
| Texas | | | 14.3 | % | | | — | % |
| California | | | 9.3 | % | | | — | % |
| New York | | | 7.2 | % | | | — | % |
| Georgia | | | 6.7 | % | | | — | % |
| Washington | | | 6.3 | % | | | — | % |
| Florida | | | 5.5 | % | | | — | % |
11.14. | Fair Value of Financial Instruments |
The Company adopted SFAS No.157 effective January 1, 2008, and accordingly all assets and liabilities measured at fair value will utilize valuation methodologies in accordance with the statement. The Company has established and documented processes for determining fair values. Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, then fair value is based upon internally developed models that primarily use inputs that are market-based or independently-sourced market parameters, including interest rate yield curves.
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 established by SFAS No.157 are defined as follows:
Level 1 - inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 - inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following describes the valuation methodologies used for the Company’s financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
a. Investment Securities Available for Sale - Fair value is generally based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will incorporate common market pricing methods, including a spread measurement to the Treasury curve or Interest Rate Swap Cure as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. If the fair value of a security is not reasonably available from a dealer, management estimates the fair value based on characteristics of the security that the Company receives from the issuer and based on available market information. Management reviews all prices used in determining valuation to ensure they represent current market conditions. This review includes surveying similar market transactions, comparisons to interest pricing models as well as offerings of like securities by dealers. The Company’s | a. | Investment Securities Available for Sale (RMBS) - Fair value for the RMBS in our portfolio is based on quoted prices provided by dealers who make markets in similar financial instruments. The dealers will incorporate common market pricing methods, including a spread measurement to the Treasury curve or interest rate swap curve as well as underlying characteristics of the particular security including coupon, periodic and life caps, collateral type, rate reset period and seasoning or age of the security. If quoted prices for a security are not reasonably available from a dealer, the security will be re-classified as a Level 3 security and, as a result, management will determine the fair value based on characteristics of the security that the Company receives from the issuer and based on available market information. Management reviews all prices used in determining valuation to ensure they represent current market conditions. This review includes surveying similar market transactions, comparisons to interest pricing models as well as offerings of like securities by dealers. The Company's investment securities that are comprised of RMBS are valued based upon readily observable market parameters and are classified as Level 2 fair values. |
b. Interest Rate Swaps and Caps - The fair value of interest rate swaps and caps are based on using market accepted financial models as well as dealer quotes. The model utilizes readily observable market parameters, including treasury rates, interest rate swap spreads and swaption volatility curves. The Company’s interest rate caps and swaps are classified as Level 2 fair values. | b. | Investment Securities Available for Sale (CMBS) - As the Company’s CMBS investments are comprised of securities for which there are not substantially similar securities that trade frequently, the Company classifies these securities as Level 3 fair values. Fair value of the Company’s CMBS investments is based on an internal valuation model that considers expected cash flows from the underlying loans and yields required by market participants. |
c. Mortgage Loans Held for Sale (Net) –The fair value of mortgage loans held for sale (net) are estimated by the Company based on the price that would be received if the loans were sold as whole loans taking into consideration the aggregated characteristics of the loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed interest rate period, life cap, periodic cap, underwriting standards, age and credit. As there are not readily available quoted prices for identical or similar loans are | c. | Investment Securities Available for Sale (CLO) - The fair value of the CLO notes, prior to December 31, 2010, was based on management’s valuation determined using a discounted future cash flows model that management believed would be used by market participants to value similar financial instruments. At each of December 31, 2011 and December 31, 2010, the fair value of the CLO notes was based on quoted prices provided by dealers who make markets in similar financial instruments. The CLO notes were previously classified as Level 3 fair values and were re-classified as Level 2 fair values in the fourth quarter of 2010. |
| d. | Investment Securities Available for Sale - The fair value of other investment securities available for sale, such as U.S. Treasury securities, are based on quoted prices provided by dealers who make markets in similar financial instruments and are typically classified as Level 2 fair values. |
| e. | Derivative Instruments - The fair value of interest rate swaps, caps, options, futures and TBAs are based on dealer quotes. The Company’s derivatives are classified as Level 1 and Level 2 fair values. |
The following table presents the Company’s financial instruments carriedmeasured at fair value on a recurring basis as of December 31, 20082011 and 2010, respectively, on the Company’s consolidated balance sheet by SFAS No.157 valuation hierarchy, as previously describedsheets (dollar amounts in thousands):
| | | Fair Value at December 31, 2008 | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Assets carried at fair value: | | | | | | | | | | | | | | | | |
| Investment securities available for sale | | $ | — | | | $ | 477,416 | | | $ | — | | | $ | 477,416 | |
| Mortgage loans held for sale (net) | | | — | | | | — | | | | 5,377 | | | | 5,377 | |
| Derivative assets (interest rate caps) | | | — | | | | 22 | | | | — | | | | 22 | |
| Total | | $ | — | | | $ | 477,438 | | | $ | 5,377 | | | $ | 482,815 | |
| Liabilities carried at fair value: | | | | | | | | | | | | |
| Derivative liabilities (interest rate swaps) | | | — | | | | 4,194 | | | | — | | | | 4,194 | |
| Total | | $ | — | | | $ | 4,194 | | | $ | — | | | $ | 4,194 | |
| | | Measured at Fair Value on a Recurring Basis at December 31, 2011 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Assets carried at fair value: | | | | | | | | | | | | | | | | |
| Investment securities available for sale: | | | | | | | | | | | | | | | | |
| Agency RMBS | | $ | — | | | $ | 132,457 | | | $ | — | | | $ | 132,457 | |
| CMBS | | | | | | | — | | | | 41,185 | | | | 41,185 | |
| Non-Agency RMBS | | | — | | | | 3,945 | | | | — | | | | 3,945 | |
| CLO | | | — | | | | 22,755 | | | | — | | | | 22,755 | |
| Derivative Assets | | | — | | | | 208,218 | | | | — | | | | 208,218 | |
| Total | | $ | — | | | $ | 367,375 | | | $ | 41,185 | | | $ | 408,560 | |
| Liabilities carried at fair value: | | | | | | | | |
| Derivative liabilities: | | | | | | | | | | | | | | | | |
| Interest rate swaps | | $ | — | | | $ | 304 | | | $ | — | | | $ | 304 | |
| U.S. Treasury futures | | | 566 | | | | — | | | | — | | | | 566 | |
| Eurodollar futures | | | 1,749 | | | | — | | | | — | | | $ | 1,749 | |
| Total | | $ | 2,315 | | | $ | 304 | | | $ | — | | | $ | 2,619 | |
| | | Measured at Fair Value on a Recurring Basis at December 31, 2010 | |
| | | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
| Assets carried at fair value: | | | | | | | | | | | | |
| Investment securities available for sale: | | | | | | | | | | | | |
| Agency RMBS | | $ | — | | | $ | 47,529 | | | $ | — | | | $ | 47,529 | |
| Non-Agency RMBS | | | — | | | | 8,985 | | | | — | | | | 8,985 | |
| CLO | | | — | | | | 29,526 | | | | — | | | | 29,526 | |
| Total | | $ | — | | | $ | 86,040 | | | $ | — | | | $ | 86,040 | |
| | | | | | | | | | | | | | | | | |
| Liabilities carried at fair value: | | | | | | | | | | | | | | | | |
| Derivative liabilities (interest rate swaps) | | $ | — | | | $ | 1,087 | | | $ | — | | | $ | 1,087 | |
| Total | | $ | — | | | $ | 1,087 | | | $ | — | | | $ | 1,087 | |
The following table details changes in valuationsvaluation for the Level 3 assets for the three months and yearyears ended December 31, 2008 (dollar amounts2011 and 2010, respectively (amounts in thousands):
Investment securities available for sale:
| | | Years Ended December 31, | |
| | | 2011 | | | 2010 | |
| Balance at beginning of period | | $ | — | | | $ | 17,599 | |
| Total gains (realized/unrealized) | | | | | | | | |
| Included in earnings (1) | | | — | | | | 2,100 | |
| Included in other comprehensive income/(loss) | | | (1,036 | ) | | | 9,827 | |
| Purchases | | | 42,221 | | | | — | |
| Transfers out of Level 3 (2) | | | — | | | | (29,526 | ) |
| Balance at the end of period | | $ | 41,185 | | | $ | — | |
| (1) – | Amounts included in interest income. |
| Mortgage Loans Held for Sale (Net) | | Three Months Ended December 31, 2008 | | | Year Ended December 31, 2008 | |
| | | | | | | |
| Beginning balance | | $ | 5,391 | | | $ | 8,077 | |
| Principal paydown | | | (14 | ) | | | (2,746 | ) |
| LOCOM adjustment | | | — | | | | 46 | |
| Ending balance | | $ | 5,377 | | | $ | 5,377 | |
| (2) – | The CLOs were re-classified from Level 3 to Level 2 fair values during the fourth quarter of 2010 due to management determining that inputs and assumptions for these assets based upon quoted prices provided by dealers who make markets in similar investments became more observable. |
Any changes to the valuation methodology are reviewed by management to ensure the changes are appropriate. As markets and products develop and the pricing for certain products becomes more transparent, the Company continues to refine its valuation methodologies. The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The Company uses inputs that are current as of the measurementeach reporting date, which may include periods of market dislocation, during which time price transparency may be reduced. This condition could cause the Company’s financial instruments to be reclassified from Level 2 to Level 3 in future periods.
