Apollo Residential Mortgage, Inc. - FORM 10-Q - August 6, 2014

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________
        
FORM 10-Q
_________________________________________
  (Mark One)
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2014
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 001-35246
____________________________________________________ 
Apollo Residential Mortgage, Inc.
(Exact name of Registrant as specified in its charter)
____________________________________________________
Maryland
 
45-0679215
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
Apollo Residential Mortgage, Inc.
c/o Apollo Global Management, LLC
9 West 57th Street, 43rd Floor
New York, New York 10019
(Address of Registrant’s principal executive offices)
(212) 515–3200
(Registrant’s telephone number, including area code)
  ____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer
 
o
 
Accelerated filer
 
þ
 
 
 
 
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934).    Yes  o    No  þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date. As of August 4, 2014 there were 32,063,141 shares, par value $0.01, of the registrant’s common stock issued and outstanding.




TABLE OF CONTENTS


2



Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands—except share and per share data)
 
 
June 30, 2014
 
December 31,
2013
 
 
(Unaudited)
 
 
Assets:
 
 
 
 
Cash
 
$
98,014

 
$
127,959

Restricted cash
 
45,092

 
67,458

Residential mortgage-backed securities, at fair value (of which $3,379,235 and $3,317,060 were pledged as collateral, respectively)
 
3,581,597

 
3,503,326

Securitized mortgage loans (transferred to a consolidated variable interest entity), at fair value
 
109,712

 
110,984

Other investment securities, at fair value (of which $11,846 and $11,515 were pledged as collateral, respectively)
 
11,846

 
11,515

Warehouse line receivable
 
13,462

 
—

Investment related receivable (of which $0 and $21,959 were pledged as collateral, respectively)
 
3,136

 
24,887

Interest receivable
 
10,087

 
10,396

Deferred financing costs, net
 
817

 
882

Derivative instruments, at fair value
 
20,942

 
53,315

Other assets
 
705

 
854

Total Assets
 
$
3,895,410

 
$
3,911,576

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
Liabilities:
 
 
 
 
Borrowings under repurchase agreements
 
$
2,991,989

 
$
3,034,058

Non-recourse securitized debt, at fair value
 
38,656

 
43,354

Investment related payable
 
13,299

 
—

Obligation to return cash held as collateral
 
11,426

 
38,654

Accrued interest payable
 
11,077

 
8,708

Derivative instruments, at fair value
 
8,729

 
4,610

Payable to related party
 
5,218

 
5,444

Dividends payable
 
16,912

 
16,812

Accounts payable and accrued expenses
 
1,069

 
2,335

Total Liabilities
 
3,098,375

 
3,153,975

 
 
 
 
 
Commitments and Contingencies (Note 12)
 

 

 
 
 
 
 
Stockholders’ Equity:
 
 
 
 
Preferred stock, $0.01 par value, 50,000,000 shares authorized, 6,900,000 shares issued and outstanding ($172,500 aggregate liquidation preference)
 
$
69

 
$
69

Common stock, $0.01 par value, 450,000,000 shares authorized, 32,051,303 and 32,038,970 shares issued and outstanding, respectively
 
320

 
320

Additional paid-in capital
 
792,877

 
792,010

Retained earnings/(accumulated deficit)
 
3,769

 
(34,798
)
Total Stockholders’ Equity
 
797,035

 
757,601

Total Liabilities and Stockholders’ Equity
 
$
3,895,410

 
$
3,911,576



See notes to unaudited consolidated financial statements.

3


Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(in thousands—except per share data)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Interest income:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
 
$
35,991

 
$
39,032

 
$
71,816

 
$
75,946

Securitized mortgage loans
 
1,927

 
2,297

 
4,173

 
3,630

Other
 
223

 
—

 
332

 
—

Total interest income
 
38,141

 
41,329

 
76,321

 
79,576

Interest expense:
 
 
 
 
 
 
 
 
Repurchase agreements
 
(7,078
)
 
(6,729
)
 
(13,904
)
 
(12,636
)
Securitized debt
 
(432
)
 
(508
)
 
(874
)
 
(818
)
Total interest expense
 
(7,510
)
 
(7,237
)
 
(14,778
)
 
(13,454
)
 
 
 
 
 
 
 
 
 
Net interest income
 
30,631

 
34,092

 
61,543

 
66,122

 
 
 
 
 
 
 
 
 
Other income/(loss), net:
 
 
 
 
 
 
 
 
Realized loss on sale of residential mortgage-backed securities, net
 
(7,072
)
 
(47,508
)
 
(18,882
)
 
(31,713
)
Gain/(loss) on derivative instruments, net (includes ($14,467), $79,778, ($33,185), and $78,119 of unrealized gains/(losses), respectively)
 
(27,133
)
 
83,369

 
(64,323
)
 
77,571

Unrealized gain/(loss) on residential mortgage-backed securities, net
 
51,590

 
(134,822
)
 
102,237

 
(167,870
)
Unrealized gain/(loss) on securitized debt
 
(364
)
 
887

 
(354
)
 
15

Unrealized gain/(loss) on securitized mortgage loans, net
 
2,042

 
(3,473
)
 
3,096

 
(625
)
Unrealized gain on other investment securities
 
54

 
—

 
176

 
—

Other, net
 
(49
)
 
43

 
(31
)
 
68

Other income/(loss), net
 
19,068

 
(101,504
)
 
21,919

 
(122,554
)
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
General and administrative (includes ($408), ($146), ($867) and ($545) of non-cash stock based compensation, respectively)
 
(2,921
)
 
(2,434
)
 
(6,016
)
 
(5,285
)
Management fee – related party
 
(2,774
)
 
(2,921
)
 
(5,560
)
 
(5,710
)
Total operating expenses
 
(5,695
)
 
(5,355
)
 
(11,576
)
 
(10,995
)
 
 
 
 
 
 
 
 
 
Net income/(loss)
 
$
44,004

 
$
(72,767
)
 
$
71,886

 
$
(67,427
)
Preferred stock dividends declared
 
(3,450
)
 
(3,450
)
 
(6,900
)
 
(6,900
)
Net income/(loss) allocable to common stock and participating securities
 
$
40,554

 
$
(76,217
)
 
$
64,986

 
$
(74,327
)
 
 
 
 
 
 
 
 
 
Earnings/(loss) per common share - basic
 
$
1.26

 
$
(2.39
)
 
$
2.02

 
$
(2.59
)
Earnings/(loss) per common share - diluted
 
$
1.25

 
$
(2.39
)
 
$
2.01

 
$
(2.59
)
 
 
 
 
 
 
 
 
 
Dividends declared per share of common stock
 
$
0.42

 
$
0.70

 
$
0.82

 
$
1.40



See notes to unaudited consolidated financial statements.

4


Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
(in thousands—except share and per share data)
 
 
Preferred Stock
 
Common Stock
 
Additional
Paid- In
Capital
 
Accumulated Deficit/Retained Earnings
 
Total
 
 
Shares
 
Par
 
Shares
 
Par
 
Balance at December 31, 2013
 
6,900,000

 
$
69

 
32,038,970

 
$
320

 
$
792,010

 
$
(34,798
)
 
$
757,601

Grant of restricted stock to independent directors
 
—

 
—

 
9,208

 
—

 
—

 
—

 
—

Settlement of vested restricted stock units in common stock
 
—

 
—

 
3,125

 
—

 
—

 
—

 
—

Equity based compensation expense
 
—

 
—

 


 
—

 
867

 
—

 
867

Net income
 
—

 
—

 
—

 
—

 
—

 
71,886

 
71,886

Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
—

 
(6,900
)
 
(6,900
)
Dividends declared on common stock
 
—

 
—

 
—

 
—

 
—

 
(26,419
)
 
(26,419
)
Balance at June 30, 2014
 
6,900,000

 
$
69

 
32,051,303

 
$
320

 
$
792,877

 
$
3,769

 
$
797,035



See notes to unaudited consolidated financial statements.

