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 |
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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. |
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TermIncentive fee
| | 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. December 31, 2010, unless terminated earlier. The advisoryFrom time to time in the future and upon mutual agreement shall be automatically renewed for a one-year term each anniversary after the initial term unless we deliver prior written notice to HCS of the non-renewal not less than 180 daysparties to the Midway Management Agreement, a portion of each Midway Incentive Fee payable to Midway may be paid in shares of our common stock. The specific terms and conditions for any issuance of our common stock as payment of a portion of any Midway Incentive Fee will be determined and approved by the parties prior to any such issuance.
Adjusted net income is defined as net income (loss) calculated in accordance with generally accepted accounting principles in the expiration ofUnited States (“GAAP”), including any unrealized gains and losses, after giving effect to certain expenses. All securities managed for us by Midway will be valued in accordance with GAAP. Unlike the term (or any extension).Hurdle Rate, which is calculated on a rolling 12 month basis, the High Water Mark is calculated on a calendar 12 month basis, and will reset every 24 months. The High Water Mark will be a static dollar figure that Midway will be required to recoup, to the extent there is a deficit in the prior High Water Mark calculation period before it is eligible again to receive a Midway Incentive Fee. |
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Termination FeeEquity Compensation
| | IfIn addition to the base management and incentive fees provided for in the Midway Management Agreement, we terminateagreed to issue 213,980 shares of restricted stock to Midway on or about the advisory agreementdate of the Midway Amendment. The restricted shares vest annually in one-third increments beginning on December 31, 2012. In the event Midway terminates the Midway Management Agreement for cause, no termination fee is payable. Otherwise,any reason prior to the end of the restricted period, Midway will forfeit those restricted shares that have not vested at the time of the termination. All of the restricted shares will vest if we terminate the advisory agreement or elect notfor any reason. The restricted shares have voting rights and are entitled to renew it, we will pay a cash termination fee equal to the sum of (i) the average annual base advisory fee and (ii) the average annual incentive compensation earned during the 24-month period immediately preceding the date of termination. receive dividends. |
ForAlthough the years endedassets and invested capital managed by Midway are held in an account that is wholly owned by our company, we may only redeem invested capital in an amount equal to the lesser of 10% of our invested capital managed by Midway or $10 million as of the last calendar day of the month upon not less than 75 days written notice, subject to our authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a REIT and exemption from the Investment Company Act. Pursuant to the terms of the Midway Management Agreement, we are only permitted to make one such redemption request in any 75-day period.
In April 2011, we formed a relationship with RiverBanc, a privately owned investment management and specialty finance company founded by Kevin Donlon, for the purpose of investing in multi-family CMBS, such as Freddie Mac Multifamily Loan Securitization K-Series’ assets, and, to a lesser extent, other commercial real estate-related debt investments, such as mezzanine loans and preferred equity investments in commercial properties. Pursuant to an investment management agreement between RiverBanc and us (the “RiverBanc Management Agreement”), RiverBanc will source, structure and manage our investments in these asset classes.
RiverBanc Management Agreement
The RiverBanc Management Agreement has a term that will expire on April 5, 2013, subject to automatic annual one-year renewals thereafter. Pursuant to the terms of the RiverBanc Management Agreement, RiverBanc will receive a monthly base management fee in arrears in a cash amount equal to the product of (i) 1.50% per annum of our invested capital in one of our wholly-owned subsidiaries, RB Commercial Mortgage LLC (“RBCM”), as of the last business day of the previous month, multiplied by (ii) 1/12th. In addition, RiverBanc will be entitled to an incentive fee that is calculated quarterly and paid in cash in arrears. The incentive fee is based upon the average invested capital in RBCM during the fiscal quarter, subject to a high water mark equal to a 9% return on invested capital, and shall be payable in an amount equal to 35% of the dollar amount by which adjusted net income (as defined in the RiverBanc Management Agreement) attributable to the invested capital in RBCM, on a calendar 12-month basis and before accounting for any incentive fees payable to RiverBanc, exceeds an annual 12% rate of return on invested capital. We may terminate the RiverBanc Management Agreement or elect not to renew the agreement, subject to certain conditions and subject, in certain cases, to paying a termination fee equal to the product of (A) 24 and (B) the monthly base management earned by RiverBanc during the month immediately preceding the month in which the termination occurs.
As part of this transaction, subject to our funding of investments at various thresholds, we are eligible, through one of our TRSs, to receive an ownership interest in RiverBanc of up to 17.5%. As of March 1, 2012, we owned an approximately 7.5% ownership interest in RiverBanc.
Termination of HCS Advisory Agreement
As described above under “―Recent Developments―Termination of Advisory Agreement,” on December 30, 2011, we entered into a Termination Agreement, with HCS pursuant to which we terminated the HCS Advisory Agreement effective as of December 31, 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.
Conflicts of Interest with HCS;Our External Managers; Equitable Allocation of Investment Opportunities
HCSEach of Midway and RiverBanc manages, and is expected to continue to manage, other client accounts with similar or overlapping investment strategies. HCSIn connection with the services provided to those accounts, these managers may be compensated more favorably than for the services provided under our external management agreements, and such discrepancies in compensation may affect the level of service provided to us by our external managers. Moreover, each of our external managers may have an economic interest in the accounts they manage or the investments they propose. In addition, we have in the recent past engaged in certain co-investment opportunities with an external manager or one of its affiliates and we may participate in future co-investment opportunities with our external managers or their affiliates. In these cases, it is possible that our interests and the interests of our external managers will not always be aligned and this could result in decisions that are not in the best interests of our company.
Each of Midway and RiverBanc has agreed that, when making investment allocation decisions between us and its other client accounts, it will, in the case of RiverBanc, allocate investments in a fair and equitable manner and, in the case of Midway, seek to make available to the Managed Subsidiaries allallocate investment opportunities thaton an equitable basis and in a manner it determines,believes is in the best interests of its reasonable and good faith judgment, based on their investment objectives, policies and strategies, and other relevant factors, are appropriate for them in accordance with HCS’s written allocation procedures and policies.
accounts. Since 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.
We expect that HCS will source substantially all of the non-RMBS investments made by the Managed Subsidiaries as advisor to those entities. HCSMidway is authorized to follow broad investment guidelines in determining which assets the Managed Subsidiariesit will invest in, subject to the approval of our Board of Directors to our investment guidelines. However, as we diversify our investment portfolio in the future, our Board of Directors may elect to not review individual investments. In conducting their review of the investments held by our Managed Subsidiaries, our directors will rely primarily on information provided to them by HCS and our management. Furthermore, the Managed Subsidiaries may use complex investment strategies and transactions, which may be difficult or impossible to unwind.in. Although our Board of Directors must firstwill ultimately determine when and how much capital to allocate to assets managed by Midway, we generally will not approve an investment opportunity that falls under the advisory agreement, HCStransactions in advance of their execution. As a result, because Midway has great latitude to determine the types of assets it may decide are proper investments for the Managed Subsidiaries. Theus, there can be no assurance that we would otherwise approve of these investments individually or that they will be successful. RiverBanc, meanwhile has complete discretion and authority to manage assets on our behalf subject to investment guidelines doapproved by the Board of Directors. However, our Board of Directors may elect to change the investment guidelines or waive them for various investments. In addition to conducting periodic reviews, we will rely primarily on information provided to us by our external managers. Complicating matters further, our external managers may use complex investment strategies and transactions, which may be difficult or impossible to unwind.
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.
The advisory agreement does not restrict the ability of HCS or its affiliates from engaging in other business ventures of any nature (including other REITs), whether or not such ventures are competitive with the Managed Subsidiaries’ business so long as HCS’s management of other REITs or funds does not disadvantage us or the Managed Subsidiaries.
HCS may engage other parties, including its affiliates, to provide services to us or our subsidiaries; provided that any such agreements with affiliates of HCS shall be on terms no more favorable to such affiliate than would be obtained from a third party on an arm’s-length basis and, in certain circumstances, approved by a majority of our independent directors. With respect to portfolio management services, any agreements with affiliates shall be subject to our prior written approval and HCS shall remain liable for the performance of such services. With respect to monitoring services, any agreements with affiliates shall be subject to our prior written approval and the base advisory fee payable to HCS shall be reduced by the amount of any fees payable to such other parties, although we will reimburse any out-of-pocket expenses incurred by such other parties that are reimbursable by us.
Pursuant to Schedules 13D filed with the SEC on February 17, 2009, and a Schedule 13G/A filed on February 16, 2010, HCS, JMP Group, Inc. and Joseph A. Jolson, the Chairman and Chief Executive Officer of JMP Group Inc., beneficially owned approximately 16.7%, 12.1% and 6.7%, respectively, of our outstanding common stock as of December 31, 2008 in the case of HCS and JMP Group Inc., and as of December 31, 2009 in the case of Mr. Jolson. In addition, as of December 31, 2009, HCS and JMP Group Inc. collectively beneficially owned 100% of outstanding Series A Preferred Stock. Any outstanding shares of our Series A Preferred Stock at December 31, 2010 must be redeemed for the purchase price plus any accrued or unpaid dividends on the Series A Preferred Stock as of that date. As of February 28, 2010, $20.0 million of the Series A Preferred Stock remained outstanding. HCS is an investment adviser that manages investments and trading accounts of other persons, including certain accounts affiliated with JMP Group, Inc., and is deemed the beneficial owner of shares of our common stock held by these accounts. As noted above, Mr. Fowler and Joseph A. Jolson are affiliates of JMP Group, Inc and HCS. As a result of the combined voting power of HCS, JMP Group, Inc. and Joseph A. Jolson, these stockholders exert significant influence over matters submitted to a vote of stockholders, including the election of directors and approval of a change in control or business combination of our company, and strategic direction of our Company. This concentration of ownership may result in decisions affecting us that are not in the best interests of all our stockholders. In addition, Mr. Fowler may have a conflict of interest in situations where the best interests of our company and stockholders do not align with the interests of HCS, JMP Group, Inc. or its affiliates, which may result in decisions that are not in the best interests of all our stockholders.
Company History
We were formed as a Maryland corporation in September 2003. In June 2004, we completed our initial public offering, or IPO, that resulted in approximately $122 million in net proceeds to our company. Prior to the IPO, we did not have recurring business operations. As part of our formation transactions, concurrent with our IPO, we acquired 100% of the equity interests in HC, which at the time was a residential mortgage origination company that historically had sold or brokered all of the mortgage loans it originated to third parties. Effective with the completion of our IPO, we operated two business segments: (i) our mortgage portfolio management segment and (ii) our mortgage lending segment. Under this business model, we would retain and either finance in our portfolio selected adjustable-rate and hybrid mortgage loans that we originated or we would sell them to third parties, while continuing to sell all fixed-rate loans originated by HC to third parties.
Commencing in March 2006, we stopped retaining all loans originated by HC and began to sell these loans to third parties. With the mortgage lending business facing increasingly difficult operating conditions, we began considering strategic alternatives for our mortgage lending business in mid-2006. In the first quarter of 2007, we completed the sale of substantially all of the assets related to our retail and wholesale residential mortgage lending platform, thereby marking our exit from the mortgage lending business.
In January 2008 we formed a strategic relationship with the JMP Group, whereby HCS became the contractual advisor to the Managed Subsidiaries and the JMP Group purchased 1.0 million shares of our Series A Preferred Stock for an aggregate purchase price of $20.0 million. The Series A Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. The Series A Preferred Stock is convertible into shares of the Company's common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. The Series A Preferred Stock matures on December 31, 2010, at which time any outstanding shares must be redeemed by the Company at the $20.00 per share liquidation preference. Pursuant to Statement of Financial Accounting Standards (“SFAS”) No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, because of this mandatory redemption feature, the Company classifies these securities as a liability on its balance sheet.
In February 2008, we completed the issuance and sale of 7.5 million shares of our common stock to certain accredited investors in a private placement at a price of $8.00 per share, generating net proceeds to us of $56.5 million after payment of private placement fees and expenses.
The Company’s shares of common stock are currently listed on the NASDAQ Capital Market (“NASDAQ”) under the symbol “NYMT.” In connection with the minimum listing price requirements of NASDAQ, we have completed two separate reverse stock splits on our common stock; a 1-for-5 reverse split in October 2007 and a 1-for-2 reverse split in May 2008. The information in this Annual Report on Form 10-K gives effect to these reverse stock splits as if they occurred at the Company’s inception.
Our Structure
We conduct our business through New York Mortgage Trust, Inc., which serves as the parent company, and several of our subsidiaries, including special purpose subsidiaries established for loan securitization purposes. We conduct certain of our portfolio investment operations through our wholly-owned taxable REIT subsidiary ("TRS"), HC, in order to utilize, to the extent permitted by law, some or all of a net operating loss carry-forward held in HC that resulted from HC’s exit from the mortgage lending business. Our wholly-owned qualified REIT subsidiary ("QRS"), NYMF, currently holds certain mortgage-related assets for regulatory compliance purposes. The Company consolidates all of its subsidiaries under generally accepted accounting principles in the United States of America (“GAAP”).
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.
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.
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.
IRS guidance allows us to pay a portion of our annual distributions in shares of common stock rather than cash (generally up to 90% in 2010) if we meet certain requirements. In the event we need to preserve liquidity, we may pay a portion of our distributions in shares of our common stock.
Investment Company Act Exemption
We operate our business so as to be exempt from registration under the Investment Company Act. We rely on the exemption provided by Section 3(c)(5)(C) of the Investment Company Act. We monitor our portfolio periodically and prior to each investment to confirm that we continue to qualify for the exemption. To qualify for the exemption, we make investments so that at least 55% of the assets we own consist of qualifying mortgages and other liens on and interests in real estate, which are collectively referred to as “qualifying real estate assets,” and so that at least 80% of the assets we own consist of real estate-related assets (including our qualifying real estate assets, both as measured on an unconsolidated basis). We generally expect that our investments will be considered either qualifying real estate assets or real estate-related assets under Section 3(c)(5)(C) of the Investment Company Act. Qualification for the Section 3(c)(5)(C) exemption may limit our ability to make certain investments. In addition, we must ensure that each of our subsidiaries qualifies for the Section 3(c)(5)(C) exemption or another exemption available under the Investment Company Act.
Competition
Our success depends, in large part, on our ability to acquire assets at favorable spreads over our borrowing costs. When we invest in mortgage-backed securities, mortgage loans and other investment assets, we compete with a variety of institutional investors, including other REITs, insurance companies, mutual funds, hedge funds, pension funds, investment banking firms, banks and other financial institutions that invest in the same types of assets. Many of these investors have greater financial resources and access to lower costs of capital than we do.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
ThisWhen used in this Annual Report on Form 10-K, contains certain forward-looking statements. Forward lookingin future filings with the SEC or in press releases or other written or oral communications, statements are those which are not historical in nature, and can often be identified by their inclusion ofincluding those containing words such as “will,“believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “expect,“would,” “believe,“could,” “intend”“goal,” “objective,” “will,” “may” or similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and similar expressions. Any projectionSection 21E of revenues, earnings or losses, capital expenditures, distributions, capital structure or other financial terms is a forward-looking statement. Certain statements regarding the following particularly are forward-looking in nature:Securities Exchange Act of 1934, as amended, and, as such, may involve known and unknown risks, uncertainties and assumptions.
| · | our business and investment strategy; |
| · | future performance, developments, market and industry forecasts or projected dividends; |
| · | future interest rate and credit environments; and |
| · | projected acquisitions or joint ventures. |
It is important to note that the description of our business is general and our investment in real estate-related and financial assets in particular, is a statement about our operations as of a specific point in time and is not meant to be construed as an investment policy. The types of assets we hold, the amount of leverage we use or the liabilities we incur and other characteristics of our assets and liabilities disclosed in this report as of a specified period of time are subject to reevaluation and change without notice.
Our forward-lookingForward-looking statements are based uponon our management's beliefs, assumptions and expectations of our future operations and economic performance, taking into account theall information currently available to us. Forward-looking statements involveThese beliefs, assumptions and expectations are subject to risks and uncertainties someand can change as a result of many possible events or factors, not all of which are not currently known to usus. If a change occurs, our business, financial condition, liquidity and manyresults of whichoperations may vary materially from those expressed in our forward-looking statements. The following factors are beyond our control andexamples of those that mightcould cause our actual results performance or financial condition to be materially differentvary from our forward-looking statements: changes in interest rates and the expectationsmarket value of future results, performance or financial condition we express or imply in any forward-looking statements. Someour securities; the impact of the importantdowngrade of the long-term credit ratings of the U.S., Fannie Mae, Freddie Mac, and Ginnie Mae; market volatility; changes in the prepayment rates on the mortgage loans underlying our investment securities; increased rates of default and/or decreased recovery rates on our assets; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our qualification as a REIT for federal tax purposes; our ability to maintain our exemption from registration under the Investment Company Act; and risks associated with investing in real estate assets, including changes in business conditions and the general economy. These and other risks, uncertainties and factors, thatincluding the risk factors described in Item 1A of this Annual Report on Form 10-K, could cause our actual results performance or financial condition to differ materially from expectations are:
| · | our portfolio strategy and operating strategy may be changed or modified by our management without advance noticethose projected in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, you or stockholder approval and we may suffer losses as a result of such modifications or changes; |
| · | our ability to successfully diversify our investment portfolio and identify suitable assets for investments;
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| · | market changes in the terms and availability of repurchase agreements used and other funding sources to finance our investment portfolio activities;
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| · | reduced demand for our securities in the mortgage securitization and secondary markets; |
| · | interest rate mismatches between our mortgage-backed securities and our borrowings used to fund such purchases; |
| · | changes in interest rates and mortgage prepayment rates;
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| · | Increased rates of default and/or decreased recovery rates on our assets; |
| · | changes in the financial markets and economy generally; |
| · | effects of interest rate caps on our adjustable-rate mortgage-backed securities; |
| · | the degree to which our hedging strategies may or may not protect us from interest rate volatility; |
| · | potential impacts of our leveraging policies on our net income and cash available for distribution; |
| · | our board's ability to change our operating policies and strategies without notice to you or stockholder approval; |
| · | our ability to successfully implement and grow our alternative investment strategy; |
| · | our ability to manage, minimize or eliminate liabilities stemming from the discontinued operations including, among other things, litigation and repurchase obligations on the sale of mortgage loans; and |
| · | the other important factors identified, or incorporated by reference into this report, including, but not limited to those under the captions “Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures about Market Risk”, and those described in Part I, Item 1A – “Risk Factors” of this report and the various other factors identified in any other documents filed by us with the SEC.
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We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the events described by our forward-looking events might not occur. We qualify any and all of our forward-looking statements by these cautionary factors. In addition, you should carefully review the risk factors described in other documents we file from time to time with the SEC.