The following table presents assets measured at fair value on a non-recurring basis as of December 31, 2011 and 2010, respectively, on the consolidated balance sheets (dollar amounts in thousands):
| | Assets Measured at Fair Value on a Non-Recurring Basis at December 31, 2011 | |
| | Level 1 | | Level 2 | | Level 3 | | Total | |
| Mortgage loans held for investment | $ | | — | | $ | | — | | $ | | 5,118 | | $ | | 5,118 | |
| Mortgage loans held for sale – included in discontinued operations (net) | | | — | | | | — | | | | 3,780 | | | | 3,780 | |
| Mortgage loans held in securitization trusts – impaired loans (net) | | | — | | | | — | | | | 6,518 | | | | 6,518 | |
| Real estate owned held in securitization trusts | | | — | | | | — | | | | 454 | | | | 454 | |
| | Assets Measured at Fair Value on a Non-Recurring Basis at December 31, 2010 | |
| | Level 1 | | Level 2 | | Level 3 | | Total | |
| Mortgage loans held for investment | $ | | — | | $ | | — | | $ | | 7,460 | | $ | | 7,460 | |
| Mortgage loans held for sale – included in discontinued operations (net) | | | — | | | | — | | | | 3,808 | | | | 3,808 | |
| Mortgage loans held in securitization trusts – impaired loans (net) | | | — | | | | — | | | | 6,576 | | | | 6,576 | |
| Real estate owned held in securitization trusts | | | — | | | | — | | | | 740 | | | | 740 | |
The following table presents losses incurred for assets measured at fair value on a non-recurring basis for the years ended December 31, 2011 and 2010, respectively, on the Company’s consolidated statements of operations (dollar amounts in thousands):
| | | Years Ended December 31, | |
| | | 2011 | | | 2010 | |
| Mortgage loans held in securitization trusts – impaired loans (net) | | $ | 1,380 | | | $ | 1,560 | |
| Real estate owned held in securitization trusts | | | 87 | | | | 193 | |
Mortgage Loans Held for Investment – The Company’s mortgage loans held for investment are recorded at amortized cost less specific loan loss reserves.
Mortgage Loans Held for Sale (net) – The fair value of mortgage loans held for sale (net) are estimated by the Company based on the price that would be received if the loans were sold as whole loans taking into consideration the aggregated characteristics of the loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed interest rate period, life time cap, periodic cap, underwriting standards, age and credit.
Mortgage Loans Held in Securitization Trusts – Impaired Loans (net) – Impaired mortgage loans held in the securitization trusts are recorded at amortized cost less specific loan loss reserves. Impaired loan value is based on management’s estimate of the net realizable value taking into consideration local market conditions of the distressed property, updated appraisal values of the property and estimated expenses required to remediate the impaired loan.
Real Estate Owned Held in Securitization Trusts – Real estate owned held in the securitization trusts are recorded at net realizable value. Any subsequent adjustment will result in the reduction in carrying value with the corresponding amount charged to earnings. Net realizable value based on an estimate of disposal taking into consideration local market conditions of the distressed property, updated appraisal values of the property and estimated expenses required to sell the property.
The following table presents the carrying value and estimated fair value of the Company’s financial instruments at December 31, 2011 and 2010, respectively, (dollar amounts in thousands):
| | | December 31, 2011 | | | December 31, 2010 | |
| | | Carrying Value | | | Estimated Fair Value | | | Carrying Value | | | Estimated Fair Value | |
| Financial assets: | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 16,586 | | | $ | 16,586 | | | $ | 19,375 | | | $ | 19,375 | |
| Investment securities available for sale | | | 200,342 | | | | 200,342 | | | | 86,040 | | | | 86,040 | |
| Mortgage loans held in securitization trusts (net) | | | 206,920 | | | | 182,976 | | | | 228,185 | | | | 206,560 | |
| Derivative assets | | | 208,218 | | | | 208,218 | | | | — | | | | — | |
| Assets related to discontinued operation-mortgage loans held for sale (net) | | | 3,780 | | | | 3,780 | | | | 3,808 | | | | 3,808 | |
| Mortgage loans held for investment | | | 5,118 | | | | 5,118 | | | | 7,460 | | | | 7,460 | |
| Receivable for securities sold | | | 1,133 | | | | 1,133 | | | | 5,653 | | | | 5,653 | |
| | | | | | | | | | | | | | | | | |
| Financial Liabilities: | | | | | | | | | | | | | | | | |
| Financing arrangements, portfolio investments | | $ | 112,674 | | | $ | 112,674 | | | $ | 35,632 | | | $ | 35,632 | |
| Collateralized debt obligations | | | 199,762 | | | | 171,187 | | | | 219,993 | | | | 185,609 | |
| Derivative liabilities | | | 2,619 | | | | 2,619 | | | | 1,087 | | | | 1,087 | |
| Payable for securities purchased | | | 228,300 | | | | 228,300 | | | | — | | | | — | |
| Subordinated debentures | | | 45,000 | | | | 26,318 | | | | 45,000 | | | | 36,399 | |
In addition to the methodology to determine the fair value of the Company’s financial assets and liabilities reported at fair value on a recurring basis and non-recurring basis, as previously described, the following methods and assumptions were used by the Company in arriving at the fair value of the Company’s other financial instruments in the following table:
| | At December 31, |
| | 2008 | | 2007 | |
| Carrying Value | | Estimated Fair Value | | Carrying Value | | Estimated Fair Value | |
| Financial assets: | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 9,387 | | | $ | 9,387 | | | $ | 5,508 | | | $ | 5,508 | |
| Restricted cash | | | 7,959 | | | | 7,959 | | | | 7,515 | | | | 7,515 | |
| Mortgage loans held in securitization trusts (net) | | | 348,337 | | | | 343,028 | | | | 430,715 | | | | 420,925 | |
| | | | | | | | | | | | | | | | | |
| Financial liabilities: | | | | | | | | | | | | | | | | |
| Financing arrangements, portfolio investments | | | 402,329 | | | | 402,329 | | | | 315,714 | | | | 315,714 | |
| Collateralized debt obligations | | | 335,646 | | | | 199,503 | | | | 417,027 | | | | 417,027 | |
| Subordinated debentures (net) | | | 44,618 | | | | 10,049 | | | | 44,345 | | | | 44,345 | |
| Convertible preferred debentures (net) | | | 19,702 | | | | 16,363 | | | | — | | | | — | |
a. Cash and Cash Equivalents and Restricted Cash: cash equivalents – Estimated fair value approximates the carrying value of such assets.
b. Mortgage Loans Held in Securitization Trusts -(net) – Mortgage loans held in the securitization trusts are recorded at amortized cost. Fair value is estimated using pricing models and taking into consideration the aggregated characteristics of groups of loans such as, but not limited to, collateral type, index, interest rate, margin, length of fixed-rate period, life cap, periodic cap, underwriting standards, age and credit estimated using the estimated market prices for similar types of loans. Due to significant market dislocation secondary market prices were given minimal weighting when arriving at loan valuation at December 31, 2008.
c. Receivable for securities sold – Estimated fair value approximates the carrying value of such assets.
d. Financing arrangements, portfolio investments –- The fair value of these financing arrangements approximates cost as they are short term in nature and mature withinin 30 days.
d. e. Collateralized debt obligations –- The fair value of these collateralized debt obligationsCDOs is based on discounted cashflowscash flows as well as market pricing on comparable collateralized debt obligations.
e. f. Payable for securities purchased – Estimated fair value approximates the carrying value of such liabilities.
g. Subordinated Debentures (net) debentures –- The fair value of these subordinated debentures is based on discounted cashflowscash flows using management’s estimate for market yields.
d. Convertible preferred debentures (net) - The fair value of these subordinated debentures is based on discounted cashflows using management’s estimate for market yields.
A reconciliation of the statutory income tax provision (benefit) to the effective income tax provision for the years ended December 31, 2008, 20072011 and 2006,2010, respectively, are as follows (dollar amounts in thousands).
| | | December 31, | |
| | | 2008 | | | 2007 | | | | 2006 | |
| (Benefit) provision at statutory rate | | $ | (8,438 | ) | (35.0 | )% | | $ | (9,830 | ) | (35.0 | )% | | $ | (8.234 | ) | (35.0 | )% |
| Non-taxable REIT income (loss) | | | 7,598 | | 31.5 | % | | | 3,008 | | 10.7 | % | | | (1,891 | ) | (8.0 | )% |
| Transfer pricing of loans sold to nontaxable parent | | | — | | — | | | | — | | — | | | | 11 | | 0.0 | % |
| State and local tax benefit | | | (221 | ) | (0.9 | )% | | | (1,797 | ) | (6.4 | )% | | | (2,663 | ) | (11.3 | )% |
| Valuation allowance | | | 572 | | 2.4 | % | | | 26,962 | | 96.0 | % | | | 4,269 | | 18.1 | % |
| Miscellaneous | | | 489 | | 2.0 | % | | | 9 | | 0.0 | % | | | 14 | | 0.1 | % |
| Total provision (benefit) | | $ | — | | — | % | | $ | 18,352 | | 65.3 | % | | $ | (8,494 | ) | (36.1 | )% |
| | | December 31, | |
| | | 2011 | | | 2010 | |
| | | | | | | | | | | | | | | | | |
| Provision at statutory rate | | $ | 1,857 | | | | (35.0 | )% | | $ | 2,382 | | | | (35.0 | )% |
| Non-taxable REIT income | | | (1,088) | | | | 20.5 | % | | | (813) | | | | 11.9 | % |
| State and local tax provision | | | 239 | | | | (4.5 | )% | | | 414 | | | | (6.1 | )% |
| True-ups | | | (1,810 | ) | | | 34.1 | % | | | — | | | | — | % |
| Valuation allowance | | | 1,235 | | | | (23.3 | )% | | | (1,983) | | | | 29.2 | % |
| Total provision | | $ | 433 | | | | (8.2 | )% | | $ | — | | | | — | % |
The income tax provision for the year ended December 31, 2008 (included in discontinued operations - see note 8)2011 is comprised of the following components (dollar amounts in thousands):
| | Deferred | |
Regular tax provision | | | | |
Federal | | $ | — | |
State | | | — | |
Total tax provision | | $ | — | |
| Current income tax expense | | $ | 433 | |
| Deferred income tax expense | | | — | |
| Total provision | | $ | 433 | |
The income tax provision for the year ended December 31, 2007 (included in discontinued operations - see note 8)2010 is comprised of the following components (dollar amounts in thousands).:
| | | Deferred | |
| Regular tax provision | | | | |
| Federal | | $ | 14,522 | |
| State | | | 3,830 | |
| Total tax provision | | $ | 18,352 | |
| Current income tax expense | | $ | 83 | |
| Deferred income tax expense | | | (83 | ) |
| Total provision | | $ | — | |
The income tax benefit for the year ended December 31, 2006 (included in discontinued operations - see note 8) is comprised of the following components (dollar amounts in thousands).