5

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
Six Months Ended June 30,
 
 
2014
 
2013
Cash Flows from Operating Activities:
 
 
 
 
Net income/(loss)
 
$
71,886

 
$
(67,427
)
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Premium amortization/(discount accretion), net
 
(11,839
)
 
6,627

Amortization of deferred financing costs
 
214

 
199

Equity based compensation expense
 
867

 
545

Unrealized (gain)/loss on mortgage-backed securities, net
 
(102,237
)
 
167,870

Unrealized (gain)/loss on securitized mortgage loans, net
 
(3,096
)
 
625

Unrealized (gain)/loss on derivative instruments, net
 
33,185

 
(78,119
)
Unrealized (gain)/loss on securitized debt
 
354

 
(15
)
Unrealized (gain) on other investment securities
 
(176
)
 
—

Realized (gain) on sales of mortgage-backed securities
 
(3,392
)
 
(35,572
)
Realized loss on sales of mortgage-backed securities
 
22,274

 
67,285

Realized (gain)/ loss on derivative instruments
 
21,268

 
(10,028
)
Realized loss on real estate owned, net
 
68

 
—

Changes in operating assets and liabilities:
 
 
 
 
(Increase)/decrease in accrued interest receivable, less purchased interest
 
330

 
(1,970
)
Decrease in other assets
 
102

 
117

Increase in accrued interest payable
 
2,369

 
383

(Decrease)/increase in accounts payable and accrued expenses
 
(1,261
)
 
162

(Decrease) in payable to related party
 
(285
)
 
(884
)
Net cash provided by operating activities
 
30,631

 
49,798

 
 
 
 
 
Cash Flows from Investing Activities:
 
 
 
 
Purchases of mortgage-backed securities
 
$
(732,928
)
 
$
(2,328,588
)
Proceeds from sales of mortgage-backed securities
 
647,859

 
1,830,267

Purchases of mortgage loans, simultaneously securitized
 
—

 
(113,038
)
Purchase of other investment securities
 
(953
)
 
—

Warehouse line advances
 
(13,462
)
 
—

Proceeds from sales of real estate owned
 
30

 
—

(Increase)/decrease in restricted cash related to investing activities
 
(9,193
)
 
32,787

(Decrease)/increase in cash collateral held related to investing activities
 
(27,228
)
 
66,571

Principal payments received on mortgage-backed securities
 
137,282

 
205,373

Principal payments received on securitized mortgage loans
 
3,913

 
2,051

Principal payments received on other investment securities
 
802

 
—

Payments made on termination of derivative instruments
 
(6,424
)
 
4,312

Purchase of interest rate swaptions
 
(11,537
)
 
(10,512
)
Other, net
 
1

 
33

Net cash (used) in investing activities
 
(11,838
)
 
(310,744
)
 
 
 
 
 
Cash Flows from Financing Activities:
 
 
 
 
Proceeds from repurchase agreement borrowings
 
$
5,621,450

 
$
12,264,466

Repayments of repurchase agreement borrowings
 
(5,663,519
)
 
(11,973,805
)
(Increase)/decrease in restricted cash related to financing activities
 
31,559

 
(145,000
)
Proceeds from issuance of securitized debt
 
—

 
50,375

Principal payments on securitized debt
 
(5,052
)
 
(3,022
)
Payments made for securitization/deferred financing costs
 
(169
)
 
(777
)
Dividends paid on preferred stock
 
(6,900
)
 
(8,472
)
Dividends paid on common stock and dividend equivalent rights
 
(26,107
)
 
(47,911
)
Proceeds from issuance of common stock
 
—

 
172,040

Payment of costs to issue preferred and common stock
 
—

 
(825
)
Net cash provided/(used) by financing activities
 
(48,738
)
 
307,069

Net increase/(decrease) in cash
 
(29,945
)
 
46,123

Cash at beginning of period
 
127,959

 
149,576

Cash at end of period
 
$
98,014

 
$
195,699

(Continued on next page.)


6

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited) - Continued
(in thousands)
(Continued.)
 
 
Six Months Ended June 30,
 
 
2014
 
2013
Supplemental Disclosure of Operating Cash Flow Information:
 
 
 
 
Interest paid
 
$
12,968

 
$
13,666

 
 
 
 
 
Supplemental disclosure of non-cash investing/financing activities:
 
 
 
 
Residential mortgage-backed securities (purchased)/sold not settled, net
 
$
(13,299
)
 
$
963,603

Due from broker
 
$
3,136

 
$
1,558

Dividends and dividend equivalent rights declared, not yet paid
 
$
17,124

 
$
26,261

Payable for issuance of preferred and common stock
 
$
—

 
$
96

Deferred financing costs not yet paid
 
$
14

 
$
56

Derivative termination fee receivable for unsettled trades
 
$
—

 
$
6,680



See notes to unaudited consolidated financial statements.

7


Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
References to “we,” “us,” “our,” “AMTG” or “Company” refer to Apollo Residential Mortgage, Inc., as consolidated with its subsidiaries and variable interest entity (or, VIE). The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” refers to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the United States (or, U.S.) Government, such as Ginnie Mae; “RMBS” refer to residential mortgage-backed securities, “Agency RMBS” refer to RMBS issued or guaranteed by an Agency while “non-Agency RMBS” refer to RMBS that are not issued or guaranteed by an Agency; “ARMs” refer to adjustable rate mortgages; “Alt-A” refers to residential mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to Agency underwriting guidelines and generally allow homeowners to qualify for a mortgage loan with reduced or alternate forms of documentation; “Subprime” refers to mortgage loans that have been originated using underwriting standards that are less restrictive than those used to originate prime mortgage loans; “Option ARMs” refer to mortgages that provide the mortgagee payment options, which may initially include a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment or a 30-year fully amortizing payment; “ARM-RMBS” refer to RMBS collateralized by ARMs; “Hybrids” refer to mortgage loans that have fixed interest rates for a period of time and, thereafter generally adjust annually based on an increment over a specified interest rate index; “Agency IO” and “Agency Inverse IO” refer to Agency interest-only and Agency inverse interest-only securities, which receive some or all of the interest payments, but no principal payments, made on a related series of Agency RMBS, based on a notional principal balance; “TBA Contracts” refer to to-be-announced contracts to purchase or sell certain Agency RMBS on a forward basis; “Long TBA Contracts” refer to TBA Contracts for which we would be required to buy certain Agency RMBS on a forward basis; “Short TBA Contracts” refer to TBA Contracts for which we would be required to sell certain Agency RMBS on a forward basis; and “REO” refers to real estate owned.
Note 1– Organization
We were organized as a Maryland corporation on March 15, 2011 and commenced operations on July 27, 2011. We are externally managed and advised by ARM Manager, LLC (or, Manager), an indirect subsidiary of Apollo Global Management, LLC (together with its subsidiaries, Apollo).
We operate and have elected to qualify as a real estate investment trust (or, REIT) under the Internal Revenue Code of 1986, as amended (or, Internal Revenue Code), commencing with the taxable year ended December 31, 2011. We also operate our business in a manner that allows us not to register as an investment company as defined under the Investment Company Act of 1940 (or, 1940 Act).
We invest on a levered basis in residential mortgage and mortgage-related assets in the U.S. Through June 30, 2014, our asset portfolio consisted of Agency RMBS, including Agency IO and Agency Inverse IO, non-Agency RMBS and, to a lesser extent, securitized mortgage loans, a warehouse line receivable and other mortgage-related securities. Over time, we may invest in a broader range of other residential mortgage and mortgage-related assets.
Note 2 – Summary of Significant Accounting Policies
(a)
Basis of Presentation and Consolidation
The interim unaudited consolidated financial statements include our accounts and those of our consolidated subsidiaries and a VIE in which we are the primary beneficiary. All intercompany amounts have been eliminated in consolidation. We currently operate as one business segment.
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (or, GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
In the opinion of management, all adjustments have been made (which include only normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows. Certain information and 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 our Annual Report on Form 10-K for the year ended December 31, 2013, which was filed with the Securities and Exchange Commission (or, the SEC) on February 21, 2014. Our results of operations for the quarterly period ended June 30, 2014 are not necessarily indicative of the results to be expected for the full year or any other future period.


