Attached files
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended March 31, 2012
¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the transition period from to
Commission File Number: 001-35246
Apollo Residential Mortgage, Inc.
(Exact name of Registrant as specified in its charter)
Maryland | 45-0679215 | |
(State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification Number) |
Apollo Residential Mortgage, Inc.
c/o Apollo Global Management, LLC
9 West 57th Street, 43rd Floor
New York, New York 10019
(Address of Registrants principal executive offices)
(212) 5153200
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act (check one).
Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
Non-accelerated filer | x (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practical date.
As of May 7, 2012, there were 24,182,847 shares, par value $0.01, of the registrants common stock issued and outstanding.
Table of Contents
Page | ||||||||
3 | ||||||||
ITEM 1. |
3 | |||||||
ITEM 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
17 | ||||||
ITEM 3. |
31 | |||||||
ITEM 4. |
34 | |||||||
35 | ||||||||
ITEM 1. |
35 | |||||||
ITEM 1A. |
35 | |||||||
ITEM 2. |
35 | |||||||
ITEM 3. |
35 | |||||||
ITEM 4. |
35 | |||||||
ITEM 5. |
35 | |||||||
ITEM 6. |
35 | |||||||
37 |
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PART I FINANCIAL INFORMATION
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Balance Sheets (Unaudited)
(in thousandsexcept share and per share data)
March 31, 2012 | December 31, 2011 | |||||||
Assets: |
||||||||
Cash |
$ | 41,340 | $ | 44,407 | ||||
Restricted cash |
18,749 | 10,402 | ||||||
Residential mortgage-backed securities, at fair value ($1,268,405 and 1,167,487 pledged as collateral, respectively) |
1,336,536 | 1,240,472 | ||||||
Investment related receivable |
2,186 | 116,678 | ||||||
Interest receivable |
3,927 | 3,908 | ||||||
Deferred financing costs, net |
430 | 455 | ||||||
Derivative asset |
83 | 235 | ||||||
Other assets |
203 | 370 | ||||||
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Total Assets |
$ | 1,403,454 | $ | 1,416,927 | ||||
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Liabilities and Stockholders Equity |
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Liabilities: |
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Borrowings under repurchase agreements |
$ | 1,171,177 | $ | 1,079,995 | ||||
Investment related payable |
93 | 121,144 | ||||||
Accrued interest payable |
1,021 | 1,123 | ||||||
Derivative liability |
3,898 | 3,481 | ||||||
Accounts payable and accrued expenses |
1,794 | 1,534 | ||||||
Payable to related party |
1,062 | 1,974 | ||||||
Dividends payable |
7,733 | 3,090 | ||||||
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Total Liabilities |
1,186,778 | 1,212,341 | ||||||
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Commitments and Contingencies (Note 7) |
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Stockholders Equity: |
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Common stock, $0.01 par value, 450,000,000 shares authorized, 10,273,125 and 10,271,562 shares issued and outstanding , respectively |
103 | 103 | ||||||
Preferred stock, $0.01 par value, 50,000,000 shares authorized and no shares outstanding |
| | ||||||
Additional paid-in-capital |
202,796 | 203,101 | ||||||
Retained earnings |
13,777 | 1,382 | ||||||
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Total Stockholders Equity |
216,676 | 204,586 | ||||||
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Total Liabilities and Stockholders Equity |
$ | 1,403,454 | $ | 1,416,927 | ||||
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See notes to unaudited consolidated financial statements.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Operations (Unaudited)
(in thousandsexcept per share data)
Three months ended March 31, 2012 |
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Net interest income: |
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Interest income |
$ | 12,363 | ||
Interest expense |
(1,361 | ) | ||
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Net interest income |
11,002 | |||
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Other Income (Loss) |
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Realized gain on sale of residential mortgage-backed securities, net |
6,769 | |||
Unrealized gain on residential mortgage-backed securities, net |
5,950 | |||
Loss on derivative instruments (includes $569 of unrealized losses) |
(1,318 | ) | ||
Interest income on cash balances |
2 | |||
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Other Income, net |
11,403 | |||
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Operating expenses: |
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General and administrative (includes $78 non-cash stock based compensation) |
(1,488 | ) | ||
Management fee related party |
(797 | ) | ||
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Total operating expenses |
(2,285 | ) | ||
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Net income |
$ | 20,120 | ||
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Basic and diluted net income per share of common stock |
$ | 1.95 | ||
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Basic and diluted weighted average shares of common stock outstanding |
10,301 | |||
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Dividends declared per share of common stock |
$ | 0.75 | ||
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See notes to unaudited consolidated financial statements.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders Equity (Unaudited)
(in thousandsexcept share data)
Common Stock | Additional Paid In Capital |
Retained Earnings |
Total | |||||||||||||||||
Shares | Par | |||||||||||||||||||
Balance at January 1, 2012 |
10,271,562 | $ | 103 | $ | 203,101 | $ | 1,382 | $ | 204,586 | |||||||||||
Offering costs |
| | (383 | ) | | (383 | ) | |||||||||||||
Issuance of vested stock |
1,563 | | | | | |||||||||||||||
Vesting of restricted stock |
| | 78 | | 78 | |||||||||||||||
Net income |
| | | 20,120 | 20,120 | |||||||||||||||
Dividends on common stock |
| | | (7,725 | ) | (7,725 | ) | |||||||||||||
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Balance at March 31, 2012 |
10,273,125 | $ | 103 | $ | 202,796 | $ | 13,777 | $ | 216,676 | |||||||||||
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See notes to unaudited consolidated financial statements.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Cash Flows (Unaudited)
(in thousands)
Three months ended March 31, 2012 |
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Cash flows used in operating activities: |
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Net income |
$ | 20,120 | ||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||
Premium amortization and (discount accretion), net |
(220 | ) | ||
Amortization of deferred financing costs |
46 | |||
Restricted stock amortization expense |
78 | |||
Unrealized gain on mortgage-backed securities |
(5,950 | ) | ||
Unrealized loss on derivative instruments |
569 | |||
Realized gain on sale of mortgage-backed securities |
(6,769 | ) | ||
Changes in operating assets and liabilities: |
||||
Increase in accrued interest receivable, less purchased interest |
(6 | ) | ||
Decrease in other assets |
167 | |||
Decrease in accrued interest payable |
(102 | ) | ||
Decrease in accounts payable and accrued expenses |
(65 | ) | ||
Decrease in payable to related party |
(550 | ) | ||
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Net cash provided by operating activities |
7,318 | |||
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Cash flows used in investing activities: |
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Purchase of mortgage-backed securities |
(627,032 | ) | ||
Proceeds from sale of mortgage-backed securities |
460,393 | |||
Principal payments received on mortgage-backed securities |
31,940 | |||
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Net cash used in investing activities |
(134,699 | ) | ||
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Cash flows from financing activities: |
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Payment of offering costs |
(387 | ) | ||
Proceeds from repurchase agreement borrowings |
1,881,000 | |||
Repayments of repurchase agreement borrowings |
(1,744,816 | ) | ||
Restricted cash |
(8,347 | ) | ||
Deferred financing costs |
(54 | ) | ||
Payment of dividends |
(3,082 | ) | ||
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Net cash provided by financing activities |
124,314 | |||
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Net decrease in cash |
(3,067 | ) | ||
Cash beginning of period |
44,407 | |||
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Cash end of period |
$ | 41,340 | ||
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Supplemental disclosure of operating cash flow information: |
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Interest paid |
$ | 1,416 | ||
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Supplemental disclosure of non-cash financing/investing activities: |
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Mortgage-backed securities purchased / sold not settled, net |
$ | 2,079 | ||
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Repurchase agreement not settled |
$ | 13 | ||
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Dividends declared, not yet paid |
$ | 7,733 | ||
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See notes to unaudited consolidated financial statements.
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Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(in thousandsexcept share and per share data)
The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: Agency or Agencies refer to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae; references to RMBS refer to residential mortgage-backed securities, Agency RMBS refer to RMBS issued or guaranteed by the Agencies while non-Agency RMBS refer to RMBS that are not issued or guaranteed by the Agencies; references to ARMs refers to adjustable rate mortgages and Alt-A mortgage loans refers to residential mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to Agency underwriting guidelines and generally allow homeowners to qualify for a mortgage loan with reduced or alternate forms of documentation; and references to Agency Derivatives refer to interest-only and inverse interest-only securities used to collateralize Agency RMBS.
Note 1 Organization
Apollo Residential Mortgage, Inc. (together with its consolidated subsidiaries, is referred to throughout this report as the Company) is a residential real estate finance company that invests in residential mortgage assets in the United States. The Company has selectively constructed a portfolio of assets that currently consists of Agency RMBS and non-Agency RMBS and that over time may be diversified to cover a broader range of other residential mortgage assets, including residential mortgage loans. The Company refers to the assets it targets for acquisition as the Companys target assets.
The Company was organized as a Maryland corporation on March 15, 2011 and commenced operations on July 27, 2011. The Company is externally managed and advised by ARM Manager, LLC (referred to as the Manager), an indirect subsidiary of Apollo Global Management, LLC (together with its subsidiaries, Apollo).
The Company intends to elect and qualify as a real estate investment trust (a REIT) under the Internal Revenue Code of 1986, as amended (the Internal Revenue Code), commencing with its taxable year ended December 31, 2011. The Company also intends to operate its business in a manner that will allow the Company not to register as an investment company under the Investment Company Act of 1940 (the 1940 Act).
Note 2 Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited consolidated financial statements include the accounts of the Company and those of its consolidated subsidiaries. All intercompany amounts have been eliminated. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the Companys financial position, results of operations and cash flows have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q. These consolidated financial statements should be read in conjunction with the Companys annual report on Form 10-K for the year ended December 31, 2011 which was filed with the Securities and Exchange Commission (the SEC) on March 8, 2012. The results of operations for the period ended March 31, 2012 are not necessarily indicative of the results to be expected for the full year or any other future period.
The Company currently operates as one business segment.
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Recent accounting pronouncements
Accounting Standards Adopted in 2012
In April 2011, the Financial Accounting Standards Board (FASB) amended existing guidance for agreements to transfer financial assets that both entitle and obligate the transferor to repurchase or redeem the financial assets before their maturity. The amendments remove from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and the collateral maintenance implementation guidance related to that criterion. The guidance became effective for the first interim or annual period beginning on or after December 15, 2011 on a prospective basis. The adoption of this guidance did not have a material impact on the Companys financial statements.