| | | Deferred | |
| Regular tax benefit | | | | |
| Federal | | $ | (6,721 | ) |
| State | | | (1,773 | ) |
| Total tax benefit | | $ | (8,494 | ) |
The gross deferred tax asset at December 31, 20082011 is $30.1 million; the Company continued to reserve 100% of deferred tax asset as the facts continue to support the Company's inability to utilize the deferred tax asset.
$27.2 million. The major sources of temporary differences included in the deferred tax assets and their deferred tax effect as of December 31, 20082011 are as follows (dollar amounts in thousands):
| Deferred tax assets: | | | | | | | | |
| Net operating loss carryover | | $ | 27,655 | | | $ | 27,052 | |
| Mark to market adjustment | | | 313 | | |
| Sec. 267 disallowance | | | 268 | | |
| Charitable contribution carryforward | | | 1 | | |
| GAAP reserves | | | 769 | | | | 105 | |
| Rent expense | | | 1,074 | | |
| Gross deferred tax asset | | | 30,080 | | | | 27,157 | |
| Valuation allowance | | | (30,080 | ) | | | (27,157 | ) |
| Net deferred tax asset | | $ | — | | | $ | — | |
At December 31, 2008, the Company2011, HC had approximately $64.0$59 million of net operating loss carryforwards which may be used to offset future taxable income. The carryforwards will expire in 2024 through 2028.2029. The Internal Revenue Code places certain limitations on the annual amount of net operating loss carryforwards that can be utilized if certain changes in the Company’s ownership occur. The Company may havedetermined during 2011 that it had undergone an ownership change within the meaning of IRC section 382 that would impose suchwill limit the net loss carryforwards to be used to offset future taxable income to $660,000 per year. The Company has recorded a limitation, but a final conclusion has not been made. Managementfull valuation allowance against its deferred tax assets because at this time management does not believe that the limitation would cause a significant amount of the Company's net operating losses to expire unused.
During the quarter ended December 31, 2007 management determined that the Company would likely not be able to utilize the deferred tax asset and accordingly recorded a 100% valuation allowance. The Company continues to record a 100% allowance against the deferred tax benefit as factors resulting in the 100% reserve have not changed materially.assets will be realized.
The gross deferred tax asset at December 31, 2007 includes a deferred tax asset of $0.1 million and a deferred tax liability of $0.1 million which represents the tax effect of differences between tax basis and financial statement carrying amounts of assets and liabilities.2010 is $26.0 million. The major sources of temporary differences included in the deferred tax assets and their deferred tax effect atas of December 31, 20072010 are as follows (dollar amounts in thousands):
| Deferred tax assets: | | | | |
| Net operating loss carryover | | $ | 25,662 | |
| GAAP reserves | | | 342 | |
| Gross deferred tax asset | | | 26,004 | |
| Valuation allowance | | | (25,921 | ) |
| Net deferred tax asset | | $ | 83 | |
| Deferred tax assets: | | | | |
| Net operating loss carryover | | $ | 27,434 | |
| Restricted stock, performance shares and stock option expense | | | 489 | |
| Mark to market adjustment | | | 86 | |
| Sec. 267 disallowance | | | 268 | |
| Charitable contribution carryforward | | | 1 | |
| GAAP reserves | | | 994 | |
| Rent expense | | | 252 | |
| Loss on sublease | | | 50 | |
| Gross deferred tax asset | | | 29,574 | |
| Valuation allowance | | | (29,509 | ) |
| Net deferred tax asset | | $ | 65 | |
| | | | | |
| Deferred tax liabilities: | | | | |
| Depreciation | | $ | 65 | |
| Total deferred tax liability | | $ | 65 | |
The Company files income tax returns with the U.S. federal government and various state and local jurisdictions. The Company is no longer subject to tax examinations by tax authorities for years prior to 2007. HC is presently undergoing an IRS examination for the taxable years ended December 31, 2010 and 2009.
During the quarteryears ended December 31, 2007 management determined that2011 and 2010, the Company would likely not be ableCompany’s two TRSs recorded approximately $0.4 million and $0, respectively, of income tax expense for income attributable to utilize the deferred tax assetsubsidiaries. The Company’s estimated taxable income differs from the federal statutory rate as a result of state and accordingly recordedlocal taxes, non-taxable REIT income and a 100% valuation allowance. The allowance was expensed in continuing operations because the potential deferred tax benefit remains with the Company.
Until March 31, 2007, theThe Company operated two strategies, managingmanages a mortgage portfolio and operating a mortgage lending business. Upon the salecomprised of substantially all of the mortgage lending operatingprimarily mortgage-related assets to Indymacwhich operates as of March 31, 2007, the Company exited the mortgage lending business and accordingly no longer reports segment information as it only has one operatingreporting segment.
14.17. | Capital Stock and Earnings per Share |
The Company had 400,000,000 shares of common stock, par value $0.01 per share, authorized with 9,320,09413,938,273 and 9,425,442 shares issued and outstanding as of December 31, 20082011 and 1,817,927 shares issued and outstanding as2010, respectively. As of December 31, 2007. The2011 and 2010, the Company had 200,000,000 shares of preferred stock, par value $0.01 per share, authorized, including 2,000,000with 0 shares of Series A Cumulative Convertible Redeemable Preferred Stock ( “Series A Preferred Stock”) authorized. As of December 31, 2008 and December 31, 2007, the Company had issued and outstanding 1,000,000 and 0 shares, respectively, of Series A Preferred Stock.outstanding. Of the common stock authorized 103,111 shares (plus forfeited shares of 32,832 previously granted) were reserved for issuance as restricted stock awards to employees, officers and directors pursuant to the 2005 Stock Incentive Plan. As ofat December 31, 2008, 103,111shares remain2011 and 2010, 1,154,992 shares and 1,182,823 shares, respectively, were reserved for issuance under the 2005Company’s 2010 Stock Incentive Plan. The Company issued 4,512,831 and 11,177 shares of common stock during the years ended December 31, 2011 and 2010, respectively. In addition, 0 and 829 shares of common stock were forfeited during the years ended December 31, 2011 and 2010, respectively.
On February 21, 2008,The following table presents cash dividends declared by the Company completed the issuance and sale of 7.5 million shares ofon its common stock in a private placement at a price of $8.00 per share. This private offering of the Company's common stock generated net proceedswith respect to the Company of $56.5 million after payment of private placement fees and expenses. In connection with this private offering of our common stock, we entered into a Common Stock registration rights agreement, pursuant to which we were required to file with the Securities and Exchange Commission, or SEC, a resale shelf registration statement registering for resale the 7.5 million shares sold in this private offering. The Company filed a resale shelf registration statement on Form S-3 on April 4, 2008 which became effective on April 18, 2008.
On April 21, 2008, the Company declared a $0.12 per share cash dividend on its common stock. The dividend was payable on May 15, 2008 to common stockholders of record as of April 30, 2008. On June 26, 2008, the Company declared a $0.16 per share cash dividend on its common stock. The dividend was payable on July 25, 2008 to common stockholders of record as of July 10, 2008. On September 29, 2008, the Company declared a $0.16 per share cash dividend on its common stock. The dividend was payable on October 27, 2008 to common stockholders of record as of October 10, 2008. On December 23, 2008, the Company declared a $0.10 per share cash dividend on its common stock. The dividend was payable on January 26, 2009 to common stockholders of record as of January 5, 2009.