8

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(b)
Cash and Cash Equivalents
We consider all highly liquid short term investments with original maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. We deposit our cash with what we believe to be high credit quality institutions. From time to time, our cash may include amounts pledged to us by our counterparties as collateral for our derivative instruments. At June 30, 2014 and December 31, 2013, our cash and cash equivalents were primarily comprised of cash on deposit with our prime broker (which is domiciled in the U.S.); substantially all of which was in excess of applicable insurance limits.
(c)
Obligation to Return Cash Held as Collateral
From time to time, we may hold cash pledged as collateral to us by certain of our derivative counterparties as a result of margin calls made by us. Cash pledged to us is unrestricted in use and, accordingly, is included as a component of cash on our consolidated balance sheets. In addition, a corresponding liability is reported as an obligation to return cash held as collateral.
(d)
Restricted Cash
Restricted cash represents cash held by our counterparties as collateral against our repurchase agreement borrowings, interest rate swaps (or, Swaps) or other derivative instruments. Restricted cash is not available for general corporate purposes, but may be applied against amounts due to counterparties under our repurchase agreement borrowings and Swaps, or returned to us when our collateral requirements are exceeded or at the maturity or termination of the derivative instrument or repurchase agreement.
(e)
Residential Mortgage-Backed Securities, Securitized Mortgage Loans, Other Investment Securities and Non-Recourse Securitized Debt
Our RMBS portfolio is comprised of mortgage pass-through certificates, collateralized mortgage obligations (or, CMOs), including Agency IO and Agency Inverse IO representing interests in or obligations backed by pools of mortgage loans. Our securitized mortgage loan portfolio is comprised of a pool of performing, re-performing and non-performing mortgage loans that we purchased at a discount to principal balance.
Balance Sheet Presentation
Purchases and sales of RMBS and other investment securities are recorded on the trade date. Our RMBS and other investment securities pledged as collateral against borrowings under repurchase agreements are included in “Residential mortgage-backed securities, at fair value” and “Other investment securities, at fair value” on our consolidated balance sheet, respectively, with the fair value of securities pledged disclosed parenthetically.
The aggregate fair value of the mortgage loans that we securitized are presented on our consolidated balance sheet as “Securitized mortgage loans (transferred to a consolidated variable interest entity), at fair value.” Such assets can be used only to settle obligations of the consolidated VIE. (See Notes 5 and 13.)
Determination of Accounting Policy
For purposes of determining the applicable accounting policy with respect to our investment securities, we review credit ratings available from each of the three major credit rating agencies (i.e., Moody’s Investors Services, Inc., Standard & Poor’s Ratings Services and Fitch, Inc.) for each investment security at the time of purchase and apply the lowest rating.
Designation and Fair Value Option Election
Our investment securities are designated as available for sale. To date, we have elected the fair value option for all of our investment securities at the time of purchase and, as a result, record the change in the estimated fair value of such assets in earnings as unrealized gains/(losses). We generally intend to hold our investment securities to generate interest income; however, we have and may continue to sell certain of our investment securities as part of the overall management of our assets and liabilities and operating our business. Realized gains/(losses) on the sale of investment securities are recorded in earnings using the specific identification method.
Our securitized mortgage loans are considered held for investment purposes, as we expect that we will be required to continue to consolidate the VIE in which such loans are held and generally do not have the authority to sell the mortgage loans held in such VIE. Consistent with our investments in RMBS, we have elected the fair value option for our securitized mortgage loans and, as a result, we record changes in the estimated fair value of such assets in earnings as unrealized gains/(losses).


9

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


We believe that our election of the fair value option for our investment securities, securitized mortgage loans and securitized debt improves financial reporting, as such treatment is consistent with how we present the changes in the fair value of our Swaps, interest rate swaptions (or, Swaptions) and TBA Contracts, all of which are derivative instruments, through earnings.
Determination of Fair Value
To determine the fair value of our investment securities, TBA Contracts and non-recourse securitized debt, we obtain third-party broker quotes which, while non-binding, are indicative of fair value. To validate the reasonableness of the broker quotes obtained, we compare such quotes to valuations received from a third-party pricing service.
We estimate the fair value of our securitized mortgage loans based upon an estimated price that would be received for the mortgage loans if sold into a securitization, which was considered to be the most advantageous market for such assets for the periods presented. To value our securitized mortgage loans, we estimate the cash flows for the securitized mortgage loans using observable inputs, such as loan balances, loan interest rates and loan payment status as well as certain unobservable inputs, such as estimated future prepayment speeds, default rates and loss severities, which inputs are significant in arriving at the estimate of cash flows. Given the significance of unobservable inputs in arriving at the fair value of our securitized mortgage loans, we consider such valuations to be categorized as Level III in the fair value hierarchy.
Impairments
RMBS and Other Investment Securities: We have elected the fair value option for our RMBS and other investment securities. As such, all changes in the market value of our RMBS and other investment securities are recorded through earnings, including other-than-temporary impairments (or, OTTI), if any. When the fair value of an investment security is less than its amortized cost at the balance sheet date, the security is considered impaired. We assess our impaired securities on at least a quarterly basis and designate such impairments as either “temporary” or “other-than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell an impaired security before its anticipated recovery, then we recognize an OTTI, which reduces the amortized cost basis of the impaired security. Following the recognition of an OTTI, a new cost basis is established for the security. Changes in the fair value of the security on which an OTTI charge was made will be reflected in unrealized gains/(losses) but will not result in a change to the amortized cost of the impaired security. Increases in interest income may be recognized on a security that an OTTI charge was taken, if the performance of such security subsequently improves. The determination as to whether an OTTI exists is subjective, given that such determination is based on information available at the time of assessment as well as our Manager’s estimate of the future performance and cash flow projections for the individual security. (See Note 4.)
Securitized Mortgage Loans: We have elected the fair value option for our securitized mortgage loans. As such, all changes in the estimated fair value of our securitized mortgage loans are recorded through earnings, including OTTI, if any. Our securitized mortgage loans had evidence of deterioration of credit quality at the time of acquisition. We analyze our securitized mortgage loan pool at least quarterly to assess the actual performance compared to the expected performance. If the revised cash flow estimates on our securitized mortgage loans provide a lower yield than the previous yield, we recognize an OTTI (i.e., a reduction in the amortized cost of the securitized mortgage loans that is recorded in earnings) in an amount such that the yield will remain unchanged. If cash flow estimates on our securitized mortgage loans increase subsequent to recording an OTTI, we will reverse previously recognized OTTI(s) before any increase to the yield is made. (See Note 5.)
Other Investment Securities
At June 30, 2014, our other investment securities were comprised of investments in Freddie Mac’s Structured Agency Credit Risk debt notes (or, STACR Notes). The STACR Notes represent unsecured general obligations of Freddie Mac and are structured to be subject to the performance of a certain pool of residential mortgage loans. STACR Notes are included in “Other investment securities, at fair value” on our consolidated balance sheet. Interest income on the STACR Notes is included in “Interest income - other” and changes in the estimated fair value of the security are included in “Unrealized gain on other investment securities” on our consolidated statements of operations.
(f)
Interest Income Recognition
Investment Securities
Interest income on Agency pass-through RMBS and other investment securities is accrued based on the outstanding principal balance and the current coupon interest rate on each security. In addition, premiums and discounts associated with Agency RMBS, non-Agency RMBS and other investment securities rated AA and higher at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. In order to determine the effective yield,


