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Recent Developments
Investments 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, 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 statement of operations for the year ended December 31, 2011. We expect that the termination of the HCS Advisory Agreement will eliminate approximately $1.0 million of general 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, (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 achievecontinue our principal business objectivestrategy of generating net income for distribution tobuilding a residential portfolio that includes elements of both interest rate and credit risk by focusing our stockholders by buildinginvestments on leveraged Agency RMBS, which we expect will include both Agency ARMs and managing a diversified investment portfolio comprised of a broad class ofAgency IOs, while also expanding our investments in “credit residential” assets, which we define as multi-family CMBS and other commercial real estate-related and financialdebt investments. At the same time we pursue these targeted assets, that in aggregate, will generate attractive risk-adjusted total returns for our stockholders. We have invested in the past and intend to invest in the future in assets that collectively allow us to maintain our REIT status and our exemption from registration under the Investment Company Act. In building and managing our current investment portfolio, we:
Our Targeted Asset Classesinvestment 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.
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Investments in Agency RMBS
We intend to achieve more stable cash flows on our collective investments in Agency RMBS Issuedacross 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 are backed by ARMs or hybrid ARMs. Our current portfolio of Agency ARMs has interest reset periods generally less than two years and an average seasoning of approximately four years. We believe this amount of seasoning better protects the securities from delinquency buyouts by Fannie Mae or Freddie Mac and Collateralized by Hybrid ARM Loans. provides better overall prepayment behavior profiles.
Agency RMBS consists 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 to the holders of the pass-through certificate. CMOs dividecash flow from a pool of mortgage loans into multiple tranches with different principal and interest payment characteristics.
It should be noted that the guarantee provided by the GSEs on Agency RMBS issued by them 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, primarily 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 beyond. 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 mortgage balance in excess of Agencywide geographic footprint. All loans have been underwritten to Freddie Mac underwriting guidelines borrower characteristics, loan characteristics and insufficient documentation. Consequently, the principal and interest on non-Agency RMBSstandards, however our securities are not guaranteed by GSEs,Freddie Mac.
We also may invest in other commercial real estate-related debt investments, such as Fannie Maemezzanine loans and Freddie Mac, orpreferred equity investments in commercial properties. In the event we do pursue investments of this type in the casefuture, 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 acquisition of Ginnie Mae, the U.S. Government.seasoned or distressed commercial loan portfolios. Our multi-family CMBS and 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.
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Our Financing Strategy
We strive to maintain and achieve a balanced and diverse funding mix to finance our investment portfolio. Weassets and operations. To achieve this, we rely primarily on a combination of short-term borrowings or repurchase agreements, collateralized bydebt obligations and 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 1 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 Agency RMBS and CDOs in order to finance the Agency RMBS in our investment portfolio and prime ARM loans held in our securitization trusts.portfolio. Repurchase agreements provide us with short-term borrowings (typically 30 days) that bear interest rates that are linked to 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, 2009,2011, we had repurchase agreements outstanding with five different counterparties totaling $85.1 million. As of December 31, 2009, we financed approximately $276.2 million offinance our prime ARM loans we holdheld in securitization trusts permanently with approximately $9.9$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 $266.8 million of CDOs. with available cash from our balance sheet.
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Our Hedging and Interest Rate Risk Management StrategiesStrategy
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 securities collateralized by ARM loans, many of the underlying hybrid ARM loans that back the RMBS in our 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 RMBS assets and prime ARM loans held in securitization trusts. 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 RMBS in our 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 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.
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The Midway Group, L.P.
A portion of our Board of Directors.
Midway is responsible for administering the business activities and day-to-day operations of our investments in Agency IOs, which represent the right to receive the interest portion of the cash 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 agreement providingand 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 in, among other things, Agency RMBS consisting of pass-through certificates, CMOs, and POs and non-agency RMBS (which may include IOs and POs). As part of 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.
Midway has established portfolio management resources for the saleinvestment assets described above and an established infrastructure supporting those resources. We expect that we will benefit from Midway’s highly analytical investment processes, broad-based deal flow, extensive relationships in the financial community and operational expertise. Moreover, during its more than ten year history of the Series A Preferred Stockinvesting in this space, we believe Midway has developed strong relationships with a wide range of dealers and other market participants that provide Midway access to the JMP Group, James J. Fowler was appointed Chairmana broad range of our Board of Directors. Mr. Fowler, who also serves as the non-compensated Chief Investment Officer of the Managed Subsidiaries, is a managing director of HCS, a subsidiary of JMP Group Inc.trading opportunities and a significant investor in our Series A Preferred Stock.market information.
As of December 31, 2009, HCS, JMP Group Inc.2011, we had allocated approximately $39.5 million of 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., collectively beneficially ownedthe Midway Management Agreement, including our authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a significant percentage of our outstanding capital stock. See “―Conflicts of Interest with HCS; Equitable Allocation of Investment Opportunities” below for more information. In addition, in November 2008 our Board of Directors approved anREIT and 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.
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The following table 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 assets and liabilities managed on our behalf by Midway.
| Type | Description | |
| Base management fee | We pay a base management fee monthly in arrears in a cash amount equal to the product of (i) 1.50% per annum of our invested capital in the assets managed by Midway as of the last business day of the previous month, multiplied by (ii) 1/12th. | |
| In addition to the base 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 dollar amount by which adjusted net income (as defined below) attributable to the assets managed by Midway, on a rolling 12-month basis and before accounting for the Midway Incentive Fee, exceeds an annual 12.5% rate of return on invested capital (the “Hurdle Rate”) over (ii) the sum of 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 income for the Calculation Period by (ii) the weighted average of our invested capital in assets managed by Midway during the Calculation 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 previously completed quarters on an annualized basis. Adjusted net income is defined as net income (loss) calculated in accordance with generally accepted accounting principles in the Unlike the | ||
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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, 20092011. 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 was paid(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 base advisory feeprivate placement. We redeemed the $20 million of $0.8 million and $0.7 million, respectively, and anour Series A Preferred Stock in full on December 31, 2010.
Pursuant to the terms of the HCS Advisory Agreement, we will continue to pay incentive compensation fee of $0.5 million for the year endedto HCS with respect to all Incentive Tail Assets at December 31, 2009. There was no2011 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 paidis 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 year endedearlier 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, 2008.2011, JMP Group Inc. and certain of its affiliates collectively owned approximately 10.3% of our outstanding shares of common stock.
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Conflicts of Interest with HCS;Our External Managers; Equitable Allocation of Investment Opportunities
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 certain of the Managed Subsidiaries’our targeted investmentsassets are typically available only in specified quantities and since certain 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 certain investmentsassets 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.
Pursuant to the terms of the Midway Management Agreement, we may only redeem invested capital in an amount equal to the lesser of 10% of the invested capital in assets managed by Midway or $10 million as of the last calendar day of the month upon not permit HCSless than 75 days written notice, subject to investour 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, and we are only permitted to make one such redemption request in Agency RMBS, since these investmentsany 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 madethey 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 management of our business. Consequently, we may not receive the level of support and assistance that we otherwise might receive if such services were provided internally by us.
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, 20102012 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.
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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.
We must meet requirements 1 through 4 during our entire taxable year and must meet requirement 5 during at least 335 days of 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 20%25% 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 20%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.
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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.
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.do..
Corporate Offices and Personnel
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, 20092011, we employed fourthree 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
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Item 1A. RISK FACTORS
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 RMBS and CLOsecurities within our investment portfolio isare classified for accounting purposes 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.
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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 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 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.
Prepayment rates can change, adversely affecting the performance of our 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 RMBS is affected by a variety of factors, including the prevailing level of 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 on their mortgage loans. A significant percentage of the mortgage loans underlying our existing 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 the 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.
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 terms 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 us to incur substantial losses.
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 operations.
During the historical relationship betweenpast 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 changes and prepayment trends, which would make it more difficult for us to analyze our investment portfolio.
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.
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 risks 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 portfolio is recorded 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 market quotations for assets in our portfolio,securities, default, we may be unableincur losses on those loans or investment securities. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income and our ability to obtain quotations from brokers and dealers for certainacquire our targeted assets within our investment portfolio in the future in which case our management may need to determine in good faith the fair value of these assets.
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.
Our 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 we expect to receive from Agency RMBS, thereby tightening the spread between the interest we earn on those assets and our cost of financing those assets. A reduction in the supply of Agency RMBS could also negatively affect the pricing of Agency RMBS by reducing the spread between the interest we earn on our Agency RMBS and our 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 or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on investments in Agency RMBS issued by Fannie Mae or Freddie Mac.
Commercial mortgage loans that we may invest directly in and those underlyingacquire or that back our CMBS and RMBS are subject to risks of delinquency and foreclosure and risks of loss which could resultthat may be greater than similar risks associated with residential mortgage loans.
We currently own and may acquire in losses to us.
We may invest in high yield or subordinated and 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.
We may invest 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.
Failure to procure adequate funding and capital would adversely affect our results and may, in turn, negatively affect the value of our common stock and our ability to distribute cash to our stockholders.
We depend upon the availability of adequate funding and capital for our operations. To maintain our status as a REIT, we are required to distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction 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 of 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 our 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 the 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 concentrated 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 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 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 our acquisitions, growth, operations, indebtedness, capitalization and distributions or approve transactions that deviate from these policies without a vote of, or notice to, our shareholders. In addition, certain of our external managers have great latitude in making investment 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.
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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 residential 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.
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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.
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In response to the 2008 financial and credit crisis, the Federal Reserve lowered the Federal Funds Target Rate to near zero in an asset, we revieweffort to stabilize markets and improve liquidity. Recently, the loans or other assets comprisingFederal 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 and other factors that we believe are material tosecurities because in a period of rising interest rates, the performancerelative value of the investment.interest earning assets we own can be expected to fall and reduce our book value. In this process,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 relyearn on the resources available to us and, in some cases, an investigation by HCS, its affiliates or third parties. This process is particularly important and subjective with respect to new or private companies because there may be little or no information publicly available about them. Our due diligence processes mightour fixed-rate interest earning assets would not uncover all relevant facts, thus resulting in investment losses.change.
Risk Related to Our Debt Financing and Hedging
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.
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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. |
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.
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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. Given the continued uncertainty in the credit markets, we believe that maintaining a maximum leverage ratio in the range of six to eight times for our Agency RMBS portfolio and an overall leverage ratio of four to five times is appropriate at this time. At December 31, 2009, 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 1 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. 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.
Our liquidity may be adversely affected by margin calls under our repurchase agreements because we 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 us to post additional collateral to cover the decrease. When we are subject to such a margin call, we must provide the lender with additional collateral or repay a portion of the outstanding borrowings with minimal notice. Any such margin call could harm our liquidity, results of operation and financial condition. Additionally, in order to obtain cash to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause it to incur further losses and adversely affect our results of operations and financial condition.
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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.
| · | 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 |
| · | available |
| · | the |
| · | many hedges are structured as over-the-counter contracts with counterparties whose creditworthiness is not guaranteed, raising the |
| · | to the |
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.
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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.
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.
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.
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We compete with HCS’sour external managers’ other clients for access to HCS.them.
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.
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.
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.
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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 period, which ends on December 31, 2010,term 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 sumproduct of (A) 24 and (B) the average annual base advisorymanagement fee and the average annual incentive compensation earned by itRiverBanc during the 24-monthone month period immediately preceding the date of termination calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.date. Thus, in the event we elect not to renew the advisory agreementRiverBanc Management Agreement for any reason other than cause (as definedor as otherwise described in the advisory agreement),this paragraph, we will be required to pay this termination fee. In addition, the RiverBanc Management Agreement provides RiverBanc with an exclusive right of first refusal to purchase any of our assets managed by it subject to certain exceptions, in the event we terminate them for any reason. This provision could result in our loss of assets that our earnings are dependent upon or may cause us to sell assets prior to our recovery of 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.
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.
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’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.
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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.
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.
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 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.
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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.
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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 2010)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.
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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 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.
In connection with our investment in Agency IOs, we may purchase Agency RMBS through TBAs, or dollar roll transactions. In certain instances, rather than take delivery of the Agency RMBS subject to a TBA, we will dispose of the TBA through a dollar roll transaction in which we agree to purchase similar securities in the future at a predetermined price or otherwise, which may result in the recognition of income or gains. We account for dollar roll transactions as purchases and sales. The law is unclear regarding whether TBAs will be qualifying assets for the 75% asset test and whether income and gains from dispositions of TBAs will be qualifying income for the 75% gross income test.
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.
Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2.PROPERTIES
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, 2009,2011, our principal executive and administrative offices are located in leased space at 52 Vanderbilt Avenue, Suite 403, New York, New York 10017.