In May 2011, the FASB issued an update which includes amendments that result in common fair value measurement and disclosure requirements in GAAP and IFRS. Consequently, the amendments change the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. The guidance also requires enhanced disclosures about fair value measurements, including, among other things, (a) for fair value measurements categorized within Level III of the fair value hierarchy, (1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, (2) the valuation process used by the reporting entity, and (3) a narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any, and (b) the categorization by level of the fair value hierarchy for items that are not measured at fair value in the statement of financial position but for which the fair value is required to be disclosed (for example, a financial instrument that is measured at amortized cost in the statement of financial position but for which fair value is disclosed). The guidance also amends disclosure requirements for significant transfers between Level I and Level II and now requires disclosure of all transfers between Levels I and II in the fair value hierarchy. The update is effective for interim and annual periods beginning after December 15, 2011 for public entities with the amendments to be applied prospectively. The impact of the guidance is primarily limited to enhanced disclosure; where applicable and, therefore the adoption of this guidance did not have a material impact on the Companys financial statements or disclosures.
In June 2011, the FASB issued guidance with respect to the presentation of comprehensive income, which allows an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income (OCI) either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Either presentation requires the presentation on the face of the financial statements any reclassification adjustments for items that are reclassified from OCI to net income in the statement(s) where the components of net income and the components of OCI are presented. This guidance requires retrospective application and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. In December 2011, the FASB deferred certain aspects of this guidance. The Companys adoption of the guidance and deferral of the effective date with respect to such guidance beginning on January 1, 2012 did not have any impact on the Companys financial statements, as the Company had no items included other comprehensive income.
Accounting Standards to be Adopted in Future Periods
In December 2011, the FASB issued guidance requiring additional disclosure information about offsetting and related arrangements. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transaction subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on the basis of GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (IFRS). The guidance is effective for periods beginning on or after January 1, 2013 and interim periods within those annual periods. In conjunction with the FASBs fair value measurement guidance, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio. While this guidance may result in certain additional disclosures, it is not expected to have a material impact on the Companys financial statements.
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Note 3 Fair Value Disclosure
Fair Value Accounting Elections
The Company has elected the fair value option for all of its RMBS and as a result, all changes in the estimated fair value of such securities are reflected in the results of operations. The following tables present the Companys financial instruments carried at fair value as of March 31, 2012 and December 31, 2011, based upon the consolidated balance sheet by the valuation hierarchy:
March 31, 2012 Estimated Fair Value |
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Level I | Level II | Level III | Total | |||||||||||||
Assets |
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RMBS |
$ | | $ | 1,157,567 | $ | 178,969 | $ | 1,336,536 | ||||||||
Derivative assets |
| 83 | | 83 | ||||||||||||
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Total |
$ | | $ | 1,157,650 | $ | 178,969 | $ | 1,336,619 | ||||||||
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Liabilities |
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Derivative liabilities |
$ | | $ | 3,898 | $ | | $ | 3,898 | ||||||||
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Total |
$ | | $ | 3,898 | $ | | $ | 3,898 | ||||||||
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December 31, 2011 Estimated Fair Value |
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Level I | Level II | Level III | Total | |||||||||||||
Assets |
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RMBS |
$ | | $ | 1,128,126 | $ | 112,346 | $ | 1,240,472 | ||||||||
Derivative assets |
| 235 | | 235 | ||||||||||||
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Total |
$ | | $ | 1,128,361 | $ | 112,346 | $ | 1,240,707 | ||||||||
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Liabilities |
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Derivative liabilities |
$ | | $ | 3,481 | $ | | $ | 3,481 | ||||||||
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Total |
$ | | $ | 3,481 | $ | | $ | 3,481 | ||||||||
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The following table presents additional information about the Companys non-Agency RMBS which are measured at fair value, based upon broker quotes, on a recurring basis and are considered to be Level III measurements of fair value:
March 31, 2012 | December 31, 2011 | |||||||
Beginning balance |
$ | 112,346 | $ | | ||||
Purchases |
101,147 | 120,642 | ||||||
Sales |
(36,208 | ) | (2,766 | ) | ||||
Principal repayments |
(8,310 | ) | (6,218 | ) | ||||
Total net gains / (losses) included in net income |
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Realized gains/(losses), net |
830 | 91 | ||||||
Unrealized gains/(losses), net |
5,717 | (3,263 | ) | |||||
Premium and discount amortization, net |
3,447 | 3,860 | ||||||
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Ending balance |
$ | 178,969 | $ | 112,346 | ||||
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The Company uses the average of broker quotes to determine the estimated fair value of its RMBS. Given that broker quotes are only indicative of fair value, management compares broker quotes to the values received from a pricing service to validate the reasonableness of the prices obtained from brokers.
Note 4 Residential Mortgage-Backed Securities
The following table presents certain information about the Companys investment portfolio at March 31, 2012:
Principal Balance (1) |
Unamortized Premium (Discount) |
Amortized Cost (1) (2) |
Unrealized Gain (Loss) |
Estimated Fair Value (1) |
Net Weighted Average Coupon (3) |
Weighted Average Yield (4) |
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Agency RMBS: |
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30-Year Mortgage |
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Coupon Rate: |
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>3% to 4% |
$ | 376,327 | $ | 20,987 | $ | 397,314 | $ | 281 | $ | 397,595 | 4.0 | % | 3.0 | % | ||||||||||||||
>4% to 5% |
384,601 | 25,554 | 410,155 | 6,562 | 416,717 | 4.6 | % | 3.2 | % | |||||||||||||||||||
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Total 30 yr |
$ | 760,928 | $ | 46,541 | $ | 807,469 | $ | 6,843 | $ | 814,312 | 4.3 | % | 3.1 | % | ||||||||||||||
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15-Year Mortgage |
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Coupon Rate: |
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3% to 3.5% |
232,420 | 10,131 | 242,551 | 1,066 | 243,617 | 3.2 | % | 2.3 | % | |||||||||||||||||||
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ARM |
81,898 | 4,149 | 86,047 | 801 | 86,848 | 2.5 | % | 1.1 | % | |||||||||||||||||||
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Agency Derivatives |
102,944 | (90,513 | ) | 12,431 | 359 | 12,790 | 4.0 | % | 12.8 | % | ||||||||||||||||||
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Total Agency |
1,178,190 | (29,692 | ) | 1,148,498 | 9,069 | 1,157,567 | 3.9 | % | 2.9 | % | ||||||||||||||||||
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Non Agency RMBS |
260,171 | (83,656 | ) | 176,515 | 2,454 | 178,969 | 1.1 | % | 9.4 | % | ||||||||||||||||||
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Total |
$ | 1,438,361 | $ | (113,348 | ) | $ | 1,325,013 | $ | 11,523 | $ | 1,336,536 | 3.4 | % | 3.8 | % | |||||||||||||
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(1) | Includes unsettled purchases with an aggregate cost of $93 and estimated fair value of $102 at March 31, 2012. |
(2) | Amortized cost includes unrealized losses of $971 that have been reclassified pursuant to GAAP. |
(3) | Net weighted average coupon is presented net of servicing and other fees. |
(4) | Weighted average yield incorporates estimates for future prepayment and loss assumptions. |
The following table presents certain information about the Companys investment portfolio at December 31, 2011:
Principal Balance (1) |
Unamortized Premium (Discount) |
Amortized Cost (1) (2) |
Unrealized Gain (Loss) |
Estimated Fair Value (1) |
Net Weighted Average Coupon (3) |
Weighted Average Yield (4) |
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Agency RMBS: |
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30-Year Mortgage |
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Coupon Rate: |
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4.0% |
$ | 238,884 | $ | 13,243 | $ | 252,127 | $ | 194 | $ | 252,322 | 4.0 | % | 2.9 | % | ||||||||||||||
>4% to 5% |
441,897 | 29,900 | 471,797 | 5,519 | 477,315 | 4.7 | % | 2.9 | % | |||||||||||||||||||
>5% to 5.5% |
40,824 | 3,444 | 44,268 | 246 | 44,514 | 5.5 | % | 3.0 | % | |||||||||||||||||||
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Total 30 yr |
721,605 | 46,587 | 768,192 | 5,959 | 774,151 | 4.5 | % | 2.9 | % | |||||||||||||||||||
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15-Year Mortgage |
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Coupon Rate: |
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3.5% |
107,878 | 5,055 | 112,933 | 953 | 113,886 | 3.5 | % | 2.4 | % | |||||||||||||||||||
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|||||||||||||||
ARM |
214,438 | 10,127 | 224,565 | (143 | ) | 224,422 | 2.8 | % | 1.5 | % | ||||||||||||||||||
Agency Derivatives |
125,099 | (108,901 | ) | 16,198 | (531 | ) | 15,667 | 4.4 | % | 13.2 | % | |||||||||||||||||
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|||||||||||||||
Total Agency |
1,169,020 | (47,132 | ) | 1,121,888 | 6,238 | 1,128,126 | 4.1 | % | 2.7 | % | ||||||||||||||||||
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|
|||||||||||||||
Non Agency RMBS |
198,257 | (84,275 | ) | 113,982 | (1,636 | ) | 112,346 | 1.0 | % | 13.0 | % | |||||||||||||||||
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Total |
$ | 1,367,277 | ($ | 131,407 | ) | $ | 1,235,870 | $ | 4,602 | $ | 1,240,472 | 3.6 | % | 3.7 | % | |||||||||||||
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Table of Contents
(1) | Includes unsettled purchases with an aggregate cost of $121,019 and estimated fair value of $121,294 at December 31, 2011. |
(2) | Amortized cost includes unrealized losses of $2,120 that have been reclassified pursuant to GAAP. |
(3) | Net weighted average coupon is presented net of servicing and other fees. |
(4) | Weighted average yield incorporates estimates for future prepayment and loss assumptions. |
The components of the carrying value of the Companys investment portfolio at March 31, 2012 and December 31, 2011 are as follows:
March 31, 2012 | December 31, 2011 | |||||||
Principal balance |
$ | 1,438,361 | $ | 1,367,277 | ||||
Unamortized premium |
60,821 | 61,769 | ||||||
Unamortized discount |
(174,169 | ) | (193,176 | ) | ||||
Gross unrealized gains |
13,399 | 7,766 | ||||||
Gross unrealized losses |
(1,876 | ) | (3,164 | ) | ||||
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|
|
|
|||||
Estimated fair value |
$ | 1,336,536 | $ | 1,240,472 | ||||
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|
|
As of March 31, 2012 and December 31, 2011, the Company held Agency RMBS with a fair value of $281,811 and $251,427, respectively in an unrealized loss position of $1,331 and $1,224, respectively. As of March 31, 2012 and December 31, 2011, the Company held Non-Agency RMBS with a fair value of $50,134 and $57,014, respectively in an unrealized loss position of $545 and $1,940, respectively. As of March 31, 2012 and December 31, 2011, the Company held no investments in an unrealized loss position for greater than one year. At March 31, 2012, the Company did not intend to sell any of its RMBS that were in an unrealized loss position, and it is more likely than not that the Company will not be required to sell these RMBS before recovery of their amortized cost basis, which may be at their maturity.