We paid a $0.50 per share cash dividend in each of the first three quartersquarterly periods commencing January 1, 2010 and ended December 31, 2011.
| Period | | Declaration Date | | Record Date | | Payment Date | | Cash Dividend Per Share | |
| Fourth Quarter 2011 | | December 15, 2011 | | December 27, 2011 | | January 25, 2012 | | $ | 0.35 | |
| Third Quarter 2011 | | September 20, 2011 | | September 30, 2011 | | October 25, 2011 | | | 0.25 | |
| Second Quarter 2011 | | May 31, 2011 | | June 10, 2011 | | June 27, 2011 | | | 0.22 | |
| First Quarter 2011 | | March 18, 2011 | | March 31, 2011 | | April 26, 2011 | | | 0.18 | |
| | | | | | | | | | | |
| Fourth Quarter 2010 | | December 20, 2010 | | December 30, 2010 | | January 25, 2011 | | | 0.18 | |
| Third Quarter 2010 | | October 4, 2010 | | October 14, 2010 | | October 25, 2010 | | | 0.18 | |
| Second Quarter 2010 | | June 16, 2010 | | July 6, 2010 | | July 26, 2010 | | | 0.18 | |
| First Quarter 2010 | | March 16, 2010 | | April 1, 2010 | | April 26, 2010 | | | 0.25 | |
The following table presents cash dividends declared by the Company on theits Series A Convertible Preferred Stock. OnStock from January 1, 2010 through December 23, 200831, 2010. The outstanding shares of Series A Preferred Stock were redeemed by the Company declared a $0.50 per share cash dividend, or an aggregate of $0.5 million, payable on January 30, 2009 to holders of record of our Series A Convertible Preferred Stock as of December 31, 2008. These amounts are included in interest expense as the Series A Convertible Preferred Stock is classified as a liability on the balance sheet (see note 15).2010.
| Period | | Declaration Date | | Record Date | | Payment Date | | Cash Dividend Per Share | |
| Fourth Quarter 2010 | | December 20, 2010 | | December 30, 2010 | | December 31, 2010 | | $ | 0.50 | |
| Third Quarter 2010 | | September 29, 2010 | | September 30, 2010 | | October 29, 2010 | | | 0.50 | |
| Second Quarter 2010 | | June 16, 2010 | | June 30, 2010 | | July 30, 2010 | | | 0.50 | |
| First Quarter 2010 | | March 16, 2010 | | March 31, 2010 | | April 30, 2010 | | | 0.63 | |
During 2008,2011, taxable dividends for our common stock were $0.44$1.00 per share. For tax reporting purposes, the 20082011 taxable dividend wasdividends were classified as $0.26$1.00 per share ordinary income and $0.18 as a return of capital.income.
During 2007,2010, taxable dividends for our common stock were $0.50$0.23 per share. For tax reporting purposes, the 2007 taxable dividend was2010 dividends were classified as $0.23 per share ordinary income and $0.81 per share a return of capital.
On June 28, 2011, we entered into an underwriting agreement relating to the offer and sale of 1,500,000 shares of our common stock at a public offering price of $7.50 per share, which shares were issued and proceeds received on July 1, 2011. On July 14, 2011, we issued an additional 225,000 shares of common stock to the underwriter pursuant to their exercise of an over-allotment option. The Boardproceeds from the shares issued pursuant to the over-allotment option were received on July 14, 2011. We received total net proceeds of Directors declared a one-for-two reverse stock split$11.9 million from the issuance of the Company’s1,725,000 shares.
On December 1, 2011, we entered into an underwriting agreement relating to the offer and sale of 2,400,000 shares of our common stock effectiveat a public offering price of $6.90 per share, which shares were issued and proceeds received on May 27, 2008, decreasingDecember 6, 2011. On December 16, 2011, we issued an additional 360,000 shares of common stock to the numberunderwriter pursuant to their exercise of an over-allotment option. The proceeds from the shares outstandingissued pursuant to approximately 9.3 million.
The Boardthe over-allotment option were received on December 16, 2011.We received total net proceeds of Directors declared a one-for-five reverse stock split$17.9 million from the issuance of the Company's common stock, effective on October 9, 2007, decreasing the number of common shares outstanding at the time to approximately 3.6 million.2,760,000 shares.
All per share and share amounts provided in the quarterly report have been restated to give effect to both reverse stock splits.The Company calculates basic net lossincome per share by dividing net lossincome for the period by weighted-average shares of common stock outstanding for that period. Diluted net lossincome per share takes into account the effect of dilutive instruments, such as convertible preferred stock, stock options and unvested restricted or performance stock, but uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted-average number of shares outstanding.
The following table presents the computation of basic and diluted net (loss) income per share for the periods indicated (in(dollar amounts in thousands, except per share amounts):
| | | For the Years Ended December 31, | | | For the Years Ended December 31, |
| | | 2008 | | | 2007 | | | 2006 | | | 2011 | | 2010 | |
Numerator: | | | | | | | | | | | | | | | |
| Net loss – Basic | | $ | (24,107 | ) | | $ | (55,268 | ) | | $ | (15,031 | ) | |
| Net (loss) income from continuing operations | | | (25,764 | ) | | | (20,790 | ) | | | 2,166 | | |
| Net income (loss) from discontinued operations (net of tax) | | | 1,657 | | | | (34,478 | ) | | | (17,197 | ) | |
| Net income – Basic | | | $ | 4,776 | | | $ | 6,805 | |
| Net income from continuing operations | | | | 4,713 | | | | 5,670 | |
| Net income from discontinued operations (net of tax) | | | | 63 | | | | 1,135 | |
| Effect of dilutive instruments: | | | | | | | | | | | | | | | | | |
| Convertible preferred debentures (1) | | | 2,149 | | | | — | | | | — | | |
| Net loss – Dilutive | | | (24,107 | ) | | | (55,268 | ) | | | (15,031 | ) | |
| Net loss from continuing operations | | | (25,764 | ) | | | (20,790 | ) | | | 2,166 | | |
| Net income (loss) from discontinued operations (net of tax) | | $ | 1,657 | | | $ | (34,478 | ) | | $ | (17,197 | ) | |
| Convertible preferred debentures | | | | — | | | | 2,274 | |
| Net income – Dilutive | | | | 4,776 | | | | 9,079 | |
| Net income from continuing operations | | | | 4,713 | | | | 7,944 | |
| Net income from discontinued operations (net of tax) | | | $ | 63 | | | $ | 1,135 | |
| Denominator: | | | | | | | | | | | | | | | | | |
| Weighted average basis shares outstanding | | | 8,272 | | | | 1,814 | | | | 1,804 | | |
| Weighted average basic shares outstanding | | | | 10,495 | | | | 9,422 | |
| Effect of dilutive instruments: | | | | | | | | | | | | | | | | | |
| Convertible preferred debentures (1) | | | 2,384 | | | | — | | | | — | | |
| Convertible preferred debentures | | | | — | | | | 2,500 | |
| Weighted average dilutive shares outstanding | | | 8,272 | | | | 1,814 | | | | 1,804 | | | | 10,495 | | | | 11,922 | |
| EPS: | | | | | | | | | | | | | | | | | |
| Basic EPS | | $ | (2.91 | ) | | $ | (30.47 | ) | | $ | (8.33 | ) | | $ | 0.46 | | | $ | 0.72 | |
| Basic EPS from continuing operations | | | (3.11 | ) | | | (11.46 | ) | | | 1.20 | | | | 0.45 | | | | 0.60 | |
| Basic EPS from discontinued operations (net of tax) | | | 0.20 | | | | (19.01 | ) | | | (9.53 | ) | | | 0.01 | | | | 0.12 | |
| Dilutive EPS | | $ | (2.91 | ) | | $ | (30.47 | ) | | $ | (8.33 | ) | | $ | 0.46 | | | $ | 0.72 | |
| Dilutive EPS from continuing operations | | | (3.11 | ) | | | (11.46 | ) | | | 1.20 | | | | 0.45 | | | | 0.60 | |
| Basic EPS from discontinued operations (net of tax) | | | 0.20 | | | | (19.01 | ) | | | (9.53 | ) | |
| Dilutive EPS from discontinued operations (net of tax) | | | | 0.01 | | | | 0.12 | |
(1) – $2.1 million and the 2.4 million in shares are excluded from dilutive calculation as it is anti-dilutive.
15. | Convertible Preferred Debentures (net) |
In January 2008, the Company issued 1.0 million shares of our Series A Convertible Preferred Stock, with an aggregate redemption value of $20.0 million and current dividend payment rate of 10% per year. The Series A Preferred Stock matures on December 31, 2010, at which time any outstanding shares must be redeemed by the Company at the $20.00 per share liquidation preference. Pursuant to SFAS No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, because of this mandatory redemption feature, the Company classifies these securities as a liability on its balance sheet, and accordingly, the corresponding dividend is recorded as an interest expense.
We issued these shares of Series A Convertible Preferred Stock to JMP Group Inc. and certain of its affiliates for an aggregate purchase price of $20.0 million. The Series A Convertible Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. The Series A Convertible Preferred Stock is convertible into shares of the Company's common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Convertible Preferred Stock.
16.18. | Stock Incentive Plans |
2005 Stock Incentive Plan
At the Annual Meeting of Stockholders held onIn May 31, 2005,2010, the Company’s stockholders approved the adoptionCompany’s 2010 Stock Incentive Plan (the “2010 Plan”), with such stockholder action resulting in the termination of the Company’s 2005 Stock Incentive Plan (the “2005 Plan”). The 2005terms of the 2010 Plan replaced the 2004 Plan, which was terminated onare substantially the same date. Theas the 2005 Plan provides that up to 103,111 shares of the Company’s common stock may be issued thereunder. The 2005 Plan provides that the number of shares available for issuancePlan. However, any outstanding awards under the 2005 Plan may be increased bywill continue in accordance with the terms of the 2005 Plan and any award agreement executed in connection with such outstanding awards. At December 31, 2011 and 2010, there are 14,084 and 28,999 shares of restricted stock outstanding, respectively, under the 2010 and 2005 Plan.