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.
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 may change our investment strategy, operating policies and/or asset allocations without stockholder consent, any of which could result in losses.
We may change our investment strategy, operating policies and/or asset allocation with respect to investments, acquisitions, leverage, growth, operations, indebtedness, capitalization and distributions at any time without the consentMarket values of our stockholders, whichinvestments may resultalso decline without any general increase in riskier investments. For example, during 2009,interest rates for a number of reasons, such as increases in defaults, actual or perceived increases in voluntary prepayments for those investments that we commenced investments pursuanthave that are subject to an alternative investment strategy adopted by our company that was focused on a broad range of real estate- and financial-related assets that differ in structure,prepayment risk, and potential return, among other things, fromwidening of credit spreads. If the Agency RMBS that we had focused our investment efforts on since 2007. We will continue to consider a broad range of assets for investment, including those outsidemarket values of our targeted asset class, that we believe will be accretiveinvestments were to earnings and may allow us to utilize all or a portion of an approximately $62.2 million net operating loss carry-forward. The assets we may acquire in the future are comprised of a broad range of asset classes and types and may be different than our historical investments. A change in our investment strategy may increase our exposure to interest rate and/or credit risk, default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from our historical investments and in which we have limited or no investment experience. These changes could result in a decline in earnings or losses which could adversely affect our financial condition, results of operations, the market price of our common stock or our ability to pay dividends.
Continued adverse developments in the residential mortgage market, and the economy generally, may adversely affect our business, particularly our ability to acquire RMBS andfor any reason, the value of the RMBS that we hold in our portfolio as well as our ability to finance or sell our RMBS.
In recent years, the residential mortgage market in the United States has experienced a variety of difficulties and changed economic conditions, including declining home values, heightened defaults, credit losses and liquidity concerns. News of potential and actual security liquidations as a result of those economic difficulties has increased the volatility of many financial assets, including RMBS. These disruptions materially adversely affected the performance and market value in recent years of the RMBS in our portfolio and prime ARM loans held in securitization trusts, as well as other interest-earning assets that we may consider acquiring in the future. Securities backed by residential mortgage loans originated in 2006 and 2007 have had higher and earlier than expected rates of delinquencies. In addition, while some economists believe the recession ended in the fourth quarter of 2009, housing prices continue to fall in certain areas around the country while unemployment rates have risen sharply during the past year, which will further increase the risk for higher delinquency rates. Many RMBS and other interest-earning assets have been downgraded by rating agencies in recent years, and rating agencies may further downgrade these securities in the future. Lenders have imposed additional and more stringent equity requirements necessary to finance these assets, particularly in the case of non-Agency securities, and frequent impairments based on mark-to-market valuations have generated substantial collateral calls in the industry. As a result of these difficulties and changed economic conditions, many companies operating in the mortgage specialty finance sectors have failed and others, including Fannie Mae and Freddie Mac, continue to face serious operating and financial challenges. While the U.S. Federal Reserve has taken certain actions in an effort to ameliorate the current market conditions, and the U.S. Treasury and the Federal Housing Finance Agency, or FHFA, which is the federal regulator now assigned to oversee Fannie Mae and Freddie Mac, are also taking actions, despite reported stabilization in some sectors, these efforts may ultimately be ineffective. As a result of these factors, among others, the market for these securities may be adversely affected for a significant period of time.
During the past two years, housing prices and appraisal values in many states have declined or stopped appreciating, after extended periods of significant appreciation. A continued decline or an extended flattening of those values may result in additional increases in delinquencies and losses on residential mortgage loans generally, particularly with respect to second homes and investor properties and with respect to any residential mortgage loans, the aggregate loan amounts of which (including any subordinate liens) are close to or greater than the related property values.
Fannie Mae and Freddie Mac guarantee the payments of principal and interest on the Agency RMBS in our portfolio even if the borrowers of the underlying mortgage loans default on their payments. However, rising delinquencies and market perception can still negatively affect the value of our Agency RMBS or create market uncertainty about their true value. While the market disruptions have been most pronounced in the non-Agency RMBS market, the impact has extended to Agency RMBS. During a significant portion of 2008, the value of Agency RMBS were unstable and relatively illiquid compared to prior periods.
Agency RMBS guaranteed by Fannie Mae and Freddie Mac are not supported by the full faith and credit of the United States. Fannie Mae and Freddie Mac have suffered significant losses and, despite significant steps taken by the U.S. government to stabilize these entities, Fannie Mae and Freddie Mac could default on their guarantee obligations, which would materially and adversely affect the value of our RMBS or other Agency indebtedness in which we may invest in the future. The U.S. Treasury plans to release a preliminary report on the future of Fannie Mae and Freddie Mac in the near future, which report may recommend the abolishment of Fannie Mae and Freddie Mac in favor of a new system.
We generally post our Agency RMBS, and we may in the future post non-Agency RMBS, as collateral for our borrowings under repurchase agreements. Any decline in their value, or perceived market uncertainty about their value, would make it more difficult for us to obtain financing on favorable terms or at all, or to maintain our compliance with the terms of any financing arrangements. The value of RMBS may decline for several reasons, including, for example, rising delinquencies and defaults, increases in interest rates, falling home prices and credit uncertainty at Fannie Mae or Freddie Mac. In addition, in recent years, repurchase lenders have been requiring higher levels of collateral to support loans collateralized by RMBS than they have in the past, making borrowings more difficult and expensive. At the same time, market uncertainty about residential mortgage loans in general could continue to depress the market for RMBS, which means that it may be more difficult for us to sell RMBS on favorable terms or at all. Further, a decline in the value of RMBS, particularly Agency RMBS, could subject us to margin calls, for which we may have insufficient liquidity to support, resulting in forced sales of our assets at inopportune times. If market conditions result in a decline in available purchasers of RMBS or the value of our RMBS, our financial position and results of operations could be adversely affected.
The conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. government, may adversely affect our business.
The payments we expect to receive on the Agency RMBS we hold in our portfolio and in which we invest depend upon a steady stream of payments on the mortgages underlying the securities and are guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Ginnie Mae is part of a U.S. government agency and its guarantees are backed by the full faith and credit of the United States. Fannie Mae and Freddie Mac are U.S. government-sponsored enterprises, but their guarantees are not backed by the full faith and credit of the United States.
Since 2007, Fannie Mae and Freddie Mac have reported substantial losses and a need for substantial amounts of additional capital. In response to the deteriorating financial condition of Fannie Mae and Freddie Mac and the recent credit market disruption, Congress and the U.S. Treasury undertook a series of actions to stabilize these government-sponsored entities and the financial markets, generally, including placing Fannie Mae and Freddie Mac into conservatorship on September 7, 2008. The conservatorship of Fannie Mae and Freddie Mac and certain other actions taken by the U.S. Treasury and U.S. Federal Reserve were designed to boost investor confidence in Fannie Mae’s and Freddie Mac’s debt and mortgage-backed securities. The U.S. government program includes contracts between the U.S. Treasury and each government-sponsored enterprise to seek to ensure that each enterprise maintains a positive net worth. Each contract had an original capacity of $200 billion, but now has no cap. Each contract provides for the provision of cash by the U.S. Treasury to the government-sponsored enterprise if FHFA determines that its liabilities exceed its assets. Freddie Mac has drawn $60 billion and Fannie Mae has drawn $51 billion under these contracts. Both Fannie Mae and Freddie Mac have indicated they will need to request additional draws this year, and it is possible the draw request will not be granted. Although the U.S. government has described some specific steps and reforms that it intends to take as part of the conservatorship process, efforts to stabilize these entities may not be successful and the outcome and impact of these events remain highly uncertain.
Although the U.S. government has committed capital to Fannie Mae and Freddie Mac, there can be no assurance that the capital infusions will be adequate for their needs. If the financial support is inadequate, these companies could continue to suffer losses and could fail to honor their guarantees and other obligations. In June 2009, as part of the Obama administration’s far-reaching financial industry recovery proposal, the U.S. Treasury announced that it and the Department of Housing and Urban Development, in consultation with other government agencies, plans to engage in a wide-ranging initiative to develop recommendations on the future of Fannie Mae and Freddie Mac, and the Federal Home Loan Bank System. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantees could be considerably limited relative to historical measurements. A preliminary report on these future roles is expected to be released by the U.S. Treasury in the near future. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac could redefine what constitutes Agency RMBS and could have broad adverse implications for the market and for our business.
The U.S. Treasury’s RMBS purchase program is expected to end in the first quarter of 2010. The U.S. Treasury will have purchased $220 billion in RMBS when this program ends. The U.S. Treasury can hold its portfolio of RMBS to maturity and, based on mortgage market conditions, may make adjustments to the portfolio. This flexibility may adversely affect the pricing and availability for RMBS, particularly Agency RMBS. It is also possible that the U.S. Treasury could decide to purchase Agency securities in the future, which could create additional demand that would negatively affect the pricing of RMBS that we seek to acquire.
The U.S. Treasuryyour investment could also stop providing credit support to Fannie Mae and Freddie Mac in the future. The problems faced by Fannie Mae and Freddie Mac resulting in their being placed into conservatorship have stirred debate among some federal policy makers regarding the continued role of the U.S. government in providing liquidity for mortgage loans. The U.S. Treasury plans to release a preliminary report of the future of Fannie Mae and Freddie Mac in February 2010. Each of Fannie Mae and Freddie Mac could be dissolved and the U.S. government could determine to stop providing liquidity support of any kind to the mortgage market. If Fannie Mae or Freddie Mac were eliminated, we would not be able, or if their structures were to change radically, we might not be able, to acquire Agency RMBS from these companies, which would adversely affect our current business model.decline.
Our income also could be negatively affected in a number of ways depending on the manner in which related events unfold. For example, the current credit support provided by the U.S. Treasury to Fannie Mae and Freddie Mac, and any additional credit support it may provide in the future, could have the effect of lowering the interest rates we expect to receive from the Agency RMBS in our portfolio and in which we invest, thereby tightening the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio. A reduction in the supply of Agency RMBS could also negatively affect the pricing of the Agency RMBS held in our portfolio and in which we invest by reducing the spread between the interest we earn on our portfolio of targeted assets and our cost of financing that portfolio.
As indicated above, recent legislation has changed the relationship between Fannie Mae and Freddie Mac and the U.S. government. Future legislation could further change the relationship between Fannie Mae and Freddie Mac and the U.S. government, and could also nationalize or eliminate such entities entirely. In January 2010, House Financial Services Committee Chairman, Barney Frank, was reported to have indicated that his Committee would recommend abolishing Fannie Mae and Freddie Mac in their current form in favor of a whole new system of housing finance. Any law affecting these government-sponsored enterprises may create market uncertainty and have the effect of reducing the actual or perceived credit quality of securities issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase the risk of loss on investments in Fannie Mae and/or Freddie Mac Agency RMBS. It also is possible that such laws could adversely impact the market for RMBS and spreads at which such securities trade. All of the foregoing could materially adversely affect our business, operations and financial condition.
There can be no assurance that the actions taken by the U.S. and foreign governments, central banks and other governmental and regulatory bodies for the purpose of seeking to stabilize the financial markets will achieve the intended effect or benefit our business, and further government or market developments could adversely affect us.
In response to the financial issues affecting the banking system, the financial and housing markets and the economy as a whole, the U.S. government has implemented a number of initiatives intended to bolster the banking system, the financial and housing markets and the economy as a whole. These actions include: (i) the Emerging Economic Stabilization Act of 2008, or ESSA, which established the Troubled-Asset Relief Program, or TARP; (ii) the voluntary Capital Purchase Program, or the CPP, which was implemented under authority provided in the EESA and gives the U.S. Treasury the authority to purchase up to $250 billion of senior preferred shares in qualifying U.S.-controlled banks, saving associations, and certain bank and savings and loan holding companies engaged only in financial activities; (iii) a program to purchase $200 billion in direct obligations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks and $1.25 trillion in RMBS issued or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae; (iv) the creation of a new funding mechanism, the Financial Stability Trust, that will provide financial institutions with bridge financing until such institutions can raise capital in the capital markets; (v) the creation of a Public-Private Investment Fund for private investors to purchase mortgages and mortgage-related assets from financial institutions; (vi) the Term Asset-Backed Securities Loan Facility with the goal of increasing securitization activity for various consumer and commercial loans and other financial assets, including student loans, automobile loans and leases, credit card receivables, SBA small business loans and commercial mortgage-backed securities; and (vii) the American Recovery and Reinvestment Act of 2009, or the ARRA, which includes a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs. For a more detailed description of certain of these initiatives, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Current Market Conditions and Known Material Trends.”
Despite reports of stabilization in some sectors, no assurance can be given that these initiatives will have a beneficial impact on the banking system, financial market or housing market. To the extent the markets do not respond favorably to these initiatives or if these initiatives do not function as intended, the pricing, supply, liquidity and value of our assets and the availability of financing on attractive terms may be materially adversely affected.
Mortgage loan modification programs and future legislative action may adversely affect the value of, and the returns, on the interest-earning assets in which we invest.
In late 2008, the U.S. government, through the Federal Housing Authority and the Federal Deposit Insurance Corporation, or FDIC, commenced implementation of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. The programs involve, among other things, modifications 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, members of the U.S. Congress have indicated support for additional legislative relief for homeowners, including an amendment of the bankruptcy laws to permit the modification of mortgage loans in bankruptcy proceedings. These loan modification programs, as well as future legislative or regulatory actions, including amendments to the bankruptcy laws, that result in the modification of outstanding mortgage loans may as well as changes in the requirements necessary to qualify for refinancing a mortgage with Fannie Mae, Freddie Mac or Ginnie Mae adversely affect the value of, and the returns on, the interest-earning assets in which we invest, including through prepayments on the mortgage loans underlying our RMBS and the mortgage loans held in our securitization trusts.
The principal and interest payments on our non-Agency RMBS are not guaranteed by any entity, including any government sponsored entity or agency, and, therefore, are subject to increased risks, including credit risk.
Our portfolio includes non-Agency RMBS which are backed by residential mortgage loans that do not conform to the Fannie Mae or Freddie Mac underwriting guidelines. Consequently, the principal and interest on non-Agency RMBS, unlike those on Agency RMBS, are not guaranteed by government-sponsored entities such as Fannie Mae and Freddie Mac or, in the case of Ginnie Mae, the U.S. Government.
Changes in prepayment rates on our RMBS may decrease our net interest income.
Pools of mortgage loans underlie the mortgage-backed securities that we hold in our investment portfolio and in which we invest. We will generally receive principal distributions from the principal payments that are made on these underlying mortgage loans. When borrowers repay their mortgage loans faster than expected, this will result in prepayments that are faster than expected on the related-RMBS. Prepayment rates are influenced by changes in current interest rates and a variety of economic, geographic and other factors, all of which are beyond our control. Prepayment rates generally increase when interest rates fall and decrease when interest rates rise, but changes in prepayment rates are difficult to predict. Prepayment rates also may be affected by conditions in the housing and financial markets, general economic conditions and the relative interest rates on fixed-rate and adjustable-rate mortgage loans. Faster than expected prepayments could adversely affect our profitability, including in the following ways:
We have purchased RMBS, and may purchase in the future investment securities, that have a higher interest rate than the market interest rate at the time of purchase. In exchange for this higher interest rate, we are required to pay a premium over the face amount of the security to acquire the security. In accordance with accounting rules, we amortize this premium over the anticipated term of the mortgage security. If principal distributions are received faster than anticipated, we would be required to expense the premium faster. We may not be able to reinvest the principal distributions received on these investment securities in similar new mortgage-related securities and, to the extent that we can do so, the effective interest rates on the new mortgage-related securities will likely be lower than the yields on the mortgages that were prepaid.
We also may acquire RMBS or other investment securities at a discount. If the actual prepayment rates on a discount mortgage security are slower than anticipated at the time of purchase, we would be required to recognize the discount as income more slowly than anticipated. This would adversely affect our profitability. Slower than expected prepayments also may adversely affect the market value of a discount mortgage security.
On February 10, 2010, Fannie Mae and Freddie Mac announced their intention to significantly increase their purchases of delinquent loans from the pools of mortgages collateralizing their Agency RMBS beginning March 2010. Their program to purchase delinquent loans is expected to impact the rate of principal prepayments on our Agency RMBS.
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.
Interest rate capsIncreased levels of prepayments on the mortgages underlying our adjustable-ratestructured Agency RMBS, may reduce ourparticularly Agency IOs, might decrease net interest income or cause usresult in a net loss, which could materially adversely affect our business, financial condition and results of operations and our ability to suffer a loss during periods of rising interest rates.pay distributions to our stockholders.
The mortgage loansWhen we acquire structured Agency RMBS, such as Agency IOs, we anticipate that the underlying mortgages will prepay at a projected rate, generating an expected yield. When the prepayment rates on the mortgages underlying our adjustable-ratestructured Agency RMBS typically willare higher than expected, our returns on those securities may be subjectmaterially adversely affected. For example, the value of our Agency IOs is extremely sensitive to periodic and lifetimeprepayments because holders of these securities do not have the right to receive any principal payments on the underlying mortgages. Agency IOs currently comprise a large percentage of our interest rate caps. Additionally, we may invest in ARMs with an initial “teaser” rate that will provide us with a lower than market interest rate initially, which may accordingly have lower interest rate caps than ARMs without such teaser rates. Periodic interest rate caps limit the amount an interest rate can increase during a given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturity of a mortgage loan. If these interest rate caps apply toearning assets. Therefore, if the mortgage loans underlying our adjustable-rate RMBS, the interest distributions made on the related RMBS will be similarly impacted. Our borrowings may not be subject to similar interest rate caps. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while caps would limit the interest distributions on our adjustable-rate RMBS. Further, some of the mortgage loans underlying our adjustable-rate RMBS may be subject to periodic payment caps that result in a portion of the interest on those loans being deferred and added to the principal outstanding. As a result, we could receive less interest distributions on adjustable-rate RMBS, particularly those with an initial teaser rate, than we need to pay interest on our related borrowings. These factors could lower our net interest income, cause us to suffer a net loss or cause us to incur additional borrowings to fund interest payments during periods of rising interest rates or sell our investmentsAgency IOs are prepaid at a loss.
Competition may prevent us from acquiring mortgage-related assets at favorable yields,higher than anticipated rate, such securities would decline in value and provide less cash flow, which, would negatively impact our profitability.
Our net income largely depends on our ability to acquire mortgage-related assets at favorable spreads over our borrowing costs. In acquiring mortgage-related assets, we compete with other REITs, investment banking firms, savings and loan associations, banks, insurance companies, mutual funds, other lenders and other entities that purchase mortgage-related assets, many of which have greater financial resources than us. 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 mortgage-related assets at favorable spreads over our borrowing costs which, wouldturn, could materially adversely affect our profitability.