The following table presents components of interest income on the Companys Agency RMBS and non-Agency RMBS for the three months ended March 31, 2012:
Coupon Interest |
Net (Premium Amortization) Discount Accretion |
Interest Income |
||||||||||
Agency RMBS |
$ | 11,591 | $ | (3,227 | ) | $ | 8,364 | |||||
Non-Agency RMBS |
552 | 3,447 | 3,999 | |||||||||
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|
|
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Total |
$ | 12,143 | $ | 220 | $ | 12,363 | ||||||
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|
Note 5 Borrowings
As of March 31, 2012, the Company had master repurchase agreements with 18 counterparties to finance a substantial portion of its RMBS portfolio, and was in discussions with other financial institutions in order to potentially provide the Company with financing capacity. As of March 31, 2012, the Company had borrowings under repurchase agreements with 14 counterparties. For the quarter ended March 31, 2012, the Company had average borrowings under its repurchase agreements of $1,099,145 and had a maximum balance during the period of $1,177,701.
The repurchase agreements bear interest at a contractually agreed-upon rate and typically have terms ranging from one month to three months. The Companys repurchase agreement borrowings are accounted for as secured borrowings given that the Company maintains effective control of the financed assets.
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The following table summarizes certain characteristics of the Companys repurchase agreements at March 31, 2012:
Collateral |
Principal Balance |
Fair Value of Collateral Pledged (1) |
Weighted Average Interest Rate |
Weighted Average Remaining Maturity (days) |
||||||||||||
Agency RMBS |
$ | 1,040,848 | $ | 1,094,737 | 0.3 | % | 33 | |||||||||
Non-Agency RMBS |
130,329 | 180,201 | 1.9 | 32 | ||||||||||||
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Total |
$ | 1,171,177 | $ | 1,274,938 | 0.5 | % | 33 | |||||||||
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(1) | Includes $8,095 and $3,046 of cash collateral for Agency RMBS and non-Agency RMBS, respectively. |
The following table summarizes certain characteristics of the Companys repurchase agreements at December 31, 2011:
Collateral |
Principal Balance |
Fair Value of Collateral Pledged (1) |
Weighted Average Interest Rate |
Weighted Average Remaining Maturity (days) |
||||||||||||
Agency RMBS |
$ | 1,002,626 | $ | 1,055,631 | 0.4 | % | 25 | |||||||||
Non-Agency RMBS |
77,369 | 112,650 | 1.8 | 23 | ||||||||||||
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Total |
$ | 1,079,995 | $ | 1,168,281 | 0.5 | % | 27 | |||||||||
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(1) | Includes $3,490 and $2,075 of cash collateral for Agency RMBS and non-Agency RMBS, respectively. |
A reduction in the value of pledged assets typically results in the repurchase agreement counterparty initiating a margin call. As a result, the Company is required to provide additional collateral or repay a portion of the borrowing. In addition, certain repurchase agreements are subject to certain financial covenants. The Company was in compliance with all of these covenants through March 31, 2012. At March 31, 2012 and December 31, 2011, respectively, RMBS held by counterparties as security for repurchase agreements totaled $1,263,797 and $1,162,716. In addition, at March 31, 2012 and December 31, 2011, respectively, the Company had RMBS of $4,608 and $4,771 pledged as a component of clearing margin. Cash collateral held by counterparties at March 31, 2012 and December 31, 2011, respectively was $18,749 and $10,402.
Note 6 Derivative Instruments
The Company is exposed to certain risk arising from both its business operations and economic conditions. Specifically, the Companys primary source of debt funding is repurchase agreements and the Company enters into derivative financial instruments to manage exposure to variable cash flows on portions of its borrowings under those repurchase agreements. Since the interest rates on repurchase agreements typically change with market interest rates such as the London Interbank Offered Rate (LIBOR), the Company is exposed to constantly changing interest rates, which accordingly affects cash flows associated with these rates on its borrowings. To mitigate the effect of changes in these interest rates, the Company enters into interest rate swap agreements (Swaps) which help to mitigate the volatility in the interest rate exposures and their related cash flows. Swaps involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the Swap without exchange of the underlying notional amount.
While the Company has not elected to account for its derivative instruments as hedges under GAAP, it does not use derivatives for speculative purposes, but rather uses such instruments to manage interest rate risk and views them as economic hedges. Changes in the estimated fair value of derivatives not designated in hedging relationships are recorded directly in earnings.
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The Companys derivative instruments consist of the following at March 31, 2012 and December 31, 2011:
March 31, 2012 | December 31, 2011 | |||||||||||||||
Notional Amount |
Estimated Fair Value |
Notional Amount |
Estimated Fair Value |
|||||||||||||
Swaps, assets |
$ | 55,000 | $ | 83 | $ | 80,000 | $ | 235 | ||||||||
Swaps, liabilities |
355,000 | (3,898 | ) | 265,000 | (3,481 | ) | ||||||||||
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Total derivative instruments |
$ | 410,000 | $ | (3,815 | ) | $ | 345,000 | $ | (3,246 | ) | ||||||
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The following table summarizes the average fixed pay rate and average maturity for the Companys Swaps as of March 31, 2012 and December 31, 2011:
March 31, 2012 | December 31, 2011 | |||||||||||||||||||||||
Term to Maturity |
Notional Amount |
Average Fixed Pay Rate |
Average Maturity (Years) |
Notional Amount |
Average Fixed Pay Rate |
Average Maturity (Years) |
||||||||||||||||||
Greater than 1 year and less than 3 years |
$ | 25,000 | 0.6 | % | 2.4 | $ | 25,000 | 0.6 | % | 2.7 | ||||||||||||||
Greater than 3 years and less than 5 years |
360,000 | 1.4 | 4.6 | 310,000 | 1.4 | 4.8 | ||||||||||||||||||
Greater than 5 years |
25,000 | 2.4 | 9.9 | 10,000 | 2.4 | 9.9 | ||||||||||||||||||
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Total |
$ | 410,000 | 1.4 | 4.8 | $ | 345,000 | 1.3 | % | 4.8 | |||||||||||||||
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The following table summarizes the amounts recognized on the consolidated statements of operations related to the Companys derivatives for the three months ended March 31, 2012:
Derivative Instrument |
Location of Gain (Loss) Recognized in Income |
Gain (loss) recognized in income for the three months ended March 31, 2012 |
||||
Swaps |
Loss on derivative instruments realized* | $ | (749 | ) | ||
Swaps |
Loss on derivative instruments - unrealized | (569 | ) | |||
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|
|||||
Total |
$ | (1,318 | ) | |||
|
|
* | Realized losses represent the net amount paid, including accrued amounts, for Swaps during the period. |
The Companys agreements with certain of its derivative counterparties contain certain financial covenants. Through March 31, 2012, the Company was in compliance with the terms of such financial covenants.
As of March 31, 2012 and December 31, 2011, respectively, the estimated fair value of derivatives in a net liability position, which includes accrued interest, related to these agreements was approximately $4,196 and $3,646. The Company has minimum collateral posting thresholds with certain of its derivative counterparties, for which it typically pledges cash. As of March 31, 2012 and December 31, 2011, the Company had cash pledged as collateral, which is a component of the Companys restricted cash, of approximately $7,608 and $4,837, respectively. If the Company had breached any of these provisions at March 31, 2012 and December 31, 2011, respectively, it could have been required to settle its obligations under the agreements at their termination value of approximately $4,196 and $3,646.
Note 7 Related Party Transactions
Management Agreement
In connection with the Companys initial public offering (the IPO) in July 2011, the Company entered into a management agreement (the Management Agreement) with the Manager, which describes the services to be provided by the Manager and compensation for such services. The Manager is responsible for managing the Companys day-to-day operations, subject to the direction and oversight of the Companys board of directors.
Pursuant to the terms of the Management Agreement, the Manager is paid a management fee equal to 1.5% per annum of the Companys stockholders equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears.
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Table of Contents
The initial term of the Management Agreement expires on July 27, 2014 and it is automatically renewed for one-year terms on each anniversary thereafter. Following the initial term, the Management Agreement may be terminated upon the affirmative vote of at least two-thirds of the Companys independent directors, based upon (1) unsatisfactory performance by the Manager that is materially detrimental to the Company or (2) a determination that the management fee payable to the Manager is not fair, subject to the Managers right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of the Companys independent directors. The Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
For the three months ended March 31, 2012, the Company incurred approximately $797 in management fees. In addition to the management fee, the Company is also responsible for reimbursing the Manager for certain expenses paid by the Manager on behalf of the Company and for certain services provided by the Manager to the Company. For the three months ended March 31, 2012, the Company recorded expenses of $1,182 related to reimbursements for certain expenses paid by the Manager on behalf of the Company. Expenses incurred by the Manager and reimbursed by the Company are typically included in the Companys general and administrative expense on its consolidated statement of operations, or may be reflected on the consolidated balance sheet and associated consolidated statement of changes in stockholders equity, based on the nature of the item. At March 31, 2012 and December 31, 2011, approximately $797 and $784 for management fees incurred but not yet paid was included in payable to related party on the consolidated balance sheet.
Note 8 Share-Based Payments
On July 21, 2011, the Companys board of directors approved the Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan (the LTIP). The LTIP provides for grants of restricted common stock, restricted stock units (RSUs) and other equity-based awards up to an aggregate of 5% of the issued and outstanding shares of the Companys common stock (on a fully diluted basis). The LTIP is administered by the compensation committee of the Companys board of directors (the Compensation Committee) and all grants under the LTIP must be approved by the Compensation Committee.
As of March 31, 2012 a total of 20,000 shares of restricted common stock and 31,250 RSUs were granted pursuant to the LTIP.