Pursuant to the 2010 Plan, eligible employees, officers and directors of the Company are offered the opportunity to acquire the Company's common stock through the award of restricted stock and other equity awards under the 2010 Plan. The maximum number of shares covered by 2004that may be issued under the 2010 Plan awards that were forfeited or terminated after March 10, 2005. On October 12, 2006, the Company filed a registration statement on Form S-8 registering the issuance or resale of 103,111is 1,190,000. The Company’s directors have been issued 20,924 and 7,177 shares under the 2005 Plan.
Options
Each of the 2005 and 2004 Plans provide for the exercise price of options to be determined by the Compensation Committee of the Board of Directors (“Compensation Committee”) but not to be less than the fair market value on the date the option is granted. Options expire ten years after the grant date. As of December 31, 2008 and December 31, 2007 there were no options outstanding, respectively.
The Company accounts for the fair value of its grants in accordance with SFAS No. 123R. The Company incurred no compensation cost for the year ended December 31, 2008 and 2007. No cash was received for the exercise of stock options during the year ended December 31, 2008, 2007 and 2006.
A summary of the status of the Company’s options2010 Plan as of December 31, 20072011 and changes during the year then ended is presented below:
| | | Number of Options | | | Weighted Average Exercise Price | |
| Outstanding at beginning of year, January 1, 2007 | | | 46,900 | | | $ | 95.20 | |
| Granted | | | — | | | | — | |
| Canceled | | | (46,900 | ) | | | 95.20 | |
| Exercised | | | — | | | | — | |
| Outstanding at end of year, December 31, 2007 | | | — | | | $ | — | |
| Options exercisable at year-end | | | — | | | $ | — | |
The fair value of each option previously grant is estimated onDuring the date of grant using the Binomial option-pricing model with the following weighted-average assumptions:
Risk free interest rate | | | 4.5 | % |
Expected volatility | | | 10 | % |
Expected life | | 10 years | |
Expected dividend yield | | | 10.48 | % |
Restricted Stock
The Company had awarded 68,433 shares of restricted stock under the 2005 Plan, of which 50,190 shares have fully vested and 18,233 were cancelled or forfeited. There were no restricted stock awards during the year ended December 31, 2008. As of December 31, 20082011 and December 31, 2007 there were no outstanding restricted stock awards under the 2005 Plan. During the year ended December 31, 20072010, the Company recognized non-cash compensation expense of $0.6$0.1 million relating to the vested portion of restricted stock grants.and $0.2 million, respectively. Dividends are paid on all restricted stock issued, whether those shares arehave vested or not. In general, unvestednon-vested restricted stock is forfeited upon the recipient’srecipient's termination of employment.
A summary of the status of the Company’s non-vested restricted stock as of December 31, 2007 and changes during the year then ended is presented below:
| | | Number of Non-vested Restricted Shares | | | Weighted Average Grant Date Fair Value | |
| | | | | | | |
| Non-vested shares at beginning of year, January 1, 2007 | | | 21,350 | | | $ | 63.60 | |
| Granted | | | — | | | | — | |
| Forfeited | | | (15,589 | ) | | | 55.78 | |
| Vested | | | (5,761 | ) | | | 86.30 | |
| Non-vested shares as of December 31, 2007 | | | — | | | $ | — | |
| Weighted-average fair value of restricted stock granted during the period | | $ | — | | | $ | — | |
Performance Based Stock Awards
In November 2004, the Company acquired 15 full-service and 26 satellite retail mortgage banking offices located in the Northeast and Mid-Atlantic states from General Residential Lending, Inc. (“GRL”). Pursuant to that transaction, the Company committed to award 47,762 shares of the Company’s stock to certain employees of those branches. Of these committed shares, 41,251 were performance based stock awards granted upon attainment of predetermined production levels and 6,511 were restricted stock awards. As of December 31, 2007, the awards ranged in vesting periods from 3 to 6 months with a share price set at the December 2, 2004 grant date market value of $49.15 per share. During the year ended December 31, 2007, the Company recognized non-cash compensation expense reversal, inclusive of forfeitures of $0.1 million relating to these performance based stock awards. There were no outstanding performance based stock awards as of December 31, 2008 and December 31, 2007.
A summary of the statusactivity of the Company’sCompany's non-vested performance basedrestricted stock awards as offor the years ended December 31, 20072011 and changes2010, respectively, are presented below:
| | | 2011 | | | 2010 | |
| | | Number of Non-vested Restricted Shares | | | Weighted Average Per Share Grant Date Fair Value (1) | | | Number of Non-vested Restricted Shares | | | Weighted Average Per Share Grant Date Fair Value (1) | |
| Non-vested shares at January 1 | | | 28,999 | | | $ | 5.43 | | | | 60,665 | | | $ | 5.28 | |
| Granted | | | 14,084 | | | | 7.10 | | | | 4,000 | | | | 7.50 | |
| Forfeited | | | — | | | | — | | | | (829 | ) | | | 5.28 | |
| Vested | | | (28,999 | ) | | | 5.43 | | | | (34,837 | ) | | | 5.41 | |
| Non-vested shares as of December 31 | | | 14,084 | | | $ | 7.10 | | | | 28,999 | | | $ | 5.43 | |
| Weighted-average fair value of restricted stock granted during the period | | | 14,084 | | | $ | 7.10 | | | | 4,000 | | | $ | 7.50 | |
| (1) | The grant date fair value of restricted stock awards is based on the closing market price of the Company’s common stock at the grant date. |
At December 31, 2011 and 2010, the Company had unrecognized compensation expense of $0.1 million related to the non-vested shares of restricted common stock. The unrecognized compensation expense at December 31, 2011 is expected to be recognized over a weighted average period of 2.17 years. The total fair value of restricted shares vested during each of the year thenyears ended December 31, 2011 and 2010 was $0.2 million. The requisite service period is presented below:two years.
| | | Number of Non-vested Restricted Shares | | | Weighted Average Grant Date Fair Value | |
| | | | | | | |
| Non-vested shares at beginning of year, January 1, 2007 | | | 2,555 | | | $ | 98.30 | |
| Granted | | | — | | | | — | |
| Forfeited | | | (2,555 | ) | | | 98.30 | |
| Vested | | | — | | | | — | |
| Non-vested shares as of December 31, 2007 | | | — | | | $ | — | |
17.19. | Quarterly Financial Data (unaudited) |
The following table is a comparative breakdown of our unaudited quarterly results for the immediately preceding eight quarters (dollar amounts in thousands, except per share data):
| | | Three Months Ended | |
| | | Mar. 31, 2011 | | | Jun. 30, 2011 | | | Sep. 30, 2011 | | | Dec. 31, 2011 | |
| Interest income | | $ | 3,694 | | | $ | 6,482 | | | $ | 7,431 | | | $ | 6,684 | |
| Interest expense | | | 1,184 | | | | 1,181 | | | | 1,203 | | | | 1,269 | |
| Net interest income | | | 2,510 | | | | 5,301 | | | | 6,228 | | | | 5,415 | |
| Other Income (Expense): | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | (633 | ) | | | (391 | ) | | | (435 | ) | | | (234 | ) |
| Impairment loss on investment securities | | | — | | | | — | | | | — | | | | (250 | ) |
| Income from investment in limited partnership and limited liability company | | | 784 | | | | 499 | | | | 479 | | | | 405 | |
| Realized gain (loss) on investment securities and related hedges | | | 2,191 | | | | 3,283 | | | | 2,526 | | | | (2,260 | ) |
| Unrealized loss on investment securities and related hedges | | | (40 | ) | | | (695 | ) | | | (8,027 | ) | | | (895 | ) |
| Total other income (expense) | | | 2,302 | | | | 2,696 | | | | (5,457 | ) | | | (3,234 | ) |
| General, administrative and other expenses | | | 2,293 | | | | 3,454 | | | | 717 | | | | 1,859 | |
| Termination of management contract | | | — | | | | — | | | | — | | | | 2,195 | |
| Income (loss) from continuing operations before income taxes | | | 2,519 | | | | 4,543 | | | | 54 | | | | (1,873 | ) |
| Income tax expense | | | — | | | | 363 | | | | 56 | | | | 14 | |
| Income (loss) from continuing operations | | | 2,519 | | | | 4,180 | | | | (2 | ) | | | (1,887 | ) |
| Income (loss) from discontinued operation - net of tax | | | (5 | ) | | | 9 | | | | 19 | | | | 40 | |
| Net income (loss) | | | 2,514 | | | | 4,189 | | | | 17 | | | | (1,847 | ) |
| Net income attributable to noncontrolling interest | | | — | | | | 20 | | | | 32 | | | | 45 | |
| Net income (loss) attributable to common stockholders | | $ | 2,514 | | | $ | 4,169 | | | $ | (15) | | | $ | (1,892 | ) |
| Per share basic income (loss) | | $ | 0.27 | | | $ | 0.44 | | | $ | — | | | $ | (0.16 | ) |
| Per share diluted income (loss) | | $ | 0.27 | | | $ | 0.44 | | | $ | — | | | $ | (0.16 | ) |