We may experience periodsbusiness, financial condition and results of illiquidity for our assets which could adversely affect our ability to finance our business or operate profitably.
We bear the risk of being unable to dispose of our interest-earning assets at advantageous times or in a timely manner because these assets generally experience periods of illiquidity. The lack of liquidity may result from the absence of a willing buyer or an established market for these assets, legal or contractual restrictions on resale or disruptions in the secondary markets. This illiquidity may adversely affect our profitabilityoperations and our ability to financepay distributions to our businessstockholders.
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.
An increase in interest rates can have negative effects on us, including causing a decrease inflattening of the volume of newly-issued, or investor demand for, RMBS,yield curve, which could harmmaterially adversely affect our business, financial condition and results of operations and our ability to pay distributions to our stockholders.
On September 21, 2011, the Federal Reserve announced “Operation Twist,” which is a program by which it intends to purchase, by the end of June 2012, $400 billion of U.S. Treasury securities with remaining maturities between six and 30 years and sell an equal amount of U.S. Treasury securities with remaining maturities of three years or less. The effect of Operation Twist could be a flattening in the yield curve, which could result in increased prepayment rates due to lower long-term interest rates and a narrowing of our net interest margin. Consequently, Operation Twist and any other future securities purchase programs by the Federal Reserve could materially adversely affect our operations.
An increase in interest rates can have various negative affects on us. Increases in interest rates may negatively affect the fair market valuebusiness, financial condition and results of our RMBSoperations and other interest-earning assets. When interest rates rise, the value of RMBS and fixed-rate investment securities generally declines. Typically, as interest rates rise, prepayments on the underlying mortgage loans tend to slow. The combination of rising interest rates and declining prepayments may negatively affect the price of RMBS, and the effect can be particularly pronounced with fixed-rate RMBS. In accordance with GAAP, we will be required to reduce the carrying value of our RMBS by the amount of any decrease in the fair value of our RMBS compared to amortized cost. If unrealized losses in fair value occur, we will either have to reduce current earnings or reduce stockholders’ equity without immediately affecting current earnings, depending on how we classify our assets under GAAP. In either case, our net stockholders’ equity will decrease to the extent of any realized or unrealized losses in fair value and our financial position will be negatively impacted.
Furthermore, rising interest rates generally reduce the demand for consumer and commercial credit, including mortgage loans, due to the higher cost of borrowing. A reduction in the volume of mortgage loans originated may affect the volume of RMBS available to us, which could adversely affect our ability to acquire assets that satisfypay distributions to our investment objectives. Rising interest rates may also cause RMBS and other interest-earning assets that were issued prior to an interest rate increase to provide yields that are below prevailing market interest rates. If rising interest rates cause us to be unable to acquire a sufficient volume of RMBS and other interest-earning assets with a yield that is above our borrowing cost, our ability to satisfy our investment objectives and to generate income and pay dividends, may be materially and adversely affected.stockholders.
Changes in interest rates, particularly higher interest rates, can also harm the credit performance of our interest-earning assets. Higher interest rates could reduce the ability of borrowers to make interest payments or to refinance their loans and could reduce property values, all of which could increase our credit losses. In the event we experience a significant increase in credit losses as a result of higher interest rates, our earnings and financial condition will be materially adversely affected.
Market conditions may upsetThe ongoing debt crisis in Europe could have an adverse effect on our business and liquidity.
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.
Our success depends on our ability to analyze the relationship of changing interest rates on prepaymentscuts. Additionally, other governments of the mortgage loans that underlie our RMBS. Changes in interest rates and prepayments affect the market price of the RMBS that we hold in our portfolio and in which we intend to invest. In managing our investment portfolio, to assess the effects ofworld’s largest economic countries have also implemented interest rate changes and prepayment trends on our investment portfolio, we typically rely on certain assumptions that are based upon historical trends with respectcuts in response to the relationship between interest ratescrisis. There is no assurance that these and prepayments under normal market conditions.other plans and programs will be successful in halting the European credit crisis or in preventing other financial institutions from failing. If the dislocations in the residential mortgage market over the last few years or other developments change the way that prepayment trends have historically responded to interest rate changes, our ability to (i) assess the market value of our investment portfolio, (ii) effectively hedge our interest rate risk and (iii) implement techniques to reduce our prepayment rate volatility would be significantly affected, whichunsuccessful, this could materially adversely affect our business, financial positioncondition and results of operations as well as those of the entire mortgage industry.
As the European credit crisis continues, there is a growing risk to the financial condition and stability of major European financial institutions. Some of these financial institutions have U.S. banking subsidiaries which have provided financing to us, particularly repurchase agreement financing collateralized by Agency RMBS. Some of the U.S. banking subsidiaries of these major European financial institutions have recently been placed on credit watch. If the European credit crisis continues to impact these major European financial institutions, there is the possibility that it will also impact the operations and lending activities of their U.S. banking subsidiaries, which could have an adverse impact on our ability to access financing sources on favorable terms, or at all, or result in counterparty default under our repurchase agreements. In addition, it is possible that certain of our U.S. based counterparties could have significant exposure to European sovereign debt or affected European financial institutions. This could adversely affect our business, liquidity, financial condition and results of operations as well as those of the entire mortgage industry.
The downgrade of the U.S.’s, certain European countries’ and certain European financial institutions’ credit ratings and any future downgrades of the U.S.’s, certain European countries’ or certain European financial institutions’ credit ratings may materially adversely affect our business, financial condition and results of operations.
A substantial majorityOn August 5, 2011, Standard & Poor’s downgraded the U.S.’s credit rating for the first time in history. Because Fannie Mae and Freddie Mac are in conservatorship of the U.S. Government, downgrades to the U.S.’s credit rating could impact the credit risk associated with Agency RMBS withinand certain CMBS and, therefore, decrease the value of the Agency RMBS and certain CMBS in our portfolio. In addition, the downgrade of the U.S. Government’s credit rating, the credit ratings for certain European countries and certain financial institutions domiciled in Europe has created broader financial turmoil and uncertainty, which has weighed heavily on the global banking system. Therefore, the recent downgrade of the U.S.’s credit rating and the credit ratings of certain European countries and certain financial institutions domiciled in Europe, and any future downgrades of the U.S.’s credit rating or the downgrade of credit ratings for certain European countries or certain financial institutions domiciled in Europe, may materially adversely affect our business, financial condition and results of operations.
Difficult conditions in the mortgage real estate markets have caused and may cause us to experience losses and these conditions may persist for the foreseeable future.
Our business is materially affected by conditions in the residential mortgage market, the residential and commercial real estate market, the financial markets and the economy generally. Furthermore, because a significant portion of our current assets and our targeted assets are credit sensitive, we believe the 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.
Substantially allon favorable terms or at all. The further deterioration of the assets held within our investment portfolio areresidential or commercial mortgage markets, the financial markets and the economy generally may result in a decline in the form of securities that are not publicly traded on a national securities exchange or quotation system. The fair value of securities and other assets that are not publicly traded in this manner may not be readily determinable. A substantial majority of the assets in our investment portfolio are valued by us at fair value as determined in good faith by our management based on market quotations from brokers and dealers. Although we currently are able to obtain quotations from brokers and dealers for substantially all of the assets within our investment portfolio, we may be unable to obtain such quotations on other assets in our investment portfolio in the future, in which case, our manager may need to determine in good faith the fair value of these assets. Because such quotations and valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a public market for these securities existed. The value of our common stock could be adversely affected if our determinations regarding the fair value of these assets are materially higher than the values that we ultimately realize upon their disposal. Misjudgments regarding the fair value ofinvestments or cause us to experience losses related to our assets, that we subsequently recognizewhich may also result in impairments that we must recognize.
Loan delinquencies onadversely affect our prime ARM loans held in securitization trusts may increase as a result of significantly increased monthly payments required from ARM borrowers after the initial fixed period.
The scheduled increase in monthly payments on certain adjustable rate mortgage 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 adjustable rate mortgage loans. Borrowers seekingoperations, the availability and cost of credit and our ability to avoid these increased monthly payments by refinancing their mortgage loans may no longer be ablemake distributions to fund available replacement loans at comparably low interest rates or at all. A decline in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance their loans or sell their homes. In addition, these mortgage loans may have prepayment premiums that inhibit refinancing.our stockholders.
We may be required to repurchase loans if we breached representations and warranties from loan sale transactions, which could harm our profitability and financial condition.
Loans from our discontinued mortgage lending operations that were sold to third parties under agreements include numerous representations and warranties regarding the manner in which the loan was originated, the property securing the loan and the borrower. If these representations or warranties are found to have been breached, we may be required to repurchase the loan. We may be forced to resell these repurchased loans at a loss, which could harm our profitability and financial condition.
TheChanges in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. government, may adversely affect our business.
Payments on the Agency RMBS in which we invest are guaranteed by Fannie Mae and Freddie Mac. As broadly publicized, Fannie Mae and Freddie Mac have experienced significant losses in recent years, causing the U.S. Government to place Fannie Mae and Freddie Mac under federal conservatorship and to inject significant capital in these businesses. Questions regarding the continued viability of Fannie Mae and Freddie Mac, as currently structured, including the guarantees that back the RMBS issued by them, and the U.S. Government’s participation in the U.S. residential mortgage market through the GSEs, continue to persist. In February 2011, the U.S. Department of the Treasury along with the U.S. Department Housing and Urban Development released a much-awaited report titled “Reforming America’s Housing Finance Market”, which outlines recommendations for reforming the U.S. housing system, specifically the roles of Fannie Mae and Freddie Mac and transforming the government’s involvement in the housing market and its relationship to Fannie Mae and Freddie Mac. It is unclear how future legislation may impact the housing finance market and the investing environment for mortgage-related securities and more specifically, Agency RMBS and non-Agency RMBS, as the method of reform is undecided and has not yet been defined by the regulators. New regulations and programs related to Fannie Mae and Freddie Mac, including those affecting the relationship between the GSEs and the U.S. Government or the guarantees that back the RMBS issued by the GSEs, may adversely affect the pricing, supply, liquidity and value of Agency RMBS and otherwise materially harm our business and operations.
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.
Our investment strategy permits us to consider a broad range of asset types, includingthe future CMBS non-Agency RMBS and otherbacked by commercial mortgage assets, includingloans or may directly acquire commercial mortgage loans. Commercial mortgage loans are secured by multi-familymultifamily or commercial property. Theyproperty and are subject to risks of delinquency and foreclosure and risks of loss that are greater than similar risks associated with loans made on the security of single-family residential property.mortgage loans. The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of thesuch property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Such income can be affected by many factors.
ResidentialIf we incur losses on CMBS, or commercial mortgage loans, are secured by single-family residential property. They are subject to risksour business, financial condition and results of delinquencyoperations and foreclosure, and risks of loss. Theour ability of a borrower to repay a loan secured by a residential property depends on the income or assets of the borrower. Many factors may impair borrowers’ abilities to repay their loans. ABS are bonds or notes backed by loans or other financial assets.
In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan. This could impair our cash flow from operations. In the event of the bankruptcy of a mortgage loan borrower, the loan will be deemed secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court). The lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure of a mortgage loan can be expensive and lengthy. This could impair our anticipated return on the foreclosed mortgage loan. Moreover, RMBS represent interests in or are secured by pools of residential mortgage loans and CMBS represent interests in or are secured by a single commercial mortgage loan or a pool of commercial mortgage loans. To the extent a foreclosure or loss occurs on the underlying mortgage loan, we will receive less principal and interest from that security in the future. Accordingly, the CMBS and non-Agency RMBS we may invest in are subject to all of the risks of the underlying mortgage loans.
Our investments in subordinated CMBS or RMBS could subject us to increased risk of losses.
We may also invest in securities that represent subordinated tranches of CMBS or non-Agency RMBS. In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by any cash reserve fund or letter of credit provided by the borrower, and then by the first loss subordinated security holder. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit—and any classes of securities junior to those in which we invest—we may not be able to recover all of our investment in the securities we purchase. In addition, if the underlying mortgage portfolio has been overvalued by the originator, or if the values subsequently decline and, as a result, less collateral is available to satisfy delinquent interest and principal payments due on the related CMBS or RMBS, the securities in which we invest may effectively become the first loss position behind the more senior securities, which may result in significant losses to us.
The prices of lower credit quality securities are generally less sensitive to interest rate changes than more highly rated investments, but more sensitive to adverse economic downturns or individual issuer developments. A projection of an economic downturn, for example, could cause a decline in the price of lower credit quality securities because the ability of obligors of mortgages underlying mortgage-backed securities to make principal and interest payments ordistributions to refinanceour stockholders may be impaired. In this case, existing credit support in the securitization structure may be insufficient to protect us against loss of our principal on these securities.materially adversely affected.
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.
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.
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.
Our due diligence may not reveal all the liabilities associated with an investment and may not reveal other investment performance issues.
Before investingA change in the Federal Reserve's intention to hold the Federal Funds Target Rate near zero through mid-2014 that would result in higher interest rates may adversely affect the market value of our interest earning assets and, therefore, also our book value.
In response to the 2008 financial and credit crisis, the Federal Reserve lowered the Federal Funds Target Rate to near zero in an 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
Continued adverse developments in the residential mortgage market and financial markets, including recent mergers, acquisitions or bankruptcies of potential repurchase agreement counterparties, as well as defaults, credit losses and liquidity concerns, could make it difficult for usOur access to borrow money to fund our investment strategy or continue to fund our investment portfolio on a leveraged basis,financing sources, which may not be available on favorable terms, or at all, which couldespecially in light of current market conditions, may be limited, and this may materially adversely affect our profitability.business, financial condition and results of operations and our ability to make distributions to our stockholders.
We rely ondepend upon the availability of adequate capital and financing to acquire Agency RMBS andsources to fund our investment portfoliooperations. However, as previously discussed, the capital and credit markets have experienced unprecedented levels of volatility and disruption in recent years, as most recently caused by the U.S. deficit debate and Eurozone sovereign debt concerns which exerted downward pressure on a leveraged basis. Since March 2008, there have been several announcements of proposed mergers, acquisitions or bankruptcies of investment banksstock prices and commercial banks that have historically acted as repurchase agreement counterparties. This has resulted in a fewer number of potential repurchase agreement counterparties operating in the market and reduced financing capacity. In addition, many commercial banks, investment banks and insurance companies have announced extensive losses from exposure to the residential mortgage market. These losses have reduced financial industry capital, leading to reduced liquiditycredit capacity for some institutions. Institutions from which we seek to obtain financing may have owned or financed RMBS which have declined in value and caused them to suffer losses as a result of the recent downturn in the residential mortgage market.lenders. If these conditions persist, these institutions may be forced to exit the repurchase market, merge with another counterparty, become insolvent or further tighten their lending standards or increase the amount of equity capital or haircut required to obtain financing. Moreover, because our equity market capitalization places us at the low endlevels of market capitalization among all mortgage REITs, continued adverse developments in the residential mortgage market mayvolatility and disruption continue or worsen, it could materially adversely affect one or more of our lenders and could cause someone or more of our lenders to reducebe unwilling or terminateunable to provide us with financing, or to increase the costs of that financing, or to become insolvent. Moreover, we are currently party to repurchase agreements of a short duration and there can be no assurance that we will be able to roll over or re-set these borrowings on favorable terms, if at all. In the event we are unable to roll over or re-set our access to future borrowings before those of our competitors. Any of these events could makereverse repos, it may be more difficult for us to obtain debt financing on favorable terms or at all. Our profitability willIn addition, if regulatory capital requirements imposed on our lenders change, they may be adversely affected ifrequired to limit, or increase the cost of, financing they provide to us. In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell assets at an inopportune time or price. Under current market conditions, securitizations are generally unavailable or limited, which has also limited borrowings under warehouse facilities and other credit facilities that are intended to be refinanced by such securitizations. Consequently, depending on market conditions at the relevant time, we are unablemay have to obtain cost-effectiverely on additional equity issuances to meet our capital and financing needs, which may be dilutive to our stockholders, or we may have to rely on less efficient forms of debt financing that consume a larger portion of our cash flow from operations, thereby reducing funds available for our investments.operations, future business opportunities, cash distributions to our stockholders and other purposes. We cannot assure you that we will have access to such equity or debt capital on favorable terms (including, without limitation, cost and term) at the desired times, or at all, which may cause us to curtail our investment activities and/or dispose of assets, which could materially adversely affect our business, financial condition and results of operations and our ability to make distributions to our stockholders.
We may incur increased borrowing costs related to repurchase agreements and that would adversely affect our profitability.
Currently, a significant portion of our borrowings are collateralized borrowings in the form of repurchase agreements. If the interest rates on these agreements increase at a rate higher than the increase in rates payable on our investments, our profitability would be adversely affected.
Our borrowing costs under repurchase agreements generally correspond to short-term interest rates such as LIBOR or a short-term Treasury index, plus or minus a margin. The margins on these borrowings over or under short-term interest rates may vary depending upon a number of factors, including, without limitation:
· | the movement of interest rates; |
· | the the availability of financing in the market; and |
· | the the value and liquidity of our mortgage-related assets. |
Currently,During 2008 and 2009, many repurchase agreement lenders are requiringrequired higher levels of collateral than they havehad required in the past to support repurchase agreements collateralized by Agency RMBS and if this continues itRMBS. Although these collateral requirements have been reduced to more appropriate levels, we cannot assure you that they will make our borrowings and use of leverage less attractive and more expensive. Many financial institutions have increased lending margins for Agency RMBS to approximately 5.0% on average, which means that we are required to pledge Agency RMBS havingnot again experience a value of 105% of the amount of our borrowings. These increased lending margins may require us to post additional cash collateral for our Agency RMBS.dramatic increase. If the interest rates, lending margins or collateral requirements under these repurchase agreements increase, or if lenders impose other onerous terms to obtain this type of financing, our results of operations will be adversely affected.
Failure to procure adequate debt financing, or to renew or replace existing debt financing as it matures, would adversely affect our results and may, in turn, negatively affect the value of our common stock and our ability to distribute dividends.
We use debt financing as a strategy to increase our return on investment securities in our investment portfolio. However, we may not be able to achieve our desired debt-to-equity ratio for a number of reasons, including the following:
· | our lenders do not make debt financing available to us at acceptable rates; or |
· | our lenders require that we pledge additional collateral to cover our borrowings, which we may be unable to do. |
The dislocations in the residential mortgage market and credit markets have led lenders, including the financial institutions that provide financing for our investment securities, to heighten their credit review standards, and, in some cases, to reduce or eliminate loan amounts available to borrowers. As a result, we cannot assure you that any, or sufficient, debt funding will be available to us in the future on terms that are acceptable to us. In the event that we cannot obtain sufficient funding on acceptable terms, there may be a negative impact on the value of our common stock and our ability to make distributions, and you may lose part or all of your investment.