The Company recognized stock-based compensation expense of $78 for the three months ended March 31, 2012 related to restricted stock and RSU vesting. The following is a summary of restricted stock and RSU vesting dates as of March 31, 2012:
Vesting Date |
Shares Vesting |
RSUs Vesting |
Total Awards |
|||||||||
April 2012 |
1,668 | 2,886 | 4,554 | |||||||||
July 2012 |
1,664 | 2,575 | 4,239 | |||||||||
October 2012 |
1,668 | 2,572 | 4,240 | |||||||||
January 2013 |
1,668 | 2,575 | 4,243 | |||||||||
April 2013 |
1,664 | 2,568 | 4,232 | |||||||||
July 2013 |
1,668 | 2,573 | 4,241 | |||||||||
October 2013 |
1,668 | 2,573 | 4,241 | |||||||||
January 2014 |
1,664 | 2,574 | 4,238 | |||||||||
April 2014 |
1,668 | 2,572 | 4,240 | |||||||||
July 2014 |
1,668 | 2,576 | 4,244 | |||||||||
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|
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16,668 | 26,044 | 42,712 | ||||||||||
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- 14 -
Table of Contents
Note 9 Stockholders Equity
For the three months ended March 31, 2012, the Companys board of directors declared the following cash dividends:
Declaration Date |
Record Date |
Payment Date |
Dividend per share | |||||
March 6, 2012 |
March 31, 2012 | April 30, 2012 | $ | 0.75 |
Note 10 Fair Value of Financial Instruments
The following table presents the carrying value and estimated fair value of the Companys financial instruments not carried at estimated fair value on the consolidated balance sheet at March 31, 2012 and December 31, 2011:
March 31, 2012 | December 31, 2011 | |||||||||||||||
Carrying Value | Estimated Fair Value (Level III) |
Carrying Value | Estimated Fair Value (Level III) |
|||||||||||||
Borrowings under repurchase agreements |
$ | 1,171,177 | $ | 1,171,809 | $ | 1,079,995 | $ | 1,079,429 |
Cash and restricted cash on the Companys consolidated balance sheet reflect their respective estimated fair value. To determine estimated fair value of the Companys borrowings under repurchase agreements, market interest rates, which are based upon actual transactions executed by the Company, are used to discount contractual cash flows. The estimated fair values are not necessarily indicative of the amount the Company could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have a material effect on the estimated fair value amounts. The Companys borrowings under repurchase agreements had a weighted average remaining term to maturity of 33 days and 27 days at March 31, 2012 and December 31, 2011, respectively.
Note 11 Net Income per Share
GAAP requires use of the two-class method of computing earnings per share for all periods presented for each class of common stock and participating security as if all earnings for the period had been distributed. Under the two-class method, during periods of net income, the net income is first reduced for dividends declared on all classes of securities to arrive at undistributed earnings. During periods of net losses, the net loss is reduced for dividends declared on participating securities only if the security has the right to participate in the earnings of the entity and an objectively determinable contractual obligation to share in net losses of the entity.
The remaining earnings are allocated to common stockholders and participating securities to the extent that each security shares in earnings as if all of the earnings for the period had been distributed. Each total is then divided by the applicable number of shares to arrive at basic earnings per share. For the diluted earnings, the denominator includes all outstanding common shares and all potential common shares assumed issued if they are dilutive. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of these potential common shares.
- 15 -
Table of Contents
The table below presents basic and diluted net income per share of common stock using the two-class method for the three months ended March 31, 2012:
For the three months ended March 31, 2012 |
||||
Numerator: |
||||
Net income attributable to common stockholders and participating securities for basic and diluted earnings per share |
$ | 20,120 | ||
|
|
|||
Denominator: |
||||
Weighted average shares of common stock outstanding |
10,273,125 | |||
Weighted average participating securities |
28,125 | |||
|
|
|||
Denominator for basic and diluted earnings per shareweighted average shares of common stock outstanding and common stock equivalents outstanding |
10,301,250 | |||
|
|
|||
Basic and diluted net income per weighted average share of common stock |
$ | 1.95 | ||
|
|
Note 12 Subsequent Events
Public Offering. On April 20, 2012, the Company completed a follow-on public offering of 13,900,000 shares of common stock at a price of $18.00 per share, raising net proceeds of approximately $249,500. From April 1, 2012 through April 30, 2012, the Company purchased Agency RMBS of approximately $1,442,009 and non-Agency RMBS of approximately $90,139 and entered into Swaps with an aggregate notional amount of $515,000, a weighted average fixed pay rate of 1.25% and a weighted average term of 5.6 years. The investments were funded using the proceeds from the public offering on a leveraged basis and, to a lesser extent, with cash generated from investment activities.
- 16 -
Table of Contents
ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
(Amounts in thousandsexcept share and per share data)
FORWARD-LOOKING INFORMATION
The Company makes forward-looking statements herein and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such Section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Companys control. These forward-looking statements include information about possible or assumed future results of the Companys business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words believe, expect, anticipate, estimate, plan, continue, intend, should, may or similar expressions, the Company intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in the Companys industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; the Companys business and investment strategy; the Companys projected operating results; actions and initiatives of the U.S. Government and changes to U.S. Government policies and the execution and impact of these actions, initiatives and policies; the state of the U.S. economy generally or in specific geographic regions; economic trends and economic recoveries; the Companys ability to obtain and maintain financing arrangements, including securitizations; the favorable Agency RMBS return dynamics available; the level of government involvement in the U.S. mortgage market; the anticipated default rates on non-Agency RMBS; the return of the non-Agency RMBS securitization market; general volatility of the securities markets in which the Company participates; changes in the value of the Companys assets; the Companys expected portfolio of assets; the Companys expected investment and underwriting process; interest rate mismatches between the Companys target assets and any borrowings used to fund such assets; changes in interest rates and the market value of the Companys target assets; changes in prepayment rates on the Companys target assets; effects of hedging instruments on the Companys target assets; rates of default or decreased recovery rates on the Companys target assets; the degree to which the Companys hedging strategies may or may not protect the Company from interest rate volatility; impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; the Companys ability to maintain the Companys qualification as a REIT for U.S. federal income tax purposes; the Companys ability to maintain its exemption from registration under the Investment Company Act of 1940, as amended (the 1940 Act); availability of opportunities to acquire Agency RMBS, non-Agency RMBS, residential mortgage loans and other residential mortgage assets; availability of qualified personnel; estimates relating to the Companys ability to make distributions to its stockholders in the future; and the Companys understanding of its competition.
The forward-looking statements are based on the Companys beliefs, assumptions and expectations of its future performance, taking into account all information currently available to it. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to the Company. See Item 1A - Risk Factors of the Companys annual report on Form 10-K for the year ended December 31, 2011. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that the Company files with the SEC, could cause its actual results to differ materially from those included in any forward-looking statements the Company makes. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect the Company. Except as required by law, the Company is not obligated to, and does not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with the Companys consolidated financial statements and the accompanying notes to the Companys consolidated financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in the Companys annual report on Form 10-K filed for the year ended December 31, 2011.
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Table of Contents
Overview
The Company invests in residential mortgage assets in the United States. The Company currently invests in Agency RMBS, whose underlying collateral includes fixed rate mortgages, ARMs and Agency Derivatives. The Company also invests in non-Agency RMBS, and over time will consider investing in residential mortgage loans and other residential mortgage assets. The Company refers collectively to the assets it targets for acquisition as its target assets. At March 31, 2012, the Companys portfolio was comprised of approximately $1,157,567 Agency RMBS and $178,969 non-Agency RMBS.
The Company, organized as a Maryland corporation, is structured as a holding company and conducts its businesses primarily through ARM Operating, LLC and its other operating subsidiaries. The Company intends to elect and qualify as a REIT for U.S. federal income tax purposes commencing with the Companys taxable year ended December 31, 2011. The Company also intends to operate its business in a manner that will permit the Company not to register as an investment company under the 1940 Act.
The Company is externally managed and advised by the Manager, an indirect subsidiary of Apollo. The Company currently acquires and manages a portfolio consisting primarily of Agency RMBS, and to a lesser extent non-Agency RMBS. The Company anticipates that over time the Company may invest in single family residential mortgage loans, which the Company primarily expects to source through bulk acquisitions of pools of whole loans originated by third parties.
On July 27, 2011, the Company completed its IPO, pursuant to which it sold 10,000,000 shares of its common stock to the public at a price of $20.00 per share for gross proceeds of $200,000. Concurrently with the closing of the IPO, the Company completed a private placement in which the Company sold 250,000 shares of its common stock to certain affiliates and personnel of Apollo at a price of $20.00 per share. The Company received gross proceeds of $5,000 from the concurrent private placement. In connection with the IPO, $8,000 in underwriting discounts and commissions were paid by the Manager. The Company did not pay any underwriting discounts or commissions in connection with the IPO or the private placement. Net proceeds after the payment of offering costs of approximately $1,939 were $203,061.
The Company uses leverage, currently comprised of borrowings under repurchase agreements, as part of its business strategy in order to increase potential returns to stockholders. As of March 31, 2012, the Company had entered into master repurchase agreements with 18 counterparties representing over $4 billion of potential funding capacity, and is in discussions with other financial institutions for additional repurchase agreement capacity. As of March 31, 2012, the Company had $1,171,177 of borrowings outstanding under its repurchase agreements collateralized by $1,086,642 Agency RMBS and $177,155 non-Agency RMBS. The Company has entered into Swaps to effectively fix the floating interest rate of $410,000 of borrowings under its repurchase agreements at March 31, 2012.
Recent Market Conditions and Strategy
Early in 2012 the U.S. Federal Reserve Board (the Federal Reserve) announced their intention to maintain its accommodative policy through late 2014, which was a year longer than previously stated. As a result, the market believed that some form of quantitative easing would be forthcoming in 2012, and accordingly both the 10-year note and the 2-year note stayed in the trading ranges that had been established in late 2011. In mid-March 2012, employment gains in the U.S. as well as the appearance of a stabilizing global economy were reflected in the 10-year note trading to a 5 month high of 2.40%, and the 2 year note trading almost as high as 40 basis points. However, interest rates then fell from their mid-March peak to the 1.90 2.00% range on the 10-year Treasury note and to approximately 0.20% on the 2-year Treasury note by the end of the quarter. The Company believes that this downward movement was partly attributable to a series of remarks by the Chairman of the Board of Governors of the Federal Reserve designed to ease rates as well as a series of soft economic reports emanating from China and around the globe that were announced in mid to late March 2012.
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Table of Contents
The Company reviews its investment assets to ensure it is optimizing its portfolio opportunities on an on-going basis. As the markets rallied in the early part of the first quarter of 2012, the Company continued with its strategy, which commenced in the fourth quarter of 2011, of acquiring Agency RMBS with lower coupons. As mortgage spreads began tightening in late 2011 and market prices for certain specified pools of Agency RMBS increased, the Company sold 30-year fixed rate 5.5% coupon Agency RMBS and invested in 4.5% Agency RMBS. As market prices on Agency RMBS continued to rally in the first quarter of 2012, the Company continued with its lower coupon strategy, selling some of its 5.0% and all of its 5.5% Agency RMBS and purchasing 4.0% and 4.5% Agency RMBS. In mid-March 2012, as the long end of the treasury curve steepened, prices on the Companys Agency RMBS collateralized by 7/1 hybrid ARMs held up very well as their spreads tightened materially. The Company viewed this as an opportunity to rebalance the portfolio and, as a result, sold Agency RMBS collateralized by 7/1 hybrid ARMs and purchased low loan balance 15 year fixed-rate RMBS along with 15 year interest only (I/O) securities.