10

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


we estimate prepayments for each security. For those securities, if prepayment levels differ, or are expected to differ in the future from our previous assessment, we adjust the amount of premium amortization recognized in the period that such change is made, applying the retrospective method, resulting in a cumulative catch-up reflecting such change. To the extent that prepayment activity varies significantly from our previous prepayment estimates, we may experience volatility in our interest income. For Agency pass-through RMBS that we acquired subsequent to June 30, 2013, we do not estimate prepayments to determine premium amortization or discount accretion on such securities. Instead, the amount of premium amortization/discount accretion on Agency pass-through RMBS acquired subsequent to June 30, 2013 is based upon actual prepayment experience, which may vary significantly over time.
For Agency IO and Agency Inverse IO, income is accrued based on the amortized cost and the effective yield. Cash received on Agency IO and Agency Inverse IO is first applied to accrued interest and then to reduce the amortized cost. At each reporting date, the effective yield is adjusted prospectively based on the current cash flow projections, which reflect prepayment estimates and the contractual terms of the security.
Interest income on non-Agency RMBS and other investment securities rated below AA or not rated by a nationally recognized statistical rating organization is recognized based on the effective yield method. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on our observation of current information and events and include assumptions related to the future path of interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models and our judgment about interest rates, prepayment speeds, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and the payment priority structure of the security; therefore, actual maturities are generally shorter than the stated contractual maturities of the underlying mortgages. Based on the projected cash flows for our non-Agency RMBS, we generally expect that a portion of the purchase discount on such securities will not be recognized as interest income and is instead viewed as a credit discount. The credit discount mitigates our risk of loss on our non-Agency securities. The amount considered to be credit discount may change over time, based on the actual performance of the underlying mortgage collateral, actual and projected cash flows from such collateral, economic conditions and other factors. If the performance of a non-Agency RMBS with a credit discount is more favorable than forecasted, we may accrete more discount into interest income than expected at the time of purchase or when performance was last assessed. Conversely, if the performance of a non-Agency RMBS with a credit discount is less favorable than forecasted, the amount of discount accreted into income may be less than expected at the time of purchase or when performance was last assessed and/or impairment and write-downs of such securities to a new lower cost basis could result.
Securitized Mortgage Loans
Application of the interest method of accounting for our pool of securitized mortgage loans requires the use of estimates to calculate a projected yield. We calculate the yield based on the projected cash flows for the pool of mortgages. To the extent the actual performance of the pool is better than last expected, the yield is adjusted upward prospectively to reflect the revised estimate of cash flows over the remaining life of the mortgage pool. However, if the revised cash flow estimates on our securitized mortgage loans provide a lower yield than the original or the last calculated yield, we recognize an OTTI (i.e., a reduction in the amortized cost of the securitized mortgage loans that is recorded in earnings) such that the yield will remain unchanged, decreasing yields arising solely from a change in the contractual interest rate on variable rate loans are not treated as an OTTI. If future cash collections are materially different in amount or timing than projected cash collections, earnings could be affected, either positively or negatively.
On at least a quarterly basis, our Manager reviews and, if appropriate, makes adjustments to cash flow projections based on input and analysis received from external sources, internal models and our Manager’s judgment about interest rates, prepayment speeds, home prices, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such loans and/or the recognition of an OTTI.
(g)
Variable Interest Entities
VIEs are defined as entities in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The entity that consolidates a VIE is known as its primary beneficiary and is generally the entity with (i) the power to direct the activities that most significantly impact the VIE’s economic performance and (ii) the right to


11

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE. For VIEs that do not have substantial on-going activities, the power to direct the activities that most significantly impact the VIE’s economic performance may be determined by an entity’s involvement with the design of the VIE.
We consolidate a VIE when we determine that we are the primary beneficiary of such VIE. We are required to re-evaluate whether to consolidate a VIE each reporting period, based upon the facts and circumstances pertaining to the VIE during such period.
Mortgage Loan Securitization
In February 2013, we purchased a pool of residential mortgage loans and simultaneously completed a securitization transaction collateralized by such mortgage loans. In determining the accounting treatment to be applied to this securitization transaction, we evaluated whether the trust used to facilitate the transaction was a VIE and, if so, whether it should be consolidated. Based on our evaluation, we concluded that the trust was a VIE which should be consolidated by us. (See Note 13.)
(h)
Deferred Financing Costs
Costs incurred in connection with securing our financings are capitalized and amortized using the effective interest rate method over the respective financing term with such amortization reflected on our consolidated statements of operations as a component of interest expense. We incurred such costs in connection with our repurchase agreements and, beginning in February 2013, in connection with our whole-loan securitization transaction and issuance of beneficial interests by the consolidated VIE. Our deferred financing costs may include legal, accounting and other related fees. These deferred charges are included on our consolidated balance sheet as a component of “Deferred financing costs, net.” The amortization of deferred charges associated with our securitized debt is adjusted to reflect actual repayments of the securitized debt. (See Note 13.)
(i)
Earnings Per Share
Basic earnings per share (or, EPS) is computed using the two-class method, which includes the weighted-average number of shares of common stock outstanding during the period and other securities that participate in dividends, such as our unvested restricted stock and restricted stock units (or, RSUs), to arrive at total common equivalent shares. In applying the two-class method, earnings are allocated to both shares of common stock and securities that participate in dividends based on their respective weighted-average shares outstanding for the period. During periods of net loss, losses are allocated only to the extent that the participating securities are required to absorb their share of such losses. (See Note 16.)
(j)
Derivative Instruments
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments, currently comprised of Swaps, Swaptions and, from time to time, TBA Contracts, as part of our interest rate risk management. We view our derivative instruments as economic hedges, which we believe mitigate interest rate risk associated with our borrowings under repurchase agreements and/or the fair value of our RMBS portfolio. We do not enter into derivative instruments for speculative purposes.
All derivatives are reported as either assets or liabilities on the balance sheet at estimated fair value. We have not elected hedge accounting for our derivative instruments and, as a result, changes in the fair value for our derivatives are recorded in earnings. The fair value adjustments, along with the related interest income or interest expense, are recognized in our consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”
To-Be-Announced Securities
TBA Contracts are forward contracts for the purchase or sale of Agency RMBS by a specified issuer and for a specified face amount, coupon and stated term, at a predetermined price on the date stated in the contract. The particular Agency RMBS (i.e., Committee on Uniform Securities Identification Procedures, or CUSIP) delivered into the contract upon the settlement date are not known at the time of the transaction. We recognize in earnings unrealized gains and losses associated with TBA Contracts that are not subject to the regular-way exception, which applies: (i) when there is no other way to purchase or sell that security; (ii) if delivery of that security and settlement will occur within the shortest period possible for that type of security; and (iii) if it is probable at inception and throughout the term of the individual contract that physical delivery of the security will occur. Changes in the value of our TBA Contracts and realized gains or losses on settlement are recognized in our consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”