Furthermore, because we rely primarily on short-term borrowings to finance our investment securities, our ability to achieve our investment objective depends not only on our ability to borrow money in sufficient amounts and on favorable terms, but also on our ability to renew or replace on a continuous basis our maturing short-term borrowings. As of December 31, 2009, substantially all of our borrowings under repurchase agreements bore maturities of 30 days or less. If we are not able to renew or replace maturing borrowings, we will have to sell some or all of our assets, possibly under adverse market conditions.
The repurchase agreements that we use to finance our investments may require us to provide additional collateral, which could reduce our liquidity and harm our financial condition.
We intend to use repurchase agreements to finance our investments. If the market value of the loans or securities pledged or sold by us to a funding source decline in value, we may be required by the lending institution to provide additional collateral or pay down a portion of the funds advanced, but we may not have the funds available to do so. Posting additional collateral to support our repurchase agreements will reduce our liquidity and limit our ability to leverage our assets. In the event we do not have sufficient liquidity to meet such requirements, lending institutions can accelerate our indebtedness, increase our borrowing rates, liquidate our collateral at inopportune times and terminate our ability to borrow. This could result in a rapid deterioration of our financial condition and possibly require us to file for protection under the U.S. Bankruptcy Code.
We currentlyintend to leverage our equity, which will exacerbate any losses we incur on our current and future investments and may reduce cash available for distribution to our stockholders.
We currentlyintend to leverage our equity through borrowings, generally through the use of repurchase agreements and other short-term borrowings or through longer-term structured debt, such as CDOs, which are obligations issued in multiple classes secured by an underlying portfolio of securities, and wesecurities. We may, in the future, utilize other forms of borrowing. The amount of leverage we incur varies depending on our ability to obtain credit facilitiesborrowings, the cost of the debt and our lenders’ estimates of the value of our portfolio’s cash flow. The return on our investments and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions cause the cost of our financing to increase relative to the income that can be derived from the assets we hold in our investment portfolio. Further, the leverage on our equity may exacerbate any losses we incur.
Our debt service payments will reduce the net income available for distribution to our stockholders. We may not be able to meet our debt service obligations and, to the extent that we cannot, we risk the loss of some or all of our assets to sale to satisfy our debt obligations. A decrease in the value of the assets may lead to margin calls under our repurchase agreements which we will have to satisfy. Significant decreases in asset valuation, such as occurred during March 2008, could lead to increased margin calls, and we may not have the funds available to satisfy any such margin calls. WeAlthough we have aestablished target overall leverage amountamounts for many of our RMBS investment portfolio of seven to nine times our equity, butassets, there is no established limitation, other than may be required by our financing arrangements, on our leverage ratio or on the aggregate amount of our borrowings.
If we are unable to leverage our equity to the extent we currently anticipate, the returns on certain of our RMBS portfolioassets could be diminished, which may limit or eliminate our ability to make distributions to our stockholders.
If we are limited in our ability to leverage certain of our assets, such as Agency RMBS or certain commercial mortgage-related securities, the returns on our portfoliothese assets may be harmed. A key element of our strategy is our use of leverage to increase the size of our RMBS portfolio in an attempt to enhance our returns. 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.
Our hedging transactions may limit our gains or result in losses.
We use derivatives, primarilyHedging against credit events and interest rate swapschanges and caps,other risks may materially adversely affect our business, financial condition and results of operations and our ability to hedge our liabilities and this has certain risks, including the risk that losses on a hedging transaction will reduce the amount of cash available for distributionmake distributions to our stockholders and that such losses may exceedshareholders.
Subject to compliance with the amount invested in such instruments. Our Board of Directors has adopted a general policy with respectrequirements to the use of derivatives, and which generally allows us to use derivatives when we deem appropriate for risk management purposes, but does not set forth specific guidelines. To the extent consistent with maintaining our statusqualify as a REIT, we may use derivatives, including interest rate swaps and caps, options, term repurchase contracts, forward contracts and futures contracts,engage in our risk management strategycertain hedging transactions to limit the effects ofour exposure to changes in interest rates onand therefore may expose ourselves to risks associated with such transactions. We may utilize instruments such as interest rate swaps, caps, collars and floors and Eurodollar and U.S. Treasury futures to seek to hedge the interest rate risk associated with our operations.portfolio. Hedging against a decline in the values of our portfolio positions does not eliminate the possibility of fluctuations in the values of such positions or prevent losses if the values of such positions decline. However, we may establish other hedging positions designed to gain from those same developments, thereby offsetting the decline in the value of such portfolio positions. Such hedging transactions may also limit the opportunity for gain if the values of the portfolio positions should increase. Moreover, at any point in time we may choose not to hedge all or a portion of these risks, and we generally will not hedge maythose risks that we believe are appropriate for us to take at such time, or that we believe would be impractical or prohibitively expensive to hedge.
Even if we do choose to hedge certain risks, for a variety of reasons we generally will not be effective in eliminatingseek to establish a perfect correlation between our hedging instruments and the risks inherent in any particular position. Our profitabilitybeing hedged. Any such imperfect correlation may be adversely affected during any period as a result ofprevent us from achieving the use of derivatives in a hedging transaction.
Our use of hedging strategies to mitigate our interest rate exposure may not be effectiveintended hedge and may expose us to counterparty risks.
In accordance with our operating policies, we may pursue various typesrisk of hedging strategies, including swaps, caps and other derivative transactions, to seek to mitigate or reduce our exposure to losses from adverse changes in interest rates.loss. Our hedging activity will vary in scope based on the composition of our portfolio, our market views, and changing market conditions, including the level and volatility of interest rates, the type of assets held and financing sources used and other changing market conditions. No hedging strategy, however, can completely insulate us from the interest rate risksrates. When we do choose to which we are exposed or that the implementation of any hedging strategy would have the desired impact on our results of operations or financial condition. Certain of the U.S. federal income tax requirements that we must satisfy in order to qualify as a REIT may limit our ability to hedge, against such risks. We will not enter into derivative transactions if we believe that they will jeopardize our qualification as a REIT.
Interest rate hedging may fail to protect or could materially adversely affect us because, among other things:
| · | either we or our external managers may fail to correctly assess the degree of correlation between the performance of the instruments used in the hedging strategy and the performance of the assets in the portfolio being hedged; |
| · | either we or our external managers may fail to recalculate, re-adjust and execute hedges in an efficient and timely manner; |
| · | the hedging transactions may actually result in poorer over-all performance for us than if we had not engaged in the hedging transactions; |
| · | credit hedging can be expensive, particularly when the market is forecasting future credit deterioration and when markets are more illiquid; |
| · | interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates; |
· | · | available interest rate hedges may not correspond directly with the interest rate riskrisks for which protection is sought; |
| · | the durationdurations of the hedgehedges may not match the durationdurations of the related liability;assets or liabilities being hedged; |
· | · | many hedges are structured as over-the-counter contracts with counterparties whose creditworthiness is not guaranteed, raising the amount of incomepossibility that a REIT may earn from hedging transactions (other than through taxable REIT subsidiaries (or TRSs)) to offset interest rate losses is limited by U.S. federal tax provisions governing REITs; |
· | the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our ability to sell or assign our side of the hedging transaction;counterparty may default on their payment obligations; and |
· | · | to the party owing money inextent that the creditworthiness of a hedging transactioncounterparty deteriorates, it may default on its obligationbe difficult or impossible to pay.terminate or assign any hedging transactions with such counterparty. |
We primarily use swaps to hedge against anticipated future increases in interest rates onFor these and other reasons, our repurchase agreements. Should a swap counterparty be unable to make required payments pursuant to such swap, the hedged liability would cease to be hedged for the remaining term of the swap. In addition, wehedging activity may be at risk for any collateral held by a hedging counterparty to a swap, should such counterparty become insolvent or file for bankruptcy. Our hedging transactions, which are intended to limit losses, may actuallymaterially adversely affect our earnings, which could reducebusiness, financial condition and results of operations and our cash available for distributionability to make distributions to our stockholders.
Hedging instruments involve risk since they often areand other derivatives historically have not, in many cases, been traded on regulated exchanges, or been guaranteed or regulated by an exchangeany U.S. or its clearing house,foreign governmental authorities and involve risks and costs that could result in material losses.
Hedging instruments and other derivatives involve risk because they historically have not, in many cases, been traded on regulated exchanges and have not been guaranteed or regulated by any U.S. or foreign governmental authorities. Consequently, for these instruments there are no requirements with respect to record keeping, financial responsibility or segregation of customer funds and positions. Furthermore, the enforceability of hedging instruments may depend on compliance with applicable statutory and commodity and other regulatory requirements and, depending on the identity of the counterparty, applicable international requirements. We are restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with one counterparty. The business failure of a hedging counterparty with whom we enter into a hedging transaction will most likely result in its default.a default under the hedging agreement. Default by a party with whom we enter into a hedging transaction may result in the loss of unrealized profitslosses and may force us to cover our commitments, if any,re-initiate similar hedges with other counterparties at the then currentthen-prevailing market price. Although generallylevels. Generally we will seek to reserve the right to terminate our hedging positions, ittransactions upon a counterparty’s insolvency, but absent an actual insolvency, we may not always be possibleable to dispose of or close outterminate a hedging positiontransaction without the consent of the hedging counterparty, and we may not be able to assign or otherwise dispose of a hedging transaction to another counterparty without the consent of both the original hedging counterparty and the potential assignee. If we terminate a hedging transaction, we may not be able to enter into an offsettinga replacement contract in order to cover our risk. We cannot assure youThere can be no assurance that a liquid secondary market will exist for hedging instruments purchased or sold, and therefore we may be required to maintain aany hedging position until exercise or expiration, which could resultmaterially adversely affect our business, financial condition and results of operations.
The U.S. Commodity Futures Trading Commission and certain commodity exchanges have established limits referred to as speculative position limits or position limits on the maximum net long or net short position which any person or group of persons may hold or control in losses.particular futures and options. Limits on trading in options contracts also have been established by the various options exchanges. It is possible that trading decisions may have to be modified and that positions held may have to be liquidated in order to avoid exceeding such limits. Such modification or liquidation, if required, could materially adversely affect our business, financial condition and results of operation and our ability to make distributions to our stockholders.
Our delayed delivery transactions, including TBAs, subject us to certain risks, including price risks and counterparty risks.
We purchase a significant portion of our Agency RMBS through delayed delivery transactions, including TBAs. In a delayed delivery transaction, we enter into a forward purchase agreement with a counterparty to purchase either (i) an identified Agency RMBS, or (ii) a to-be-issued (or “to-be-announced”) Agency RMBS with certain terms. As with any forward purchase contract, the value of the underlying Agency RMBS may decrease between the contract date and the settlement date. Furthermore, a transaction counterparty may fail to deliver the underlying Agency RMBS at the settlement date. If any of the above risks were to occur, our financial condition and results of operations may be materially adversely affected.
Risks Related to the Advisory AgreementOur Agreements with HCSOur External Managers
We are dependent on HCSour external managers and certain of itstheir key personnel and may not find a suitable replacement if HCS terminates the advisory agreementthey terminate their respective management agreements with us or such key personnel are no longer available to us.
PursuantWe historically were organized as a self-advised company that acquired, originated, sold and managed its assets; however, as we modified our business strategy and the targeted assets we seek to acquire in response to changing market conditions, we began to outsource the advisory agreement, subjectmanagement of certain targeted asset classes for which we had limited internal resources or experience. We presently are a party to oversight bytwo separate management agreements with Midway and RiverBanc that provide for the external management of certain of our Boardassets and investment strategies. Each of Directors, HCS advises the Managed Subsidiaries. HCSour external managers, in some manner, identifies, evaluates, negotiates, structures, closes and monitors certain investments on our behalf. In each case, we have engaged these third parties because of the Managed Subsidiaries, other than assets that we contributed to the Managed Subsidiaries to facilitate compliance withexpertise of certain key personnel of our exclusion from regulation under the Investment Company Act.external managers. The departure of any of the senior officers of HCS,our external managers, or of a significant number of investment professionals or principals of HCS,our external managers, could have a material adverse effect on our ability to achieve our investment objectives. We are subject to the risk that HCSour external managers will terminate the advisorytheir respective management agreement with us or that we may deem it necessary to terminate the advisorysuch agreement or prevent certain individuals from performing services for us, and that no suitable replacement will be found to manage the Managed Subsidiaries.certain of our assets and investment strategies.
Pursuant to the advisory agreement, HCS isour management agreements, our external managers are entitled to receive an advisorya management fee that is payable regardless of the performance of the assets of the Managed Subsidiaries.under their management.
We will pay HCSeach of Midway and RiverBanc substantial advisorybase management fees, based on the Managed Subsidiaries’ equityour invested capital (as such term is defined in the advisory agreement)respective management agreements), regardless of the performance of the Managed Subsidiaries’ portfolio. In addition, pursuant to the advisory agreement, we will pay HCS a base advisory fee even if they are not managing any assets of the Managed Subsidiaries' portfolio. HCS’sunder their management. The external managers’ entitlement in many cases to non-performance based compensation may reduce its incentive to devote the time and effort of its professionals to seeking profitable investment opportunities for the Managed Subsidiaries’ portfolio,our company, which could result in a lower performancethe under-performance of assets under their portfoliomanagement and negatively affect our ability to pay distributions to our stockholders or to achieve capital appreciation.
Pursuant to the advisory agreement, HCS isterms of our management agreements, our external managers are generally entitled to receive an incentive fee, which may induce itthem to make certain investments, including speculative or high risk investments.
In addition to its advisory fee, HCS isthe base management fees, payable to our external managers, our external managers are generally entitled to receive incentive compensation based, in part, upon the Managed Subsidiaries’ achievement of targeted levels of net income. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on net income may lead HCSour external managers to place undue emphasis on the maximization of net income at the expense of other criteria, such as preservation of capital, maintaining liquidity and/or management of interest rate, credit risk or market risk,risks, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative. In addition, HCSMidway has broad discretion regarding the types of investments it will make pursuant to the advisory agreement.its management agreement with us. This could result in increased risk to the value of our assets under the Managed Subsidiaries’ invested portfolio.management of our external managers.
We compete with HCS’sour external managers’ other clients for access to HCS.them.
HCS has sponsored and/or currentlyEach of Midway and RiverBanc manages, other pools of capital and investment vehicles with an investment focus that overlaps with the Managed Subsidiaries’ investment focus, and is expected to continue to do somanage, other client accounts with similar or overlapping investment strategies. In connection with the services provided to those accounts, these managers may be compensated more favorably than for the services provided under our external management or advisory agreements, and such discrepancies in compensation may affect the level of service provided to us by our external managers. Moreover, each of our external managers may have an economic interest in the future. Furthermore, HCS is not restricted in any way from sponsoringaccounts they manage or accepting capital from new clients or vehicles, even for investing in asset classes or investment strategies that are similar to, or overlappingthe investments they propose. As a result, we will compete with the Managed Subsidiaries’ asset classes or investment strategies. Therefore, the Managed Subsidiaries competethese other accounts and interests for access to Midway and RiverBanc and the benefits that their relationship with HCS provides them.derived from those relationships. For the same reasons, the personnel of HCSeach of Midway and RiverBanc may be unable to dedicate a substantial portion of their time managing our investments to the Managed Subsidiaries’ investments if HCS managesextent they manage or are associated with any future investment vehicles.
vehicles not related to us. There are conflicts of interest in our relationshiprelationships with HCS,our external managers, which could result in decisions that are not in the best interests of our stockholders.
The Managed SubsidiariesWe may haveacquire or pursue investments in securitiessell assets in which HCSan external manager or certain of its affiliates have or may have an interest, or we may participate in co-investment opportunities with our external managers or their affiliates. In these cases, it is possible that our interests and the interests of our external managers will not always be aligned and this could result in decisions that are seeking an interest.not in the best interests of our company. Similarly, HCSour external managers or certain of its affiliates may invest in securitiesacquire or sell assets in which the Managed Subsidiarieswe have or may have an interest. Although such investmentsacquisitions or dispositions may present conflicts of interest, we nonetheless may pursue and consummate such transactions. Additionally, the Managed Subsidiarieswe may engage in transactions directly with HCSour external managers or any of itstheir affiliates, including the purchase and sale of all or a portion of a portfolio investment.targeted asset.
HCS may from time to time simultaneously seek to purchase investments for the Managed Subsidiaries and other entities with similar investment objectives for which it serves as a manager, or for its clients or affiliates and has no duty to allocate such investment opportunities in a manner that favors the Managed Subsidiaries. Additionally, such investmentsAcquisitions made for entities with similar investment objectives may be different from those made on the Managed Subsidiaries’our behalf. HCSOur external managers may have economic interests in or other relationships with others in whose obligations or securities we may acquire. In particular, such persons may make and/or hold an investment in securities that we acquire that may be pari passu, senior or junior in ranking to our interest in the Managed Subsidiaries may invest.securities or in which partners, security holders, officers, directors, agents or employees of such persons serve on boards of directors or otherwise have ongoing relationships. Each of such ownership and other relationships may result in securities laws restrictions on transactions in such securities and otherwise create conflicts of interest. In such instances, HCSthe external managers may, in itstheir sole discretion, make investment recommendations and decisions regarding such securities for other entities that may be the same as or different from those made with respect to the Managed Subsidiaries’ investmentssecurities acquired by us and may take actions (or omit to take actions) in the context of these other economic interests or relationships, the consequences of which may be adverse to the Managed Subsidiaries’our interests.
Although the officersThe key personnel of our external managers and employees of HCSits affiliates devote as much time to the Managed Subsidiariesus as HCS deemsour external managers deem appropriate, the officers and employeeshowever, these individuals may have conflicts in allocating their time and services among the Managed Subsidiariesus and HCS’s and its affiliates' other accounts. In addition, HCS and its affiliates, in connection with their other business activities,accounts and investment vehicles. During turbulent conditions in the mortgage industry, distress in the credit markets or other times when we will need focused support and assistance from our external managers, other entities for which our external managers serve as manager, or their accounts, will likewise require greater focus and attention, placing the resources of our external managers in high demand. In such situations, we may acquire material non-publicnot receive the necessary support and assistance we require or would otherwise receive if we were internally managed.
We, directly or through our external managers, may obtain confidential information thatabout the companies or securities in which we have invested or may restrict HCS from purchasinginvest. If we do possess confidential information about such companies or securities, or selling securities for itself or its clients (includingthere may be restrictions on our ability to dispose of, increase the Managed Subsidiaries)amount of, or otherwise usingtake action with respect to the securities of such information for the benefit of its clients or itself.