With respect to its non-Agency RMBS portfolio, the Company has continued its strategy of investing in non-Agency RMBS which it believes exhibit sufficient credit enhancement in the form of subordination or equity in the underlying property value to support the Companys target returns. In particular, the Company focused on: (a) selling some of its lower balance non-Agency RMBS and investing the proceeds in non-Agency RMBS with higher balances that the Company believes offer greater market liquidity and greater financing availability; and (b) focusing on non-Agency RMBS at the top of the capital structure, rather than second and third pay non-Agency RMBS, which the Company believes provide greater cash flow in the near term.
Investment Strategy
The Companys principal objective is to provide attractive risk-adjusted returns to its stockholders over the long term, primarily through dividend distributions and secondarily through capital appreciation. The Company pursues this objective by selectively constructing a portfolio of assets that currently consists of Agency RMBS and non-Agency RMBS, and over time may invest in a broader range of other residential mortgage assets, including residential mortgage loans.
The Company relies on its Managers expertise in identifying assets within the target assets described below and, to the extent that leverage is employed, efficiently financing those assets. The Manager makes decisions based on a variety of factors, including expected risk-adjusted returns, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as meeting the Companys REIT qualification and its exemption from registration under the 1940 Act.
In order to capitalize on the changing sets of investment opportunities that may be present in the various points of an economic cycle, the Company may expand or refocus its investment strategy by emphasizing investments in different parts of the capital structure and different sectors of real estate. The Companys board of directors may, without stockholder approval, amend the Companys investment strategy at any time.
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Table of Contents
Target Assets
The following is a summary of the assets that the Company targets for investment:
Asset Classes | Principal Assets | |
Agency RMBS |
Agency RMBS, primarily whole pool Agency RMBS, and Agency collateralized mortgage obligations. | |
Non-Agency RMBS |
Non-Agency RMBS, including highly rated, as well as non-investment grade and unrated, tranches backed by Alt-A mortgage loans, subprime mortgage loans and prime mortgage loans, which may be adjustable-rate, hybrid or fixed-rate. | |
Residential Mortgage Loans |
Prime mortgage loans, jumbo mortgage loans, Alt-A mortgage loans and subprime mortgage loans. These may be performing, sub-performing or non-performing and may be adjustable-rate, hybrid or fixed-rate. | |
Other Residential Mortgage Assets |
Interest-only and principal-only Agency RMBS and non-Agency RMBS, inverse floating rate and floating rate securities, and other Agency and non-Agency RMBS derivative securities, as well as other financial assets, including common stock, preferred stock and debt of other real estate-related entities. |
In addition, in the future the Company may invest in assets other than its target assets, in each case subject to maintaining its qualification as a REIT for U.S. federal income tax purposes and its exemption from registration under the 1940 Act.
Financing Strategy
The Company uses leverage primarily for the purposes of financing its portfolio and increasing potential returns to stockholders and not for speculative purposes. The amount of leverage the Company chooses to employ for particular assets will depend upon the Managers assessment of a variety of factors, which include the availability of particular types of financing and the Managers assessment of the credit, liquidity, price volatility and other risks of those assets and the creditworthiness of its financing counterparties.
During the quarter ended March 31, 2012, the Company financed its Agency RMBS with repurchase agreements employing, on a debt-to-equity basis, between approximately six-to-one and ten-to-one leverage. During the quarter ended March 31, 2012, the Company financed its non-Agency RMBS with repurchase agreements employing, on a debt-to-equity basis, between approximately one-to-one and three-to-one leverage. In the future, the Company may, however, be limited or restricted in the amount of leverage it may employ by the terms and provisions of any financing or other agreements, and is subject to margin calls as a result of its financing activity. The Company had aggregate debt-to-equity of 5.4 times and 5.3 times at March 31, 2012 and December 31, 2011, respectively.
The Company has initially financed its RMBS with repurchase agreement financing, the term of which is typically one to three months, but in some cases may be longer. At March 31, 2012, the Company had entered into master repurchase agreements with 18 counterparties representing over $4 billion of potential funding capacity, and is in discussions with additional financial institutions in order to potentially provide the Company with additional repurchase agreement capacity. As of March 31, 2012, the Company had $1,171,177 outstanding under its repurchase facilities. Over time, as market conditions change, in addition to these financings, the Company may use other forms of leverage, including warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities), and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements.
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Table of Contents
Hedging Strategy
Subject to maintaining the Companys qualification as a REIT for U.S. federal income purposes, the Company pursues various hedging strategies to seek to reduce its exposure to adverse changes in interest rates. The U.S. federal income tax rules applicable to REITs may require the Company to implement certain of these techniques through a domestic taxable REIT subsidiary that is fully subject to federal corporate income taxation. The Companys hedging activity varies in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. As of March 31, 2012, the Company had entered into Swaps designed to mitigate the effects of increases in interest rates under a portion of its repurchase agreements. These Swaps provide for fixed interest rates indexed off of LIBOR and effectively fix the floating interest rates on $410,000 of borrowings under its repurchase agreements as of March 31, 2012. To date, the Company has not elected to apply hedge accounting for its Swaps and, as a result, records the change in estimated fair value of its Swaps and the associated Swap interest in earnings.
Critical Accounting Policies
A summary of the Companys accounting policies was set forth in its annual report on Form 10-K for the year ended December 31, 2011 under Item 7Management Discussion and Analysis- Critical Accounting Policies.
Results of Operations
The following discussion of the Companys results of operations highlights the Companys performance for the three months ended March 31, 2012.
Investments
The following table presents certain information about the Companys investment portfolio at March 31, 2012:
Principal Balance (1) |
Unamortized Premium (Discount) |
Amortized Cost (1) (2) |
Unrealized Gain (Loss) |
Estimated Fair Value (1) |
Net Weighted Average Coupon (3) |
Weighted Average Yield (4) |
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Agency RMBS: |
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30-Year Mortgage |
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Coupon Rate: |
||||||||||||||||||||||||||||
>3% to 4% |
$ | 376,327 | $ | 20,987 | $ | 397,314 | $ | 281 | $ | 397,595 | 4.0 | % | 3.0 | % | ||||||||||||||
>4% to 5% |
384,601 | 25,554 | 410,155 | 6,562 | 416,717 | 4.6 | % | 3.2 | % | |||||||||||||||||||
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Total 30 yr |
$ | 760,928 | $ | 46,541 | $ | 807,469 | $ | 6,843 | $ | 814,312 | 4.3 | % | 3.1 | % | ||||||||||||||
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15-Year Mortgage |
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Coupon Rate: |
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3% to 3.5% |
232,420 | 10,131 | 242,551 | 1,066 | 243,617 | 3.2 | % | 2.3 | % | |||||||||||||||||||
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ARM |
81,898 | 4,149 | 86,047 | 801 | 86,848 | 2.5 | % | 1.1 | % | |||||||||||||||||||
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Agency Derivatives |
102,944 | (90,513 | ) | 12,431 | 359 | 12,790 | 4.0 | % | 12.8 | % | ||||||||||||||||||
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Total Agency |
1,178,190 | (29,692 | ) | 1,148,498 | 9,069 | 1,157,567 | 3.9 | % | 2.9 | % | ||||||||||||||||||
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Non Agency RMBS |
260,171 | (83,656 | ) | 176,515 | 2,454 | 178,969 | 1.1 | % | 9.4 | % | ||||||||||||||||||
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Total |
$ | 1,438,361 | $ | (113,348 | ) | $ | 1,325,013 | $ | 11,523 | $ | 1,336,536 | 3.4 | % | 3.8 | % | |||||||||||||
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(1) | Includes unsettled purchases with an aggregate cost of $93 and estimated fair value of $102 at March 31, 2012. |
(2) | Amortized cost includes unrealized losses of $971 that have been reclassified pursuant to GAAP. |
(3) | Net weighted average coupon is presented net of servicing and other fees. |
(4) | Weighted average yield incorporates estimates for future prepayment and loss assumptions. |
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As of March 31, 2012, the Companys Agency RMBS consisted primarily of RMBS which the Manager believes exhibit prepayment mitigation attributes, including Agency RMBS collateralized by low loan balances or loans where the underlying borrower is unable to access the Making Home Affordable Program, including the Home Affordable Refinance Program. The Companys fixed-rate Agency RMBS portfolio experienced prepayments at a three month average CPR of 5%. Including adjustable rate RMBS and Agency derivatives, the Agency RMBS portfolio experienced an average three month CPR of 6%.
As of March 31, 2012, the Companys non-Agency RMBS consisted primarily of RMBS comprised of seasoned sub-prime mortgages and, to a lesser extent, RMBS comprised of Alt-A mortgages. The weighted average cost basis of the Companys non-Agency RMBS portfolio was 67.9% of par as of March 31, 2012.
Investment Activity
RMBS. During the three months ended March 31, 2012, the Company acquired $404,834 of Agency RMBS and $101,147 of non-Agency RMBS. During the same period, the Company received principal payments of $23,611 and $8,310 for Agency RMBS and non-Agency RMBS, respectively. Proceeds from sales received during the three months ended March 31, 2012 were $354,727 for Agency RMBS and $36,208 for non-Agency RMBS. The average unlevered yield on Agency RMBS and non-Agency RMBS for the three months ended March 31, 2012 was 2.7% and 11.4%, respectively.
Financing and Other Liabilities. The Company has entered into repurchase agreements to finance a substantial majority of its Agency RMBS and non-Agency RMBS. These agreements are secured by a portion of its Agency RMBS and non-Agency RMBS and bear interest at rates that have historically moved in close relationship to LIBOR. At March 31, 2012, the Company had outstanding repurchase agreement borrowings with 14 counterparties totaling $1,171,177.
The Company records the liability for RMBS purchased for which settlement has not taken place as an investment related payable. As of March 31, 2012, the Company had investment related payables of $93 of which no items were outstanding greater than 30 days.