12

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(k)
Repurchase Agreements
Investment securities financed under repurchase agreements are treated as collateralized borrowings, unless they meet sale treatment or are deemed to be linked transactions. Through June 30, 2014, none of our repurchase agreements had been accounted for as components of linked transactions. With the exception of securities obtained in connection with our securitization that were eliminated in consolidation, through June 30, 2014, all securities financed through a repurchase agreement have remained on our consolidated balance sheet as an asset (with the fair value of the securities pledged as collateral disclosed parenthetically) and cash received from the lender was recorded on our consolidated balance sheet as a liability. Interest paid and accrued in connection with our repurchase agreements is recorded as interest expense.
(l)
Share-based Payments
We account for share-based awards granted to our independent directors, to our Manager and to employees of our Manager and its affiliates using the fair value based methodology prescribed by GAAP. Expense related to restricted common stock issued to our independent directors is based on the fair value of our common stock on the grant date, and amortized into expense over the award vesting period on a straight-line basis. Expense related to RSUs issued to our Manager and to employees of our Manager and its affiliates are based on the estimated fair value of such award at the grant date and are remeasured quarterly for unvested awards. We measure the fair value of our RSUs using the price of our common stock and other measurement assumptions, including implied volatility and discount rates. We use the graded vesting attribution method to amortize expense related to RSUs granted to our Manager and its affiliates.
(m)
Income Taxes
We elected to be taxed as a REIT for U.S. Federal income tax purposes, commencing with our taxable year ended December 31, 2011. Pursuant to the Internal Revenue Code, a REIT that distributes at least 90% of its net taxable income, excluding net capital gains, as a dividend to its stockholders each year and which meets certain other conditions, will not be taxed on the portion of its taxable income that is distributed to its stockholders. We expect to meet the conditions required to enable us to continue to operate as a REIT and to distribute all of our taxable income, including net gains for the periods presented and therefore we have not recorded any provisions for income taxes on our consolidated statements of operations.
We have elected to treat one wholly-owned subsidiary as a taxable REIT subsidiary (or, TRS). A TRS may participate in non-real estate-related activities and is subject to U.S. Federal, state and local income tax at regular corporate tax rates. The TRS was established in connection with the purchase of the pool of residential mortgage loans in February 2013 and the securitization transaction as discussed in Notes 5 and 13.
Our major tax jurisdictions are U.S. Federal, New York State and New York City. The statute of limitations is open for all jurisdictions for tax years beginning 2011 to date. We do not have any unrecognized tax benefits and do not expect a change in our position for unrecognized tax benefits in the next twelve months.
(n)
Recent Accounting Pronouncements
Accounting Standards Adopted
In June 2013, the Financial Accounting Standards Board (or, FASB) issued guidance to change the assessment of whether an entity is an investment company by developing a new two-tiered approach that requires an entity to possess certain fundamental characteristics while allowing judgment in assessing certain typical characteristics. The fundamental characteristics that an investment company is required to have include the following: (1) it obtains funds from one or more investors and provides the investor(s) with investment management services; (2) it commits to its investor(s) that its business purpose and only substantive activities are investing the funds solely for returns from capital appreciation, investment income or both; and (3) it does not obtain returns or benefits from an investee or its affiliates that are not normally attributable to ownership interests. The typical characteristics of an investment company that an entity should consider before concluding whether it is an investment company include the following: (1) it has more than one investment; (2) it has more than one investor; (3) it has investors that are not related parties of the parent or the investment manager; (4) it has ownership interests in the form of equity or partnership interests; and (5) it manages substantially all of its investments on a fair value basis. The new approach requires an entity to assess all of the characteristics of an investment company and consider its purpose and design to determine whether it is an investment company. The guidance includes disclosure requirements about an entity’s status as an investment company and financial support provided or contractually required to be provided by an investment company to its investees. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2013 and earlier application is prohibited. Given that this new guidance does not apply to REITs and is not intended to change current practice for real estate entities, its adoption on January 1, 2014 did not impact our consolidated financial statements.


13

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


In July 2013, the FASB issued guidance to eliminate the diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carry forward, a similar tax loss, or when a tax credit carry forward exists. Under the new guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carry forward, a similar tax loss, or a tax credit carry forward, except as follows. To the extent a net operating loss carry forward, a similar tax loss, or a tax credit carry forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statement as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date (e.g., an entity should not evaluate whether the deferred tax asset expires before the statute of limitations on the tax position or whether the deferred tax asset may be used prior to the unrecognized tax benefit being settled). The guidance does not require new recurring disclosures. The guidance applies to all entities that have unrecognized tax benefits when a net operating loss carry forward, similar tax loss, or a tax credit carry forward exists at the reporting date. The guidance became effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The amendments are to be applied prospectively to all unrecognized tax benefits that exist at the effective date, although retrospective application is permitted. The adoption of this guidance did not impact our consolidated financial statements.
Accounting Standards Issued but Not Yet Adopted
In January 2014, the FASB issued guidance in order to help determine when a creditor should derecognize a loan receivable and recognize the real estate property by clarifying when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. The guidance is effective for public business entities for fiscal years beginning after December 15, 2014. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In June 2014, the FASB issued guidance that changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. These transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. In addition, the guidance requires additional disclosures. The guidance is effective for the first interim or annual period beginning after December 15, 2014. Earlier application for a public company is prohibited. The new guidance is not expected to have a material impact on our consolidated financial statements.
Note 3 – Fair Value of Financial Instruments
(a) General
We disclose the estimated fair value of our financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). We are required to provide enhanced disclosures regarding instruments in the Level III category, including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP provides a framework for measuring estimated fair value and for providing financial statement disclosure requirements for fair value measurements. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level I - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level II - Fair values are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These inputs may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.
Level III - Fair values are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.


14

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


The level in the fair value hierarchy, within which a fair measurement falls in its entirety, is based on the lowest level input that is significant to the fair value measurement. When available, we use quoted market prices to determine the estimated fair value of an asset or liability.
Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices received for such assets could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold are also subject to significant judgment, particularly in times of market illiquidity.
We have controls over our valuation processes that are intended to ensure that the valuations for our financial instruments are fairly presented in accordance with GAAP on a consistent basis. Our Manager and our Chief Executive Officer oversee our valuation process, which is carried out by our Manager and Apollo’s pricing group. Our audit committee has final oversight for the valuation process for all of our financial instruments and, on a quarterly basis, reviews and provides final approval for such process.
Any changes to our valuation methodology will be reviewed by our Manager and audit committee to ensure the changes are appropriate. We may refine our valuation methodologies as markets and products develop. The methods used by us may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and are believed to result in valuations consistent with other market participants, the use of different methodologies, or assumptions, to determine the estimated fair value of certain financial instruments could result in a different estimate of estimated fair value at the reporting date. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.
The following describes the valuation methodologies used for our financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
(b) Agency RMBS, non-Agency RMBS, TBA Contracts, Non-Recourse Securitized Debt and Other Investment Securities
To determine the fair value of our Agency RMBS, non-Agency RMBS, TBA Contracts, securitized debt and other investment securities, we obtain third-party broker quotes which, while non-binding, are indicative of fair value. To validate the reasonableness of the broker quotes, our Manager obtains and compares the broker quotes to valuations received from a third-party pricing service and reviews the range of quotes received for outliers, compares quotes to recent market activity observed for similar securities and reviews significant changes in quarterly price levels. We generally do not adjust the prices we obtain from brokers; however, adjustments to valuations may be made as deemed appropriate to capture observable market information at the valuation date. Further, broker quotes are used provided that there is not an ongoing material event that affects the issuer of the securities being valued or the market thereof. If there is such an ongoing event, we will determine the estimated fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates and prepayment rates and, with respect to non-Agency RMBS, default rates and loss severities. Valuation techniques for RMBS may be based on models that consider the estimated cash flows of each debt tranche of the issuer, establish a benchmark yield, and develop an estimated tranche-specific spread to the benchmark yield based on the unique attributes of the tranche including, but not limited to, assumptions related to prepayment speed, the frequency and severity of defaults and attributes of the collateral underlying such securities. To the extent the inputs are observable and timely, the values would be categorized in Level II of the fair value hierarchy; otherwise they would be categorized as Level III. There were no events that resulted in us using internal models to value our Agency and non-Agency RMBS or other investment securities in our consolidated financial statements for the periods presented. Given the high level of liquidity and price transparency for Agency RMBS, our other investment securities and TBA Contracts, prices obtained from brokers and pricing services are readily verifiable to observable market transactions; as such, we categorize Agency RMBS, TBA Contracts and other investment securities as Level II valuations. While market liquidity exists for non-Agency RMBS, periods of less liquidity or even illiquidity may also occur periodically for certain of these assets. As a result of this market dynamic and that observable market transactions may or may not exist from time to time, our non-Agency RMBS and securitized debt are categorized as Level III.