HCS and JMP Group, Inc. beneficially owned approximately 16.7% and 12.1%, respectively, of our outstanding common stock as of December 31, 2009. HCS is an investment adviser that manages investments and trading accountscompanies. Our external managers’ management of other persons, including certain accounts affiliated with JMP Group, Inc., and is deemed the beneficial owner of shares of our common stock held by these accounts. James J. Fowler, the Non-Executive Chairman of our Board of Directors and also the non-compensated chief investment officer of the Managed Subsidiaries, is a managing director of HCS. HCS is an affiliate of JMP Group, Inc. Joseph A. Jolson, the Chairman and Chief Executive Officer of JMP Group Inc. and HCS, beneficially owned approximately 6.7% of the Company’s outstanding common stock as of December 3, 2009. In addition, in November 2008, our Board of Directors approved an exemption from the ownership limitations contained in our Charter, to permit Mr. Jolson to beneficially own up to 25% of the aggregate value of our outstanding capital stock. As a result of the combined voting power of HCS, JMP Group, Inc. and Mr. Jolson, these stockholders exert significant influence over matters submitted to a vote of stockholders, including the election of directors and approval of a change in control or business combination of our company. This concentration of ownership may result in decisions affecting us that are not in the best interests of all our stockholders. In addition, Mr. Fowler may havecould create a conflict of interest to the extent such external manager is aware of material non-public information concerning potential investment decisions and this in situations where the best intereststurn could impact our ability to make necessary investment decisions. Any limitations that develop as a result of our companyaccess to confidential information could therefore materially adversely affect our business, financial condition and stockholders do not align withresults of operations and our ability to make distributions to our stockholders.
There are limitations on our ability to withdraw invested capital from the interestsaccount managed by Midway and our inability to withdraw our invested capital when necessary may materially adversely affect our business, financial condition and results of HCS, JMP Group, Inc. or its affiliates, whichoperations and our ability to make distributions to our stockholders.
Pursuant to the terms of the Midway Management Agreement, we may resultonly redeem invested capital in decisions that are notan amount equal to the lesser of 10% of the invested capital in the best interestsaccount managed by Midway or $10 million as of allthe last calendar day of the month upon not less than 75 days written notice, subject to our stockholders.authority to direct Midway to modify its investment strategy for purposes of maintaining our qualification as a REIT and exemption from the Investment Company Act. In addition, we are only permitted to make one such redemption request in any 75-day period. In the event of a significant market event or shock, we may be unable to effect a redemption of invested capital in greater amounts or at a greater rate unless we obtain the consent of Midway. Moreover, because a reduction of invested capital would reduce the base management fee under the Midway Management Agreement, Midway may be less inclined to consent to such redemptions. If we are unable to withdraw invested capital as needed to meet our obligations in the future, our business and financial condition could be materially adversely affected.
Termination of the advisory agreementour external management agreements may be difficult and costly.
Termination of the advisory agreementRiverBanc Management Agreement without cause is subject to several conditions which may make such a termination difficult and costly. The advisory agreementRiverBanc Management Agreement provides that itwe may only be terminatedterminate RiverBanc without cause followingand not be obligated to pay a termination fee unless we realize a negative 15% return on the assets managed for us by RiverBanc. Moreover, except as described in the preceding sentence, we can not terminate RiverBanc without cause until expiration of the initial three-year 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.
31Pursuant to the Midway Management Agreement, we are not permitted to terminate our agreement with Midway prior to the end of the initial term, and while we have agreed with Midway that we could suspend additional capital contributions to Midway in the event we experience a 20% decline in cumulative return on our invested capital in assets managed by Midway during any calendar year in the initial term, we do not have the right to cause Midway to liquidate the assets in that account. In the event we determine to terminate the Midway Management Agreement at any time in the future following expiration of the initial term, Midway has the right to liquidate the assets it manages on our behalf in its sole discretion. Moreover, as discussed above, there are certain restrictions on our ability to redeem invested capital under the Midway Management Agreement. As a result, we may have little control over the liquidation of any of our assets that are managed by Midway or the timing of the full redemption of our invested capital, which may make it more difficult to terminate our agreement with Midway and could have a material adverse effect on our business, financial condition and results of operations.
Risks Related to an Investment in Our Capital Stock
The market price and trading volume of our common stock may be volatile.
The market price of our common stock is highly volatile and subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Some of the factors that could result in fluctuations in the price or trading volume of our common stock include, among other things: actual or anticipated changes in our current or future financial performance; changes in market interest rates and general market and economic conditions. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly.
No active trading market for the Series A Preferred Stock currently exists and one may not develop in the future.
The shares of Series A Preferred Stock were issued in a private placement transaction pursuant to Section 4(2) of the Securities Act of 1933, as amended, and are not listed on the NASDAQ Capital Market or any other market. Furthermore, even if the Series A Preferred Stock is accepted for listing on the NASDAQ Capital Market or another securities exchange, an active trading market may not develop and the market price of the Series A Preferred Stock may be volatile. As a result, an investor in our Series A Preferred Stock may be unable to sell his/her shares of Series A Preferred Stock at a price equal to or greater than that which the investor paid, if at all.
We have not established a minimum dividend payment level for our common stockholders and there are no assurances of our ability to pay dividends to common or preferred stockholders in the future.
We intend to pay quarterly dividends and to make distributions to our common stockholders in amounts such that all or substantially all of our taxable income in each year, subject to certain adjustments, is distributed. This, along with other factors, should enable us to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code of 1986, as amended, or Internal Revenue Code. We have not established a minimum dividend payment level for our common stockholders and our ability to pay dividends may be harmed by the risk factors described herein. From July 2007 until April 2008, our Board of Directors elected to suspend the payment of quarterly dividends on our common stock. Our Board’s decision reflected our focus on the elimination of operating losses through the sale of our mortgage lending business and the conservation of capital to build future earnings from our portfolio management operations. All distributions to our common stockholders will be made at the discretion of our Board of Directors and will depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our Board of Directors may deem relevant from time to time. There are no assurances of our ability to pay dividends in the future.future at the current rate or at all.
In addition, in the event that we do not have legally available funds, or any of our financing agreements in the future restrict our ability, to pay cash dividends on shares of our Series A Preferred Stock, we will be unable to pay cash dividends on our Series A Preferred Stock, unless, in the case of restrictions imposed by our financing agreements, we can refinance amounts outstanding under those agreements. Although the dividends on our Series A Preferred Stock would continue to accrue, we may pay dividends on shares of our Series A Preferred Stock only if we have legally available funds for such payment.
Upon conversion of our Series A Preferred Stock, we will be required to issue shares of common stock to holders of our Series A Preferred Stock, which will dilute the holders of our outstanding common stock. Our outstanding shares of Series A Preferred Stock are senior to our common stock for purposes of dividend and liquidation distributions and have voting rights equal to those of our common stock.
On January 18, 2008, we completed the issuance and sale of 1.0 million shares of Series A Preferred Stock to the JMP Group for an aggregate purchase price of $20.0 million. The Series A Preferred Stock entitles the holders to receive a cumulative dividend of 10% per year, subject to an increase to the extent any future quarterly common stock dividends exceed $0.20 per share. Holders of our Series A Preferred Stock have dividend and liquidating distribution preferences over holders of our common stock, which may negatively affect a Series A Preferred Stockholder’s ability to receive dividends or liquidating distributions on his or her shares. The Series A Preferred Stock also has voting rights equal to the voting rights attached to our common stock, except that each share of Series A Preferred Stock is entitled to a number of votes equal to the conversion rate for the Series A Preferred Stock.
The shares of Series A Preferred Stock are convertible into shares of our common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. Upon conversion of the Series A Preferred Stock, we will issue common stock to the holders of our Series A Preferred Stock, which will dilute the holders of our outstanding common stock.
The Series A Preferred Stock represents approximately 21% of our outstanding capital stock, on a fully diluted basis, as of February 15, 2010. Therefore, the holders of our Series A Preferred Stock have voting control over us.
The Series A Preferred Stock represents approximately 21% of our outstanding capital stock, on a fully diluted basis, as of February 15, 2010. The Series A Preferred Stock also has voting rights equal to the voting rights attached to our common stock, except that each share of Series A Preferred Stock is entitled to a number of votes equal to the conversion rate. Therefore, the holders of our Series A Preferred Stock have voting control over us, which may limit your ability to effect corporate change through the shareholder voting process.
Future offerings of debt securities, which would rank senior to our common stock and preferred stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings of equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our preferred stock and common stock, with holders of our preferred stock having priority over holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our Series A Preferred Stock has a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock, and any preferred stock issued by us in the future could have similar terms. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings in us.
We may not be able to pay the redemption price of our Series A Preferred Stock on the redemption date.
We have an obligation to redeem any remaining outstanding shares of our Series A Preferred Stock on or about December 31, 2010, at a redemption price equal to 100% of the $20.00 per share liquidation preference, plus all accrued and unpaid dividends. Our common stock is currently trading below the conversion price for our Series A Preferred Stock. As a result, as of December 31, 2009, 100% of the Series A Preferred Stock remained outstanding, which represents an aggregate redemption price (excluding accrued and unpaid dividends) of approximately $20.0 million. We may be unable to finance the redemption on favorable terms, or at all. Consequently, we may not have sufficient cash to purchase the shares of our Series A Preferred Stock.
We may not issue preferred stock that is senior to the Series A Preferred Stock without the consent of the holders of 66 2/3% of the shares of Series A Preferred Stock, which limits the flexibility of our capital structure.
As long as the Series A Preferred Stock is outstanding, we may not issue preferred stock that is senior to the Series A Preferred Stock with respect to dividend or liquidation rights without the consent of the holders of 66 2/3% of the shares of Series A Preferred Stock. This limitation restricts the flexibility of our capital structure and may prevent us from issuing equity that would otherwise be in the best interests of our company and common stockholders.
Future sales of our common stock could have an adverse effect on our common stock price.
We cannot predict the effect, if any, of future sales of common stock, or the availability of shares for future sales, on the market price of our common stock. For example, upon conversion of our Series A Preferred Stock, we will be required to issue shares of our common stock to holders of our Series A Preferred Stock, which will increase the number of shares available for sale and dilute existing holders of our common stock. Sales of substantial amounts of common stock, or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock.
Risks Related to Our Company, Structure and Change in Control Provisions
Our directors have approved broad investment guidelines for us and do not approve each investment we make.
Our Board of Directors has given us substantial discretionexternal managers are generally authorized to invest in accordance with ourfollow broad investment guidelines. Our Boardguidelines in determining which assets we will invest in. Although our board of Directors periodically reviewsdirectors will ultimately determine when and how much capital to allocate to our investment guidelines and our portfolio. However, our Boardstrategies, we generally will not, with certain exceptions, approve transactions in advance of Directors does not review each proposed investment.their execution by these managers. In addition, in conducting periodic reviews, our directorswe will rely primarily on information provided to themus by our executive officersexternal managers. Complicating matters further, our external managers may use complex investment strategies and HCS. Furthermore, transactions, entered into by uswhich may be difficult or impossible to unwind by the time they are reviewed byunwind. As a result, because our directors. Our management and HCSexternal managers have substantial discretion within our broad investment guidelines in determininggreat latitude to determine the types of assets weit may decide are proper investments for us.us, there can be no assurance that we would otherwise approve of these investments individually or that they will be successful.
We are dependent on certain key personnel.
We are a small company with only three full-time employees and are dependent upon the efforts of certain key individuals, including James J. Fowler, the Chairman of our Board of Directors, and Steven R. Mumma, our Chief Executive Officer and President, Steven R. Mumma, and Chief Financial Officer.certain key individuals employed by our external managers. The loss of any key personnel or their services could have an adverse effect on our operations.
Our Chief Executive Officer has an agreement with us that provides him with benefits in the event his employment is terminated following a change in control.
We have entered into an agreement with our Chief Executive Officer, Steven R. Mumma, that provides him with severance benefits if his employment ends under specified circumstances following a change in control. These benefits could increase the cost to a potential acquirer of us and thereby prevent or discourage a change in control that might involve a premium price for your shares or otherwise be in your best interest.
The stock ownership limit imposed by our charter may inhibit market activity in our common stock and may restrict our business combination opportunities.
In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of the issued and outstanding shares of our capital stock may be owned, actually or constructively, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year (other than our first year as a REIT). This test is known as the “5/50 test.” Attribution rules in the Internal Revenue Code apply to determine if any individual or entity actually or constructively owns our capital stock for purposes of this requirement. Additionally, at least 100 persons must beneficially own our capital stock during at least 335 days of each taxable year (other than our first year as a REIT). To help ensure that we meet these tests, our charter restricts the acquisition and ownership of shares of our capital stock. Our charter, with certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and provides that, unless exempted by our Board of Directors, no person may own more than 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.
Certain provisions of Maryland law and our charter and bylaws could hinder, delay or prevent a change in control which could have an adverse effect on the value of our securities.
Certain provisions of Maryland law, our charter and our bylaws may have the effect of delaying, deferring or preventing transactions that involve an actual or threatened change in control. These provisions include the following, among others:
· | our charter provides that, subject to the rights of one or more classes or series of preferred stock to elect one or more directors, a director may be removed with or without cause only by the affirmative vote of holders of at least two-thirds of all votes entitled to be cast by our stockholders generally in the election of directors; |
· | our bylaws provide that only our Board of Directors shall have the authority to amend our bylaws; |
· | under our charter, our Board of Directors has authority to issue preferred stock from time to time, in one or more series and to establish the terms, preferences and rights of any such series, all without the approval of our stockholders; |
· | the Maryland Business Combination Act; and |
· | the Maryland Control Share Acquisition Act. |
Although our Board of Directors has adopted a resolution exempting us from application of the Maryland Business Combination Act and our bylaws provide that we are not subject to the Maryland Control Share Acquisition Act, our Board of Directors may elect to make the “business combination” statute and “control share” statute applicable to us at any time and may do so without stockholder approval.
Maintenance of our Investment Company Act exemption imposes limits on our operations.
We have conducted and intend to continue to conduct our operations so as not to become regulated as an investment company under the Investment Company Act. We believe that there are a number of exemptionsexclusions under the Investment Company Act that are applicable to us. To maintain the exemption,exclusion, the assets that we acquire are limited by the provisions of the Investment Company Act and the rules and regulations promulgated under the Investment Company Act. In addition,On August 31, 2011, the SEC published a concept release entitled “Companies Engaged in the Business of Acquiring Mortgages and Mortgage Related Instruments” (Investment Company Act Rel. No. 29778). This release suggests that the SEC may modify the exemption relied upon by companies similar to us that invest in mortgage loans and mortgage-backed securities. If the SEC acts to narrow the availability of, or if we otherwise fail to qualify for, our exclusion, we could, among other things, be required either (a) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (b) to register as an investment company, either of which could have ana material adverse effect on our operations and the market price forof our securities.common stock.
Tax Risks Related to Our Structure
Failure to qualify as a REIT would adversely affect our operations and ability to make distributions.
We have operated and intend to continue to operate so to qualify as a REIT for federal income tax purposes. Our continued qualification as a REIT will depend on our ability to meet various requirements concerning, among other things, the ownership of our outstanding stock, the nature of our assets, the sources of our income, and the amount of our distributions to our stockholders. In order to satisfy these requirements, we might have to forego investments we might otherwise make. Thus, compliance with the REIT requirements may hinder our investment performance. Moreover, while we intend to continue to operate so to qualify as a REIT for federal income tax purposes, given the highly complex nature of the rules governing REITs, there can be no assurance that we will so qualify in any taxable year.
If we fail to qualify as a REIT in any taxable year and we do not qualify for certain statutory relief provisions, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. We might be required to borrow funds or liquidate some investments in order to pay the applicable tax. Our payment of income tax would reduce our net earnings available for investment or distribution to stockholders. Furthermore, if we fail to qualify as a REIT and do not qualify for certain statutory relief provisions, we would no longer be required to make distributions to stockholders. Unless our failure to qualify as a REIT were excused under the federal income tax laws, we generally would be disqualified from treatment as a REIT for the four taxable years following the year in which we lost our REIT status.
REIT distribution requirements could adversely affect our liquidity.
In order to qualify as a REIT, we generally are required each year to distribute to our stockholders at least 90% of our REIT taxable income, excluding any net capital gain. To the extent that we distribute at least 90%, but less than 100% of our REIT taxable income, we will be subject to corporate income tax on our undistributed REIT taxable income. In addition, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which certain distributions paid by us with respect to any calendar year are less than the sum of (i) 85% of our ordinary REIT income for that year, (ii) 95% of our REIT capital gain net income for that year, and (iii) 100% of our undistributed REIT taxable income from prior years.
We have made and intend to continue to make distributions to our stockholders to comply with the 90% distribution requirement and to avoid corporate income tax and the nondeductible excise tax. However, differences in timing between the recognition of REIT taxable income and the actual receipt of cash could require us to sell assets or to borrow funds on a short-term basis to meet the 90% distribution requirement and to avoid corporate income tax and the nondeductible excise tax.
Certain of our assets may generate substantial mismatches between REIT taxable income and available cash. Such assets could include mortgage-backed securities we hold that have been issued at a discount and require the accrual of taxable income in advance of the receipt of cash. As a result, our taxable income may exceed our cash available for distribution and the requirement to distribute a substantial portion of our net taxable income could cause us to:
· | · | sell assets in adverse market conditions, |
· | · | borrow on unfavorable terms or |
| · | distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt in order to comply with the REIT distribution requirements. |
Further, our lenders could require us to enter into negative covenants, including restrictions on our ability to distribute funds or to employ leverage, which could inhibit our ability to satisfy the 90% distribution requirement.
Dividends payable by REITs do not qualify for the reduced tax rates on dividend income from regular corporations.
The maximum U.S. federal income tax rate for dividends payable to domestic shareholders that are individuals, trust and estates is 15% (through 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.
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.
Our ability to invest in and dispose of “to be announced” securities could be limited by our REIT status, and we could lose our REIT status as a result of these investments.
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.
Item 4.(REMOVED AND RESERVED)36
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 | | — | | $ | — | | 8,111 | |
Plan Category | | Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights | | | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | | | Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans | |
Equity compensation plans approved by security holders | | | — | | | $ | — | | | $ | 1,154,992 | |
Item 6. SELECTED FINANCIAL DATA
We are a smaller reporting company and, therefore, are not required to provide the information required by this Item.