Item 3.LEGAL PROCEEDINGS
We are at times subject to various legal proceedings arising in the ordinary course of our business. As of the date of this report, we do not believe that any of our current legal proceedings, individually or in the aggregate, will have a material adverse effect on our operations, financial condition or cash flowsflows.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
Item 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
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, 2009,2011, we had 9,415,09413,938,273 shares of common stock outstanding and as of March 1, 2010,8, 2012, there were approximately 3068 holders of record of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.
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. The data below has been sourced from http://www.bloomberg.com.
| Common Stock Prices | Cash Dividends | Common Stock Prices | Cash Dividends | |||||||||||||||||||||||||||||||||||||
| High | Low | Close | Declared | Paid or Payable | Amount per Share | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2009 | ||||||||||||||||||||||||||||||||||||||||
| High | Low | Close | Declared | Paid or Payable | Amount Per Share | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2011 | ||||||||||||||||||||||||||||||||||||||||
| Fourth quarter | $ | 8.75 | $ | 5.74 | $ | 7.19 | 12/21/09 | 01/26/10 | $ | 0.25 | $ | 7.36 | $ | 6.22 | $ | 7.21 | 12/15/11 | 01/25/12 | $ | 0.35 | ||||||||||||||||||||
| Third quarter | 8.03 | 5.05 | 7.60 | 09/28/09 | 10/26/09 | 0.25 | 7.50 | 6.59 | 6.97 | 09/20/11 | 10/25/11 | 0.25 | ||||||||||||||||||||||||||||
| Second quarter | 5.97 | 2.23 | 5.16 | 06/14/09 | 07/27/09 | 0.23 | 7.93 | 6.49 | 7.45 | 05/31/11 | 06/27/11 | 0.22 | ||||||||||||||||||||||||||||
| First quarter | 3.80 | 1.82 | 3.80 | 03/25/09 | 04/27/09 | 0.18 | 7.43 | 6.88 | 7.07 | 03/18/11 | 04/26/11 | 0.18 | ||||||||||||||||||||||||||||
Common Stock Prices(1) | Cash Dividends | Common Stock Prices | Cash Dividends | |||||||||||||||||||||||||||||||||||||
| High | Low | Close | Declared | Paid or Payable | Amount per Share | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2008 | ||||||||||||||||||||||||||||||||||||||||
| High | Low | Close | Declared | Paid or Payable | Amount Per Share | |||||||||||||||||||||||||||||||||||
| Year Ended December 31, 2010 | ||||||||||||||||||||||||||||||||||||||||
| Fourth quarter | $ | 4.37 | $ | 1.51 | $ | 2.20 | 12/23/08 | 01/26/09 | $ | 0.10 | $ | 6.96 | $ | 6.23 | $ | 6.96 | 12/20/10 | 01/25/11 | $ | 0.18 | ||||||||||||||||||||
| Third quarter | 5.99 | 2.50 | 3.17 | 09/29/08 | 10/27/08 | 0.16 | 6.52 | 5.68 | 6.26 | 10/04/10 | 10/25/10 | 0.18 | ||||||||||||||||||||||||||||
| Second quarter | 6.24 | 4.00 | 6.20 | 06/30/08 | 07/25/08 | 0.16 | 7.77 | 6.51 | 6.62 | 06/16/10 | 07/26/10 | 0.18 | ||||||||||||||||||||||||||||
| First quarter | 9.80 | 4.40 | 5.40 | 04/21/08 | 05/15/08 | 0.12 | 8.03 | 6.54 | 7.55 | 03/16/10 | 04/26/10 | 0.25 | ||||||||||||||||||||||||||||
(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. | ||||||||||||||||||||||||||||||||||||||||
We intend to continue to pay quarterly dividends to holders of shares of common stock. Future dividendsdistributions will be at 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 our Board of Directors deems relevant.
| Declaration Date | Record Date | Payment Date | Cash Distribution per share | Income Dividends | Short-term Capital Gain | Total Taxable Ordinary Dividend | Return of Capital | |||||||||||||
| 12/23/08 | 01/07/09 | 01/26/09 | $ | 0.1000 | $ | 0.1000 | $ | 0.0000 | $ | 0.1000 | $ | 0.0000 | ||||||||
| 03/25/09 | 04/06/09 | 04/27/09 | $ | 0.1800 | $ | 0.1800 | $ | 0.0000 | $ | 0.1800 | $ | 0.0000 | ||||||||
| 06/14/09 | 06/26/09 | 07/27/09 | $ | 0.2300 | $ | 0.2300 | $ | 0.0000 | $ | 0.2300 | $ | 0.0000 | ||||||||
| 09/28/09 | 10/13/09 | 10/26/09 | $ | 0.2500 | $ | 0.2500 | $ | 0.0000 | $ | 0.2500 | $ | 0.0000 | ||||||||
| Total 2009 Cash Distributions | $ | 0.7600 | $ | 0.7600 | $ | 0.0000 | $ | 0.7600 | $ | 0.0000 | ||||||||||
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The Company 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 and currently has no intention to recommence repurchases in the near-term..near-future.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of December 31, 20092011 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 | — | $ | — | $ | 1,154,992 | |||||||
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We are a smaller reporting company and, therefore, are not required to provide the information required by this Item.
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| As of and For the Year Ended December 31, | ||||||||||||||||||||
| (Dollar amounts in thousands, except per share amounts) | 2009 | 2008 | 2007 | 2006 | 2005 | |||||||||||||||
| Operating Data: | ||||||||||||||||||||
| Revenues: | ||||||||||||||||||||
| Interest income | $ | 31,095 | $ | 44,123 | $ | 50,564 | $ | 64,881 | $ | 62,725 | ||||||||||
| Interest expense | 14,235 | 36,260 | 50,087 | 60,097 | 49,852 | |||||||||||||||
| Net interest income | 16,860 | 7,863 | 477 | 4,784 | 12,873 | |||||||||||||||
| Provision for loan losses | (2,262 | ) | (1,462 | ) | (1,683 | ) | (57 | ) | — | |||||||||||
| Realized gains (losses) on securities and related hedges | 3,282 | (19,977 | ) | (8,350 | ) | (529 | ) | 2,207 | ||||||||||||
| Impairment loss on investment securities | (119 | ) | (5,278 | ) | (8,480 | ) | — | (7,440 | ) | |||||||||||
| Total other income (expenses) | 901 | (26,717 | ) | (18,513 | ) | (586 | ) | (5,233 | ) | |||||||||||
| Expenses: | ||||||||||||||||||||
| Salaries and benefits | 2,118 | 1,869 | 865 | 714 | 1,934 | |||||||||||||||
| General and administrative expenses | 4,759 | 5,041 | 1,889 | 1,318 | 2,384 | |||||||||||||||
| Total expenses | 6,877 | 6,910 | 2,754 | 2,032 | 4,318 | |||||||||||||||
| Income (loss) before from continuing operations | 10,884 | (25,764 | ) | (20,790 | ) | 2,166 | 3,322 | |||||||||||||
| Income (loss) from discontinued operation – net of tax (1) | 786 | 1,657 | (34,478 | ) | (17,197 | ) | (8,662 | ) | ||||||||||||
| Net income (loss) | $ | 11,670 | $ | (24,107 | ) | $ | (55,268 | ) | $ | (15,031 | ) | $ | (5,340 | ) | ||||||
| Basic net income (loss) per share | $ | 1.25 | $ | (2.91 | ) | $ | (30.47 | ) | $ | (8.33 | ) | $ | (2.96 | ) | ||||||
| Diluted net income (loss) income per share | $ | 1.19 | $ | (2.91 | ) | $ | (30.47 | ) | $ | (8.33 | ) | $ | (2.96 | ) | ||||||
| Dividends declared per common share | $ | 0.91 | $ | 0.54 | $ | 0.50 | $ | 4.70 | $ | 9.20 | ||||||||||
| Balance Sheet Data: | ||||||||||||||||||||
| Cash and cash equivalents | $ | 24,522 | $ | 9,387 | $ | 5,508 | $ | 969 | $ | 9,056 | ||||||||||
| Investment securities available for sale | 176,691 | 477,416 | 350,484 | 488,962 | 716,482 | |||||||||||||||
| Mortgage loans held in securitization trusts | 276,176 | 346,972 | 428,030 | 587,535 | 780,670 | |||||||||||||||
| Assets related to discontinued operation (1) | 4,217 | 5,854 | 8,876 | 212,805 | 248,871 | |||||||||||||||
| Total assets | 488,814 | 853,300 | 808,606 | 1,321,979 | 1,789,943 | |||||||||||||||
| Financing arrangements, portfolio investments | 85,106 | 402,329 | 315,714 | 815,313 | 1,166,499 | |||||||||||||||
| Collateralized debt obligations | 266,754 | 335,646 | 417,027 | 197,447 | 228,226 | |||||||||||||||
| Subordinated debentures (net) | 44,892 | 44,618 | 44,345 | 44,071 | 43,650 | |||||||||||||||
| Convertible preferred debentures | 19,851 | 19,702 | — | — | — | |||||||||||||||
| Liabilities related to discontinued operation (1) | 1,778 | 3,566 | 5,833 | 187,705 | 231,925 | |||||||||||||||
| Total liabilities | 425,827 | 814,052 | 790,188 | 1,250,407 | 1,688,985 | |||||||||||||||
| Total stockholders’ equity | $ | 62,987 | $ | 39,248 | $ | 18,418 | $ | 71,572 | $ | 100,958 | ||||||||||
Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
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 use to finance our leveraged assets and our operating costs, which we refer to as our net interest income.over diverse economic conditions. We intend to achieve this objective by investing inthrough a broad classcombination of real estate-relatednet interest margin and financial assets, including those listed above, that in aggregate, will generate attractive risk-adjusted total returns for our stockholders.
Since 2009, we commencedhave endeavored to build a repositioning of ourdiversified investment portfolio to transition the portfolio from one primarily focused on leveraged Agency RMBS and prime ARM loans held in securitization trusts, which primarily involve interest rate risk, to a more diversified portfolio that includes elements of interest rate and credit risk, as we believe a portfolio diversified among interest rate and 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 reduced leverage. The repositioning included a reductionthis 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 the Agency RMBS held in our portfolio through the dispositioncomprised of $193.8 million of GSE-issued collateralizedIOs, which we sometimes refer to as Agency IOs, and CMBS backed by commercial mortgage obligation floating rate securities,loans on multi-family properties, which we refer to as “Agency CMO floaters”,multi-family CMBS. Our investment focus having moved away from the alternative assets sourced by HCS, our Board of Directors determined to terminate the advisory agreement with HCS on December 30, 2011, resulting in a net increaseone-time charge of approximately $27.5 million (par value) in our non-Agency RMBS position$2.2 million.
We believe we are well positioned heading into 2012 with seasoned investment managers, a focused residential strategy and our opportunistic purchase in March 2009 of discounted notes issued by a CLO.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 |
| · | multi-family CMBS. |
We have elected to be taxed as a REIT for federal income tax purposes commencingand have complied, and intend to continue to comply, with our taxable year ended on December 31, 2004. As a result,the provisions of the Internal Revenue Code, with respect thereto. Accordingly, we generally willdo not expect to be subject to federal income tax on our REIT taxable income that is distributedwe currently distribute to our stockholders.stockholders if certain asset, income and ownership tests and recordkeeping requirements are fulfilled. Even if we maintain our qualification as a REIT, we expect to be subject to some federal, state and local taxes on our income generated in our TRSs.
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 recovery on our assets or the mortgages or loans assets; |
| · | general economic and financial and credit market conditions; |
| · | our leverage, our access to funding and our borrowing costs; |
| · | our hedging activities; |
| · | 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 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 and other operating costs.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. With the maturities of our assets generally of longer duration than those of our liabilities, interest rate increases will tend to decrease the net interest income we derive from, and the market value of our interest rate sensitive assets (and therefore our book value), including Agency RMBS, prime ARM loans and certain non-Agency RMBS.. 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 relatedmortgage-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.
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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-agency RMBS and other investments. Ourmore credit-sensitive assets, such as our non-Agency RMBS, CMBS, equity investment in a pool of mortgage loans and CLOCLOs. These investments and certain of our targeted assets, as well as other assets that we may acquire from time-to-time, expose us to credit risk; however,risk and various market risks. To mitigate the credit support built into non-Agency RMBS deal structures is designed to provide a levelrisks associated with these assets, we may acquire more senior pieces of protection against potentialthe capital structure, purchase the assets at discounted prices or hedge with credit losses. In addition, the discounted purchase prices paid for the non-Agency RMBS and CLO investments in our portfolio provide further insulation from credit losses in the event, as we expect, that we receive less than 100% of par value on such assets.sensitive derivative instruments. Nevertheless, ifif credit losses on our investments, loans, or the loans underlying our investments exceed our expectations or our ability to adequately hedge against these losses, it may have an adverse effect on our performance and our earnings.