15

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(c) Securitized Mortgage Loans
The fair value of our securitized mortgage loans is based upon an estimated exit price in the securitization market, as that was determined to be the most advantageous market for such assets for the periods presented. As part of the valuation process, we estimated cash flows for the securitized mortgage loans using observable inputs, such as loan balances and loan interest rates. In addition, we used certain unobservable inputs, which are significant in arriving at the estimate of fair value, such as prepayment speeds, default rates and loss severities. We then determined where our mortgage pool would price on a securitized basis at the time of valuation. Given the significance of unobservable inputs in arriving at the fair value of our securitized mortgage loans, we consider such valuations to be Level III.
(d) Swaps and Swaptions
We determine the estimated fair value of our Swaps and Swaptions based on market valuations obtained from a third party with expertise in valuing such instruments. With respect to Swap valuations, the expected future cash flows are determined for the fixed and floating rate leg of the Swap. To arrive at the expected cash flows for the fixed leg of a Swap, the coupon rate stated in the Swap agreement is used and to arrive at the expected cash flows for the floating leg, the forward rates derived from raw yield curve data are used. Finally, both the fixed and floating legs’ cash flows are discounted using the calculated discount factors and the fixed and floating leg valuations are netted to arrive at a single valuation for the Swap at the valuation date. Swaptions require the same market inputs as Swaps with the addition of implied Swaption volatilities quoted by the market. The valuation inputs for Swaps and Swaptions are observable and, as such, their valuations are categorized as Level II in the fair value hierarchy.
(e) Fair Value Hierarchy
The following tables present our financial instruments carried at estimated fair value as of June 30, 2014 and December 31, 2013 based upon our consolidated balance sheet by the valuation hierarchy:
 
 
Estimated Fair Value at June 30, 2014
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$
—

 
$
2,168,403

 
$
1,413,194

 
$
3,581,597

Securitized mortgage loans
 
—

 
—

 
109,712

 
109,712

Other investment securities
 
—

 
11,846

 
—

 
11,846

Swaps/Swaptions
 
—

 
20,942

 
—

 
20,942

Total
 
$
—

 
$
2,201,191

 
$
1,522,906

 
$
3,724,097

Liabilities:
 
 
 
 
 
 
 
 
Swaps
 
$
—

 
$
8,729

 
$
—

 
$
8,729

Non-recourse securitized debt
 
—

 
—

 
38,656

 
38,656

Total
 
$
—

 
$
8,729

 
$
38,656

 
$
47,385

 
 
Estimated Fair Value at December 31, 2013
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$
—

 
$
2,290,537

 
$
1,212,789

 
$
3,503,326

Securitized mortgage loans
 
—

 
—

 
110,984

 
110,984

Other investment securities
 
—

 
—

 
11,515

 
11,515

Short TBA Contracts
 
—

 
750

 
—

 
750

Swaps/Swaptions
 
—

 
52,565

 
—

 
52,565

Total
 
$
—

 
$
2,343,852

 
$
1,335,288

 
$
3,679,140

Liabilities:
 
 
 
 
 
 
 
 
Swaps
 
$
—

 
$
4,610

 
$
—

 
$
4,610

Non-recourse securitized debt
 
—

 
—

 
43,354

 
43,354

Total
 
$
—

 
$
4,610

 
$
43,354

 
$
47,964



16

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(f) Level III Fair Value Measurement Disclosures
Our non-Agency RMBS, securitized mortgage loans and securitized debt are measured at fair value and are considered to be Level III measurements of fair value.
The following table presents a summary of changes in the fair value of our non-Agency RMBS for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Beginning balance
 
$
1,298,541

 
$
595,838

 
$
1,212,789

 
$
605,197

Purchases
 
134,285

 
186,464

 
231,877

 
231,478

Sales
 
(4,742
)
 
(7,575
)
 
(11,309
)
 
(65,563
)
Principal repayments
 
(34,871
)
 
(25,194
)
 
(62,990
)
 
(48,609
)
Realized gains, net
 
298

 
1,442

 
2,434

 
9,730

Unrealized gains/(loss), net (1) 
 
4,815

 
(8,035
)
 
11,285

 
2,915

Discount accretion
 
14,868

 
8,084

 
29,108

 
15,876

Ending balance
 
$
1,413,194

 
$
751,024

 
$
1,413,194

 
$
751,024

 
(1) 
Includes unrealized losses that have been classified as OTTI of $1,462 and $1,227 for the three months ended June 30, 2014 and June 30, 2013, respectively, and $2,633 and $1,531 for the six months ended June 30, 2014 and June 30, 2013, respectively.
The following table presents a summary of the changes in the fair value of our securitized mortgage loans for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Beginning balance
 
$
110,307

 
$
114,881

 
$
110,984

 
$
—

Purchases
 
—

 
—

 
—

 
113,038

Principal repayments
 
(2,414
)
 
(1,054
)
 
(3,913
)
 
(2,051
)
Discount accretion and other adjustments
 
(223
)
 
(76
)
 
(264
)
 
(84
)
Unrealized gain/(loss) during the period, net (1)
 
2,042

 
(3,473
)
 
3,096

 
(625
)
Transfer to REO
 
—

 
—

 
(191
)
 
—

Ending balance
 
$
109,712

 
$
110,278

 
$
109,712

 
$
110,278

(1) 
Amount is net of losses recognized as OTTI of $782 and $0 for the three months ended June 30, 2014 and June 30, 2013, respectively, and $2,967 and $0 for the six months ended June 30, 2014 and June 30, 2013, respectively.
During the six months ended June 30, 2014, we transferred our other investment securities from Level III to Level II of the fair value hierarchy, all of which occurred during the three months ended March 31, 2014. These securities, comprised of STACR Notes, were transferred to Level II measurements of fair value based on the availability of significant observable market inputs which are used to price these securities. Transfers between levels are deemed to take place on the first day of the reporting period in which the transfer occurred.
The following table presents a summary of the changes in the fair value of our Level III other investment securities for the six months ended June 30, 2014:
 
 
Six Months Ended June 30, 2014 (1)
Beginning balance
 
$
11,515

Transfer out of Level III fair values
 
(11,515
)
Ending balance
 
$
—

(1) 
We did not have any securities included in "Other investment securities, at fair value" prior to July 2013.