The following table presents the Companys borrowings by type of collateral pledged as of March 31, 2012, and the respective effective cost of funds for the period then ended:
Collateral |
Current Balance | Cost of Funds |
Effective Cost of Funds (1) |
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Agency RMBS |
$ | 1,040,848 | 0.3 | % | 0.7 | % | ||||||
Non-Agency RMBS |
130,329 | 1.9 | 2.0 | |||||||||
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Total |
$ | 1,171,177 | 0.5 | % | 0.8 | % | ||||||
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(1) | The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on Swaps of $749. While Swaps are not accounted for using hedge accounting, such instruments are viewed by the Company as an economic hedge against increases in interest rates. |
Derivative Instruments. As of March 31, 2012, the Company had entered into Swaps designed to mitigate the effects of increases in interest rates under a portion of its repurchase agreements. These Swaps provide for fixed interest rates indexed off of LIBOR and are viewed by the Company to effectively fix the floating interest rates on $410,000 of borrowings under the Companys repurchase agreements as of March 31, 2012.
The following table presents information about the Companys Swaps as of March 31, 2012:
Remaining Interest Rate Swap Term |
Notional Amount |
Average Fixed Pay Rate |
Average Maturity (Years) |
|||||||||
Greater than 1 year and less than 3 years |
$ | 25,000 | 0.6 | % | 2.4 | |||||||
Greater than 3 years and less than 5 years |
360,000 | 1.4 | 4.6 | |||||||||
Greater than 5 years |
25,000 | 2.4 | 9.9 | |||||||||
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Total |
$ | 410,000 | 1.4 | % | 4.8 | |||||||
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Net Interest Income
The Company earned interest income of approximately $12,363 for the three months ended March 31, 2012, representing interest earned on the Companys assets. The Company incurred interest expense of approximately $1,361 for the three months ended March 31, 2012, which were related to borrowings from repurchase agreements. The following table sets forth certain information regarding the Companys net investment income for the three months ended March 31, 2012, December 31, 2011, and for the period from July 27, 2011(commencement of operations) through September 30, 2011.
For the three months Ended | For the period from July 27, 2011 (commencement of operations) through September 30, 2011 |
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March 31, 2012 | December 31, 2011 | |||||||||||||||||||||||||||||||||||
Agency | Non- Agency |
Total | Agency | Non- Agency |
Total | Agency | Non- Agency |
Total | ||||||||||||||||||||||||||||
Average RMBS held (1) |
$ | 1,220,907 | $ | 138,902 | $ | 1,359,809 | $ | 810,179 | $ | 99,957 | $ | 910,136 | $ | 161,062 | $ | 27,745 | $ | 188,807 | ||||||||||||||||||
Total interest income |
$ | 8,364 | $ | 3,999 | $ | 12,363 | $ | 5,503 | $ | 3,675 | $ | 9,178 | $ | 892 | $ | 663 | $ | 1,555 | ||||||||||||||||||
Yield on average RMBS |
2.7 | % | 11.4 | % | 3.6 | % | 2.7 | % | 14.4 | % | 3.9 | % | 3.1 | % | 13.2 | % | 4.6 | % | ||||||||||||||||||
Average balance of repurchase agreements |
$ | 1,005,133 | $ | 94,012 | $ | 1,099,145 | $ | 715,008 | $ | 67,827 | $ | 782,835 | $ | 109,676 | $ | 19,518 | $ | 129,194 | ||||||||||||||||||
Total interest expense |
$ | 900 | $ | 461 | $ | 1,361 | $ | 685 | $ | 310 | $ | 995 | $ | 82 | $ | 61 | $ | 143 | ||||||||||||||||||
Average cost of funds (2)(3) |
0.4 | % | 2.0 | % | 0.5 | % | 0.4 | % | 1.8 | % | 0.5 | % | 0.4 | % | 1.8 | % | 0.6 | % | ||||||||||||||||||
Net interest income |
$ | 7,464 | $ | 3,538 | $ | 11,002 | $ | 4,818 | $ | 3,365 | $ | 8,183 | $ | 810 | $ | 602 | $ | 1,412 | ||||||||||||||||||
Net interest rate spread |
2.3 | % | 9.4 | % | 3.1 | % | 2.3 | % | 12.6 | % | 3.4 | % | 2.7 | % | 11.4 | % | 4.0 | % | ||||||||||||||||||
Total interest expense including realized cost of derivatives (4) |
$ | 1,649 | $ | 461 | $ | 2,110 | $ | 1,285 | $ | 310 | $ | 1,595 | $ | 197 | $ | 61 | $ | 258 | ||||||||||||||||||
Average cost of funds including realized derivative costs |
0.7 | % | 2.0 | % | 0.8 | % | 0.4 | % | 1.1 | % | 0.5 | % | 1.0 | % | 1.8 | % | 1.1 | % | ||||||||||||||||||
Net interest income including realized derivative costs |
$ | 6,715 | $ | 3,538 | $ | 10,253 | $ | 4,218 | $ | 3,365 | $ | 7,583 | $ | 695 | $ | 602 | $ | 1,297 | ||||||||||||||||||
Net interest rate spread including realized derivative costs |
2.0 | % | 9.4 | % | 2.8 | % | 2.2 | % | 13.3 | % | 3.5 | % | 2.1 | % | 11.4 | % | 3.5 | % |
(1) | Amount reflects amortized cost, which does not include changes in unrealized gains (losses). |
(2) | Cost of funds by investment type is based on the underlying investment type of the RMBS assigned as collateral. |
(3) | Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, those costs are included in gain (loss) on derivative instruments in the consolidated statement of operations. |
(4) | Realized losses represent the net amount paid, including accrued amounts, for Swaps during the period. |
Interest income is subject to interest rate risk. Refer to Item 3, Quantitative and Qualitative Disclosures about Market Risk, for more information relating to interest rate risk and its impact on the Companys operating results.
Realized and Unrealized Gain (Loss)
During the three months ended March 31, 2012, the Company sold Agency RMBS of $354,727 realizing gross gains of $3,382 and gross losses of $41 and sold non-Agency RMBS of $36,208 realizing gross gains of $3,456 and gross losses of $28. These RMBS were primarily sold in order to mitigate prepayment risk in the Companys RMBS portfolio, as the Company sold certain higher coupon fixed rate Agency RMBS and sold some hybrid adjustable rate RMBS. The Company has no continuing involvement with any of these RMBS sales.
With respect to the Companys RMBS, the Company elected the fair value option and, as a result records the change in estimated fair value related to RMBS in earnings. The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of the Companys RMBS portfolio and derivative instruments that are included in the Companys consolidated statement of operations for the three months ended March 31, 2012, December 31, 2011, and for the period from July 27, 2011(commencement of operations) through September 30, 2011.
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Three months ended | For the period from July 27, 2011 (commencement of operations) through September 30, 2011 |
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March 31, 2012 | December 31, 2011 | |||||||||||
Realized gain on RMBS |
$ | 6,769 | $ | 550 | 335 | |||||||
Unrealized gain on RMBS |
5,950 | 3,765 | (1,283 | ) | ||||||||
Realized loss on derivative instruments |
(749 | ) | (515 | ) | (115 | ) | ||||||
Unrealized loss on derivative instruments |
(569 | ) | (3,138 | ) | (108 | ) | ||||||
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Total |
$ | 11,401 | $ | 662 | $ | (1,171 | ) | |||||
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In order to mitigate interest rate risk resulting from the Companys repurchase agreements, the Company entered into Swaps with an aggregate notional amount of $410,000. While not designated as a hedge for accounting purposes, the Companys Swaps are viewed as an economic hedge on a portion of the Companys floating-rate borrowings. Since the Company does not apply hedge accounting for its Swaps, it records the change in estimated fair value related to such agreements in earnings as unrealized gain or loss on derivative transactions. Included in realized gain or loss on derivative instruments are the net Swap payments (including accrued amounts) associated with the Companys Swaps.
Expenses
General and Administrative Expenses. The Company incurred general and administrative expenses of approximately $1,488 for the three months ended March 31, 2012, which represents professional fees, insurance, non-cash stock based compensation and overhead costs of the Company.
Management Fee Expense. The Company incurred management fee expense of approximately $797 for the three months ended March 31, 2012, of which $797 was payable to the Manager under the Management Agreement at March 31, 2012. Pursuant to the terms of the Management Agreement, the Manager is paid a management fee equal to 1.5% per annum of the Companys stockholders equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears.
The management fees, expense reimbursements and the relationship between the Manager and the Company are discussed further in Note 7, Related Party Transactions, to the consolidated financial statements contained in this Quarterly Report on Form 10-Q.
Dividends
The following table presents cash dividends declared by the Company on its common stock from July 27, 2011 (commencement of operations) through March 31, 2012:
Declaration Date |
Record Date |
Payment Date |
Amount per Share |
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March 6, 2012 |
March 31, 2012 |
April 30, 2012 |
$ | 0.75 | ||||
December 15, 2011 |
December 31, 2011 |
January 12, 2012 |
$ | 0.30 |
Subsequent Events
Public Offering. On April 20, 2012, the Company completed a follow-on public offering of 13,900,000 shares of common stock at a price of $18.00 per share, raising net proceeds of approximately $249,500. From April 1, 2012 through April 30, 2012, the Company purchased Agency RMBS of approximately $1,422,099 and non-Agency RMBS of approximately $90,139, and entered into Swaps with an aggregate notional amount of $515,000, a weighted average fixed pay rate of 1.25% and a weighted average term of 5.6 years. These investments were funded using the proceeds from the public offering on a leveraged basis and, to a lesser extent, with funds generated from investing and operating activities.
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Table of Contents
Liquidity and Capital Resources
General
Liquidity is a measure of the Companys ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain its assets and operations, make distributions to its stockholders and other general business needs. The Company uses significant cash to purchase its target assets, repay principal and interest on its borrowings, make distributions to its stockholders and fund its operations.
Under the Companys repurchase agreements, lenders retain the right to mark the collateral pledged to estimated fair value. A reduction in the value of the collateral pledged will require the Company to provide additional collateral or fund cash margin calls. As part of the Companys risk management process, the Manager closely monitors the Companys liquidity position and subjects the Companys balance sheet to scenario testing designed to assess the Companys liquidity in the face of different economic and market developments. The Company believes it has sufficient current liquidity and access to additional liquidity to meet financial obligations for at least the next 12 months.
The Companys primary sources of liquidity are as follows:
Cash Generated from Public Offering
On April 20, 2012, the Company completed a follow-on public offering of 13,900,000 shares of its common stock at a price of $18.00 per share, generating net proceeds of approximately $249,500.