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.
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Current Market Conditions and Known Material TrendsCommentary
On August 5, 2011, Standard & Poor’s lowered its long term sovereign credit rating of the assets in our portfolio, and reduced available financing for certain assets. In responseU.S. from AAA to these conditions,AA+. The downgrade reflected Standard & Poor’s view that the fiscal consolidation plan of the U.S. Government, Federal Reserve, U.S. Treasury, FDIC and other governmental and regulatory bodies have taken or are considering taking other actions in an effortCongress at that time fell short of what would be necessary to stabilize the creditU.S. government’s medium term debt dynamics. In addition, many economists and financial markets and stimulateanalysts continue to believe that other rating agencies may lower their long term sovereign credit ratings of the economy. These actions include, among other things,U.S. in the conservatorship ofnear future. Because the guarantees provided by Fannie Mae and Freddie Mac EESA, TARP,are perceived by investors to be guaranteed by the CPP, TALF, ARRAU.S. government, if the U.S.’s credit rating were further downgraded or downgraded by other ratings agencies, it would likely impact the credit risk associated with Agency RMBS and, therefore, decrease the Homeowner Affordability and Stability Plan, or HASP. Although the impact from manyvalue of these actions remains uncertain, certain sectors have reported signs of stabilizing recently, including the Agency RMBS market.in our portfolio. Moreover, any further downgrade of the U.S.’s credit rating may create broader financial turmoil and uncertainty, which could have significant consequences for the global banking system and credit markets generally.
Recent Government Actions. Many political and 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 recent years, the U.S. Government and the Federal Reserve and other governmental regulatory bodies have, however, taken numerous actions to stabilize or improve market and economic conditions in the U.S. or to assist homeowners and may in the future take additional significant actions that may impact our portfolio and our business. A description of recent government actions that we believe are most relevant to our operations and business is included below:
| · | 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. |
| · | 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. |
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| · | 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 which we invest are guaranteed by Fannie Mae and Freddie Mac. Because of the guarantee and the underwriting standards associated with mortgages underlying Agency RMBS, they have historically had high price stability and been considered to present low credit risk. However, the recent turmoil in the residential mortgage sector severely weakened the financial condition ofAs broadly publicized, Fannie Mae and Freddie Mac. As a result, Agency RMBSMac have experienced increased price volatility. In responsesignificant 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 severely weakened financial conditionfuture of Fannie Mae and Freddie Mac are unknown and the corresponding impact that this weakened condition was having on the U.S. mortgage, creditwill continue to evolve. New regulations and financial markets, in 2008 the U.S. Government placedprograms related to Fannie Mae and Freddie Mac under federal conservatorship. In connection withmay adversely affect the placement of Fannie Maepricing, supply, liquidity and Freddie Mac in conservatorship, the U.S. Treasury agreed to provide certain financial support to these entities, including a larger-scale Agency RMBS purchasing program that is scheduled to terminate during the 2010 first quarter. We expect that the U.S. Government’s conservatorship of Fannie Mae and Freddie Mac will allow these institutions to continue to issue Agency RMBS. However, no assurance can be given that the conservatorship of Fannie Mae and Freddie Mac will continue to have a positive effect on the supply of Agency RMBS. For example, at a hearing on January 22, 2010, the Chairman of the House Financial Services Committee stated that the committee will be recommending to the U.S. Congress to abolish Fannie Mae and Freddie Mac in favor of a new system of providing housing finance.
Credit Quality. SpreadsThe deterioration. 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 factors, including concerns related to a possible global economic slowdown, the European sovereign debt crisis and continued concern with respect to certain U.S. housing marketdomestic economic policies. Additionally, HARP II has created a perception that prepayment speeds will rise in the near future, thereby placing additional pressure on credit spreads. Finally, during the third quarter of 2011 the 10 year U.S treasury note reached a yield of 1.72%, a historic low and increased only marginally during the fourth quarter of 2011. All of these factors have contributed to significant widening of credit spreads, which typically has a negative impact on credit-sensitive assets such as CLOs and multi-family CMBS, as well as the recent economic downturn have caused U.S. residential mortgage delinquency rates to remain at high levels for various types of mortgage loans. Recent months have seen some stabilization or improvement of certain measures of credit quality, although this stabilization and/or improvement may ultimately prove to be temporaryAgency IOs.
Financing markets and liquidity. Actions by the Federal Reserve and the U.S. Treasury over the past two years appear to have stabilized the financing and liquidity environment for Agency RMBS. The liquidity facilities created by the Federal Reserve during 2007 and 2008 and its lowering of the Federal Funds Target Rate to 0 – 0.25%, along with the reduction of the 30-day LIBOR to 0.23% as of December 31, 2009, have lowered our financing costs (which most closely correlates with the 30-day LIBOR) and stabilized the availability of repurchase agreement financing for Agency RMBS. Moreover, collateral requirements improved throughout 2009. However, available leverage for non-Agency RMBS and other financial assets has remained scarce during 2009 due to the recent conditions in the housing and credit markets. More recently, some investment banks have, to a limited extent, begun making term financing available for non-Agency RMBS. As of the date of this report, our investment in Agency RMBS and a CLO remained unlevered; however, should the prospects foris stable reliable and favorable repurchase agreement financing for non-Agency RMBS develop in the future, we would expect to increase our repurchase agreement borrowings collateralized by non-Agency RMBS.
Prepayment rates.rates. As a result of various government initiatives including HASP and the reduction in intermediate and longer-term treasury yields, rates on conforming mortgages have declined, nearingreached and remained at historical lows during 2009. Hybridthe second half of 2011 and adjustable-rate mortgage originationsinto early 2012. While these trends have declined substantially, ashistorically resulted in higher rates on these types of mortgages are comparable with rates available on 30-year fixed-rate mortgages. We experienced similarrefinancing and thus higher prepayment speeds, we continue to experience relatively low prepayment rates on both our Agency RMBS and prime ARM loans duringfor the second, third and fourth quarters of 2009. We expect speeds to be higher in the first half of 2010 due to the announced delinquent loan buyback program from Fannie Mae. We do not expect this will have a material impact on the Company.current interest rate environment.
Note Regarding Discontinued Operation
In connection with the sale of our wholesale and retail mortgage lending platform assets in the first quarter of 2007, during the fourth quarter of 2006, we classified our mortgage lending business as a discontinued operation. As a result, we have reported revenues and expenses related to the mortgage lending business as a discontinued operation and the related assets and liabilities as assets and liabilities related to a discontinued operation 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 are part of our ongoing operations and accordingly, we have not been classified as a discontinued operation. See note 8 in the notes to our consolidated financial statements.
The discontinued operations had net income of $0.8$0.1 million and $1.1 million for the yearyears ended December 31, 2009. The Company continues2011 and 2010, respectively. We continue to wind down the discontinued operations and anticipatesanticipate to be substantially complete with such winding down by the end of 2010.2012.
Financial Condition
As of December 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. At December 31, 20092011, our securities portfolio consists of Agency RMBS, Non-agencyincluding Agency ARM pass-through certificates and Agency IOs, CMBS, non-Agency RMBS originally rated AAA and Collateralized Loan Obligations.CLOs. At December 31, 2009,2011, we had no investment securities in a single issuer or entity, other than Fannie Mae, that had an aggregate book value in excess of 10% of our total assets. The following tables set forth the credit characteristicsbalances of our investment securities available for sale as of December 31, 20092011 and December 31, 2008:2010, respectively:
| December 31, 2009 | Sponsor or Rating (1) | Par Value | Carrying Value | % of Portfolio | Coupon | Yield | |||||||||||
| Credit | |||||||||||||||||
| Agency RMBS | FNMA | $ | 110,324 | $ | 116,226 | 65.8 | % | 5.14 | % | 2.37 | % | ||||||
| Non-Agency RMBS | AAA | 2,195 | 1,717 | 1.0 | % | 4.97 | % | 11.26 | % | ||||||||
| AA | 1,270 | 886 | 0.5 | % | 5.18 | % | 15.03 | % | |||||||||
| A | 364 | 321 | 0.2 | % | 4.43 | % | 4.92 | % | |||||||||
| BB | 13,384 | 11,336 | 6.3 | % | 1.65 | % | 12.79 | % | |||||||||
| B | 11,743 | 8,812 | 5.0 | % | 4.03 | % | 9.57 | % | |||||||||
| CCC or Below | 28,028 | 19,794 | 11.2 | % | 5.13 | % | 7.49 | % | |||||||||
| Collateralized Loan Obligation | BBB | 10,400 | 5,408 | 3.1 | % | 1.37 | % | 15.20 | % | ||||||||
| BB | 15,300 | 5,508 | 3.1 | % | 2.67 | % | 23.45 | % | |||||||||
| B | 20,250 | 6,683 | 3.8 | % | 5.27 | % | 30.22 | % | |||||||||
| Total/Weighted Average | $ | 213,258 | $ | 176,691 | 100.0 | % | 4.51 | % | 6.23 | % | |||||||
| December 31, 2008 | Sponsor or Rating (1) | Par Value | Carrying Value | % of Portfolio | Coupon | Yield | |||||||||||
| Credit | |||||||||||||||||
| Agency RMBS | FNMA/FHLMC | $ | 455,447 | $ | 455,871 | 95 | % | 3.67 | % | 5.99 | % | ||||||
| Non-Agency RMBS | AAA | 23,289 | 18,118 | 4 | % | 1.27 | % | 15.85 | % | ||||||||
| AA | 609 | 530 | 0 | % | 1.22 | % | 4.32 | % | |||||||||
| A | 3,648 | 2,828 | 1 | % | 2.30 | % | 4.08 | % | |||||||||
| CCC or Below | 2,058 | 69 | 0 | % | 5.67 | % | 20.33 | % | |||||||||
| Not Rated | 405 | — | 0 | % | 5.67 | % | 0 | % | |||||||||
| 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 | % | ||||||
Less than 6 Months | More than 6 Months To 24 Months | More than 24 Months To 60 Months | Total | |||||||||||||||||||||||||||||
| December 31, 2009 | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | Carrying Value | Weighted Average Yield | ||||||||||||||||||||||||
| Agency RMBS | $ | — | — | % | $ | 42,893 | 2.07 | % | $ | 73,333 | 2.54 | % | $ | 116,226 | 2.37 | % | ||||||||||||||||
| Non-Agency RMBS | 22,065 | 10.15 | % | 4,865 | 7.23 | % | 15,936 | 9.57 | % | 42,866 | 9.61 | % | ||||||||||||||||||||
| Collateralized Loan Obligation | 17,599 | 23.48 | % | — | — | % | — | — | % | 17,599 | 23.48 | % | ||||||||||||||||||||
| Total/Weighted Average | $ | 39,664 | 16.07 | % | $ | 47,758 | 2.60 | % | $ | 89,269 | 3.80 | % | $ | 176,691 | 6.23 | % | ||||||||||||||||
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 RMBS | $ | 197,675 | 8.54 | % | $ | 66,910 | 3.69 | % | $ | 191,286 | 4.02 | % | $ | 455,871 | 5.99 | % | ||||||||||||||||
| Non-Agency RMBS | 21,476 | 14.11 | % | — | — | % | 69 | 16.99 | % | 21,545 | 14.35 | % | ||||||||||||||||||||
| Total/Weighted Average | $ | 219,151 | 9.21 | % | $ | 66,910 | 3.69 | % | $ | 191,355 | 4.19 | % | $ | 477,416 | 6.51 | % | ||||||||||||||||
The following table details performanceour CMBS loan characteristics of our non-Agency RMBS portfolio(first loss securities) as of December 31, 2009 (amounts2011 (dollar amounts in thousands):thousands, except as noted). We did not invest in CMBS prior to 2011.
Acquired in 2009 | Acquired prior to 2009 | |||||||
| Current Par Value | $ | 38,682 | $ | 18,302 | ||||
| Collateral Type: | ||||||||
| Fixed Rate | $ | 3,738 | $ | 17,693 | ||||
| Arms | $ | 34,944 | $ | 609 | ||||
| Weighted average Purchase Price | 60.51 | % | 92.05 | % | ||||
| Weighted average Credit Support | 8.76 | % | 4.06 | % | ||||
| Weighted average 60++ Delinquencies (including 60+, REO and Foreclosure) | 20.61 | % | 3.66 | % | ||||
| Weighted average 3 month Constant Prepayment Rate | 16.24 | % | 17.46 | % | ||||
| Weighted average 3 month Voluntary Prepayment Rate | 9.78 | % | 15.84 | % | ||||
| 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 compositionComposition of loans securitizing our collateralized loan obligationsLoans Securitizing Our CLOs
The following tables summarize the loans securitizing our CLOs grouped by range of outstanding balance industry and Moody’s Investors Services, Inc's (“Moody’s”) rating categoryindustry as of December 31, 2009.2011 and 2010, respectively (dollar amounts in thousands).