Performance GraphThe following line graph sets forth, for the period December 31, 2004 through December 31, 2009, a comparison of the percentage change in the cumulative total stockholder return on the Company's common stock compared to the cumulative total return of the NYSE Composite Index and the National Association of Real Estate Investment Trusts ("NAREIT") Mortgage REIT Index. The graph assumes that the value of the investment in each of the Company's common stock and the indices was $100 as of December 31, 2004 and that all dividends were reinvested. The performance reflected in the graph is not necessarily indicative of future performance.
The foregoing graph and chart shall not be deemed incorporated by reference by any general statement incorporating by reference this Annual Report on Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent we specifically incorporate this information by reference, and shall not otherwise be deemed filed under those acts.
Item 6.SELECTED FINANCIAL DATAThe following selected consolidated financial data is derived from our audited consolidated financial statements and the notes thereto for the periods presented and should be read in conjunction with the more detailed information therein and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this annual report. Operating results are not necessarily indicative of future performance.
| | 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 | |
(1) | In connection with the sale of our wholesale mortgage origination platform assets on February 22, 2007 and the sale of our retail mortgage origination platform assets on March 31, 2007, we classify our mortgage lending business as a discontinued operation in (see note 8 in the notes to our consolidated financial statements). |
Item 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
New York Mortgage Trust, Inc., together with its consolidated subsidiaries (“NYMT”, the “Company”, “we”, “our”, and “us”), isWe are 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-ratemortgage-related and, fixed-rate mortgage-backed securities (“RMBS”), for which the principal and interest payments are guaranteed byto 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”) mortgage loans (“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 andlesser extent, 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. These assets, together with non-Agency RMBS and CLOs, typically present greater credit risk and less interest rate risk than our investments in Agency RMBS and prime ARM loans, and may also permit us to potentially utilize all or part of a significant net operating loss carry-forward held by Hypotheca Capital, LLC (“HC,” then doing business as The New York Mortgage Company LLC), our wholly-owned subsidiary and former mortgage lending business.
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.
Prior to 2009,net realized capital gains from our investment portfolio. Our portfolio was primarily comprisedincludes investments sourced from distressed markets over the previous two years that create the potential for capital gains as well as more traditional types of mortgage-related investments, such as Agency RMBS, prime ARM loans held in securitization trustsARMs and certain non-agency RMBS rated in the highest rating category by two rating agencies. The prime ARM loans in our portfolio were purchased from third parties or originated by us through HC and were subsequently securitized by us and are held in our four securitization trusts. Beginning in the first quarter ofAgency IOs, that generate interest income.
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 |
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 that underlieunderlying such assets; assets; |
· | general economic and financial and credit market conditions; conditions; |
· | our leverage, our access to funding and our borrowing costs; |
· | changes in the credit quality or ratings of the loans, securities, and other assets we own; |
· | changes in the market value of our investments; |
| |
· | liabilities related to our discontinued operation, including repurchase obligations on the sales allocation of mortgage loans; and capital between various asset classes; |
· | liabilities related to our discontinued operation; |
| |
· | the performance of our external managers; |
| |
· | legislative or regulatory changes, as well as actions taken by the U.S. Federal Reserve and the U.S. Government; and |
| |
· | requirements to maintain REIT status and to qualify for an exemption from registration under the Investment Company Act. |
We earn income and generate cash through our investments. Our income is generated primarily from the net spread, which we refer to as net interest income, which is the difference between the interest and other income we earn on assets in our investment portfolio and the cost of our borrowings and hedging activities 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.
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.
As it relatesIn addition to loans sold previously under certain loan sale agreements bythe impact of credit risk, our discontinued mortgage lending business, wereturns may be required to repurchase some of those loans or indemnify the loan purchaser for damages causedimpacted by a breach of the loan sale agreement. Whilechanges in the past we complied with the repurchase demands by repurchasing the loan with cash and reselling it atmarket values of these assets. Market values of these investments may decline for a loss, thus reducing our cash position. More recently, we have addressed these requests by negotiating a net cash settlement based on thenumber of reasons, such as actual or assumed loss onperceived increases in defaults or prepayment experience, or the loan in lieuwidening of repurchasingcredit spreads. If the loans. Asmarket values of December 31, 2009, the amount of repurchase requests outstanding was approximately $2.0 million, against which we had a reserve of approximately $0.3 million. We cannot assure you that we willour investments were to decline for any reason, our book value would likely be successful in settling the remaining repurchase demands on favorable terms, or at all. If we are unable to continue to resolve our current repurchase demands through negotiated net cash settlements, our liquidity could be adversely affected.negatively impacted.
For more information regarding the factors and risks that affect our operations and performance, see “Item 1A. Risk Factors” above and “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” below.
Current Market Conditions and Known Material TrendsCommentary
In recent years,General. Despite some positive momentum and optimism in early 2011 with respect to an acceleration of the residential housingU.S. economic recovery, the economy and mortgage and credit and financial markets generally exhibited continued lackluster economic growth in the United StatesU.S. in 2011 due to a lack of job growth and globally have experienced a variety of difficulties and changed economic conditions, including loan defaults, credit losses and decreased liquidity. These conditions, together with liquidating sales by several large institutions, have resulted insignificant volatility in the valuefinancial markets, which was primarily due to concerns regarding Euro zone sovereign debt and the U.S. federal deficit and debt ceiling debates. It remains unclear what impact these events may have on the global economy in 2012. Additionally, despite recent labor reports from the U.S. Department of most real estate-relatedLabor that suggest that labor market conditions are improving and financial assets, including manyrecent data suggesting the U.S. economic outlook is improving, inflation and wage pressure expectations remain low and the U.S. housing market continues to face significant headwinds. In August 2011 and again in November 2011, the Federal Reserve announced that it intends to keep the Federal Funds Target Rate near zero through mid-2014, thereby suggesting, in our view, that the Federal Reserve expects sluggish growth again in 2012. This environment has fostered continued strong demand for Agency RMBS backed by ARMs and fixed-rate mortgages while also helping to keep the costs of financing and hedging at or near historical lows.
On August 5, 2011, Standard & Poor’s lowered its long term sovereign credit rating of the 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. |
| · | 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.
Prior to December 2009, the financing arrangement between the U.S. Treasury and Fannie Mae and Freddie Mac required these entities to cap their Agency RMBS portfolio at $900 billion each and then begin reducing their portfolio of Agency RMBS by 10% per year beginning in 2010. In December 2009, the U.S. Treasury loosened this requirement by allowing the portfolio reduction requirements to be applied to the maximum allowable size of the portfolios, rather than the actual size of the portfolios. Also, the U.S. Treasury originally was going to require Fannie Mae and Freddie Mac to pay a quarterly commitment fee to the U.S. Treasury beginning on March 31, 2010. The U.S. Treasury subsequently postponed that start date to December 31, 2010. The change to Fannie Mae and Freddie Macs portfolio reduction requirements could extend the time period by which these entities sell portions of their Agency RMBS portfolios in the market, which, in turn, could cause the supply of Agency RMBS to be smaller than we originally anticipated.
More recently, in February of this year, Fannie Mae and Freddie Mac announced that the GSEs will be purchasing delinquent loans from mortgage pools guaranteed by them. Delinquent loans for this program will be those that are 120 days or greater delinquent as of measurement date. Freddie Mac stated that it will be consummating all of its purchases at once, based on the delinquencies as of February 2010, with payments to securities holders on March 15th and April 15th. On March 1, 2010, Fannie Mae reported that it would buy approximately $127 billion of loans out of guaranteed RMBS pools beginning in March and running through about June of this year. These actions could decrease the net income derived from our Agency RMBS.
Mortgage asset values. During 2009, the market value of the Agency RMBS inand otherwise materially harm our portfolio was positively impacted by the Federal Reserve’s program to purchase $1.25 trillion of Agency MBS. This purchase program implemented by the Federal Reserve increased market prices of Agency RMBS during 2009, thereby reducing their market yield. As a result, we did not acquire any Agency RMBS during 2009,business and instead opportunistically disposed of the Agency CMO floaters in our portfolio. The Federal Reserve has indicated it will complete its planned purchases of Agency RMBS by the end of the 2010 first quarter. If no further action is taken by the Federal Reserve, the market value of Agency RMBS may decline, which among other things, could cause the market value of our Agency RMBS to decline.operations.
Market demand for non-Agency RMBS increased over the course of 2009 due to increased demand and the reduced market yields for Agency RMBS. Accordingly, while non-Agency RMBS remain available at a discount, such discounts have narrowed relative to discounts available in early 2009 and late 2008 and may continue to narrow in the future, reducing the market yields on these assets. Nevertheless, we believe that despite higher market prices and lower yields, that risk-adjusted returns on non-Agency RMBS continue to represent attractive investment opportunities.
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.
In addition to a stabilizing financing environment for Agency RMBS, collateral requirements improved throughout 2009. With respect towith interest rates becausebetween 0.30% and 0.60% for 30-90 day repurchase agreements. The 30-day London Interbank Offered Rate (“LIBOR”) was 0.30% at December 30, 2011, marking an increase of continued uncertainty inapproximately 6 basis points from September 30, 2011, and an increase of 4 basis points from the credit markets and difficult U.S. economic conditions,previous year end. While we expect interest rates to rise over the longer term, we believe that interest rates, and thus our short-term financing costs, are likely to remain at these historically low levels until such time as the economic data begin to confirm a sustainable improvement in thean acceleration of overall economy.economic recovery.
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.
Until March 31, 2007, our discontinued mortgage lending operation contributed to our then current period financial results. Subsequent to March 31, 2007, our discontinued mortgage lending operation has impacted our financial results due to liabilities remaining after the sale of the operation’s assets. As of December 31, 20092011 and 2010, discontinued operations consist of $4.2$4.0 million in assets and $1.8 million in liabilities, down from $5.9 million in assets and $3.6 million in liabilities at December 31, 2008.
Prior to March 31, 2007, we originated a wide range of residential mortgage loan products including prime, alternative-A, and to a lesser extent sub-prime loans, home equity lines of credit, second mortgages, and bridge loans. We originated $0.4 billion in mortgage loans during three months ended March 31, 2007. Our sale of the mortgage lending platform assets on March 31, 2007 marked our exit from the mortgage lending business.
As of December 31, 2009, the Company had $4.2 million in assets related to discontinued operations, including(including $3.8 million in loans held for sale. sale) and $0.5 million in liabilities, and $4.0 million in assets and $0.6 million in liabilities, respectively, and are included in receivables and other assets and accrued expenses and other liabilities in the consolidated balance sheets included in this Annual Report.
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:
Credit CharacteristicsBalances of Our Investment Securities (dollar amounts in thousands):
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 | % |
(1) – Ratings based on S&P categories, however securities may have been rated by either Fitch or Moody’s.
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 | % |
(1) – Ratings based on S&P categories, however securities may have been rated by either Fitch or Moody’s.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 | % |
The following table sets forth the stated reset periods and weighted average yields of our investment securities available for sale at December 31, 2009 and December 31, 2008 (dollar amounts in thousands):
| | Less than 6 Months | | | More than 6 Months To 24 Months | | | More than 24 Months To 60 Months | | | Total | |
December 31, 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 | % |
Performance characteristics of non-Agency RMBS CMBS Loan Characteristics
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 | |
December 31, 2011
Industry | Number of Loans | | Outstanding Balance | | | % of Outstanding Balance |
| | | | | | |
Healthcare, Education & Childcare | 24 | | $ | 61,543 | | | 13.9% |
Retail Store | 14 | | | 35,704 | | | 8.1% |
Electronics | 13 | | | 31,721 | | | 7.2% |
Telecommunications | 13 | | | 27,638 | | | 6.3% |
Chemicals, Plastics and Rubber | 12 | | | 25,336 | | | 5.7% |
Diversified/Conglomerate Service | 15 | | | 22,320 | | | 5.1% |
Beverage, Food & Tobacco | 10 | | | 20,274 | | | 4.6% |
Leisure, Amusement, Motion Pictures & Entertainment | 8 | | | 18,904 | | | 4.3% |
Personal & Non-Durable Consumer Products | 8 | | | 18,203 | | | 4.1% |
Aerospace & Defense | 10 | | | 17,254 | | | 3.9% |
Utilities | 5 | | | 16,723 | | | 3.8% |
Hotels, Motels, Inns and Gaming | 5 | | | 15,914 | | | 3.6% |
Personal, Food & Misc. Services | 12 | | | 14,598 | | | 3.3% |
Containers, Packaging and Glass | 7 | | | 14,493 | | | 3.3% |
Finance | 8 | | | 11,471 | | | 2.6% |
Printing & Publishing | 4 | | | 11,404 | | | 2.6% |
Automobile | 7 | | | 9,829 | | | 2.2% |
Diversified/Conglomerate Mfg. | 6 | | | 9,643 | | | 2.2% |
Banking | 3 | | | 8,777 | | | 2.0% |
Broadcasting & Entertainment | 3 | | | 6,293 | | | 1.4% |
Mining, Steel, Iron and Non-Precious Metals | 3 | | | 6,242 | | | 1.4% |
Machinery (Non-Agriculture, Non-Construction & Non-Electronic) | 4 | | | 6,029 | | | 1.4% |
Textiles & Leather | 5 | | | 5,281 | | | 1.2% |
Personal Transportation | 2 | | | 4,969 | | | 1.1% |
Grocery | 3 | | | 4,911 | | | 1.1% |
Buildings and Real Estate | 2 | | | 4,887 | | | 1.1% |
Insurance | 2 | | | 4,352 | | | 1.0% |
Diversified Natural Resources, Precious Metals and Minerals | 1 | | | 2,227 | | | 0.5% |
Ecological | 2 | | | 1,984 | | | 0.4% |
Farming & Agriculture | 1 | | | 1,900 | | | 0.4% |
Cargo Transport | 1 | | | 990 | | | 0.2% |
| 213 | | $ | 441,814 | | | 100.0% |
December 31, 2010
Industry | Number of Loans | | Outstanding Balance | | | % of Outstanding Balance |
| | | | | | |
Healthcare, Education & Childcare | 19 | | $ | 52,537 | | | 11.55% |
Retail Store | 10 | | | 29,388 | | | 6.46% |
Electronics | 10 | | | 29,148 | | | 6.41% |
Telecommunications | 13 | | | 26,410 | | | 5.81% |
Leisure , Amusement, Motion Pictures & Entertainment | 10 | | | 22,316 | | | 4.91% |
Personal, Food & Misc Services | 10 | | | 21,179 | | | 4.66% |
Chemicals, Plastics and Rubber | 9 | | | 20,962 | | | 4.61% |
Beverage, Food & Tobacco | 9 | | | 18,666 | | | 4.10% |
Utilities | 5 | | | 17,035 | | | 3.75% |
Aerospace & Defense | 7 | | | 16,468 | | | 3.62% |
Insurance | 3 | | | 16,245 | | | 3.57% |
Hotels, Motels, Inns and Gaming | 5 | | | 15,389 | | | 3.38% |
Farming & Agriculture | 5 | | | 14,983 | | | 3.29% |
Cargo Transport | 3 | | | 14,372 | | | 3.16% |
Diversified/Conglomerate Mfg | 6 | | | 13,914 | | | 3.06% |
Personal & Non-Durable Consumer Products | 5 | | | 13,774 | | | 3.03% |
Printing & Publishing | 4 | | | 11,944 | | | 2.63% |
Diversified/Conglomerate Service | 5 | | | 10,841 | | | 2.38% |
Broadcasting & Entertainment | 4 | | | 10,037 | | | 2.21% |
Ecological | 4 | | | 8,763 | | | 1.93% |
Finance | 3 | | | 7,803 | | | 1.72% |
Containers, Packaging and Glass | 4 | | | 7,635 | | | 1.68% |
Machinery (Non-Agriculture, Non-Construction & Non-Electronic) | 4 | | | 7,482 | | | 1.65% |
Personal Transportation | 3 | | | 7,306 | | | 1.61% |
Buildings and Real Estate | 3 | | | 6,970 | | | 1.53% |
Banking | 2 | | | 6,750 | | | 1.48% |
Automobile | 5 | | | 6,544 | | | 1.44% |
Mining, Steel, Iron and Non-Precious Metals | 3 | | | 5,466 | | | 1.20% |
Textiles & Leather | 3 | | | 4,359 | | | 0.96% |
Oil & Gas | 2 | | | 3,994 | | | 0.88% |
Grocery | 3 | | | 3,808 | | | 0.84% |
Diversified Natural Resources, Precious Metals and Minerals | 1 | | | 2,251 | | | 0.49% |
| 182 | | $ | 454,739 | | | 100.00% |
| | 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 | % |
Prepayment Experience. The constant prepayment rate (“CPR”) on our overall portfolio averaged approximately 19% during 2009 as compared to 12% during 2008. CPRs on our purchased portfolio of investment securities averaged approximately 18% while the CPRs on loans held in our securitization trusts averaged approximately 19% during 2009. When prepayment expectations over the remaining life of assets increase, we have to amortize premiums over a shorter time period resulting in a reduced yield to maturity on our investment assets. Conversely, if prepayment expectations decrease, the premium would be amortized over a longer period resulting in a higher yield to maturity. We monitor our prepayment experience on a monthly basis and adjust the amortization rate to reflect current market conditions.