17

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


The following table presents a summary of the changes in the fair value of our securitized debt for the periods presented: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Beginning balance
 
$
41,226

 
$
49,852

 
$
43,354

 
$
—

Debt issued during the period
 
—

 
—

 
—

 
50,375

Principal paid
 
(2,934
)
 
(1,627
)
 
(5,052
)
 
(3,022
)
Unrealized (gain)/loss
 
364

 
(887
)
 
354

 
(15
)
Ending balance
 
$
38,656

 
$
47,338

 
$
38,656

 
$
47,338

The following table presents key unobservable input assumptions used to arrive at the estimated fair value of our securitized mortgage loans at June 30, 2014:
Assumption
 
Weighted    
Average    
 
Range
Default rate
 
5.78
%
 
—
%
 
to
 
11.64
%
Loss severity
 
51.71
%
 
—
%
 
to
 
81.55
%
Voluntary prepayments
 
1.15
%
 
—
%
 
to
 
1.40
%
Discount rate
 
7.07
%
 
2.29
%
 
to
 
15.00
%
(g) Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on our consolidated balance sheet, at June 30, 2014 and December 31, 2013: 
 
 
June 30, 2014
 
December 31, 2013
 
 
Carrying Value
 
Estimated  Fair
Value
 
Carrying Value
 
Estimated  Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
Investment related receivable (1)
 
$
3,136

 
$
3,136

 
$
24,887

 
$
24,887

Warehouse line receivable (1)
 
$
13,462

 
$
13,462

 
$
—

 
$
—

Financial liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
$
2,991,989

 
$
2,992,139

 
$
3,034,058

 
$
3,034,230

Investment related payable (1)
 
$
13,299

 
$
13,299

 
$
—

 
$
—

(1) 
Carrying value approximates fair value due to the short-term nature of the item.
To determine the estimated fair value of our borrowings under repurchase agreements, contractual cash flows from such borrowings are discounted at estimated market interest rates, which rates may be based upon actual transactions executed by us or indicative rates quoted by brokers. The estimated fair values are not necessarily indicative of the amount we would realize on disposition of the financial instruments. Our borrowings under repurchase agreements had a weighted average remaining term to maturity of 77 days and 42 days at June 30, 2014 and December 31, 2013, respectively. Adjustments to valuations may be made as deemed appropriate to capture market information at the valuation date. Inputs used to arrive at the fair value of our repurchase agreement borrowings are generally observable and therefore the fair value of our repurchase agreement borrowings are classified as Level II valuations in the fair value hierarchy.



18

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Note 4 – Residential Mortgage-Backed Securities and Other Investment Securities
(a) RMBS
The following tables present certain information about our RMBS portfolio at June 30, 2014 and December 31, 2013:
 
 
Principal
Balance
 
Unamortized
Premium/
(Discount), Net (1)
 
Amortized
Cost (2) 
 
Estimated
Fair Value
 
Gross
Unrealized
Gain
 
Gross
Unrealized
Losses
 

Weighted
Average
Coupon
 
Estimated Weighted
Average
Yield (3)
 
 
June 30, 2014
Agency RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
3.5% Coupon
 
$
88,735

 
$
5,167

 
$
93,902

 
$
91,263

 
$
—

 
$
(2,639
)
 
3.50
%
 
2.58
%
4.0% Coupon
 
1,295,054

 
95,147

 
1,390,201

 
1,372,490

 
7,399

 
(25,110
)
 
4.00
%
 
2.83
%
4.5% Coupon
 
537,388

 
40,294

 
577,682

 
584,812

 
7,130

 
—

 
4.50
%
 
2.96
%
 
 
1,921,177

 
140,608

 
2,061,785

 
2,048,565

 
14,529

 
(27,749
)
 
4.12
%
 
2.86
%
Agency RMBS - 15-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
3.0% Coupon
 
50,435

 
1,352

 
51,787

 
52,309

 
522

 
—

 
3.00
%
 
2.48
%
Agency IO (4) 
 
—

 
—

 
39,144

 
42,368

 
3,224

 
—

 
3.96
%
 
0.67
%
Agency Inverse IO (4)
 
—

 
—

 
25,070

 
25,161

 
228

 
(137
)
 
6.06
%
 
13.52
%
Total Agency
 
1,971,612

 
141,960

 
2,177,786

 
2,168,403

 
18,503

 
(27,886
)
 
4.17
%
 
2.93
%
Non-Agency RMBS
 
1,630,824

 
(309,156
)
 
1,321,668

 
1,413,194

 
95,014

 
(3,488
)
 
1.23
%
 
6.16
%
Total RMBS
 
$
3,602,436

 
$
(167,196
)
 
$
3,499,454

 
$
3,581,597

 
$
113,517

 
$
(31,374
)
 
3.01
%
 
4.15
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
Agency RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
ARM-RMBS
 
$
11,619

 
$
782

 
$
12,401

 
$
12,339

 
$
—

 
$
(62
)
 
4.12
%
 
1.06
%
3.5% Coupon
 
303,026

 
19,925

 
322,951

 
301,068

 
—

 
(21,883
)
 
3.50
%
 
2.54
%
4.0% Coupon
 
1,558,943

 
120,636

 
1,679,579

 
1,602,080

 
—

 
(77,499
)
 
4.00
%
 
2.84
%
4.5% & 5.0% Coupons
 
235,127

 
18,266

 
253,393

 
250,136

 
—

 
(3,257
)
 
4.52
%
 
3.18
%
 
 
2,108,715

 
159,609

 
2,268,324

 
2,165,623

 
—

 
(102,701
)
 
3.99
%
 
2.82
%
Agency RMBS - 15-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
 
 
3.0% Coupon
 
52,699

 
1,413

 
54,112

 
53,711

 
—

 
(401
)
 
3.00
%
 
2.50
%
Agency IO (4)
 
—

 
—

 
41,521

 
44,425

 
3,254

 
(350
)
 
3.95
%
 
1.58
%
Agency Inverse IO (4)
 
—

 
—

 
27,673

 
26,778

 
50

 
(945
)
 
6.16
%
 
15.16
%
Total Agency
 
2,161,414

 
161,022

 
2,391,630

 
2,290,537

 
3,304

 
(104,397
)
 
4.08
%
 
2.94
%
Non-Agency RMBS
 
1,438,007

 
(302,827
)
 
1,135,180

 
1,212,789

 
81,876

 
(4,267
)
 
1.24
%
 
6.73
%
Total RMBS
 
$
3,599,421

 
$
(141,805
)
 
$
3,526,810

 
$
3,503,326

 
$
85,180

 
$
(108,664
)
 
3.09
%
 
4.16
%
Note: We apply trade-date accounting. Included in the above table are unsettled purchases with an aggregate cost of $13,299 at June 30, 2014 with an estimated fair value of $13,202. We had no unsettled purchases at December 31, 2013.
(1) 
A portion of the purchase discount on non-Agency RMBS is not expected to be recognized as interest income, and is instead viewed as a credit discount. See table included in Note 4(h).
(2) 
Amortized cost is reduced by unrealized losses that are classified as OTTI. We recognized OTTI of $2,219 and $2,015 for the three months ended June 30, 2014 and June 30, 2013, respectively, and $3,390 and $4,952 for the six months ended June 30, 2014 and June 30, 2013, respectively.
(3) 
The estimated weighted average yield at the date presented incorporates estimates for future prepayment assumptions on all RMBS and loss assumptions on non-Agency RMBS.
(4) 
Agency IO and Agency Inverse IO have no principal balance and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on such securities. At June 30, 2014 and December 31, 2013, our Agency IO had a notional balance of $401,322 and $410,187, respectively, and our Agency Inverse IO had a notional balance of $123,339 and $145,650, respectively.