As of December 31, 2009 (amounts in thousands) | ||||||||
| Range of Outstanding Balance | Number of Loans | Maturity Date | Total Principal | |||||
| $0 - $500,000 | 7 | 03/2014 - 03/2017 | $ | 3,471 | ||||
| $500,001 - $2,000,000 | 18 | 12/2011 - 12/2015 | 24,722 | |||||
| $2,000,001 - $5,000,000 | 55 | 5/2011 - 2/2016 | 198,895 | |||||
| $5,000,001 - $10,000,000 | 28 | 11/2010 - 10/2014 | 202,080 | |||||
| +$10,000,000 | 3 | 12/2009 - 10/2012 | 32,292 | |||||
| Total | 111 | $ | 461,460 | |||||
| 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 | |||||||||
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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% | ||||
48
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% | ||||
49
| As of December 31, 2009 | ||||||||||||
| Industry | Number of Loans | Outstanding Balance | % of Outstanding Balance | |||||||||
| (amounts in thousands) | ||||||||||||
| Healthcare, Education & Childcare | 14 | $ | 57,190 | 12.4 | % | |||||||
| Diversified/Conglomerate Service | 6 | 42,348 | 9.2 | % | ||||||||
| Personal, Food & Misc Services | 6 | 38,638 | 8.4 | % | ||||||||
| Electronics | 7 | 26,532 | 5.7 | % | ||||||||
| Printing & Publishing | 4 | 23,990 | 5.2 | % | ||||||||
| Telecommunications | 6 | 23,098 | 5.0 | % | ||||||||
| Insurance / Finance | 5 | 22,915 | 5.0 | % | ||||||||
| Utilities / Oil & Gas | 6 | 21,782 | 4.7 | % | ||||||||
| Personal & Non-Durable Consumer Products | 6 | 21,298 | 4.6 | % | ||||||||
| Retail Store | 6 | 21,211 | 4.6 | % | ||||||||
| Aerospace & Defense | 6 | 20,462 | 4.4 | % | ||||||||
| Cargo Transport / Personal Transportation | 3 | 19,499 | 4.2 | % | ||||||||
| Chemicals, Plastics and Rubber | 6 | 18,532 | 4.0 | % | ||||||||
| Hotels, Motels, Inns and Gaming | 4 | 18,183 | 3.9 | % | ||||||||
| Broadcasting & Entertainment | 3 | 16,496 | 3.6 | % | ||||||||
| Beverage, Food & Tobacco | 6 | 15,880 | 3.4 | % | ||||||||
| Leisure, Amusement, Motion Pictures & Entertainment | 4 | 11,146 | 2.4 | % | ||||||||
| Other | 13 | 42,260 | 9.3 | % | ||||||||
| Total | 111 | $ | 461,460 | 100.0 | % | |||||||
| As of December 31, 2009 | ||||||||||||
| Moody's Rating Category | Number of Loans | Outstanding Balance | % of Outstanding Balance | |||||||||
| (amounts in thousands) | ||||||||||||
| Baa3 | 2 | $ | 6,955 | 1.5 | % | |||||||
| Ba1 | 9 | 28,242 | 6.1 | % | ||||||||
| Ba2 | 9 | 26,418 | 5.7 | % | ||||||||
| Ba3 | 15 | 44,374 | 9.6 | % | ||||||||
| B1 | 17 | 51,355 | 11.1 | % | ||||||||
| B2 | 28 | 106,325 | 23.0 | % | ||||||||
| B3 | 21 | 137,531 | 29.8 | % | ||||||||
| Caa1 | 5 | 23,850 | 5.2 | % | ||||||||
| Caa2 | 3 | 26,311 | 5.7 | % | ||||||||
| Caa3 | 1 | 540 | 0.1 | % | ||||||||
| D | 1 | 9,559 | 2.2 | % | ||||||||
| Total | 111 | $ | 461,460 | 100.0 | % | |||||||
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 and that we subsequently securitized. The Company hasWe have completed four securitizations; three were classified as financings and one, New York Mortgage Trust 2006-1, qualified as a sale, which resulted in the recording of residual assets and mortgage servicing rights. The Company sold all the residual assets related to the 2006-1 securitization during the third quarter ended September 30, 2009 incurring a realized loss of approximately $32,000.
At December 31, 2009,2011, mortgage loans held in securitization trusts totaled approximately $276.2$206.9 million, or 56.5%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, 2011. Of the mortgage loans held in securitized trusts, 100% are traditional ARMs or hybrid ARMs, 80.9%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 period is typically 10 years, which mitigates the “payment shock” at the time of interest rate reset. None 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, 20092011 and December 31, 20082010, 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 | |||||||||
| # of Loans | Par Value | Coupon | Carrying Value | Yield | ||||||||||||||||
| December 31, 2009 | 647 | $ | 277,007 | 5.19 | % | $ | 276,176 | 5.40 | % | |||||||||||
| December 31, 2008 | 789 | $ | 345,619 | 5.56 | % | $ | 346,972 | 3.96 | % | |||||||||||
Characteristics of Our Mortgage Loans Held in Securitization:
The following table sets forth the composition of our loans held in securitization trusts as of December 31, 20092011 (dollar amounts in thousands):
| 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 (dollar amounts in thousands) | $ | 456 | $ | 2,950 | $ | 48 | |||||
| Current Coupon Rate | 5.19 | % | 7.25 | % | 1.38 | % | |||||
| Gross Margin | 2.37 | % | 5.00 | % | 1.13 | % | |||||
| Lifetime Cap | 11.26 | % | 13.25 | % | 9.13 | % | |||||
| Original Term (Months) | 360 | 360 | 360 | ||||||||
| Remaining Term (Months) | 304 | 312 | 271 | ||||||||
| Average Months to Reset | 6 | 12 | 1 | ||||||||
| Original Average FICO Score | 732 | 820 | 593 | ||||||||
| Original Average LTV (% of original home value) | 70.3 | 95.0 | 13.9 | ||||||||
| % of Outstanding Loan Balance | Weighted Average Gross Margin (%) | |||||||
| General Loan Characteristics: | ||||||||
| One Month Libor | 3.0 | % | 1.67 | % | ||||
| Six Month Libor | 71.8 | % | 2.40 | % | ||||
| One Year Libor | 16.6 | % | 2.27 | % | ||||
| One Year CMT | 8.6 | % | 2.66 | % | ||||
| Total / Weighted Average | 100.0 | % | 2.37 | % | ||||
The following tablestable sets forth the composition of our loans held in securitization trusts and loans backing the retained interests from our securitizations as of December 31, 20082010 (dollar amounts in thousands):
| 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 | % | ||||||
| Average | High | Low | |||||||||
| General Loan Characteristics: | |||||||||||
| Original Loan Balance (dollar amounts in thousands) | $ | 468 | $ | 3,500 | $ | 48 | |||||
| Current Coupon Rate | 5.56 | % | 8.13 | % | 4.00 | % | |||||
| Gross Margin | 2.36 | % | 5.00 | % | 1.13 | % | |||||
| Lifetime Cap | 11.21 | % | 13.38 | % | 9.13 | % | |||||
| Original Term (Months) | 360 | 360 | 360 | ||||||||
| Remaining Term (Months) | 316 | 324 | 283 | ||||||||
| Average Months to Reset | 15 | 24 | 1 | ||||||||
| Original Average FICO Score | 735 | 820 | 593 | ||||||||
| Original Average LTV (% of original home value) | 69.6 | 95.0 | 13.9 | ||||||||
| % 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 | % | ||||
| % of Outstanding Loan Balance | Weighted Average Gross Margin (%) | |||||
| General Loan Characteristics: | ||||||
| One Month Libor | 2.6 | % | 1.69 | % | ||
| Six Month Libor | 71.6 | % | 2.41 | % | ||
| One Year Libor | 16.3 | % | 2.27 | % | ||
| One Year CMT | 9.5 | % | 2.65 | % | ||
| Total / Weighted Average | 100.0 | % | 2.39 | % |
The following table details loan summary information for loans held in securitization trusttrusts at December 31, 2009 (all2011 (dollar amounts in thousands):
| 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 | 11 | 5.88 | 3.38 | 4.97 | 12/01/34 | 11/01/35 | 360 | NA | $ | 1,724 | $ | 766 | $ | - | ||||||||||||||
| FAMILY | <= $250,000 | 71 | 7.25 | 3.13 | 5.33 | 09/01/32 | 12/01/35 | 360 | NA | 14,605 | 12,765 | 640 | |||||||||||||||||
| �� | <= $500,000 | 121 | 7.13 | 2.75 | 5.21 | 10/01/32 | 01/01/36 | 360 | NA | 45,220 | 42,278 | 5,471 | |||||||||||||||||
| <=$1,000,000 | 50 | 6.38 | 1.63 | 4.99 | 12/01/34 | 12/01/35 | 360 | NA | 38,363 | 36,553 | 2,186 | ||||||||||||||||||
| >$1,000,000 | 26 | 6.25 | 1.50 | 5.47 | 01/01/35 | 01/01/36 | 360 | NA | 45,082 | 44,329 | 6,246 | ||||||||||||||||||
| Summary | 279 | 7.25 | 1.50 | 5.22 | 09/01/32 | 01/01/36 | 360 | NA | $ | 144,994 | $ | 136,691 | $ | 14,543 | |||||||||||||||
| 2-4 | <= $100,000 | 1 | 6.63 | 6.63 | 6.63 | 02/01/35 | 02/01/35 | 360 | NA | $ | 80 | $ | 75 | $ | 76 | ||||||||||||||
| FAMILY | <= $250,000 | 6 | 6.75 | 4.38 | 5.75 | 12/01/34 | 07/01/35 | 360 | NA | 1,115 | 996 | - | |||||||||||||||||
| <= $500,000 | 18 | 7.25 | 2.13 | 4.98 | 09/01/34 | 01/01/36 | 360 | NA | 6,262 | 6,012 | 254 | ||||||||||||||||||
| <=$1,000,000 | 3 | 5.75 | 4.63 | 5.25 | 12/01/34 | 08/01/35 | 360 | NA | 2,540 | 2,539 | - | ||||||||||||||||||
| >$1,000,000 | 0 | - | - | - | - | - | 360 | NA | - | - | - | ||||||||||||||||||
| Summary | 28 | 7.25 | 2.13 | 5.23 | 09/01/34 | 01/01/36 | 360 | NA | $ | 9,997 | $ | 9,622 | $ | 330 | |||||||||||||||
| Condo | <= $100,000 | 16 | 6.38 | 3.00 | 4.99 | 01/01/35 | 12/01/35 | 360 | NA | $ | 2,707 | $ | 1,150 | $ | - | ||||||||||||||
| <= $250,000 | 82 | 6.50 | 2.88 | 5.37 | 08/01/32 | 01/01/36 | 360 | NA | 15,859 | 14,747 | 1,024 | ||||||||||||||||||
| <= $500,000 | 74 | 6.88 | 1.50 | 4.93 | 09/01/32 | 12/01/35 | 360 | NA | 25,467 | 24,445 | 919 | ||||||||||||||||||
| <=$1,000,000 | 27 | 6.13 | 1.63 | 5.08 | 08/01/33 | 11/01/35 | 360 | NA | 19,442 | 18,490 | 546 | ||||||||||||||||||
| > $1,000,000 | 12 | 6.13 | 3.88 | 5.44 | 07/01/34 | 09/01/35 | 360 | NA | 18,773 | 18,186 | 1,669 | ||||||||||||||||||
| Summary | 211 | 6.88 | 1.50 | 5.15 | 08/01/32 | 01/01/36 | 360 | NA | $ | 82,248 | $ | 77,018 | $ | 4,158 | |||||||||||||||
| CO-OP | <= $100,000 | 4 | 5.50 | 3.00 | 4.56 | 09/01/34 | 06/01/35 | 360 | NA | $ | 1,350 | $ | 221 | $ | - | ||||||||||||||
| <= $250,000 | 21 | 6.13 | 2.88 | 5.02 | 10/01/34 | 12/01/35 | 360 | NA | 4,089 | 3,662 | 212 | ||||||||||||||||||
| <= $500,000 | 34 | 6.38 | 1.38 | 5.02 | 08/01/34 | 12/01/35 | 360 | NA | 13,817 | 12,474 | - | ||||||||||||||||||
| <=$1,000,000 | 16 | 5.63 | 4.75 | 5.40 | 11/01/34 | 11/01/35 | 360 | NA | 11,284 | 11,082 | - | ||||||||||||||||||
| > $1,000,000 | 5 | 6.00 | 2.25 | 4.38 | 11/01/34 | 12/01/35 | 360 | NA | 7,544 | 6,992 | - | ||||||||||||||||||
| Summary | 80 | 6.38 | 1.38 | 5.12 | 08/01/34 | 12/01/35 | 360 | NA | $ | 38,084 | $ | 34,431 | $ | 212 | |||||||||||||||
| PUD | <= $100,000 | 1 | 5.63 | 5.63 | 5.63 | 07/01/35 | 07/01/35 | 360 | NA | $ | 100 | $ | 94 | $ | - | ||||||||||||||
| <= $250,000 | 20 | 6.50 | 2.75 | 5.23 | 01/01/35 | 12/01/35 | 360 | NA | 4,439 | 3,836 | - | ||||||||||||||||||
| <= $500,000 | 21 | 6.88 | 2.75 | 4.78 | 08/01/32 | 12/01/35 | 360 | NA | 7,168 | 6,857 | 183 | ||||||||||||||||||
| <=$1,000,000 | 5 | 5.88 | 3.40 | 4.83 | 09/01/33 | 12/01/35 | 360 | NA | 3,432 | 3,286 | 455 | ||||||||||||||||||
| > $1,000,000 | 4 | 6.13 | 3.22 | 5.21 | 04/01/34 | 12/01/35 | 360 | NA | 5,233 | 5,172 | - | ||||||||||||||||||
| Summary | 51 | 6.88 | 2.75 | 5.01 | 08/01/32 | 01/01/36 | 360 | NA | $ | 20,372 | $ | 19,245 | $ | 638 | |||||||||||||||
| Summary | <= $100,000 | 33 | 6.63 | 3.00 | 5.00 | 10/01/34 | 12/01/35 | 360 | NA | $ | 5,961 | $ | 2,306 | $ | 76 | ||||||||||||||
| <= $250,000 | 200 | 7.25 | 2.75 | 5.32 | 08/01/32 | 01/01/36 | 360 | NA | 40,107 | 36,006 | 2,059 | ||||||||||||||||||
| <= $500,000 | 268 | 7.25 | 1.38 | 5.21 | 08/01/32 | 01/01/36 | 360 | NA | 97,934 | 92,066 | 7,099 | ||||||||||||||||||
| <=$1,000,000 | 101 | 6.38 | 1.63 | 5.08 | 07/01/33 | 12/01/35 | 360 | NA | 75,061 | 71,950 | 2,732 | ||||||||||||||||||