| Dividends declared per common share | | $ | 0.18 | | | $ | 0.22 | | | $ | 0.25 | | | $ | 0.35 | |
| Weighted average shares outstanding-basic | | | 9,433 | | | | 9,447 | | | | 11,146 | | | | 11,919 | |
| Weighted average shares outstanding-diluted | | | 9,433 | | | | 9,447 | | | | 11,146 | | | | 11,919 | |
| | | Three Months Ended | |
| | | Mar. 31, 2008 | | | Jun. 30, 2008 | | | Sep. 30, 2008 | | | Dec. 31, 2008 | |
| Revenues: | | | | | | | | | | | | |
| Interest income | | $ | 13,253 | | | $ | 10,755 | | | $ | 10,324 | | | $ | 9,791 | |
| Interest expense | | | 11,979 | | | | 8,256 | | | | 8,142 | | | | 7,883 | |
Net interest income | | | 1,274 | | | | 2,499 | | | | 2,182 | | | | 1,908 | |
| Other Expense: | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | (1,433 | ) | | | (22 | ) | | | (7 | ) | | | — | |
| Realized losses on securities and related hedges | | | (19,848 | ) | | | (83 | ) | | | 4 | | | | (50 | ) |
| Impairment loss on investment securities | | | — | | | | — | | | | — | | | | (5,278 | ) |
| Total other expense | | | (21,281 | ) | | | (105 | ) | | | (3 | ) | | | (5,328 | ) |
| Expenses: | | | | | | | | | | | | | | | | |
| Salaries and benefits | | | 313 | | | | 417 | | | | 258 | | | | 881 | |
| General and administrative expenses | | | 1,118 | | | | 1,543 | | | | 1,177 | | | | 1,203 | |
| Total expenses | | | 1,431 | | | | 1,960 | | | | 1,435 | | | | 2,084 | |
| (Loss) income from continuing operations | | | (21,438 | ) | | | 434 | | | | 744 | | | | (5,504 | ) |
| Income from discontinued operations - net of tax | | | 180 | | | | 829 | | | | 285 | | | | 363 | |
| Net (loss) income | | $ | (21,258 | ) | | $ | 1,263 | | | $ | 1,029 | | | $ | (5,141 | ) |
| Per share basic and diluted (loss) income | | $ | (4.19 | ) | | $ | 0.14 | | | $ | 0.11 | | | $ | (0.55 | ) |
| Dividends declared per common share | | $ | 0.12 | | | $ | 0.16 | | | $ | 0.16 | | | $ | 0.10 | |
| | | Three Months Ended |
| | | Mar. 31, 2010 | | | Jun. 30, 2010 | | | Sep. 30, 2010 | | | Dec. 31, 2010 | |
| Interest income | | $ | 6,221 | | | $ | 5,185 | | | $ | 4,536 | | | $ | 3,957 | |
| Interest expense | | | 2,813 | | | | 2,495 | | | | 2,311 | | | | 1,992 | |
| Net interest income | | | 3,408 | | | | 2,690 | | | | 2,225 | | | | 1,965 | |
| Other Income: | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | (2 | ) | | | (600 | ) | | | (734 | ) | | | (894) | |
| Income from investment in limited partnership | | | — | | | | — | | | | 150 | | | | 346 | |
| Realized gain on investment securities and related hedges | | | 807 | | | | 1,291 | | | | 1,860 | | | | 1,404 | |
| Impairment loss on investment securities | | | — | | | | — | | | | — | | | | (296) | |
| Total other income | | | 805 | | | | 691 | | | | 1,276 | | | | 560 | |
| General, administrative and other expenses | | | 1,856 | | | | 2,107 | | | | 2,222 | | | | 1,765 | |
| Income from continuing operations | | | 2,357 | | | | 1,274 | | | | 1,279 | | | | 760 | |
| Income from discontinued operation - net of tax | | | 311 | | | | 268 | | | | 298 | | | | 258 | |
| Net income | | $ | 2,668 | | | $ | 1,542 | | | $ | 1,577 | | | $ | 1,018 | |
| Per share basic income | | $ | 0.28 | | | $ | 0.16 | | | $ | 0.17 | | | $ | 0.11 | |
| Per share diluted income | | $ | 0.28 | | | $ | 0.16 | | | $ | 0.17 | | | $ | 0.11 | |
| Dividends declared per common share | | $ | 0.25 | | | $ | 0.18 | | | $ | — | | | $ | 0.36 | |
| Weighted average shares outstanding-basic | | | 9,418 | | | | 9,419 | | | | 9,425 | | | | 9,425 | |
| Weighted average shares outstanding-diluted | | | 11,918 | | | | 11,919 | | | | 9,425 | | | | 9,425 | |
| 20. | Related Party Transactions |
| | | Three Months Ended | |
| | | Mar. 31, 2007 | | | Jun. 30, 2007 | | | Sep. 30, 2007 | | | Dec. 31, 2007 | |
| Revenues: | | | | | | | | | | | | |
| Interest income | | $ | 13,713 | | | $ | 12,898 | | | $ | 12,376 | | | $ | 11,577 | |
| Interest expense | | | 13,966 | | | | 12,786 | | | | 12,107 | | | | 11,228 | |
| Net interest income | | | (253 | ) | | | 112 | | | | 269 | | | | 349 | |
| Other expense | | | | | | | | | | | | | | | | |
| Provision for loan losses | | | — | | | | (940 | ) | | | (99 | ) | | | (644 | ) |
| Loss on sale of securities and related hedges | | | — | | | | (3,821 | ) | | | (1,013 | ) | | | (3,516 | ) |
| Impairment loss on investment securities | | | — | | | | — | | | | — | | | | (8,480 | ) |
| Total other expense | | | — | | | | (4,761 | ) | | | (1,112 | ) | | | (12,640 | ) |
| Expenses: | | | | | | | | | | | | | | | | |
| Salaries and benefits | | | 345 | | | | 151 | | | | 178 | | | | 191 | |
| General and administrative expenses | | | 302 | | | | 378 | | | | 668 | | | | 541 | |
| Total expenses | | | 647 | | | | 529 | | | | 846 | | | | 732 | |
| Loss from continuing operations | | | (900 | ) | | | (5,178 | ) | | | (1,689 | ) | | | (13,023 | ) |
| Loss from discontinued operations - net of tax | | | (3,841 | ) | | | (9,018 | ) | | | (19,027 | ) | | | (2,592 | ) |
| Net loss | | $ | (4,741 | ) | | $ | (14,196 | ) | | $ | (20,716 | ) | | $ | (15,615 | ) |
| Per share basic and diluted loss | | $ | (2.62 | ) | | $ | (7.84 | ) | | $ | (11.40 | ) | | $ | (8.59 | ) |
| Dividends declared per common share | | $ | 0.50 | | | $ | — | | | $ | — | | | $ | — | |
18. Related Party TransactionsTermination of Advisory Agreement
Concurrent and in connection with the issuance of our Series A Preferred Stock onOn January 18, 2008, wethe Company entered into an advisory agreement (the “Prior Advisory Agreement”) with Harvest Capital Strategies LLC (“HCS”) (formerly known as JMP Asset Management LLC), pursuant to which HCS was responsible for implementing and managing the Company’s investments in certain real estate-related and financial assets. The Company entered into the Prior Advisory Agreement concurrent and in connection with its private placement of Series A Preferred Stock to JMP Group Inc. and certain of its affiliates. HCS is an affiliatea wholly-owned subsidiary of JMP Group Inc. Pursuant to Schedule 13D's filed with the SEC asAs of December 31, 2008,2011, HCS and JMP Group Inc. collectively beneficially owned approximately 16.8% and 12.2%10.3% of ourthe Company’s common stock. UnderIn addition, until its redemption on December 31, 2010, HCS and JMP Group Inc. collectively beneficially owned 100% of the agreement, HCS advisesCompany’s Series A Preferred Stock. The Company’s Series A Preferred Stock matured on December 31, 2010, at which time it redeemed all the Managed Subsidiaries. As previously disclosed, we have an approximately $64.0 million net operating loss carry-forward that remains with us afteroutstanding shares at the sale$20.00 per share liquidation preference plus accrued dividends of our mortgage lending business. As an advisor$0.5 million.
Pursuant to the Managed Subsidiaries, we expectPrior Advisory Agreement, HCS managed investments made by HC and NYMF (other than certain RMBS that HCS will, at some pointare held in the future, focusthese entities for regulatory compliance purposes) as well as any additional subsidiaries that were acquired or formed to hold investments made on the acquisitionCompany’s behalf by HCS. The Company sometimes refers to these subsidiaries in its periodic reports filed with the Securities and Exchange Commission as the “Managed Subsidiaries.” The Prior Advisory Agreement provided for the payment to HCS of alternative mortgage related investments on behalf of the Managed Subsidiaries. Some of those investments may allow us to utilize all or a portion of the net operating loss carry-forward to the extent available by law. The commencement of any activity by HCS must be approved by the Board of Directors and any subsequent investment on behalf of Managed Subsidiaries must adhere to investment guidelines adopted by our Board of Directors. HCS will earn a base advisory fee of 1.5%that was equal to 1.50% per annum of the “equity capital” (as defined in the advisory agreement) of the Managed Subsidiaries; and an incentive fee upon the Managed Subsidiaries achieving certain investment hurdles. HCS was also eligible to earn an incentive fee on the managed assets. Pursuant to the Prior Advisory Agreement, HCS was entitled to an incentive fee equal to 25% of the GAAP net income of the Managed Subsidiaries attributable to the investments that are managed by HCS that exceed a hurdle rate equal to the greater of (a) 8.00% and (b) 2.00% plus the ten year treasury rate for such fiscal year. The incentive fee is alsopayable by us to HCS in cash, quarterly in arrears; provided, however, that a portion of the incentive compensation may be paid in shares of our common stock. The Prior Advisory Agreement was terminated effective July 26, 2010 upon execution and effectiveness of an amended and restated advisory agreement among the Company, HC, NYMF and HCS (the “HCS Advisory Agreement”).