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 | % |
Loans Held in Securitization Trusts: | | % 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 | |
Index / Reset Characteristics:
| | % 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):
Loans Held in Securitization Trusts: | | 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 | % |
Index / Reset Characteristics:
| | % 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 | |
| Balance | | | | | Max | | | Min | | | Avg | | | Min | | | Max | | | | | | | | | | | | | | |
Single | <= $100 | | | 14 | | | | 3.00 | | | | 2.50 | | | | 2.88 | | | 09/01/34 | | | 11/01/35 | | | | 360 | | NA | | $ | 1,658 | | | $ | 1,055 | | | $ | - | |
FAMILY | <= $250 | | | 71 | | | | 4.50 | | | | 2.50 | | | | 2.96 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 16,299 | | | | 13,107 | | | | 956 | |
| <= $500 | | | 89 | | | | 3.75 | | | | 2.50 | | | | 2.87 | | | 07/01/33 | | | 01/01/36 | | | | 360 | | NA | | | 33,896 | | | | 31,056 | | | | 6,135 | |
| <=$1,000 | | | 34 | | | | 3.50 | | | | 1.50 | | | | 2.77 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 27,122 | | | | 25,368 | | | | 3,411 | |
| >$1,000 | | | 21 | | | | 3.25 | | | | 2.63 | | | | 2.81 | | | 01/01/35 | | | 11/01/35 | | | | 360 | | NA | | | 37,357 | | | | 36,811 | | | | 9,047 | |
| Summary | | | 229 | | | | 4.50 | | | | 1.50 | | | | 2.88 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 116,332 | | | $ | 107,397 | | | $ | 19,549 | |
2-4 | <= $100 | | | 2 | | | | 3.63 | | | | 3.00 | | | | 3.31 | | | 02/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 212 | | | $ | 168 | | | $ | 75 | |
FAMILY | <= $250 | | | 6 | | | | 3.63 | | | | 2.63 | | | | 3.02 | | | 12/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 1,283 | | | | 1,094 | | | | - | |
| <= $500 | | | 15 | | | | 7.25 | | | | 2.13 | | | | 3.10 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 5,554 | | | | 5,134 | | | | 254 | |
| <=$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| >$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| Summary | | | 23 | | | | 7.25 | | | | 2.13 | | | | 3.10 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | $ | 7,049 | | | $ | 6,396 | | | $ | 329 | |
Condo | <= $100 | | | 13 | | | | 3.25 | | | | 2.63 | | | | 2.81 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | $ | 1,640 | | | $ | 844 | | | $ | - | |
| <= $250 | | | 72 | | | | 3.50 | | | | 1.50 | | | | 2.93 | | | 02/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 14,297 | | | | 12,415 | | | | 468 | |
| <= $500 | | | 58 | | | | 3.75 | | | | 2.38 | | | | 2.84 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 20,942 | | | | 18,891 | | | | - | |
| <=$1,000 | | | 14 | | | | 3.88 | | | | 1.63 | | | | 2.76 | | | 08/01/33 | | | 09/01/35 | | | | 360 | | NA | | | 10,339 | | | | 9,996 | | | | - | |
| > $1,000 | | | 10 | | | | 2.88 | | | | 2.63 | | | | 2.73 | | | 01/01/35 | | | 09/01/35 | | | | 360 | | NA | | | 14,914 | | | | 14,559 | | | | - | |
| Summary | | | 167 | | | | 3.88 | | | | 1.50 | | | | 2.86 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 62,132 | | | $ | 56,705 | | | $ | 468 | |
CO-OP | <= $100 | | | 4 | | | | 2.88 | | | | 2.50 | | | | 2.69 | | | 10/01/34 | | | 08/01/35 | | | | 360 | | NA | | $ | 443 | | | $ | 306 | | | $ | - | |
| <= $250 | | | 15 | | | | 3.38 | | | | 2.25 | | | | 2.78 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 3,423 | | | | 2,573 | | | | 212 | |
| <= $500 | | | 23 | | | | 3.50 | | | | 1.38 | | | | 2.78 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 9,537 | | | | 8,233 | | | | - | |
| <=$1,000 | | | 11 | | | | 2.88 | | | | 2.63 | | | | 2.69 | | | 12/01/34 | | | 10/01/35 | | | | 360 | | NA | | | 8,563 | | | | 8,321 | | | | - | |
| > $1,000 | | | 4 | | | | 2.75 | | | | 2.25 | | | | 2.59 | | | 11/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,659 | | | | 5,232 | | | | - | |
| Summary | | | 57 | | | | 3.50 | | | | 1.38 | | | | 2.72 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 27,625 | | | $ | 24,665 | | | $ | 212 | |
PUD | <= $100 | | | 1 | | | | 2.63 | | | | 2.63 | | | | 2.63 | | | 07/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 100 | | | $ | 89 | | | $ | - | |
| <= $250 | | | 18 | | | | 3.13 | | | | 2.50 | | | | 2.87 | | | 08/01/35 | | | 12/01/35 | | | | 360 | | NA | | | 3,958 | | | | 3,656 | | | | 160 | |
| <= $500 | | | 10 | | | | 3.00 | | | | 2.63 | | | | 2.88 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 3,665 | | | | 3,422 | | | | 315 | |
| <=$1,000 | | | 4 | | | | 3.25 | | | | 2.75 | | | | 2.99 | | | 05/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 2,832 | | | | 2,593 | | | | - | |
| > $1,000 | | | 3 | | | | 2.88 | | | | 2.75 | | | | 2.83 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 4,148 | | | | 4,011 | | | | - | |
| Summary | | | 36 | | | | 3.25 | | | | 2.50 | | | | 2.87 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | $ | 14,703 | | | $ | 13,771 | | | $ | 475 | |
Summary | <= $100 | | | 34 | | | | 3.63 | | | | 2.50 | | | | 2.85 | | | 09/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 4,053 | | | $ | 2,462 | | | $ | 75 | |
| <= $250 | | | 182 | | | | 4.50 | | | | 1.50 | | | | 2.93 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 39,260 | | | | 32,845 | | | | 1,796 | |
| <= $500 | | | 195 | | | | 7.25 | | | | 1.38 | | | | 2.87 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 73,594 | | | | 66,736 | | | | 6,704 | |
| <=$1,000 | | | 63 | | | | 3.88 | | | | 1.50 | | | | 2.77 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 48,856 | | | | 46,278 | | | | 3,411 | |
| > $1,000 | | | 38 | | | | 3.25 | | | | 2.25 | | | | 2.77 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 62,078 | | | | 60,613 | | | | 9,047 | |
| Grand Total | | | 512 | | | | 7.25 | | | | 1.38 | | | | 2.82 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 227,841 | | | $ | 208,934 | | | $ | 21,033 | |
The following table details loan summary information for loans held in securitization trusts at December 31, 2010 (dollar amounts in thousands):
Description | | | Interest Rate | | | Final Maturity | | | Periodic Payment | | | | Original Amount | | | Current Amount | | | Principal Amount of Loans | |
| Balance | | | | | Max | | | Min | | | Avg | | | Min | | | Max | | | | | | | of Principal | | | of Principal | | | | |
Single | <= $100 | | | 12 | | | | 3.88 | | | | 2.63 | | | | 3.21 | | | 12/01/34 | | | 11/01/35 | | | | 360 | | NA | | $ | 1,508 | | | $ | 914 | | | $ | - | |
FAMILY | <= $250 | | | 70 | | | | 6.25 | | | | 2.63 | | | | 3.40 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 14,580 | | | | 12,615 | | | | 417 | |
| <= $500 | | | 103 | | | | 6.50 | | | | 2.63 | | | | 3.23 | | | 10/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 39,299 | | | | 35,981 | | | | 7,606 | |
| <=$1,000 | | | 39 | | | | 5.75 | | | | 1.50 | | | | 3.01 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 31,128 | | | | 29,236 | | | | 3,411 | |
| >$1,000 | | | 21 | | | | 3.25 | | | | 2.75 | | | | 2.97 | | | 01/01/35 | | | 11/01/35 | | | | 360 | | NA | | | 37,357 | | | | 36,857 | | | | 10,162 | |
| Summary | | | 245 | | | | 6.50 | | | | 1.50 | | | | 3.22 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 123,872 | | | $ | 115,603 | | | $ | 21,596 | |
2-4 | <= $100 | | | 1 | | | | 3.88 | | | | 3.88 | | | | 3.88 | | | 02/01/35 | | | 02/01/35 | | | | 360 | | NA | | $ | 80 | | | $ | 73 | | | $ | 75 | |
FAMILY | <= $250 | | | 7 | | | | 4.00 | | | | 2.75 | | | | 3.25 | | | 12/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 1,415 | | | | 1,221 | | | | 191 | |
| <= $500 | | | 15 | | | | 7.25 | | | | 2.13 | | | | 3.53 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 5,554 | | | | 5,259 | | | | 254 | |
| <=$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| >$1,000 | | | - | | | | - | | | | - | | | | - | | | | - | | | | - | | | | 360 | | NA | | | - | | | | - | | | | - | |
| Summary | | | 23 | | | | 7.25 | | | | 2.13 | | | | 3.46 | | | 09/01/34 | | | 01/01/36 | | | | 360 | | NA | | $ | 7,049 | | | $ | 6,553 | | | $ | 520 | |
Condo | <= $100 | | | 15 | | | | 3.50 | | | | 2.75 | | | | 3.04 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | $ | 1,912 | | | $ | 938 | | | $ | 55 | |
| <= $250 | | | 74 | | | | 6.38 | | | | 2.75 | | | | 3.35 | | | 02/01/34 | | | 01/01/36 | | | | 360 | | NA | | | 14,512 | | | | 13,036 | | | | 444 | |
| <= $500 | | | 64 | | | | 6.25 | | | | 1.50 | | | | 3.20 | | | 09/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 21,957 | | | | 20,844 | | | | 272 | |
| <=$1,000 | | | 21 | | | | 4.00 | | | | 1.63 | | | | 2.96 | | | 08/01/33 | | | 10/01/35 | | | | 360 | | NA | | | 15,489 | | | | 14,558 | | | | - | |
| > $1,000 | | | 10 | | | | 3.25 | | | | 2.75 | | | | 2.96 | | | 01/01/35 | | | 09/01/35 | | | | 360 | | NA | | | 14,914 | | | | 14,654 | | | | - | |
| Summary | | | 184 | | | | 6.38 | | | | 1.50 | | | | 3.21 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 68,784 | | | $ | 64,030 | | | $ | 771 | |
CO-OP | <= $100 | | | 4 | | | | 3.00 | | | | 2.63 | | | | 2.84 | | | 10/01/34 | | | 08/01/35 | | | | 360 | | NA | | $ | 443 | | | $ | 331 | | | $ | - | |
| <= $250 | | | 19 | | | | 6.13 | | | | 2.25 | | | | 3.16 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 4,135 | | | | 3,399 | | | | 212 | |
| <= $500 | | | 26 | | | | 6.38 | | | | 1.38 | | | | 3.16 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 10,724 | | | | 9,533 | | | | - | |
| <=$1,000 | | | 12 | | | | 3.25 | | �� | | 2.75 | | | | 2.91 | | | 12/01/34 | | | 10/01/35 | | | | 360 | | NA | | | 9,089 | | | | 8,896 | | | | - | |
| > $1,000 | | | 4 | | | | 6.00 | | | | 2.25 | | | | 3.44 | | | 11/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,659 | | | | 5,339 | | | | - | |
| Summary | | | 65 | | | | 6.38 | | | | 1.38 | | | | 3.16 | | | 08/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 30,050 | | | $ | 27,498 | | | $ | 212 | |
PUD | <= $100 | | | 1 | | | | 3.00 | | | | 3.00 | | | | 3.00 | | | 07/01/35 | | | 07/01/35 | | | | 360 | | NA | | $ | 100 | | | $ | 92 | | | $ | - | |
| <= $250 | | | 16 | | | | 6.50 | | | | 2.63 | | | | 3.66 | | | 01/01/35 | | | 12/01/35 | | | | 360 | | NA | | | 3,260 | | | | 3,092 | | | | 113 | |
| <= $500 | | | 14 | | | | 6.13 | | | | 2.63 | | | | 3.37 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | | 4,969 | | | | 4,671 | | | | 770 | |
| <=$1,000 | | | 4 | | | | 3.50 | | | | 2.75 | | | | 3.19 | | | 05/01/34 | | | 07/01/35 | | | | 360 | | NA | | | 2,832 | | | | 2,650 | | | | - | |
| > $1,000 | | | 4 | | | | 6.13 | | | | 2.75 | | | | 3.66 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 5,233 | | | | 5,134 | | | | 1,085 | |
| Summary | | | 39 | | | | 6.50 | | | | 2.63 | | | | 3.49 | | | 08/01/32 | | | 12/01/35 | | | | 360 | | NA | | $ | 16,394 | | | $ | 15,639 | | | $ | 1,968 | |
Summary | <= $100 | | | 33 | | | | 3.88 | | | | 2.63 | | | | 3.10 | | | 10/01/34 | | | 12/01/35 | | | | 360 | | NA | | $ | 4,043 | | | $ | 2,348 | | | $ | 130 | |
| <= $250 | | | 186 | | | | 6.50 | | | | 2.25 | | | | 3.38 | | | 09/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 37,902 | | | | 33,363 | | | | 1,377 | |
| <= $500 | | | 222 | | | | 7.25 | | | | 1.38 | | | | 3.23 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | | 82,503 | | | | 76,288 | | | | 8,902 | |
| <=$1,000 | | | 76 | | | | 5.75 | | | | 1.50 | | | | 2.99 | | | 08/01/33 | | | 12/01/35 | | | | 360 | | NA | | | 58,538 | | | | 55,340 | | | | 3,411 | |
| > $1,000 | | | 39 | | | | 6.13 | | | | 2.25 | | | | 3.09 | | | 04/01/34 | | | 12/01/35 | | | | 360 | | NA | | | 63,163 | | | | 61,984 | | | | 11,247 | |
| Grand Total | | | 556 | | | | 7.25 | | | | 1.38 | | | | 3.16 | | | 08/01/32 | | | 01/01/36 | | | | 360 | | NA | | $ | 246,149 | | | $ | 229,323 | | | $ | 25,067 | |
The following table details activity for loans held in securitization trusttrusts (net) for the year ended December 31, 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 | |
2011 (dollar amounts in thousands):
Delinquency Status | | 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 | |
As ofThe following table details activity for loans held in securitization trusts (net) for the year ended December 31, 2009, we had 41 delinquent loans totaling approximately $19.9 million categorized as2010 (dollar amounts in thousands)
| | Principal | | | Premium | | | Allowance for Loan Losses | | | Net Carrying Value | |
Balance, January 1, 2010 | | $ | 277,007 | | | $ | 1,750 | | | $ | (2,581 | ) | | $ | 276,176 | |
Principal repayments | | | (45,721 | ) | | | — | | | | — | | | | (45,721 | ) |
Provision for loan loss | | | — | | | | — | | | | (1,560 | ) | | | (1,560 | ) |
Transfer to real estate owned | | | (1,963 | ) | | | — | | | | 564 | | | | (1,399 | ) |
Charge-Offs | | | — | | | | — | | | | 988 | | | | 988 | |
Amortization for premium | | | — | | | | (299 | ) | | | — | | | | (299 | ) |
Balance, December 31, 2010 | | $ | 229,323 | | | $ | 1,451 | | | $ | (2,589 | ) | | $ | 228,185 | |
Delinquency Status 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.
Cash and Cash Equivalents. We had unrestricted cash and cash equivalents of $24.5 million at December 31, 2009.
Restricted Cash. Restricted cash totaled $3.0 million as of December 31, 2009. Included in restricted cash was $2.9 million related to amounts deposited to meet margin calls on interest rate swaps and $0.1 million related to a letter of credit for the corporate headquarter lease.
Prepaid and Other Assets. Prepaid and other assets totaled $2.1 million as of December 31, 2009 and consisted mainly of $0.5 million real estate owned (“REO”), $0.2 million in escrow advances related to mortgage loans held in securitization trust, $0.5 million of capitalization expenses related to equity and bond issuance cost and $0.3 million prepaid insurance.
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.
$25.0 million of ourOur subordinated debentures in the amount of $25 million have a floating interest rate equal to three-month LIBOR plus 3.75%, resetting quarterly, (4.00%quarterly; the interest rate on these subordinated debentures was 4.33% at December 31, 2009).2011. These securities mature on March 15, 2035 and may be called at par by us any time after March 15, 2010. HCThe subsidiary that issued these securities entered into an interest rate cap agreement to limit the maximum interest rate cost of these trust preferred securities to 7.5% through March 15, 2010. The term of2010, at which point the interest rate cap agreement is five years and resets quarterly in conjunction with the reset periods of the trust preferred securities and is schedule to mature in March 2010.expired.
$20.0 million of ourOur subordinated debentures havein the amount of $20 million had a fixed interest rate equal to 8.35% up to and including July 30, 2010, at which point the interest rate is converted to a floating rate equal to one-month LIBOR plus 3.95% until maturity.maturity; the interest rate on these subordinated debentures was 4.38% at December 31, 2011. The securities mature on October 30, 2035 and may be called at par by us any time after October 30, 2010.
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.
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.
We enter into derivative transactions solely for risk management purposes. The decision of whether or not a given transaction, or a portion thereof, is hedged is made on a case-by-case basis, based on the risks involved and other factors as determined by senior management, including the financial impact on income and asset valuation and the restrictions imposed on REIT hedging activities by the Internal Revenue Code, among others. In determining whether to hedge a risk, we may consider whether other assets, liabilities, firm commitments and anticipated transactions already offset or reduce the risk. All transactions undertaken as a hedge are entered into with a view towards minimizing the potential for economic losses that could be incurred by us. Generally, all derivatives entered into are intended to qualify as cash flow hedges. To this end, terms of the hedges are matched closely to the terms of hedged items.
The following table summarizespresents the estimated fair value of derivative assetsinstruments designated as hedging instruments and liabilities as oftheir location in the Company’s consolidated balance sheets at December 31, 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.
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
56
The following table analyzes the changes in book value for the quarter and year ended December 31, 2011 (amounts in thousands, except per share): | | 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:
RevenuesNet Interest income. Our primary source of income is net interest income on our portfolio of assets. Net interest income is the difference between interest income, which is the income that we earn on our assets, and interest expense, which is the expense we pay on our portfolio borrowings, subordinated debt and convertible preferred debentures. Prior to our exit from the mortgage lending business in March 2007, net interest income was also earned on the majority of loan originations by HC for the period of time commencing upon the closing of a loan and ending upon the sale of such loan to a third party.
Other 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.
ExpensesGeneral, administrative and other expenses. Expenses we incur in our business consist primarily of salary and employee benefits, rent for office spacefees payable to HCS, Midway and equipment expenses,RiverBanc pursuant to the advisory and management agreements, professional fees, insurance and other general and administrative expenses. Other general and administrative expenses include expenses for professional fees, office rent, supplies postage and shipping,equipment, computer and software, telephone, insurance, travel and entertainment, outsourced accounting services and other miscellaneous operating expenses. Beginning in 2008, expenses include the fees payable to HCS pursuant to the advisory agreement.
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.
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.
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 year ended December 31, 2008, we reported a net loss of $24.1 million, as compared to a net loss of $55.3 million for the year ended December 31, 2007. The decrease in net loss of $31.2income from discontinued operations, a $0.4 million was due to the following factors: $7.4increase in general, administrative and other expenses, a $0.4 million improvementincrease in income tax expense, partially offset by a $9.2 million increase in net interest margin due mainly from reduced financing costs, $36.1on our investment portfolio and loans held in securitization trusts, a $1.7 million net earnings improvement in our discontinued operations which was due to the sale of the mortgage origination business in March of 2007, offset by an increase in income from investments in limited partnership and limited liability company, a $0.5 million decrease in provision for loan loss for the loans held in securitization trusts, and a $0.4 million increase in net realized losses from sale ofgain on securities and termination of interest rate swaps in 2008.