| > $1,000,000 | 47 | 6.25 | 1.50 | 5.32 | 04/01/34 | 01/01/36 | 360 | NA | 76,632 | 74,679 | 7,915 | ||||||||||||||||||
| Grand Total | 649 | 7.25 | 1.38 | 5.19 | 08/01/32 | 01/01/36 | 360 | NA | $ | 295,695 | $ | 277,007 | $ | 19,881 | |||||||||||||||
| Description | Interest Rate | Final Maturity | Periodic Payment | Original Amount | Current Amount | Principal Amount of Loans Subject to Delinquent | ||||||||||||||||||||||||||||||||||||
Property Type | Balance | Loan Count | Max | Min | Avg | Min | Max | Term (months) | Prior Liens | of Principal | of Principal | or Interest | ||||||||||||||||||||||||||||||
| 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 | ||||||||||||||||||||||||||||
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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 Subject to Delinquent | ||||||||||||||||||||||||||||||||||||
Property Type | Balance | Loan Count | Max | Min | Avg | Min | Max | Term (months) | Prior Liens | of Principal | of Principal | or Interest | ||||||||||||||||||||||||||||||
| 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 | ||||||||||||||||||||||||||||
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The following table details activity for loans held in securitization trusttrusts (net) for the year ended December 31, 2009.
| Principal | Premium | Allowance for Loan Losses | Net Carrying Value | |||||||||||||
| Balance, December 31, 2008 | $ | 345,619 | $ | 2,197 | $ | (844 | ) | $ | 346,972 | |||||||
| Additions | — | — | — | — | ||||||||||||
| Principal repayments | (67,380 | ) | — | — | (67,380 | ) | ||||||||||
| Provision for loan loss | — | — | (2,192 | ) | (2,192 | ) | ||||||||||
| Transfer to real estate owned | (1,232 | ) | — | 406 | (826 | ) | ||||||||||
| Charge-Offs | — | — | 49 | 49 | ||||||||||||
| Amortization for premium | — | (447 | ) | — | (447 | ) | ||||||||||
| Balance, December 31, 2009 | $ | 277,007 | $ | 1,750 | $ | (2,581 | ) | $ | 276,176 | |||||||
| 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 | |||||||
| 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 of Our Mortgage Loans Held in Securitization Trusts (net)(Net). In addition we had two REO properties totaling approximately $0.7 million included in prepaid and other assets. The number of delinquent loans in our securitization trusts was significantly higher asAs of December 31, 20092011, we had 38 delinquent loans totaling approximately $21.0 million categorized as compared to delinquencies asmortgage 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, 2008. The increase was due,2011 and 2010 are the same loans as the foreclosure process can take multiple years to be completed, particularly in part,certain states, including New York, Massachusetts and New Jersey. Loans originated in judicial states are required to higher delinquency rates nationally, which equaled approximately 9.5%go through the supervision of all loans outstanding as of the end of the 2009 fourth quarter, and also as a result of the services of our loans treating as delinquent certain of the loans in our portfolio that are subject to, temporary modification plans. Excluding this treatment of loans subject to temporary modification plans the delinquency rate on the loans held in our securitization trusts as of December 31, 2009 would have been lower.court for foreclosure resolution. The table below shows delinquencies in our loan portfolio of loans held in securitization trusts as of December 31, 20092011 (dollar amounts in thousands):
| Days Late | Number of Delinquent Loans | Total Dollar Amount | % of Loan Portfolio | Number of Delinquent Loans | Total Dollar Amount | % of Loan Portfolio | ||||||||||||||
| 30-60 | 5 | $ | 2,816 | 1.01 | % | 2 | $ | 517 | 0.25 | % | ||||||||||
| 61-90 | 4 | $ | 1,150 | 0.41 | % | 1 | $ | 378 | 0.18 | % | ||||||||||
| 90+ | 32 | $ | 15,915 | 5.73 | % | 35 | $ | 20,138 | 9.61 | % | ||||||||||
| Real Estate Owned (REO) | 2 | $ | 739 | 0.27 | % | 3 | $ | 656 | 0.31 | % | ||||||||||
As of December 31, 2008,2010, we had 1746 delinquent loans totaling approximately $7.4$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, 20082010 (dollar amounts in thousands):
| Days Late | Number of Delinquent Loans | Total Dollar Amount | % of Loan Portfolio | Number of Delinquent Loans | Total Dollar Amount | % of Loan Portfolio | ||||||||||||||
| 30-60 | 3 | $ | 1,363 | 0.39 | % | 7 | $ | 2,515 | 1.09 | % | ||||||||||
| 61-90 | 1 | $ | 263 | 0.08 | % | 4 | $ | 4,362 | 1.89 | % | ||||||||||
| 90+ | 13 | $ | 5,734 | 1.65 | % | 35 | $ | 18,191 | 7.90 | % | ||||||||||
| Real Estate Owned (REO) | 4 | $ | 1,927 | 0.55 | % | 3 | $ | 894 | 0.39 | % | ||||||||||
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.
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Equity Investment in Limited Partnership. The following table details loan summary information for loans held in the limited partnership in which we have an equity interest as of December 31, 2011 and 2010, respectively, which is accounted for under the equity method (dollar amounts in thousands):
| 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, 2009,2011, there were approximately $85.1$112.7 million of repurchase agreement borrowings outstanding. Our repurchase agreements typically provide forhave terms of 30 days.days or less. As of December 31, 2009,2011, the current weighted average borrowing rate on these financing facilities was 0.27%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, 2009,2011, we had $266.8$199.8 million of collateralized debt obligations, or CDOs, outstanding with a weighted average interest rate of 0.61%0.68%.
Subordinated Debentures. As of December 31, 2009,2011, one of our wholly owned subsidiary, HC,subsidiaries had trust preferred securities outstanding of $44.9 million net of deferred bond issuance costs of $0.1$45.0 million with a weighted average interest rate of 5.93%4.35%. The securities are fully guaranteed by our 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 our consolidated balance sheet.sheet included in this Annual Report.
Convertible Preferred Debentures. At December 31, 2009 we had $19.9The Company issued $20.0 million of convertible preferred debentures outstanding, net of $0.1 million of deferred debt issuance cost. We issued these shares ofin Series A 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 quarterly common stock dividends exceed $0.20 per share. The current dividend rate is 12.5% based on the fourth quarter common stock dividend of $0.25. The Series A Preferred Stock is 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. Any shares of Series AConvertible Preferred Stock that remain outstandingmatured on December 31, 2010 must be2010. The outstanding shares were redeemed in exchange forby the Company at the $20.00 per share liquidation amount, which is $20.0 millionpreference plus all accrued and unpaid dividends. Because of this mandatory redemption feature, we classify these securities as a liabilitydividends on our balance sheet.December 31, 2010.
55
Derivative Assets and LiabilitiesLiabilities. .We generally hedge the riskrisks related to changes in the benchmark interest rate used in the variable rate index, usually a London Interbank Offered Rate (“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 fee,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 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 not guarantycannot guarantee we do not have counterparty failures.
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, 20092011 and December 31, 20082010, respectively (dollar amounts in thousands):
December 31, 2009 | December 31, 2008 | |||||||
| Derivative assets: | ||||||||
| Interest rate caps | $ | 4 | $ | 22 | ||||
| Total derivative assets | $ | 4 | $ | 22 | ||||
| Derivative liabilities: | ||||||||
| Interest rate swaps | $ | 2,511 | $ | 4,194 | ||||
| Total derivative liabilities | $ | 2,511 | $ | 4,194 | ||||
| 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.
56
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, 20092011 was $63.0$85.3 million and included $11.8$11.3 million of netaccumulated other comprehensive income. The accumulated other comprehensive income consisted of $12.8 million in unrealized gains $2.9primarily related to our CLOs, $1.2 million in unrealized losses related 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 $14.7included $17.7 million of accumulated other comprehensive income. The accumulated other comprehensive income consisted of $18.8 million in unrealized gains primarily related to available for sale securities presented as accumulated other comprehensive income.our CLOs and $1.1 million in unrealized derivative losses related to cash flow hedges.
Analysis of Changes in Book Value
| 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”). |
Statement of Operations Analysis
The following is a brief description of key terms from our statements of operations:
Other Incomeincome (expense). Other income (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 income (expense) includestrusts, impairment losses on investment securities, net realized gains (losses) from the sale of investments securities or the early termination of interest rate swaps.and related hedges, net unrealized losses on investment securities and related hedges associated with our Agency IOs and income from our investment in a limited partnership and limited liability company.
Income (loss) from discontinued operation. Income (loss) from discontinued operations includes all revenues and expenses related to our discontinued mortgage lending business excluding those costs that will be retained by us. See note 8 to our consolidated financial statements included in this Annual Report on Form 10-K for more information regarding our discontinued operations.business.
57
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 due 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 the termination of its advisory agreement with HCS, which negatively impacted net income for the 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 compared 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 Company’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 credit sensitive securities of approximately $0.12 per share, the net loss for the fourth quarter of $0.16 per share and dividends of $0.35 per share. The decline in book 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 Company’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 investment 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 income 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 and 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, which 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 CLOs, Agency IOs and multi-family CMBS at December 31, 2011. However, while the markets anticipated an escalation in 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.