Pursuant to the HCS Advisory Agreement, HCS provided investment advisory services to the Company and managed on the Company’s behalf “new program assets” acquired after the date of the HCS Advisory Agreement. The terms for new program assets, including the compensation payable thereunder to HCS by the Company, was to be negotiated on a transaction-by-transaction basis. For those new program assets identified as “Managed Assets”, HCS was (A) entitled to receive a quarterly base advisory fee (payable in arrears) in an amount equal to the product of (i) one-fourth of the amortized cost of the Managed Assets as of the end of the quarter, and (ii) 2%, and (B) eligible to earn incentive compensation ifon the Managed Subsidiaries achieveAssets for each fiscal year during the term of the Agreement in an amount (not less than zero) equal to 35% of the GAAP net income attributable to the Managed Assets for the full fiscal year (including paid interest and realized gains), after giving effect to all direct expenses related to the Managed Assets, including but not limited to, the annual consulting fee (described below) and base advisory fees, that exceeds a hurdle rate of 13% based on the average equity of the Company invested in Managed Assets during that particular year. For those new program assets identified as Scheduled Assets, HCS received compensation, which may include base advisory and incentive compensation, agreed upon between the Company and HCS and set forth in a term sheet or other documentation related to the transaction. Under the terms of the HCS Advisory Agreement, HCS is eligible to earn incentive compensation on those assets held by the Company as of the effective date of the HCS Advisory Agreement that are deemed to be managed assets under the Prior Advisory Agreement. Incentive compensation for these “legacy assets” is calculated in the manner prescribed in the Prior Advisory Agreement. Lastly, during the term of the HCS Advisory Agreement, the Company was required to pay HCS an annual consulting fee equal to $1 million, subject to reduction under certain performancecircumstances, payable on a quarterly basis in arrears, for consulting and support services. The HCS Advisory Agreement had an initial term that was to expire on June 30, 2012, subject to automatic annual one-year renewals thereafter. Under the terms of the HCS Advisory Agreement, the Company has the right to terminate or not renew the HCS Advisory Agreement, subject to certain conditions and subject to paying a termination fee equal to the product of (A) 1.5 and (B) the sum of (i) the average annual base advisory fee earned by HCS during the 24-month period preceding the effective termination date, and (ii) the annual consulting fee.
For the years ended December 31, 2011 and 2010, HCS earned aggregate base advisory and consulting fees of approximately $1.1 million and $0.9 million, respectively, and an incentive fee of approximately $1.7 and $2.0 million, respectively. As of December 30, 2011 and 2010, approximately $34.1 million and $48.2 million, respectively, of the Company’s assets were managed pursuant to the HCS Advisory Agreement. As of December 31, 2011 and 2010, the Company had a management fee payable totaling $0.8 million and $0.7 million, respectively, included in accrued expenses and other liabilities.
On December 30, 2011, the Company and HCS agreed to terminate the HCS Advisory Agreement effective on December 31, 2011, with HCS agreeing to waive the 180-day advance notice requirement provided in the HCS Advisory Agreement. In addition, the Company and HCS agreed that, in consideration of the termination of the HCS Advisory Agreement, the Company will pay to HCS a termination fee equal to $2,235,000 (the “Agreed Fee”), which fee is the sum of (a) the termination fee provided in the HCS Advisory Agreement and (b) $500,000, which represents the fees that otherwise would have been payable through the end of the term of the HCS Advisory Agreement. The Agreed Fee will be paid to HCS by the Company in three separate installments with the first installment of $1,735,000 paid on December 30, 2011, and the final two installments of $250,000 payable on March 31, 2012 and on the date the transitional consulting services referred to below are terminated by the Company.
In connection with the payment of the Agreed Fee, HCS has agreed to provide certain transitional consulting services at the request of the Company until the earlier of (i) the day immediately prior to the Company’s annual stockholders’ meeting in May or June 2012 or (ii) a majority vote of the independent directors of the Company to terminate such transitional consulting services. As part of the transitional consulting services to be provided by HCS, James J. Fowler, a portfolio manager for HCS and a managing director of JMP Group Inc. and the current Chairman of the Company’s Board of Directors, has agreed to continue to serve as a director and Chairman of the Company’s Board of Directors until the earlier of (a) the Company’s 2012 annual stockholders’ meeting, (b) his successor is duly qualified and appointed by the Company’s Board of Directors or (c) he determines that his resignation is legally or for regulatory reasons advisable or appropriate under the circumstances.
Pursuant to the terms of the HCS Advisory Agreement, following the termination date of December 31, 2011, the Company will continue to pay incentive compensation to HCS with respect to all assets of the Company that were, as of the effective termination date, managed pursuant to the HCS Advisory Agreement (the “Incentive Tail Assets”) until such time as such Incentive Tail Assets are disposed of by the Company or mature. The Company expensed $2,195,000 in 2011 relating to the termination of the HCS Advisory Agreement.
On April 5, 2011, RBCM entered into a management agreement with RiverBanc LLC (“RiverBanc”), pursuant to which RiverBanc provides investment management services to RBCM. At December 31, 2011, HCS owned a 28% equity interest in RiverBanc and, accordingly, may receive a portion of the fees paid to RiverBanc by RBCM. Under the terms of RiverBanc’s operating agreement, we may acquire up to 17.5% of the limited liability company interests of RiverBanc, upon satisfying certain funding thresholds. As of December 31, 2008, HCS was not managing any assets in2011, we owned none of the Managed Subsidiaries, but was earning a base advisory fee onoutstanding limited liability company interests of RiverBanc. On January 4, 2012, we acquired 7.5% of the net proceeds to our Company from our private offerings in eachoutstanding limited liability company interests of January 2008 and February 2008.RiverBanc. For the three and twelve monthsyear ended December 31, 2008, HCS2011, RBCM paid approximately $68,000 in fees to RiverBanc.
JMP and its affiliates have, at times, co-invested with the Company and/or made debt or equity investments in investees they introduced to the Company.
Accounting Outsourcing Agreement
The Company entered into an outsourcing agreement with Real Estate Systems Implementation Group, LLC (“RESIG”) effective May 1, 2010, pursuant to which RESIG, among other things, (a) performs day-to-day accounting services for the Company and (b) effective October 4, 2010, provided a Chief Financial Officer to the Company. During the years ended December 31 2011 and 2010, respectively, RESIG earned $0.6 million and $0.2 million and $0.7 million respectively, in advisory fees.
In addition, pursuant to the stock purchase agreement providing for the sale of the Series A Convertible Preferred Stock to JMP Group, Inc. and certain of its affiliates, James J. Fowler and Steven M. Abreu were appointed to our Board of Directors, with Mr. Fowler being appointed the non-executive chairman of our Board of Directors. In addition, concurrent with the completion of the issuance and sale of the Series A Convertible Preferred Stock and pursuant to the stock purchase agreement, four of our then-existing directors resigned from the Board.
James J. Fowler, the Non-Executive Chairman of our Board of Directors and also the non-compensated Chief Investment Officer of Hypotheca Capital, LLC and New York Mortgage Funding, LLC, is a managing director of HCS. HCS is a wholly-owned subsidiary of JMP Group, Inc.
On February 21, 2008,March 9, 2012, we completedentered into a First Amendment (the “Midway Amendment”) to Investment Management Agreement (as amended, the issuance“Midway Management Agreement”) with Midway pursuant to which we amended the manner in which the incentive fee payable to Midway under the Midway Management Agreement shall be calculated and provide for the payment of 7.5 millionequity compensation to Midway. Specifically, the Midway Amendment (i) raises the “high water mark” to 11%, (ii) reduces the incentive fee to 35% of the dollar amount by which adjusted net income (as defined in the Midway Management Agreement) exceeds the hurdle rate, (iii) reduces the hurdle rate to an annual 12.5% rate of return on invested capital, (iv) provides that the incentive fee will be calculated on a rolling 12-month basis, (v) amends the definition of adjusted net income, (vi) provides that, upon mutual agreement of the parties, a portion of each incentive fee payable to Midway under the Midway Management Agreement may be paid in shares of our common stock, and (vii) provides for the grant, on or about the date of the Midway Amendment, of 213,980 shares of restricted stock to Midway that will vest annually in a private placement to certain accredited investors, resulting in $56.5 million in net proceedsone-third increments beginning on December 31, 2012. Pursuant to the Company. JMP Securities LLC, an affiliateMidway Amendment, which became effective as of HCS and JMP Group, Inc., served asJanuary 1, 2012, the sole placement agent forinitial term of the transaction and was paid a $3.0 million placement fee from the gross proceeds.Midway Management Agreement will now expire on December 31, 2013.
EXHIBIT INDEX
Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below. Management contracts or compensatory plans are filed as Exhibits 10.3, 10.1310.7, 10.8, 10.10, 10.11 and 10.14.10.12.