Comparative Net Interest Income
| | For the years ended December 31, | |
| | 2009 | | | 2008 | | | 2007 | |
| | Average Balance | | | Amount | | | Yield/ Rate | | | Average Balance | | | Amount | | | Yield/ Rate | | | Average Balance | | | Amount | | | Yield/ Rate | |
| | ($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 $4.7 million gain on the sale of loans held in securitization trusts realized net margins of approximately 387 basis points for the year ended December 31, 2009.CLOs.
Comparative Net Interest Income
Our results of operations for our mortgageinvestment portfolio management business during a given period typically reflectreflects the net interest spreadincome earned on our investment portfolio of residential mortgageAgency and non-Agency RMBS, CMBS, prime ARM loans held in securitization trusts, loans held for investment, loans held for sale, CLOs, and U.S. Treasury securities and loans as well as CLO.(our “Interest Earning Assets”). The net interest spread is impacted by factors such as our cost of financing, the interest rate that our investments are earningbear and our interest rate hedging strategies. Furthermore, the cost of loans held in our portfolio, the amount of premium or discount paid on purchased portfolio investments and the prepayment rates on portfolio investments will impact the net interest spread as such factors will be amortized over the expected term of such investments.
For Realized and unrealized gains and losses on TBAs, Eurodollar and Treasury futures and other derivatives associated with our portfolioAgency IO investments, which do not utilize hedge accounting for financial reporting purposes, are included in other (expense) income in our statement of investment securities, mortgage loans held for investmentsoperations and loans heldtherefore not reflected in securitization trusts, ourthe net interest spread as well as average CPR by quarter since we began our portfolio investment activities is as follows:
Quarter Ended | | Average Interest Earning Assets ($ 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 | % |
● | $0.2 million increase in payroll due to increased compensation(1) | Our average balance of Interest Earning Assets is calculated each period as the daily average balance for performance related bonuses in 2009.the period of our Interest Earning Assets, excluding unrealized gains and losses. Our average balance of interest bearing liabilities is calculated each period as the daily average balance for the period of our financing arrangements (portfolio investments), CDOs, subordinated debentures and convertible preferred debentures. |
| (2) | Our net yield on Interest Earning Assets is calculated by dividing our interest income from our Interest Earning Assets for the period by our average Interest Earning Assets during the same period. Our interest expense rate is calculated by dividing our interest expense from our interest bearing liabilities for the period by our average interest bearing liabilities. The interest expense includes interest incurred on interest rate swaps. |
Comparative Net Interest Spread- Interest Earning Assets
The following table sets forth, among other things, the net interest spread for our portfolio of Interest Earning Assets by quarter for the eight most recently completed quarters, excluding the costs of our subordinated debentures and convertible preferred debentures.
Quarter Ended | | Average Interest Earning Assets ($ millions) (1) | | | Weighted Average Coupon (2) | | | Weighted Average Cash Yield on Interest Earning Assets (3) | | | Cost of Funds (4) | | | Net Interest Spread (5) | | | Constant Prepayment Rate (CPR) (6) | |
December 31, 2011 | | $ | 372.9 | | | | 4.43 | % | | | 7.17 | % | | | 0.97 | % | | | 6.20 | % | | | 15.8 | % |
September 30, 2011 | | $ | 369.8 | | | | 4.47 | % | | | 8.04 | % | | | 0.89 | % | | | 7.15 | % | | | 10.8 | % |
June 30, 2011 | | $ | 341.7 | | | | 4.28 | % | | | 7.59 | % | | | 0.94 | % | | | 6.65 | % | | | 8.8 | % |
March 31, 2011 | | $ | 310.2 | | | | 3.19 | % | | | 4.76 | % | | | 1.08 | % | | | 3.68 | % | | | 9.6 | % |
December 31, 2010 | | $ | 318.0 | | | | 3.24 | % | | | 4.98 | % | | | 1.45 | % | | | 3.53 | % | | | 13.8 | % |
September 30, 2010 | | $ | 343.5 | | | | 3.76 | % | | | 5.29 | % | | | 1.66 | % | | | 3.63 | % | | | 21.1 | % |
June 30, 2010 | | $ | 393.8 | | | | 4.22 | % | | | 5.28 | % | | | 1.58 | % | | | 3.70 | % | | | 20.5 | % |
March 31, 2010 | | $ | 425.1 | | | | 4.50 | % | | | 5.85 | % | | | 1.60 | % | | | 4.25 | % | | | 18.6 | % |
● | $0.6 million increase(1) | Our Average Interest Earning Assets is calculated each quarter as the daily average balance of our Interest Earning Assets for the quarter, excluding unrealized gains and losses. |
| (2) | The Weighted Average Coupon reflects the weighted average rate of interest paid on our Interest Earning Assets for the quarter, net of fees paid. The percentages indicated in management fees relatedthis column are the interest rates that will be effective through the interest rate reset date, where applicable, and have not been adjusted to incentive fee payments earned in 2009.reflect the purchase price we paid for the face amount of the security. |
| (3) | Our Weighted Average Cash Yield on Interest Earning Assets was calculated by dividing our annualized interest income from Interest Earning Assets for the quarter by our average Interest Earning Assets for the quarter. |
| (4) | Our Cost of Funds was calculated by dividing our annualized interest expense from our Interest Earning Assets for the quarter by our average financing arrangements, portfolio investments and CDOs for the quarter. |
| (5) | Net Interest Spread is the difference between our Weighted Average Cash Yield on Interest Earning Assets and our Cost of Funds. |
| (6) | Our Constant Prepayment Rate, or CPR, is the proportion of principal of our pool of loans that were paid off during each quarter. |
● | $0.5 million decrease in other expenses due to one-time penalty fees of $0.7 million paid in 2008 related to delayed shelf registration filing for our private placement of common stock. |
The increase in total expenses for the year ended December 31, 2008 as compared to total expenses for the year ended December 31, 2007 was primarily the result of the sale of our mortgage lending business and the classification of that business in 2007 as a discontinued operation. Prior to the sale of our mortgage lending business, certain expenses of our Company were part of our discontinued mortgage lending business and are included as expenses of our discontinued operation for the year ended December 31, 2007.
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 | % |
Off-Balance Sheet ArrangementsPrepayment Experience. The constant prepayment rate (“CPR”) on our overall portfolio averaged approximately 11% and 19% during 2011 and 2010, respectively. CPRs on our purchased portfolio of investment securities averaged approximately 14% while the CPRs on mortgage loans held in our securitization trusts averaged approximately 8% during 2011, as compared to 25% and 16%, respectively, during 2010. When prepayment expectations over the remaining life of assets increase, we have to amortize premiums over a shorter time period resulting in a reduced yield to maturity on our investment assets. Conversely, if prepayment expectations decrease, the premium would be amortized over a longer period resulting in a higher yield to maturity. In addition, the market values and cash flows from our Agency IOs can be materially adversely affected during periods of elevated prepayments. We monitor our prepayment experience on a monthly basis and adjust the amortization rate to reflect current market conditions.
Since inception,The following table sets forth the constant prepayment rates for selected asset classes, by quarter:
Quarter Ended | | Agency RMBS | | | Non-Agency RMBS | | | Securitizations | | | Total Investment Portfolio | |
December 31, 2011 | | | 19.2 | % | | | 12.6 | % | | | 5.2 | % | | | 15.8 | % |
September 30, 2011 | | | 10.8 | % | | | 14.7 | % | | | 10.2 | % | | | 10.8 | % |
June 30, 2011 | | | 9.0 | % | | | 11.2 | % | | | 8.4 | % | | | 8.8 | % |
March 31, 2011 | | | 12.0 | % | | | 20.8 | % | | | 7.0 | % | | | 9.6 | % |
December 31, 2010 | | | — | % | | | 18.4 | % | | | 11.5 | % | | | 13.8 | % |
September 30, 2010 | | | — | % | | | 15.5 | % | | | 18.7 | % | | | 21.1 | % |
June 30, 2010 | | | — | % | | | 13.5 | % | | | 11.9 | % | | | 20.5 | % |
March 31, 2010 | | | — | % | | | 18.0 | % | | | 20.9 | % | | | 18.6 | % |
Prepayment 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%.
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. |
Net Income Excluding Management Contract Termination and Unrealized Gains and Losses Associated with Agency IO Investments
During the quarter and year ended December 31, 2011, we incurred a one-time $2.2 million termination fee in connection with our termination of the HCS Advisory Agreement and experienced unusually excessive market volatility that impacted unrealized gains and losses on our Agency IOs and related hedges. A reconciliation between net income excluding the one-time fee for the management contract termination and unrealized gains and losses related to our investments in Agency IOs and related hedges and GAAP net income attributable to common stockholders for the years and quarters ended December 31, 2011 and 2010, respectively, is presented below (dollar amounts in thousands, except per share amounts):
| | For the Year Ended December 31, 2011 | | | For the Year Ended December 31, 2010 | |
| | Amounts | | | Per Share | | | Amounts | | | Per Share | |
| | | | | | | | | | | | |
Net Income Attributable to Common Stockholders - GAAP | | $ | 4,776 | | | $ | 0.46 | | | $ | 6,805 | | | $ | 0.72 | |
Adjustments | | | | | | | | | | | | | | | | |
Unrealized gains and losses on investment securities and related hedges associated with Agency IO investments | | | 9,657 | | | | 0.91 | | | | - | | | | - | |
Termination of management contract | | | 2,195 | | | | 0.21 | | | | - | | | | - | |
Net income excluding termination of management contract and unrealized gains and losses | | $ | 16,628 | | | $ | 1.58 | | | $ | 6,805 | | | $ | 0.72 | |
| | For the Quarter Ended December 31, 2011 | | | For the Quarter Ended December 31, 2010 | |
| | Amounts | | | Per Share | | | Amounts | | | Per Share | |
| | | | | | | | | | | | |
Net (Loss) Income Attributable to Common Stockholders - GAAP | | $ | (1,892 | ) | | $ | (0.16 | ) | | $ | 1,018 | | | $ | 0.11 | |
Adjustments | | | | | | | | | | | | | | | | |
Unrealized gains and losses on investment securities and related hedges associated with Agency IO investments | | | 895 | | | | 0.08 | | | | - | | | | - | |
Termination of management contract | | | 2,195 | | | | 0.18 | | | | - | | | | - | |
Net income excluding termination of management contract and unrealized gains and losses | | $ | 1,198 | | | $ | 0.10 | | | $ | 1,018 | | | $ | 0.11 | |
Comparative Expenses (dollar amounts in thousands)
| | For the Year Ended December 31, |
General, administrative and other expenses: | | 2011 | | | 2010 | | | % Change | |
Salaries and benefits | | $ | 1,518 | | | $ | 1,780 | | | | (14.7 | )% |
Professional fees | | | 1,521 | | | | 1,199 | | | | 26.9 | % |
Management fees | | | 3,250 | | | | 2,852 | | | | 14.0 | % |
Termination of management contract | | | 2,195 | | | | — | | | | 100.0 | % |
Other | | | 2,034 | | | | 2,119 | | | | (4.0 | )% |
Total | | $ | 10,518 | | | $ | 7,950 | | | | 32.3 | % |
The 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. |
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.
The Company also has $19.9 million of its Series A Convertible Preferred Stock outstanding, net of deferred issuance costs. The Series A Preferred Stock matures on December 31, 2010, at which time we must redeem any outstanding shares at the $20.00 per share liquidation preference plus any accrued and unpaid dividends at that time. The Series A Preferred Stock is convertible into shares of the Company’s common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 ½) shares of common stock for each share of Series A Preferred Stock. As of March 1, 2010, our common stock was trading below the $8.00 conversion price for our Series A Preferred Stock. As a result, as of December 31, 2009, 100% of the Series A Preferred Stock remained outstanding, which represents an aggregate redemption price (excluding accrued and unpaid dividends) of approximately $20.0 million. In the event we are required to redeem all or a portion of the outstanding Series A Preferred Stock at December 31, 2010 we expectreflects the use of additional capital in 2011 to use working capital to satisfy the redemption terms. Basedacquire our targeted assets.
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.
Given the continued uncertainty in the credit markets, we believe that maintaining a maximum leverage ratio in the rangeinvestment portfolio. As of 6 to 8 times for our Agency RMBS portfolio and an overall Company leverage ratio of 4 to 5 times is appropriate at this time. At December 31, 2009 the leverage ratio for our portfolio of Agency RMBS, which2011, we define as our outstanding indebtedness under repurchase agreements divided by the sum of total stockholders’ equity and our Series A Preferred Stock, was 1 to 1 and, excluding our Series A Preferred Stock, the leverage ratio was 1.4 to 1.
We hadhave outstanding repurchase agreements, a form of collateralized short-term borrowing, with five different financial institutions as of December 31, 2009.institutions. These agreements are secured by certain of our Agency RMBSinvestment securities and bear interest rates that have historically moved in close relationship to LIBOR. Our borrowings under repurchase agreements are based on the fair value of our mortgage backedinvestment securities portfolio. Interest rate changes and increased prepayment activity can have a negative impact on the valuation of these securities, reducing the amount we can borrow under these agreements. Moreover, our repurchase agreements allow the counterparties to determine a new market value of the collateral to reflect current market conditions and because these lines of financing are not committed, the counterparty can call the loan at any time. If a counterparty determines that the value of the collateral has decreased, the counterparty may initiate a margin call and require us to either post additional collateral to cover such decrease or repay a portion of the outstanding borrowing in cash, on minimal notice. Moreover, Inin the event an existing counterparty elected to not resetrenew the outstanding balance at its maturity into a new repurchase agreement, we would be required to repay the outstanding balance with cash or proceeds received from a new counterparty or to surrender the mortgage-backed securities that serve as collateral for the outstanding balance, or any combination thereof. If we are unable to secure financing from a new counterparty and had to surrender the collateral, we would expect to incur a significant loss. In addition, in the event one of our lenders under the repurchase agreement defaults on its obligation to “re-sell” or return to us the securities that are securing the borrowings at the end of the term of the repurchase agreement, we would incur a loss on the transaction equal to the amount of “haircut” associated with the repurchase agreement.
At December 31, 2011, the Company had short term borrowings or repurchase agreements of $112.7 million as compared to $35.6 million as of December 31, 2010. The increase of $77.1 million is primarily due to our investment in Agency IOs in 2011. In addition to our excess cash, the Company has $48.9 million in unencumbered securities, including $17.0 million of RMBS, of which $13.0 million are Agency RMBS. There is $16.5 million in restricted cash available to meet additional margin calls as it relates to the repurchase agreements secured by our Agency IOs. At December 31, 2011, we also had longer-term debt, including CDOs outstanding of $199.8 million and subordinated debt of $45.0 million. The CDOs are collateralized by the mortgage loans held in securitization trusts. Based on our current investment portfolio, new investment initiatives, leverage ratio and available and future possible borrowing arrangements, we believe our existing cash balances, funds available under our current repurchase agreements and cash flows from operations will meet our liquidity requirements for at least the next 12 months.
Our leverage ratio for our investment portfolio, which we define as our outstanding indebtedness under repurchase agreements divided by stockholders’ equity, was 1.3 to 1 at December 31, 2011. We have continued to utilize significantly less leverage than our previously targeted leverage due to the ongoing repositioning of our investment portfolio to a more diversified portfolio that includes elements of credit risk with reduced leverage.
As of December 31, 2011, we have provided invested capital of $39.5 million towards our Agency IO strategy and $22.1 million to RBCM in connection with our multi-family CMBS investments. We also purchased an additional $21.5 million of CMBS through RBCM that settled in the first quarter of 2012. We funded these investments primarily with proceeds from our December 2011 capital raise, excess working capital and short-term borrowings. We anticipate continuing to contribute additional capital toward the acquisition of these assets in the future from either working capital liquidity or proceeds from capital market transactions or a combination thereof.
Certain of our hedging instruments may also impact our liquidity. We use Eurodollar or other futures contracts to hedge interest rate risk associated with our investments in Agency IOs. With respect to futures contracts, initial margin deposits will be made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are recognized as unrealized gains or losses by marking to market on a daily basis to reflect the market value of the contract at the end of each day’s trading. We may be required to satisfy variation margin payments periodically, depending upon whether unrealized gains or losses are incurred.
We also use TBAs to hedge interest rate risk and spread risk associated with our investments in Agency IOs. Since delivery for these securities extends beyond the typical settlement dates for most non-derivative investments, these transactions are more prone to market fluctuations between the trade date and the ultimate settlement date, and thereby are more vulnerable, especially in the absence of margin arrangements with respect to these transactions, to increasing amounts at risk with the applicable counterparties.
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 (1) | | | 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, 2009.2011. |
(2) | Maturities of our CDOs are dependent upon cash flows received from the underlying loans receivable. Our estimate of their repayment is based on scheduled principal payments and estimated principal prepayments based on our internal prepayment model on the underlying loans receivable. This estimate will differ from actual amounts to the extent prepayments and/or loan losses are experienced. |
(3) | We terminated the HCS Advisory Agreement on December 30, 2011. Amounts include projected dividend payments on the Series A Preferred Stock. Quarterly dividend ratebase fees for Midway and RiverBanc based on the quarterly dividendcurrent invested capital, the remaining base management fees to be paid on January 26, 2010. The calculation of the dividend rate is merely a projection for the purposes of this tableto HCS and does not represent an obligation of the Company to pay all or any portion of the projected dividend amount. |
(4) | Amounts due under our advisory agreement with HCS (see below)excludes incentive fees which are based on assets under management as of December 31, 2009.future performance. |
Advisory and Management Agreements
During the 2011 fiscal year, the Company was a party to management or advisory agreements with HCS, Midway and RiverBanc. We terminated the HCS Advisory Agreement effective December 31, 2011. See “Item 1. Business –Recent Developments –Termination of Advisory Agreement.” In connection with our continuing management agreements with RiverBanc and Midway, we have agreed to pay the applicable external manager that is a party to those agreements certain fees for the performance of certain services thereunder. See “Item 1. Business” for a description of the fees and expenses payable by us under these agreements.
For the years ended December 31, 2011 and 2010, HCS earned aggregate base advisory and consulting fees of approximately $1.1 million and $0.9 million, respectively, and an incentive fee of approximately $1.7 million and $2.0 million, respectively. As of December 31, 2011 and 2010, approximately $34.0 million and $48.2 million, respectively, of the Company’s assets were being managed under the HCS Advisory Agreement. As of December 31, 2011 and 2010, the Company had a management fee payable totaling $0.8 million and $0.7 million, respectively, included in accrued expenses and other liabilities.
For the year ended December 31, 2011, Midway earned base management and incentive fees of approximately $420,000 and $0, respectively.
For the year ended December 31, 2011, RiverBanc earned base management fees of approximately $96,000.
Off-Balance Sheet Arrangements
We did not maintain any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities.
Advisory AgreementChanges 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.
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 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.
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.
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.
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 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.
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 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 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.