58
Results of Operations - Comparison of Years Ended December 31, 2009, 20082011 and 20072010
| (dollar amounts in thousands) | For the Years Ended December 31, | |||||||||||||||||||
| 2009 | 2008 | % Change | 2007 | % Change | ||||||||||||||||
| Net interest income | $ | 16,860 | $ | 7,863 | 114.4 | % | $ | 477 | 1,548.4 | % | ||||||||||
| Other income (expense) | $ | 901 | $ | (26,717 | ) | (103.4 | )% | $ | (18,513 | ) | 44.3 | % | ||||||||
| Total expenses | $ | 6,877 | $ | 6,910 | (0.5 | )% | $ | 2,754 | 150.9 | % | ||||||||||
| Income (loss) for continuing operations | $ | 10,884 | $ | (25,764 | ) | (142.2 | )% | $ | (20,790 | ) | 23.9 | % | ||||||||
| Income (loss) from discontinued operations | $ | 786 | $ | 1,657 | (52.6 | )% | $ | (34,478 | ) | (104.8 | )% | |||||||||
| Net gain (loss) | $ | 11,670 | $ | (24,107 | ) | (148.4 | )% | $ | (55,268 | ) | (56.4 | )% | ||||||||
| Basic gain (loss) per share | $ | 1.25 | $ | (2.91 | ) | (143.0 | )% | $ | (30.47 | ) | (90.4 | )% | ||||||||
| Diluted gain (loss) per share | $ | 1.19 | $ | (2.91 | ) | (140.9 | )% | $ | (30.47 | ) | (90.4 | )% | ||||||||
| (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, 2009,2011, we reported net income attributable to common stockholders of $11.7$4.8 million as compared to a net loss of $24.1$6.8 million for the year ended December 31, 2008, which represents a $35.82010. The $2.0 million improvement. The increasedecrease in net income was due primarily to significantly improved operating conditions, a first quarter 2009 portfolio restructuring that resulted$9.7 million increase in increased portfolio yields,net unrealized loss on investment securities and reduced borrowing costs that have resulted fromrelated hedges, a lower interest rate environment. The large realized lossone-time termination fee of $2.2 million recorded in 2008 was primarily a resultconnection with the termination of the March 2008 market disruption and the Company’s response to that disruption. The Company sold an aggregate of $592.8HCS Advisory Agreement, a $1.1 million of Agency RMBS in its portfolio during March 2008 in an effort to reduce its leverage and improve its liquidity position in response to the market disruption and incurred a loss of $15.0 million. In addition, the Company terminated a total of $517.7 million of notional interest rate swaps in the quarter ended March 31, 2008, resulting in a realized loss of $4.8 million.
| For the years ended December 31, | ||||||||||||||||||||||||||||||||||||
| 2009 | 2008 | 2007 | ||||||||||||||||||||||||||||||||||
Average Balance | Amount | Yield/ Rate | Average Balance | Amount | Yield/ Rate | Average Balance | Amount | Yield/ Rate | ||||||||||||||||||||||||||||
| ($Millions) | ($Millions) | ($Millions) | ||||||||||||||||||||||||||||||||||
| Interest Income: | ||||||||||||||||||||||||||||||||||||
| Investment securities and loans held in the securitization trusts | $ | 643.2 | $ | 30,085 | 4.68 | % | $ | 907.3 | $ | 44,778 | 4.94 | % | $ | 907.0 | $ | 52,180 | 5.74 | % | ||||||||||||||||||
| Amortization of net premium | (31.3 | ) | 1,010 | 0.40 | % | 1.4 | (655 | ) | (0.08 | )% | 2.4 | (1,616 | ) | (0.18 | %) | |||||||||||||||||||||
| Interest income | $ | 611.9 | $ | 31,095 | 5.08 | % | $ | 908.7 | $ | 44,123 | 4.86 | % | $ | 909.4 | $ | 50,564 | 5.56 | % | ||||||||||||||||||
| Interest Expense: | ||||||||||||||||||||||||||||||||||||
| Investment securities and loans held in the securitization trusts | $ | 537.0 | $ | 8,572 | 1.57 | % | $ | 820.5 | $ | 30,351 | 3.65 | % | $ | 864.7 | $ | 46,529 | 5.31 | % | ||||||||||||||||||
| Subordinated debentures | 45.0 | 3,189 | 6.99 | % | 45.0 | 3,760 | 8.24 | % | 45.0 | 3,558 | 7.80 | % | ||||||||||||||||||||||||
| Convertible preferred debentures | 20.0 | 2,474 | 12.20 | % | 20.0 | 2,149 | 10.60 | % | — | — | — | |||||||||||||||||||||||||
| Interest expense | $ | 602.0 | $ | 14,235 | 2.33 | % | $ | 885.5 | $ | 36,260 | 4.09 | % | $ | 909.7 | $ | 50,087 | 5.43 | % | ||||||||||||||||||
| Net interest income | $ | 16,860 | 2.75 | % | $ | 7,863 | 0.77 | % | $ | 477 | 0.13 | % | ||||||||||||||||||||||||
related hedges. The increase in net interest income for the year ended December 31, 20092011 as compared to the year ended December 31, 20082010 was primarily due to a 281 basis point increase in net interest income spread, which was mainly due to the result of the restructuringperformance 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 portfolio during 2009, which includedand 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 sale of $193.8 million of lower yielding Agency CMO floaters, the purchase of $46.0 million of CLO's that generally return a higher-yield than the Agency CMO floaters we sold and the addition of approximately $27.5 million of non-Agency RMBS at a discounted price of 60% of par value. In addition, our loans held in securitization trusts, contributed to the improvementand a $0.4 million increase in net interest incomerealized gain on securities and related hedges. Included in our total realized gains of $5.7 million for the year ended December 31, 2009. Our portfolio2011 is a $4.7 million gain on the sale of loans held in securitization trusts realized net margins of approximately 387 basis points for the year ended December 31, 2009.CLOs.
59
Comparative Net Interest Income
Our results of operations for our mortgageinvestment portfolio management business during a given period typically reflectreflects the net interest spreadincome earned on our investment portfolio of residential mortgageAgency and non-Agency RMBS, CMBS, prime ARM loans held in securitization trusts, loans held for investment, loans held for sale, CLOs, and U.S. Treasury securities and loans as well as CLO.(our “Interest Earning Assets”). The net interest spread is impacted by factors such as our cost of financing, the interest rate that our investments are earningbear and our interest rate hedging strategies. Furthermore, the cost of loans held in our portfolio, the amount of premium or discount paid on purchased portfolio investments and the prepayment rates on portfolio investments will impact the net interest spread as such factors will be amortized over the expected term of such investments.
| Quarter Ended | Average Interest Earning Assets ($ millions) | Weighted Average Coupon | Weighted Average Cash Yield on Interest Earning Assets | Cost of Funds | Net Interest Spread | Constant Prepayment Rate (CPR) | |||||||
| December 31, 2009 | $ | 476.8 | 4.75% | 5.78% | 1.45% | 4.33% | 18.1% | ||||||
| September 30, 2009 | $ | 571.0 | 4.98 % | 5.60 % | 1.47 % | 4.13 % | 22.5 % | ||||||
| June 30, 2009 | $ | 600.5 | 4.99 % | 5.09 % | 1.48 % | 3.61 % | 21.4 % | ||||||
| March 31, 2009 | $ | 797.2 | 4.22 % | 4.31 % | 1.79 % | 2.52 % | 12.3 % | ||||||
| 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 % | ||||||
| For the Year Ended December 31, | ||||||||||||||||||||
| (dollar amounts in thousands) | 2009 | 2008 | % Change | 2007 | % Change | |||||||||||||||
| Salaries and benefits | $ | 2,118 | $ | 1,869 | 13.3 | % | $ | 865 | 116.1 | % | ||||||||||
| Professional fees | 1,284 | 1,212 | 5.9 | % | 612 | 98.0 | % | |||||||||||||
| Insurance | 524 | 948 | (44.7 | )% | 474 | 100.0 | % | |||||||||||||
| Management fees | 1,252 | 665 | 88.3 | % | — | 100.0 | % | |||||||||||||
| Other | 1,699 | 2,216 | (23.3 | )% | 803 | 176.0 | % | |||||||||||||
| Total Expenses | $ | 6,877 | $ | 6,910 | (0.5 | )% | $ | 2,754 | 150.9 | % | ||||||||||
income data set forth below. The following tables set forth the changes in expensesnet interest income, yields earned on our Interest Earning Assets and rates on financing arrangements for each of the yearyears ended December 31, 20092011 and 2010, respectively (dollar amounts in thousands, except as compared to the year ended December 31, 2008 are due to the following: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 | % | ||||||||||||||||
| Our average balance of Interest Earning Assets is calculated each period as the daily average balance for |
| (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 | % | ||||||||||||
| 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 |
| (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. |
| Discontinued Operations | ||||||||||||||||||||
| For the Year Ended December 31, | ||||||||||||||||||||
| (dollar amounts in thousands) | 2009 | 2008 | % Change | 2007 | % Change | |||||||||||||||
| Revenues: | ||||||||||||||||||||
| Net interest income | $ | 235 | $ | 419 | (43.9 | )% | $ | 1,070 | (60.8 | )% | ||||||||||
| Gain on sale of mortgage loans | — | 46 | (100.0 | )% | 2,561 | (98.2 | )% | |||||||||||||
| Loan losses | (280 | ) | (433 | ) | (35.3 | )% | (8,874 | ) | (95.1 | )% | ||||||||||
| Brokered loan fees | — | — | — | 2,318 | (100.0 | )% | ||||||||||||||
| Gain on sale of retail lending segment | — | — | — | 4,368 | (100.0 | )% | ||||||||||||||
| Other income (expense) | 1,290 | 1,463 | (11.8 | )% | (67 | ) | 2,283.6 | % | ||||||||||||
| Total net revenues | $ | 1,245 | $ | 1,495 | (16.7 | )% | $ | 1,376 | 8.6 | % | ||||||||||
| Expenses: | ||||||||||||||||||||
| Salaries, commissions and benefits | $ | 4 | $ | 63 | (93.7 | )% | $ | 7,209 | (99.1 | )% | ||||||||||
| Brokered loan expenses | — | — | — | 1,731 | (100.0 | )% | ||||||||||||||
| Occupancy and equipment | 1 | (559 | ) | 100.2 | % | 1,819 | (130.7 | )% | ||||||||||||
| General and administrative | 454 | 334 | 35.9 | % | 6,743 | (95.0 | )% | |||||||||||||
| Total expenses | 459 | (162 | ) | 383.3 | % | 17,502 | (100.9 | )% | ||||||||||||
| Income (loss) before income tax (provision) benefit | 786 | 1,657 | (52.6 | )% | (16,126 | ) | (110.3 | )% | ||||||||||||
| Income tax (provision) benefit | — | — | — | (18,352 | ) | (100.0 | )% | |||||||||||||
| Gain (loss) from discontinued operations – net of tax | $ | 786 | $ | 1,657 | (52.6 | ) % | $ | (34,478 | ) | 104.8 | % | |||||||||
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| 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 History 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 that contain mortgages which are eligible for refinancing and thus may be prepaid under HARP II given the parameters of the program.
HARP II Eligible Agency RMBS (Collateralized by loans originated prior to June 2009)
| 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%.
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Non-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 not maintained any relationships withbeen reconciled to the nearest GAAP measure.
Comparative Net 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 entities or financial partnerships,investments in interest earning assets, such as entities often referredour 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 structured finance or special purpose entities, establishedadjusted 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 purposeyears ended December 31, 2011 and 2010, respectively, to our non-GAAP measure of facilitating off-balance sheet arrangementsNet 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.
| 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 | % | ||||||||||
| 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) | Our 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 losses. |
| (2) | The Weighted Average Coupon reflects the weighted average rate of interest paid on our Interest Earning Assets or Core Interest Earning Assets, as applicable, for the period, 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 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 difference between our Weighted Average Cash Yield on Interest Earning Assets or Core Interest Earning Assets, as applicable, and our Cost of Funds. |
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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 | ||||||||
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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 increase in general, administrative and other contractually narrow or limited purposes. Further, we have not guaranteed any obligationsexpenses of unconsolidated entities nor do we have any commitment or intent$2.6 million for the year ended December 31, 2011, as compared to provide fundingthe year ended December 31, 2010 was primarily due to any such entities. Accordingly, we are not materially exposedthe $2.2 million termination fee related to any market, credit, liquidity or financing risk that could arise if we had engagedthe termination of the HCS Advisory Agreement, a $0.4 million increase in such relationships.management fees due to RiverBanc and Midway, a $0.3 million increase in professional fees, offset by a $0.3 million decrease in salaries and benefits, and a $0.1 million decrease in other expenses.
Discontinued Operations (dollar amounts in thousands)
| 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. |
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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.
We fund our investments and operations 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 trust preferred debentures and, prior to their redemption, our convertible preferred debentures. At December 31, 2009,2011, we had cash balances of $24.5$16.6 million. The reduction in cash and cash equivalents from $19.4 million $85.6 million in unencumbered securities, including $25.2 million of agency RMBS and borrowings of $85.1 million under outstanding repurchase agreements. At December 31, 2009, we also had longer-term capital resources, including CDOs outstanding of $266.8 million and subordinated debt of $44.9 million.