Borrowing under Various Financing Arrangements
As of March 31, 2012, the Company had master repurchase agreements with 18 counterparties representing over $4 billion of potential funding capacity, and is in discussions with other financial institutions in order to potentially provide the Company with additional repurchase agreement capacity. The Company had borrowings under repurchase agreements with 14 counterparties at March 31, 2012. The following tables present the Companys borrowings by type of collateral pledged as of March 31, 2012, December 31, 2011 and September 30, 2011, respectively and the respective effective cost of funds for the periods then ended:
March 31, 2012 | ||||||||||||||||
Collateral |
Principal Balance |
Fair Value of Collateral Pledged (1) |
Weighted Average Interest Rate |
Effective Cost of Funds (2) |
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Agency RMBS |
$ | 1,040,848 | $ | 1,094,737 | 0.3 | % | 0.7 | % | ||||||||
Non-Agency RMBS |
130,329 | 180,201 | 1.9 | 2.0 | ||||||||||||
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Total |
$ | 1,171,177 | $ | 1,274,938 | 0.5 | % | 0.8 | % | ||||||||
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(1) | Includes $8,095 and $3,046 of cash collateral for Agency RMBS and non-Agency RMBS, respectively. |
(2) | The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on Swaps of $749. While Swaps are not accounted for using hedge accounting, such instruments are viewed by the Company as an economic hedge against increases in interest rates. |
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Table of Contents
December 31, 2011 | ||||||||||||||||
Collateral |
Principal Balance |
Fair Value of Collateral Pledged (1) |
Weighted Average Interest Rate |
Effective Cost of Funds (2) |
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Agency RMBS |
$ | 1,002,626 | $ | 1,055,631 | 0.4 | % | 0.7 | % | ||||||||
Non-Agency RMBS |
77,369 | 112,650 | 1.8 | 1.8 | ||||||||||||
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Total |
$ | 1,079,995 | $ | 1,168,281 | 0.5 | % | 0.8 | % | ||||||||
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(1) | Includes $3,490 and $2,075 of cash collateral for Agency RMBS and non-Agency RMBS, respectively. |
(2) | The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on Swaps of $600. While Swaps are not accounted for using hedge accounting, such instruments are viewed by the Company as an economic hedge against increases in interest rates. |
September 30, 2011 | ||||||||||||||||
Collateral |
Principal Balance |
Fair Value of Collateral Pledged (1) |
Weighted Average Interest Rate |
Effective Cost of Funds (2) |
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Agency RMBS |
$ | 345,736 | $ | 362,295 | 0.3 | % | 0.4 | % | ||||||||
Non-Agency RMBS |
46,837 | 64,269 | 1.7 | 1.8 | ||||||||||||
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Total |
$ | 392,573 | $ | 426,534 | 0.5 | % | 0.6 | % | ||||||||
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(1) | Includes $261 and $855 of cash collateral for Agency RMBS and non-Agency RMBS, respectively. |
(2) | The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net payments on Swaps of $115. While Swaps are not accounted for using hedge accounting, such instruments are viewed by the Company as an economic hedge against increases in interest rates. |
As of March 31, 2012, across the Companys repurchase facilities for Agency RMBS, the amount which the collateral value must exceed the loan amount, known as the haircut, ranges from a low of 3% to a high of 5.5% and for non-Agency RMBS ranges from a low of 10% to a high of 50%. Declines in the value of the Companys RMBS portfolio can trigger margin calls by the Companys lenders under its repurchase agreements. An event of default or termination event would give some of the Companys counterparties the option to terminate all existing repurchase transactions with the Company and require any amount due to the counterparties by the Company to be payable immediately.
Under the repurchase agreements, the respective lenders retain the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls. In addition, the repurchase agreements are subject to certain financial covenants. The Company was not aware of any non-compliance with these covenants at March 31, 2012. RMBS held by counterparties as security for repurchase agreements totaled $1,263,797 and RMBS held as a component of clearing margin totaled $4,608 at March 31, 2012. Cash collateral held by counterparties at March 31, 2012 was $18,749, reported on the Companys balance sheet as restricted cash, comprised of $11,141 held in connection with repurchase borrowings and $7,608 was held by the Companys Swap counterparties.
The Company had approximately $93 of unsettled securities as of March 31, 2012 which would have increased its total outstanding borrowing balance at each period if the purchases had been settled with repurchase agreements.
Cash Generated from Operations
The Companys operating activities provided net cash of approximately $7,318 for the three months ended March 31, 2012. The cash provided by operating activities was primarily a result of the Companys operating income during its initial period of operations.
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Table of Contents
The Companys investing activities used net cash of $134,699 for the three months ended March 31, 2012. During the three months ended March 31, 2012, the Company utilized cash to purchase $627,032 in RMBS which was offset by proceeds from asset sales of $460,393 and principal payments of $31,940.
Other Potential Sources of Financing
The Company held cash of approximately $41,340 at March 31, 2012. The Companys primary sources of cash currently consist of repurchase facility borrowings and investment income. In the future, the Company expects its primary sources of liquidity to consist of payments of principal and interest the Company receives on its portfolio of assets, unused borrowing capacity under its financing sources and future issuances of equity and debt securities.
To maintain its qualification as a REIT under the Internal Revenue Code, the Company must distribute annually at least 90% of its taxable income. These distribution requirements limit the Companys ability to retain earnings and thereby replenish or increase capital for operations. The Company believes that as the credit markets return to normal conditions, the Companys significant capital resources and access to financing will provide the Company with financial flexibility at levels sufficient to meet current and anticipated capital requirements, including funding new lending and investment opportunities, paying distributions to the stockholders of the Company and servicing the Companys debt obligations.
Contractual Obligations and Commitments
The Companys contractual obligations including expected interest payments as of March 31, 2012 are as follows:
Less than 1 year |
1 to 3 years |
3 to 5 years |
More than 5 years |
Total | ||||||||||||||||
Borrowings under repurchase agreements |
$ | 1,171,818 | | | | $ | 1,171,818 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|||||||||||
Total |
$ | 1,171,818 | | | | $ | 1,171,818 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
The tables above do not include amounts due under the Management Agreement as those obligations, discussed below, do not have fixed and determinable payments.
In July 2011, the Company entered into the Management Agreement with the Manager pursuant to which the Manager is entitled to receive a management fee and reimbursement of certain expenses.
Pursuant to the Management Agreement, the Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of stockholders equity of the Company (as defined in the Management Agreement), per annum. The Manager will use the proceeds from its management fee in part to pay compensation to its officers and personnel who, notwithstanding that certain of them also are officers of the Company, will receive no cash compensation directly from the Company. The Company does not reimburse the Manager or its affiliates for the salaries and other compensation of their personnel, except for the allocable share of the compensation of (1) the Companys Chief Financial Officer based on the percentage of his time spent on the affairs of the Company and (2) other corporate finance, tax, accounting, internal audit, legal, risk management, operations, compliance and other non-investment professional personnel of the Manager or its affiliates who spend all or a portion of their time managing the affairs of the Company based on the percentage of time devoted by such personnel to the affairs of the Company. The Company is also required to reimburse the Manager for operating expenses related to the Company incurred by the Manager, including expenses relating to legal, accounting, due diligence and other services. Expense reimbursements to the Manager are made in cash on a monthly basis following the end of each month. The Companys reimbursement obligation is not subject to any dollar limitation.
The initial term of the Management Agreement expires on July 27, 2014 (the third anniversary of the closing of the IPO) and it is automatically renewed for one-year terms on each anniversary thereafter. Following the
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initial term, the Management Agreement may be terminated upon the affirmative vote of at least two-thirds of the independent directors of the Company, based upon (1) unsatisfactory performance by the Manager that is materially detrimental to the Company or (2) a determination that the management fee payable to the Manager is not fair, subject to the Managers right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of the independent directors of the Company. The Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
Off-Balance Sheet Arrangements
The Company does not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured investment vehicles, or special purpose or variable interest entities, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes.
Further, the Company has not guaranteed any obligations of unconsolidated entities or entered into any commitment to provide additional funding to any such entities.
Dividends
The Company intends to make regular quarterly dividend distributions to holders of its common stock. U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. The Company intends to pay regular quarterly dividends to its stockholders in an amount equal to the net taxable income of the Company, if and to the extent authorized by its board of directors. Before the Company pays any dividend, whether for U.S. federal income tax purposes or otherwise, the Company must first meet both its operating requirements and debt service on its repurchase agreements and other debts payable. If the Companys cash available for distribution is less than its net taxable income, the Company could be required to sell assets or borrow funds to make cash distributions or the Company may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
Non-GAAP Financial Measures
Effective Cost of Funds
Effective Cost of Funds for the three months ended March 31, 2012, constitutes a non-GAAP financial measure within the meaning of Regulation G promulgated by the SEC. The Companys believes that this measure presented in this quarterly report on Form 10-Q, when considered together with GAAP financial measures, provides information that is useful to investors in understanding the Companys borrowing costs and net interest income, as viewed by the Company. An analysis of any non-GAAP financial measure should be made in conjunction with results presented in accordance with GAAP.
Effective Cost of Funds includes the net interest component related to the Companys Swaps. While the Company has not elected hedge accounting for its Swaps, such derivative instruments are viewed by the Company as an economic hedge against increases in future market interest rates, and therefore the Effective Cost of Funds reflects interest expense adjusted to include the realized gain (i.e., the interest expense component) for all of the Companys Swaps.
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The following table reconciles the Effective Cost of Funds with interest expense for the three months ended March 31, 2012 (dollar amounts in thousands):
For the Three Months Ended March 31, 2012 |
||||||||
Reconciliation | Cost of Funds/Effective Borrowing Costs |
|||||||
Interest expense |
$ | 1,361 | 0.50 | % | ||||
Adjustment: |
||||||||
Net interest paid for Swaps |
749 | 0.27 | % | |||||
|
|
|
|
|||||
Effective Borrowing Costs |
$ | 2,110 | 0.77 | % | ||||
|
|
|
|
|||||
Weighted average repurchase borrowings |
1,099,145 |
Operating Earnings
The Companys Operating Earnings was $8,048 for the three months ended March 31, 2012. Operating Earnings is a non-GAAP financial measure that is used by the Company to approximate cash available for distribution and is defined as GAAP net income as adjusted, excluding (i) non-cash equity compensation expense; (ii) any unrealized gains, losses or other non-cash items; (iii) any realized gain or loss on sale of RMBS; and (iv) one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Company, the Manager and the Companys independent directors and after approval by a majority of the Companys independent directors.
In order to evaluate the effective yield of the portfolio, the Company uses Operating Earnings to reflect the net investment income of the Companys portfolio as adjusted to reflect the net Swap interest income (expense). Operating Earnings allows the Company to isolate the interest income (expense) associated with the Companys Swaps in order to monitor and project the Companys borrowing costs and interest rate spread. In addition, the Company utilizes Operating Earnings as a key metric in conjunction with other portfolio and market factors to determine the appropriate leverage and hedge ratios, as well as the overall structure of the portfolio. The Company believes that the presentation of Operating Earnings is useful to investors because Operating Earnings isolates the net Swap interest income (expense) which provides investors with an additional metric to identify trends in the Companys portfolio as they relate to the interest rate environment. The Company also believes that its investors use Operating Earnings or a comparable supplemental performance measure to evaluate and compare the performance of the Company and its peers, and as such, the Company believes that the disclosure of Operating Earnings is useful to its investors.