Exhibit | | Description |
| 3.1 | | Articles of Amendment and Restatement of New York Mortgage Trust, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 333-111668), effective June 23, 2004). |
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| 3.1(b) | | Articles of Amendment of the Registrant (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 4, 2007). |
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| 3.1(c) | | Articles of Amendment of the Registrant (Incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on October 4, 2007). |
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| 3.1(d) | | Articles of Amendment of the Registrant (Incorporated by reference to Exhibit 3.1(d) to the Company’s Current Report on Form 8-K filed on May 16, 2008.)2008). |
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| 3.1(e) | | Articles of Amendment of the Registrant (Incorporated by reference to Exhibit 3.1(e) to the Company’s Current Report on Form 8-K filed on May 16, 2008.)2008). |
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3.2(a) 3.1(f) | | Articles of Amendment of the Registrant (Incorporated by reference to Exhibit 3.1(f) to the Company’s Current Report on Form 8-K filed on June 15, 2009). |
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| 3.2 | | Bylaws of New York Mortgage Trust, Inc., as amended (Incorporated by reference to Exhibit 3.2 to the Company’s Registration StatementAnnual Report on Form S-11 as10-K filed with the Securities and Exchange Commission (Registration No. 333-111668), effective June 23, 2004)on March 4, 2011). |
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3.2(b) | | Amendment No. 1 to Bylaws of New York Mortgage Trust, Inc. (Incorporated by reference to Exhibit 3.2(b) to Registrant's Annual Report on Form 10-K filed on March 16, 2006).
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| 4.1 | | Form of Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-11 as filed with the Securities and Exchange Commission (Registration No. 333-111668), effective June 23, 2004). |
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| 4.2(a) | | Junior Subordinated Indenture between The New York Mortgage Company, LLC and JPMorgan Chase Bank, National Association, as trustee, dated SeptemberDecember 1, 2005. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on SeptemberDecember 6, 2005). |
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| 4.2(b) | | Amended and Restated Trust Agreement among The New York Mortgage Company, LLC, JPMorgan Chase Bank, National Association, Chase Bank USA, National Association and the Administrative Trustees named therein, dated SeptemberDecember 1, 2005. (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on SeptemberDecember 6, 2005). |
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| 4.3(a) | | Articles Supplementary Establishing and Fixing the Rights and Preferences of Series A Cumulative Redeemable Convertible Preferred Stock of the Company (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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| 4.3(b) | | Form of Series A Cumulative Redeemable Convertible Preferred Stock Certificate (Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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| 10.1 | | Parent Guarantee Agreement between New York Mortgage Trust, Inc. and JPMorgan Chase Bank, National Association, as guarantee trustee, dated SeptemberDecember 1, 2005. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on SeptemberDecember 6, 2005). |
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| 10.2 | | Purchase Agreement among The New York Mortgage Company, LLC, New York Mortgage Trust, Inc., NYM Preferred Trust II and Taberna Preferred Funding II, Ltd., dated SeptemberDecember 1, 2005. (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on SeptemberDecember 6, 2005). |
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| 10.3 | | New York Mortgage Trust, Inc. 2005 Stock Incentive Plan. (Incorporated by reference to Exhibit 10.1 to the Company’s Registration Statement on Form S-3/A (File No. 333-127400) as filed with the Securities and Exchange Commission on SeptemberDecember 9, 2005). |
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| 10.4 | | Assignment and Assumption of Sublease, by and between Lehman Brothers Holdings Inc. and The New York Mortgage Company, LLC, dated as of November 14, 2006 (Incorporated by reference to Exhibit 10.63 to the Registrant's Annual Report on Form 10-K filed on April 2, 2007). |
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10.5 | | First Amendment to Assignment and Assumption of Sublease, dated as of January 5, 2007, by and between The New York Mortgage Company, LLC and Lehman Brothers Holdings, Inc. (Incorporated by reference to Exhibit 10.64 to the Registrant's Annual Report on Form 10-K filed on April 2, 2007). |
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10.6 | | Second Amendment to Assignment and Assumption of Sublease, dated as of February 8, 2007, by and between The New York Mortgage Company, LLC and Lehman Brothers Holdings, Inc. (Incorporated by reference to Exhibit 10.65 to the Registrant's Annual Report on Form 10-K filed on April 2, 2007). |
10.7 | | Third Amendment to Assignment and Assumption of Sublease, dated as of March 31, 2007, by and between The New York Mortgage Company, LLC and Lehman Brothers Holdings, Inc. (Incorporated by reference to Exhibit 10.74 to the Company’s Quarterly Report on Form 10-Q filed on May 15, 2007). |
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10.8 | | Fourth Amendment to Assignment and Assumption of Sublease, dated as of August 30, 2007, by and between The New York Mortgage Company, LLC and Lehman Brothers Holdings, Inc. (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on November 14, 2007). |
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10.9 | | Stock Purchase Agreement, by and among New York Mortgage Trust, Inc. and the Investors listed on Schedule I thereto, dated as of November 30, 2007 (Incorporated by reference to Exhibit 10.1(a) to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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10.10 | | Amendment No. 5 to Stock Purchase Agreement, by and among New York Mortgage Trust, Inc. and the Investors listed on Schedule I to the Stock Purchase Agreement, dated as of January 18, 2008 (Incorporated by reference to Exhibit 10.1(b) to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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10.1110.5 | | Registration Rights Agreement, by and among New York Mortgage Trust, Inc. and the Investors listed on Schedule I to the Stock Purchase Agreement, dated as of January 18, 2008 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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10.1210.6 | | Advisory Agreement, by and among New York Mortgage Trust, Inc., Hypotheca Capital, LLC, New York Mortgage Funding, LLC and JMP Asset Management LLC, dated as of January 18, 2008 (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on January 25, 2008). |
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10.1310.7 | | Separation Agreement and General Release, by and between New York Mortgage Trust, Inc. and David A. Akre, dated as of February 3, 2009 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 4, 2009). |
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10.1410.8 | | Amended and Restated Employment Agreement, by and between New York Mortgage Trust, Inc. and Steven R. Mumma, dated as of February 11, 2009 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 12, 2009). |
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10.15 | | Form of Purchase Agreement, by and among New York Mortgage Trust, Inc. and the Investors listed on Schedule A thereto, dated as of February 14, 2008 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 19, 2008). |
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10.1610.9 | | Form of Registration Rights Agreement, by and among New York Mortgage Trust, Inc. and the Investors listed on Schedule A thereto, dated as of February 14, 2008 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 19, 2008). |
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| 10.10 | | Form of Restricted Stock Award Agreement for Officers (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on July 14, 2009.) |
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| 10.11 | | Form of Restricted Stock Award Agreement for Officers (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on July 14, 2009.) |
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| 10.12 | | New York Mortgage Trust, Inc. 2010 Stock Incentive Plan (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on May 17, 2010). |
| 10.13 | | Amended and Restated Advisory Agreement by and among New York Mortgage Trust, Inc., Hypotheca Capital, LLC, New York Mortgage Funding, LLC and Harvest Capital Strategies, LLC, dated as of July 26, 2010 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 28, 2010). |
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| 10.14 | | Amended and Restated Employment Agreement, by and between New York Mortgage Trust, Inc. and Steven R. Mumma dated as of November 22, 2011 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 23, 2011). |
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| 10.15 | | Investment Management Agreement, by and between New York Mortgage Trust, Inc. and The Midway Group, LP dated as of February 11, 2011 (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on May 5, 2011). |
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| 10.16 | | Management Agreement, by and between RB Commercial Mortgage LLC and RiverBanc LLC, dated as of April 5, 2011 (Incorporated by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on May 5, 2011). |
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| 10.17 | | Notice of Termination and Letter Agreement, by and among New York Mortgage Trust, Inc., Hypotheca Capital, LLC, New York Mortgage Funding, LLC and Harvest Capital Strategies LLC, dated as of December 30, 2011 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 30, 2011). |
12.110.18 | | ComputationUnderwriting Agreement among New York Mortgage Trust, Inc. and the several underwriters listed therein, dated as of RatiosDecember 1, 2011 (Incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K filed on December 2, 2011). |
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| 10.19 | | First Amendment to Investment Management Agreement by and between New York Mortgage Trust, Inc. and The Midway Group, L.P., dated March 9, 2012 * |
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| 21.1 | | List of Subsidiaries of the Registrant.* |
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| 23.1 | | Consent of Independent Registered Public Accounting Firm (Deloitte & Touche(Grant Thornton LLP).* |
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| 31.1 | | Section 302 Certification of Chief Executive Officer andOfficer.* |
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| 31.2 | | Section 302 Certification of Chief Financial Officer.* |
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| 32.1 | | Section 906 Certification of Chief Executive Officer and Chief Financial Officer.* |
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| Exhibit 101.INS XBRL | | Instance Document *** |
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| Exhibit 101.SCH XBRL | | Taxonomy Extension Schema Document *** |
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| Exhibit 101.CAL XBRL | | Taxonomy Extension Calculation Linkbase Document *** |
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| Exhibit 101.DEF XBRL | | Taxonomy Extension Definition Linkbase Document *** |
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| Exhibit 101.LAB XBRL | | Taxonomy Extension Label Linkbase Document *** |
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| Exhibit 101.PRE XBRL | | Taxonomy Extension Presentation Linkbase Document *** |
| ** | Furnished herewith. Such certification shall not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended. |
| *** | Submitted electronically herewith. Attached as Exhibit 101 to this report are the following documents formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets at December 31, 2011 and 2010; (ii) Consolidated Statements of Operations for the years ended December 31, 2011 and 2010; (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2011 and 2010; (iv) Consolidated Statements of Equity for the years ended December 31, 2011 and 2010; (v) Consolidated Statements of Cash Flows for the years ended December 31, 2011 and 2010; and (vi) Notes to Consolidated Financial Statements. Users of this data are advised pursuant to Rule 406T of Regulation S-T that this interactive data file is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections. |