We rely primarily on 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 meetto finance the mortgage-backed securities in our liquidity requirements for at least the next 12 months.
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.
We enter intoalso use U.S. Treasury securities and U.S. Treasury futures and options to hedge interest rate risk associated with our investments in Agency IOs and interest rate swap agreements as a mechanism to reduce the interest rate risk of the RMBS portfolio. At December 31, 2009, we had $107.4 millionour Agency ARMs and mortgage loans held 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, 2009 the Company pledged $2.9 million in cash margin to cover decreased valuation of the interest rate swaps. The weighted average maturity of the swaps was 2.6 years at December 31, 2009.securitization trusts.
We also own approximately $3.8 million of loans held for sale.sale, which are included in discontinued operations. Our inability to sell these loans at all or on favorable terms could adversely affect our profitability as any sale for less than the current reserved 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, 2009, we had a total of $2.0 million of unresolved repurchase requests that management concluded may reasonably be deemed to have merit, against which we had a reserve of approximately $0.3 million.
We paid quarterly cash dividends of $0.10, $0.18, $0.23$0.18, $0.22 and $0.25 per common share in January, April, July,June, and October 2009,2011, respectively. On December 21, 2009,15, 2011, we declared a 20092011 fourth quarter cash dividend of $0.25 per common share and a special cash dividend of $0.10 per common share. The dividend was paid on January 26, 201025, 2012 to common stockholders of record as of January 7, 2010. On January 30, 2010, we paid a $0.63 per share cash dividend, or approximately $0.6 million in the aggregate, on shares of our Series A Preferred Stock to holders of record as of December 31, 2009. We also paid a $0.50, $0.50, $0.58 and $0.63 per share cash dividend on shares of our Series A Preferred Stock in January, April, July, and October 2009, respectively.27, 2011. Each of these dividends was paid out of the Company’sour working capital. We expect to continue to pay quarterly cash dividends on our common stock and our Series A Preferred Stock during itthe near term. However, our Board of Directors 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 $0.3 million. In addition, certain of our U.S. based counterparties may have significant exposure to European sovereign debt which could impact their future lending activities or cause them to default under agreements with us. Any counterparty defaults could result in a material adverse effect on our operating results. We refer you to Note 7, Financing Arrangements, Portfolio Investments, included in Item 8 of this Annual Report on Form 10-K.
Inflation
For the periods presented herein, inflation has been relatively low and we believe that inflation has not had a material effect on our results of operations. The impact of inflation is primarily reflected in the increased costs of our operations. Virtually all our assets and liabilities are financial in nature. Our consolidated financial statements and corresponding notes thereto have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. As a result, interest rates and other factors influence our performance far more than inflation. Inflation affects our operations primarily through its effect on interest rates, since interest rates typically increase during periods of high inflation and decrease during periods of low inflation. During periods of increasing interest rates, demand for mortgages and a borrower’s ability to qualify for mortgage financing in a purchase transaction may be adversely affected. During periods of decreasing interest rates, borrowers may prepay their mortgages, which in turn may adversely affect our yield and subsequently the value of our portfolio of mortgage assets.
Contractual Obligations and Commitments
The Company had the following contractual obligations at December 31, 2009:2011 (dollar amounts in thousands):
| ($ amounts in thousands) | Total | Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | |||||||||||||||||||||||||||||||||||
| Total | Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | ||||||||||||||||||||||||||||||||||||
| Operating leases | $ | 648 | $ | 190 | $ | 391 | $ | 67 | $ | — | $ | 265 | $ | 198 | $ | 67 | $ | — | $ | — | ||||||||||||||||||||
| Repurchase agreements | 85,124 | 85,124 | — | — | — | 112,674 | 112,674 | — | — | — | ||||||||||||||||||||||||||||||
| CDOs (1)(2) | 281,109 | 92,275 | 28,726 | 23,463 | 136,645 | 213,527 | 17,767 | 33,494 | 32,823 | 129,443 | ||||||||||||||||||||||||||||||
| Subordinated debentures (1) | 93,126 | 2,355 | 3,737 | 3,732 | 83,302 | 89,464 | 1,895 | 3,779 | 3,784 | 80,006 | ||||||||||||||||||||||||||||||
| Convertible preferred debentures (3) | 22,500 | 22,500 | — | — | — | |||||||||||||||||||||||||||||||||||
| Management fees (3) | 1,290 | 1,290 | — | — | — | |||||||||||||||||||||||||||||||||||
| Employment agreements | 300 | 300 | — | — | — | |||||||||||||||||||||||||||||||||||
| Interest rate swaps (1) | 4,057 | 2,570 | 1,448 | 39 | — | 564 | 526 | 38 | — | — | ||||||||||||||||||||||||||||||
| Management Fees (4) | 1,618 | 1,618 | — | — | — | |||||||||||||||||||||||||||||||||||
| Total contractual obligations | $ | 488,182 | $ | 206,632 | $ | 34,302 | $ | 27,301 | $ | 219,947 | $ | 418,084 | $ | 134,650 | $ | 37,378 | $ | 36,607 | $ | 209,449 | ||||||||||||||||||||
| (1) | Amounts include projected interest payments during the period. Interest based on interest rates in effect on December 31, |
| (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) | We terminated the HCS Advisory Agreement on December 30, 2011. Amounts include |
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.
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 prime ARMmortgage loans held in securitization trusts and RMBSmortgage-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 RMBSmortgage-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’smanagement 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.
Fair value.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.
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.
Mortgage Loans Held in Securitization Trusts (net) – 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.
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
68
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 securitization trusts are recorded at net realizable value. Any subsequent adjustment will result infacts and circumstances pertaining to the reduction in carryingVIE.
Fair Value Option – The fair value with the corresponding amount chargeoption provides an election that allows companies to earnings. Net realizableirrevocably elect fair value basedfor financial assets and liabilities on an estimate of disposal taking into consideration local market conditions ofinstrument-by-instrument basis at initial recognition. Changes in fair value for assets and liabilities for which the distressed property, updated appraisal values of the property and estimated expenses required sell the property.election is made will be recognized in earnings as they occur.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements and the possible effects on our financial statements is included in Note 21 — Summary of Significant Accounting Policies included in Item 8 of this Annual Report on Form 10-K.
Item 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the exposure to loss resulting from changes in interest rates, credit spreads foreign currency exchange rates, commodity prices and equity prices. Because we are invested solely in U.S.-dollar denominated instruments, primarily residential mortgage instruments, and our borrowings are also domestic and U.S. dollar denominated, we are not subject to foreign currency exchange, or commodity and equity price risk; the primary market risk that we are exposed to is interest rate risk and its related ancillary risks. Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. All of our market risk sensitive assets, liabilities and related derivative positions are for non-trading purposes only.
Management recognizes the following primary risks associated with our business and the industry in which we conduct business:
| · | Interest rate risk |
| · | Liquidity risk |
| · | Prepayment risk |
| · | Credit 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 investment securities 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.
We seek to manage interest rate risk in the portfolio by utilizing interest rate swaps, caps, Eurodollar and interest rate caps,other 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.
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, 2009, 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 | Changes in Net Interest Income | ||||
| +200 | $(3,009) | $ | 6,107 | |||
| +100 | $(1,807) | $ | 5,081 | |||
| -100 | $ 2,606 | $ | (7,822 | ) | ||
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, decreaseother 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. 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 trusts, the principal and interest payments from mortgageour assets and cash proceeds from the issuance of equity 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 other 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, 20092011 consisted of approximately $276.2$208.9 million of securitized first liens originated in 2005 and earlier. The securitized first liens were principally originated in 2005 by one of our subsidiary, HC,subsidiaries 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 70.3%70.4%, and average borrower FICO score of approximately 732.729. In addition, approximately 67.7%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 default on these loans, we cannot assure you that all borrowers will continue to satisfy their payment obligations under these loans and thereby avoid default.
As of December 31, 2009,2011 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 $42.9$3.9 million on non-Agency RMBS senior securities. The non-Agency RMBS has a weighted average amortized purchase price of approximately 70.6%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. In addition, asAs of December 31, 20092011, we own approximately $46.0$22.8 million of par value of CLOs, withnotes issued by a carrying value of $17.6 million andCLO at a discounted purchase price of approximately 19.99%equal to 28.9% of par. The securities are backed by a portfolio of middle market corporate loans.
Changes in interest rates also expose us to market risk that the market 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, 2009,2011, 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 our investment securitiesthe Company's RMBS and CDOs are generally based on market prices provided by 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 we receiveCompany receives from the issuer and on available market information.
The fair value of mortgage loans held in securitization trusts 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 over the past 18 months, secondary market prices were given minimal weighting when arriving at loan valuation at December 31, 2009 and December 31, 2008 fair value.
The fair value of these CDOsour CMBS is based on discounted cashflows as well asmanagement’s estimates using pricing models and inputs from current market pricingconditions including recent transactions. Our CMBS investments were acquired in private transactions and are not actively traded in the secondary markets. However similar assets are issued on comparable CDOs.a periodic basis that allows management to assess current market conditions when formulating a model evaluation.
The table below presents the sensitivity of the market value and net duration changes of our portfolio as of December 31, 2009,2011, using a discounted cash flow simulation 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.
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.
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.
74
Item 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our financial statements and the related notes, 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.
Item 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
Item 9A.CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures - We maintain disclosure controls and procedures that 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 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, 2009.2011. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2009.2011.
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. 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, 2009.2011.
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 our internal control over financial reporting during the quarter ended December 31, 20092011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.OTHER INFORMATION
PART III
Item 10.DIRECTORS, EXECUTIVE OFFICER AND CORPORATE GOVERNANCE
Item 11.EXECUTIVE COMPENSATION
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 20102012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
Item 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
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 20102012 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.
Item 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
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 20102012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
Item 14.PRINCIPAL ACCOUNTANTACCOUNTING FEES AND SERVICES
The information presented underrequired by this item is included in the heading “Relationship with Independent Registered Public Accounting Firm” in our 20102012 Proxy Statement to be filed with the SECand is incorporated herein by reference.
PART IV
Item 15.EXHIBITS, FINANCIAL STATEMENT SCHEDULES
| (a) | Financial Statements |
| Page | ||
| Report of Independent Registered Public Accounting Firm - Grant Thornton LLP | F-2 | |
| F-3 | ||
| Consolidated | F-4 | |
| Consolidated Statements of | F-5 | |
| Consolidated Statements of | F-6 | |
| Consolidated Statements of Cash Flows | F-7 | |
| Notes to Consolidated Financial Statements | F-8 |
| (b) | Exhibits. |
The information set forth under “Exhibit Index” below is incorporated herein by reference.
SIGNATURES
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 | By: | /s/ Steven R. Mumma |
| (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 | March | |||
| Steven R. Mumma | ||||
| /s/ Fredric S. Starker | Chief Financial Officer | March 12, 2012 | ||
| Frederic S. Starker | (Principal | |||
| /s/ James J. Fowler | Chairman of the Board | March | ||
| James J. Fowler | ||||
| /s/ Alan L. Hainey | Director | March | ||
| Alan L. Hainey | ||||
| /s/ Steven G. Norcutt | Director | March | ||
| Steven G. Norcutt | ||||
| /s/ | Director | March | ||
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
AND
For Inclusion in Form 10-K
Filed with
United States Securities and Exchange Commission
December 31, 20092011
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
| Page | ||||
| FINANCIAL STATEMENTS: | ||||
| Report of Independent Registered Public Accounting Firm - Grant Thornton LLP | F-2 | |||
| F-3 | ||||
| Consolidated | F-4 | |||
| Consolidated Statements of | F-5 | |||
| Consolidated Statements of | F-6 | |||
| Consolidated Statements of Cash Flows | F-7 | |||
| Notes to Consolidated Financial Statements | F-8 | |||
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
New York Mortgage Trust, Inc.
We have audited the accompanying consolidated balance sheetsheets of New York Mortgage Trust, Inc. (a Maryland corporation) and subsidiaries (the “Company”) as of December 31, 2009,2011 and 2010, and the related consolidated statements of operations, stockholders’comprehensive income, equity, and cash flows for each of the yeartwo years in the period ended December 31, 2009.2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.audits.
We conducted our auditaudits 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 audit 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’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 audit providesaudits provide a reasonable basis for our opinion.