The primary limitation associated with Operating Earnings as a measure of the Companys financial performance over any period is that it excludes the effects of net realized gain (loss) from investments. In addition, the Companys presentation of Operating Earnings may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, Operating Earnings should not be considered as a substitute for the Companys GAAP net income as a measure of its financial performance or any measure of its liquidity under GAAP.
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The table below summarizes the reconciliation from Net Income to Operating Earnings:
For the three months ended March 31, 2012 |
||||
Net Income GAAP |
$ | 20,120 | ||
Adjustments |
||||
Non-cash stock-based compensation expense |
78 | |||
Unrealized gain on RMBS |
(5,950 | ) | ||
Unrealized loss on derivatives |
569 | |||
Realized gain on sale of RMBS |
(6,769 | ) | ||
|
|
|||
Total adjustments |
(12,072 | ) | ||
|
|
|||
Operating Earnings |
$ | 8,048 | ||
|
|
|||
Basic and Diluted Operating Earnings per Share of Common Stock |
$ | 0.78 | ||
|
|
|||
Basic and diluted weighted average common shares outstanding |
10,301,250 | |||
|
|
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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.
The Company seeks to manage its risks related to the credit quality of its assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from its assets through ownership of the capital stock of the Company. While the Company does not seek to avoid risk completely, the Company believes the risk can be quantified from historical experience and seeks to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks the Company undertakes.
Credit Risk
The Company is subject to varying degrees of credit risk in connection with its assets. Although the Company does not expect to encounter credit risk in its Agency RMBS, the Company does expect to encounter credit risk related to non-Agency RMBS and residential mortgage loans and other mortgage related assets the Company may acquire. Investment decisions will be made following a bottom-up credit analysis and specific risk assumptions. As part of the risk management process the Manager uses detailed proprietary models to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure frequency, cost and timing. If the Manager determines that the proposed investment can meet the appropriate risk and return criteria as well as complement the Companys existing asset portfolio, the investment will undergo a more thorough analysis. To the extent the Company invests in residential mortgage loans, the Company may retain the risk of potential credit losses on the mortgage loans that the Company holds in its portfolio. With respect to any residential mortgage loans in which the Company may invest, the Company expects to seek to obtain representations and warranties from each seller stating that each loan was underwritten to its requirements or, in the event underwriting exceptions were made, the Company is informed of the exceptions so that the Company may evaluate whether to accept or reject the loans. A seller who breaches these representations and warranties in making a loan that the Company purchases may be obligated to repurchase the loan from the Company. In the event the Company invests in residential mortgage loans, the Manager will seek to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and will proactively manage positions.
Interest Rate Risk
Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond the Companys control. The Company is subject to interest rate risk in connection with its assets and its related financing obligations. In general, the Company expects to finance the acquisition of its assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances in addition to transaction or asset specific funding arrangements. Subject to maintaining its qualification as a REIT for U.S. federal income tax purposes, the Company utilizes derivative financial instruments to hedge the interest rate risk associated with the Companys borrowings. The Company also may engage in a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of its assets.
Interest Rate Effect on Net Interest Income
The Companys operating results will depend in large part on differences between the income earned on its assets and its cost of borrowing costs. The cost of the Companys borrowings will generally be based on prevailing market interest rates. During a period of rising interest rates, the Companys borrowing costs generally will increase (1) while the yields earned on the Companys leveraged fixed-rate mortgage assets will remain static and (2) at a faster pace than the yields earned on the Companys leveraged adjustable-rate and hybrid mortgage assets, which could result in a decline in the Companys net interest spread and net interest margin. The severity of any such decline would depend on the Companys asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of the Companys assets. If any of these events happen, the Company could experience a decrease in net income or incur a net loss during these periods, which could adversely affect the Companys liquidity and results of operations.
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Interest Rate Cap Risk
The Companys adjustable-rate RMBS are subject to interest rate caps, which potentially could cause such RMBS to acquire many of the characteristics of fixed-rate securities if interest rates were to rise above the cap levels. This issue is magnified to the extent the Company acquires adjustable-rate and hybrid mortgage assets that are not based on mortgages which are fully indexed. In addition, adjustable-rate and hybrid mortgage assets may be subject to periodic payment caps that result in some portion of the interest being deferred and added to the principal outstanding. This could result in the Companys receipt of less cash income on such assets than the Company would need to pay the interest cost on the Companys related borrowings. To mitigate interest rate mismatches, the Company may utilize the hedging strategies discussed above under Interest Rate Risk.
Interest Rate Effects on Estimated Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that the Company acquires. The Company faces the risk that the market value of its assets will increase or decrease at different rates than those of the Companys liabilities, including the Companys hedging instruments.
The impact of changing interest rates on estimated fair value can change significantly when interest rates change materially. Therefore, the volatility in the estimated fair value of the Companys assets could increase significantly in the event interest rates change materially. In addition, other factors impact the estimated fair value of the Companys interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, changes in actual interest rates may have a material adverse effect on the Company.
Market Risk
Market value risk. The Companys RMBS are reflected at their estimated fair value with unrealized gains and losses included in earnings. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the estimated fair value of these securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would be expected to increase.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of the Companys interest rate-sensitive investments, including Swaps, and net interest income at March 31, 2012, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on the Managers expectations. The analysis presented utilizes the Managers assumptions, models and estimates, which are based on the Managers judgment and experience.
Change in Interest Rates |
Percentage Change in Projected Net Interest Income |
Percentage Change in Projected Portfolio Value | ||||||||
+1.00% |
(7.8 | )% | (0.3 | )% | ||||||
+0.50% |
(1.8 | )% | 0.1 | % | ||||||
-0.50% |
(7.3 | )% | (0.1 | )% | ||||||
-1.00% |
(17.0 | )% | (0.6 | )% |
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at March 31, 2012. The analysis presented utilizes assumptions and estimates based on the Managers judgment and experience. Furthermore, while the Company generally expects to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change the Companys interest rate risk profile.
Prepayment Risk
The value of the Companys assets may be affected by prepayment rates on residential mortgage loans. If the Company acquires residential mortgage loans and mortgage related securities, the Company anticipates that the residential mortgage loans or the underlying residential mortgages will prepay at a projected rate generating an
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expected yield. If the Company purchases assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because the Company will have to amortize the related premium on an accelerated basis. Conversely, if the Company purchases assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because the Company will not be able to accrete the related discount as quickly as originally anticipated.
Counterparty Risk
When the Company engages in repurchase transactions, the Company generally sells securities to lenders (i.e., repurchase agreement counterparties) and receives cash from the lenders. The lenders are obligated to resell the same securities back to the Company at the end of the term of the transaction. Because the cash the Company receives from the lender when the Company initially sells the securities to the lender is less than the value of those securities (this difference is the haircut), if the lender defaults on its obligation to resell the same securities back to the Company, the Company would incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the securities). The Company would also lose money on a repurchase transaction if the value of the underlying securities has declined as of the end of the transaction term, as the Company would have to repurchase the securities for their initial value but would receive securities worth less than that amount.
If a counterparty to a Swap cannot perform under the terms of the Swap, the Company may not receive payments due under that agreement, and thus, the Company may lose any unrealized gain associated with the Swap. The Company may also risk the loss of any collateral the Company has pledged to secure the Companys obligations under Swap if the counterparty becomes insolvent or files for bankruptcy. In addition, the Swap would no longer mitigate the impact of changes in interest rates as intended.
Funding Risk
The Company has financed a substantial majority of its RMBS with repurchase agreement financing. Over time, as market conditions change, in addition to these financings, the Company may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets and the economy generally could adversely affect one or more of its potential lenders and could cause one or more of its potential lenders to be unwilling or unable to provide the Company with financing or to increase the costs of that financing.
Liquidity Risk
The assets that comprise the asset portfolio of the Company are not publicly traded. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of the assets of the Company may make it difficult for the Company to sell such assets if the need or desire arises, including in response to changes in economic and other conditions.
Inflation
Virtually all of the Companys assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence the Companys performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. The Companys financial statements are prepared in accordance with GAAP and the Companys distributions will be determined by the board of directors of the Company consistent with the Companys obligation to distribute to its stockholders at least 90% of its REIT taxable income on an annual basis in order to maintain its REIT qualification; in each case, the Companys activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.
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ITEM 4. Controls and Procedures.
The Companys Chief Executive Officer and Chief Financial Officer, based on their evaluation of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as of March 31, 2012, the Companys disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder.
During the period ended March 31, 2012, there was no change in the Companys internal control over financial reporting that has materially affected, or was reasonably likely to materially affect, the Companys internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Companys periodic reports.
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From time to time, the Company may be involved in various claims and legal actions arising in the ordinary course of business. As of March 31, 2012, the Company was not involved in any legal proceedings.
See the Companys Annual Report on Form 10-K for the year ended December 31, 2011. There have been no material changes to the Companys risk factors during the three months ended March 31, 2012.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Mine Safety Disclosures
Not Applicable.
None.
(a) | Exhibits |
Exhibit |
Description | |
3.1 | Articles of Amendment and Restatement of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.1 of the Registrants Form S-8 (Registration No. 333- 175824). | |
3.2 | Amended and Restated Bylaws of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.2 of the Registrants Form S-8 (Registration No. 333- 175824). | |
4.1 | Specimen Common Stock Certificate of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 4.1 of the Registrants Form S-11, as amended (Registration No. 333-172980). | |
31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of 18 U.S.C. Section 1350 as adopted pursuant to the Sarbanes-Oxley Act of 2002. |
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101.INS* | XBRL Instance Document | |
101.SCH* | XBRL Taxonomy Extension Schema Document | |
101.CAL* | XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF* | XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB* | XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE* | XBRL Taxonomy Extension Presentation Linkbase Document |
* | These interactive data files are furnished and not deemed filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act, and are not deemed filed for purposes of Section 18 of the Exchange Act, and otherwise are not subject to liability under those sections. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
APOLLO RESIDENTIAL MORTGAGE, INC. | ||||
May 11, 2012 | ||||
By: | /s/ Michael A. Commaroto | |||
Michael A. Commaroto | ||||
President and Chief Executive Officer | ||||
By: | /s/ Stuart A. Rothstein | |||
Stuart A. Rothstein | ||||
Chief Financial Officer, Treasurer and Secretary | ||||
(Principal Financial Officer and Principal Accounting Officer) |
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