In our opinion, the 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, 2009,2011 and 2010, and the results of its operations and its cash flows for each of the year thentwo years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP
New York, New York
March 8, 201012, 2012
F-2
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands)
December 31, 2009 | December 31, 2008 | |||||||
| ASSETS | ||||||||
| Cash and cash equivalents | $ | 24,522 | $ | 9,387 | ||||
| Restricted cash | 3,049 | 7,959 | ||||||
| Investment securities available for sale, at fair value (including pledged assets of $91,071 and $456,506 at December 31, 2009 and 2008, respectively) | 176,691 | 477,416 | ||||||
| Accounts and accrued interest receivable | 2,048 | 3,095 | ||||||
| Mortgage loans held in securitization trusts (net) | 276,176 | 346,972 | ||||||
| Prepaid and other assets | 2,107 | 2,595 | ||||||
| Derivative assets | 4 | 22 | ||||||
| Assets related to discontinued operation | 4,217 | 5,854 | ||||||
| Total Assets | $ | 488,814 | $ | 853,300 | ||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
| Liabilities: | ||||||||
| Financing arrangements, portfolio investments | $ | 85,106 | $ | 402,329 | ||||
| Collateralized debt obligations | 266,754 | 335,646 | ||||||
| Derivative liabilities | 2,511 | 4,194 | ||||||
| Accounts payable and accrued expenses | 4,935 | 3,997 | ||||||
| Subordinated debentures (net) | 44,892 | 44,618 | ||||||
| Convertible preferred debentures (net) | 19,851 | 19,702 | ||||||
| Liabilities related to discontinued operation | 1,778 | 3,566 | ||||||
| Total Liabilities | 425,827 | 814,052 | ||||||
| Commitments and Contingencies | ||||||||
| Stockholders’ Equity: | ||||||||
| Common stock, $0.01 par value, 400,000,000 shares authorized 9,415,094 shares issued and outstanding at December 31, 2009 and 9,320,094 shares issued and outstanding at December 31, 2008 | 94 | 93 | ||||||
| Additional paid-in capital | 142,519 | 150,790 | ||||||
| Accumulated other comprehensive income (loss) | 11,818 | (8,521 | ) | |||||
| Accumulated deficit | (91,444 | ) | (103,114 | ) | ||||
| Total Stockholders’ Equity | 62,987 | 39,248 | ||||||
| Total Liabilities and Stockholders’ Equity | $ | 488,814 | $ | 853,300 | ||||
December 31, 2011 | December 31, 2010 | |||||||
| 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 | ||||
See notes to consolidated financial statements.
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except per share data)
| For the Year Ended December 31, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| REVENUES: | ||||||||||||
| Interest income - investment securities and loans held in securitization trusts | $ | 31,095 | $ | 44,123 | $ | 50,564 | ||||||
| Interest expense - investment securities and loans held in securitization trusts | 8,572 | 30,351 | 46,529 | |||||||||
| Net interest income from investment securities and loans held in securitization trusts | 22,523 | 13,772 | 4,035 | |||||||||
| Interest expense - subordinated debentures | (3,189 | ) | (3,760 | ) | (3,558 | ) | ||||||
| Interest expense - convertible preferred debentures | (2,474 | ) | (2,149 | ) | — | |||||||
| Net interest income | 16,860 | 7,863 | 477 | |||||||||
| OTHER INCOME (EXPENSE) | ||||||||||||
| Provision for loan losses | (2,262 | ) | (1,462 | ) | (1,683 | ) | ||||||
| Realized gains (losses) on securities and related hedges | 3,282 | (19,977 | ) | (8,350 | ) | |||||||
| Impairment loss on investment securities | (119 | ) | (5,278 | ) | (8,480 | ) | ||||||
| Total other income (expense) | 901 | (26,717 | ) | (18,513 | ) | |||||||
| EXPENSES: | ||||||||||||
| Salaries and benefits | 2,118 | 1,869 | 865 | |||||||||
| Professional fees | 1,284 | 1,212 | 612 | |||||||||
| Insurance | 524 | 948 | 474 | |||||||||
| Management fees | 1,252 | 665 | — | |||||||||
| Other | 1,699 | 2,216 | 803 | |||||||||
| Total expenses | 6,877 | 6,910 | 2,754 | |||||||||
| INCOME (LOSS) FROM CONTINUING OPERATIONS | 10,884 | (25,764 | ) | (20,790 | ) | |||||||
| Income (loss) from discontinued operation - net of tax | 786 | 1,657 | (34,478 | ) | ||||||||
| NET INCOME (LOSS) | $ | 11,670 | $ | (24,107 | ) | $ | (55,268 | ) | ||||
| Basic net income (loss) per share | $ | 1.25 | $ | (2.91 | ) | $ | (30.47 | ) | ||||
| Diluted net income (loss) per share | $ | 1.19 | $ | (2.91 | ) | $ | (30.47 | ) | ||||
| Dividends declared per common share | $ | 0.91 | $ | 0.54 | $ | 0.50 | ||||||
| Weighted average shares outstanding-basic | 9,367 | 8,272 | 1,814 | |||||||||
| Weighted average shares outstanding-diluted | 11,867 | 8,272 | 1,814 | |||||||||
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 | ||||||
See notes to consolidated financial statements.
F-4
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollar amounts in thousands)
| 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.
F-5
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended December 31, 2009, 20082011 and 20072010
(Dollar amounts in thousands)
Common Stock | Additional Paid-In Capital | Accumulated Deficit | Accumulated Other Comprehensive Income (Loss) | Comprehensive Income (Loss) | Total | |||||||||||||||||||
| BALANCE, JANUARY 1, 2007 | $ | 18 | $ | 99,674 | $ | (23,739 | ) | $ | (4,381 | ) | — | $ | 71,572 | |||||||||||
| Net loss | — | — | (55,268 | ) | — | $ | (55,268 | ) | (55,268 | ) | ||||||||||||||
| Dividends declared | — | (909 | ) | — | — | — | (909 | ) | ||||||||||||||||
| Repurchase of common stock | — | — | — | — | — | — | ||||||||||||||||||
| Restricted stock | — | 592 | — | — | — | 592 | ||||||||||||||||||
| Reclassification adjustment for net loss included in net income | — | — | — | 3,192 | 3,192 | 3,192 | ||||||||||||||||||
| Decrease 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 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 | ||||||||||||||||
| Net income | 11,670 | $ | 11,670 | 11,670 | ||||||||||||||||||||
| Dividends declared | (8,531 | ) | (8,531 | ) | ||||||||||||||||||||
| Restricted stock | 1 | 260 | 261 | |||||||||||||||||||||
| Reclassification adjustment for net gain included in net income | (2,657 | ) | (2,657 | ) | (2,657 | ) | ||||||||||||||||||
| Increase in net unrealized gain on available for sale securities | 20,340 | 20,340 | 20,340 | |||||||||||||||||||||
| Increase in derivative instruments utilized for cash flow hedge | 2,656 | 2,656 | 2,656 | |||||||||||||||||||||
| Comprehensive income | $ | 32,009 | ||||||||||||||||||||||
| BALANCE, DECEMBER 31, 2009 | $ | 94 | $ | 142,519 | $ | (91,444 | ) | $ | 11,818 | $ | 62,987 | |||||||||||||
Common Stock | Additional Paid-In | Accumulated Deficit | Accumulated Other | Non- controlling | 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 | |||||||||||
See notes to consolidated financial statements.
F-6
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
| For the Years Ended December 31, | ||||||||||||
| 2009 | 2008 | 2007 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
| Net income (loss) | $ | 11,670 | $ | (24,107 | ) | $ | (55,268 | ) | ||||
| Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||
| Depreciation and amortization | 1,435 | 1,423 | 765 | |||||||||
| Amortization of (discount) premium on investment securities and mortgage loans | (743 | ) | 997 | 1,616 | ||||||||
| (Gain) loss on sale of securities, loans and related hedges | (3,280 | ) | 19,977 | 8,350 | ||||||||
| Impairment loss on investment securities | 119 | 5,278 | 8,480 | |||||||||
| Origination of mortgage loans held for sale | — | — | (300,863 | ) | ||||||||
| Proceeds from repayments or sales of mortgage loans | 1,196 | 2,746 | 398,678 | |||||||||
| Allowance for deferred tax asset | — | — | 18,352 | |||||||||
| Gain on sale of retail lending platform | — | — | (4,368 | ) | ||||||||
| Change in value of derivatives | — | — | 785 | |||||||||
| Provision for loan losses | 2,262 | 1,520 | 2,546 | |||||||||
| Restricted stock issuance | 261 | — | — | |||||||||
| Other | 270 | — | 1,111 | |||||||||
| Changes in operating assets and liabilities: | ||||||||||||
| Due from loan purchasers | — | — | 88,351 | |||||||||
| Escrow deposits-pending loan closings | — | — | 3,814 | |||||||||
| Accounts and accrued interest receivable | 1,055 | 415 | 4,141 | |||||||||
| Prepaid and other assets | (260 | ) | 642 | 2,903 | ||||||||
| Due to loan purchasers | — | 138 | (7,115 | ) | ||||||||
| Accounts payable and accrued expenses | (2,212 | ) | (2,767 | ) | (5,140 | ) | ||||||
| Net cash provided by operating activities | 11,773 | 6,262 | 167,138 | |||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||||||
| Restricted cash | 4,910 | (444 | ) | (4,364 | ) | |||||||
| Purchases of investment securities | (43,869 | ) | (850,609 | ) | (231,932 | ) | ||||||
| Proceeds from sale of investment securities | 296,553 | 625,986 | 246,874 | |||||||||
| Principal repayments received on loans held in securitization trust | 68,914 | 79,951 | 154,729 | |||||||||
| Proceeds from sale of retail lending platform | — | — | 12,936 | |||||||||
| Principal paydown on investment securities | 70,343 | 74,172 | 113,490 | |||||||||
| Purchases of fixed assets | — | — | (396 | ) | ||||||||
| Sale of fixed assets and real estate owned property | — | 10 | 880 | |||||||||
| Net cash provided by (used in) investing activities | 396,851 | (70,934 | ) | 292,217 | ||||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
| Increase (decrease) in financing arrangements, net | (317,223 | ) | 86,615 | (672,570 | ) | |||||||
| Collateralized debt obligation borrowings | — | — | 337,431 | |||||||||
| Collateralized debt obligation paydowns | (69,158 | ) | (81,725 | ) | (117,851 | ) | ||||||
| Dividends paid | (7,108 | ) | (4,100 | ) | (1,826 | ) | ||||||
| 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 (used in) provided by financing activities | (393,489 | ) | 68,551 | (454,816 | ) | |||||||
| NET INCREASE IN CASH AND CASH EQUIVALENTS | 15,135 | 3,879 | 4,539 | |||||||||
| CASH AND CASH EQUIVALENTS — Beginning | 9,387 | 5,508 | 969 | |||||||||
| CASH AND CASH EQUIVALENTS — End | $ | 24,522 | $ | 9,387 | $ | 5,508 | ||||||
| SUPPLEMENTAL DISCLOSURE | ||||||||||||
| Cash paid for interest | $ | 13,456 | $ | 31,479 | $ | 41,338 | ||||||
| NON CASH FINANCING ACTIVITIES | ||||||||||||
| Dividends declared to be paid in subsequent period | $ | 2,355 | $ | 932 | $ | — | ||||||
| Grant of restricted stock | $ | 261 | $ | — | $ | — | ||||||
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.
F-7
NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
| 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, in the business of acquiring, investing in, financing and managing primarily residential adjustable-rate, hybrid adjustable-rate and fixed-rate mortgage-backed securities (“RMBS”), for which the principal and interest payments are guaranteed by a U.S. Government agency, such as the Government National Mortgage Association (“Ginnie Mae”) or a U.S. Government-sponsored entity (“GSE” or “Agency”), such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), which we refer to collectively as “Agency RMBS,” RMBS backed by prime jumbo and Alternative A-paper (“Alt-A”) (“non-Agency RMBS”), and prime credit quality residential adjustable-rate mortgage (“ARM”) loans held in securitization trusts, or prime ARM loans. The remainder of our current investment portfolio is comprised of notes issued by a collateralized loan obligation (“CLO”). We also may opportunistically acquire and manage various other types of real estate-related and financial assets, including, among other things, certain non-rated residential mortgage assets, commercial mortgage-backed securities (“CMBS”), commercial real estate loans and other similar investments. 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 and our operating costs, whichcosts. 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 conducts certain of its portfolio investment operations through one of its wholly-owned TRS,TRSs, Hypotheca Capital, LLC (“HC”), in order to utilize, to the extent permitted by law, some or alla 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 for regulatory compliance purposes. The Company also may conduct certain otherits Agency IO portfolio investment operations related to its alternative investment strategy through NYMF.managed by Midway. The Company consolidates all of its subsidiaries under generally 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 have been prepared on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of 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. Actual results could differ from those estimates.
The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.
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.
F-8