19

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(b) Agency Pass-through RMBS
The following tables present certain information about our Agency pass-through RMBS by issuing Agency at June 30, 2014 and December 31, 2013:
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 
June 30, 2014
Fannie Mae
 
 
 
 
 
 
 
 
 
 
 
 
3.5% Coupon
 
$
19,598

 
$
1,054

 
$
20,652

 
$
20,183

 
$
—

 
$
(469
)
4.0% Coupon
 
577,543

 
45,966

 
623,509

 
613,558

 
1,409

 
(11,360
)
4.5% Coupon
 
429,382

 
32,439

 
461,821

 
467,485

 
5,664

 
—

 
 
1,026,523

 
79,459

 
1,105,982

 
1,101,226

 
7,073

 
(11,829
)
Freddie Mac
 
 
 


 
 
 
 
 
 
 
 
3.0% Coupon
 
50,435

 
1,352

 
51,787

 
52,309

 
522

 
—

3.5% Coupon
 
69,137

 
4,113

 
73,250

 
71,080

 
—

 
(2,170
)
4.0% Coupon
 
717,511

 
49,181

 
766,692

 
758,932

 
5,990

 
(13,750
)
4.5% Coupon
 
108,006

 
7,855

 
115,861

 
117,327

 
1,466

 
—

 
 
945,089

 
62,501

 
1,007,590

 
999,648

 
7,978

 
(15,920
)
Total Agency pass-through RMBS
 
$
1,971,612

 
$
141,960

 
$
2,113,572

 
$
2,100,874

 
$
15,051

 
$
(27,749
)
 
 
December 31, 2013
Fannie Mae
 
 
 
 
 
 
 
 
 
 
 
 
ARM-RMBS
 
$
11,619

 
$
782

 
$
12,401

 
$
12,339

 
$
—

 
$
(62
)
3.5% Coupon
 
195,625

 
12,982

 
208,607

 
194,518

 
—

 
(14,089
)
4.0% Coupon
 
867,103

 
70,437

 
937,540

 
894,009

 
—

 
(43,531
)
4.5% Coupon
 
210,356

 
16,301

 
226,657

 
223,536

 
—

 
(3,121
)
 
 
1,284,703

 
100,502

 
1,385,205

 
1,324,402

 
—

 
(60,803
)
Freddie Mac
 
 
 
 
 
 
 
 
 
 
 
 
3.0% Coupon
 
52,699

 
1,413

 
54,112

 
53,711

 
—

 
(401
)
3.5% Coupon
 
107,402

 
6,943

 
114,345

 
106,551

 
—

 
(7,794
)
4.0% Coupon
 
691,838

 
50,199

 
742,037

 
708,069

 
—

 
(33,968
)
4.5% & 5.0% Coupons
 
24,772

 
1,965

 
26,737

 
26,601

 
—

 
(136
)
 
 
876,711

 
60,520

 
937,231

 
894,932

 
—

 
(42,299
)
Total Agency pass-through RMBS
 
$
2,161,414

 
$
161,022

 
$
2,322,436

 
$
2,219,334

 
$
—

 
$
(103,102
)
(c) Non-Agency RMBS
The following tables present certain information about our non-Agency RMBS by type of underlying mortgage loan collateral type at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Subprime
 
$
1,252,886

 
$
(211,160
)
 
$
1,041,726

 
$
1,112,709

 
$
73,756

 
$
(2,773
)
Alt-A
 
195,910

 
(50,717
)
 
145,193

 
158,942

 
14,020

 
(271
)
Option ARMs
 
182,028

 
(47,279
)
 
134,749

 
141,543

 
7,238

 
(444
)
Total Non-Agency RMBS
 
$
1,630,824

 
$
(309,156
)
 
$
1,321,668

 
$
1,413,194

 
$
95,014

 
$
(3,488
)
(Tables continued on next page.)


20

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(Continued.)
 
 
December 31, 2013
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Subprime
 
$
1,128,254

 
$
(222,816
)
 
$
905,438

 
$
964,740

 
$
62,685

 
$
(3,383
)
Alt-A
 
164,010

 
(36,935
)
 
127,075

 
139,425

 
12,831

 
(481
)
Option ARMs
 
145,743

 
(43,076
)
 
102,667

 
108,624

 
6,360

 
(403
)
Total Non-Agency RMBS
 
$
1,438,007

 
$
(302,827
)
 
$
1,135,180

 
$
1,212,789

 
$
81,876

 
$
(4,267
)
(d) Unrealized Loss Positions on Investment Securities
The following table presents information about our investment securities that were in an unrealized loss position at June 30, 2014:
 
 
Unrealized Loss Position for Less than
12 Months
 
Unrealized Loss Position for 12
Months or More
 
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
Agency pass-through RMBS
 
$
—

 
$
—

 
—

 
$
1,003,992

 
$
(27,749
)
 
25

Agency IO
 
—

 
—

 
—

 
—

 
—

 
—

Agency Inverse IO
 
7,898

 
(79
)
 
2

 
1,035

 
(58
)
 
1

Total Agency RMBS
 
7,898

 
(79
)
 
2

 
1,005,027

 
(27,807
)
 
26

Non-Agency RMBS
 
263,352

 
(2,463
)
 
42

 
38,479

 
(1,025
)
 
12

Total RMBS
 
$
271,250

 
$
(2,542
)
 
44

 
$
1,043,506

 
$
(28,832
)
 
38

(e) Interest Income on RMBS
The following tables present components of interest income on our Agency RMBS and non-Agency RMBS for the periods presented:
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
Agency RMBS
 
$
24,717

 
$
(8,361
)
 
$
16,356

 
$
50,524

 
$
(17,010
)
 
$
33,514

Non-Agency RMBS
 
4,767

 
14,868

 
19,635

 
9,194

 
29,108

 
38,302

Total
 
$
29,484

 
$
6,507

 
$
35,991

 
$
59,718

 
$
12,098

 
$
71,816

 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
Agency RMBS
 
$
41,887

 
$
(13,499
)
 
$
28,388

 
$
77,691

 
$
(22,450
)
 
$
55,241

Non-Agency RMBS
 
2,560

 
8,084

 
10,644

 
4,829

 
15,876

 
20,705

Total
 
$
44,447

 
$
(5,415
)
 
$
39,032

 
$
82,520

 
$
(6,574
)
 
$
75,946



21

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(f) Realized and Unrealized Gains and Losses on RMBS
The following tables present components of net realized gains/(losses) and the change in net unrealized gains/(losses) on our RMBS portfolio for the periods presented:
 
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
RMBS Type
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
Agency pass-through - fixed rate
 
$
(7,168
)
 
$
47,672

 
$
(21,467
)
 
$
90,340

Agency IO
 
61

 
(1,334
)
 
61

 
(293
)
Agency Inverse IO
 
(263
)
 
437

 
149

 
843

Agency ARM
 
—

 
—

 
(59
)
 
62

Non-Agency
 
298

 
4,815

 
2,434

 
11,285

Total
 
$
(7,072
)
 
$
51,590

 
$
(18,882
)
 
$
102,237

RMBS Type
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
Agency pass-through - fixed rate
 
$
(49,204
)
 
$
(122,074
)
 
$
(41,850
)
 
$
(163,663
)
Agency IO
 
—

 
2,302

 
60

 
2,161

Agency Inverse IO
 
254

 
(7,014
)
 
347

 
(9,283
)
Non-Agency
 
1,442

 
(8,036
)
 
9,730

 
2,915

Total
 
$
(47,508
)
 
$
(134,822
)
 
$
(31,713
)
 
$
(167,870
)
(g) Contractual Maturities of RMBS, at Fair Value
The following table presents the maturities of our RMBS, based on the contractual maturities of the underlying mortgages at June 30, 2014 and December 31, 2013:
Contractual Maturities of RMBS (1)
 
June 30, 2014
 
December 31, 2013
> 10 years up to and including 20 years
 
$
313,840

 
$
189,243

> 20 years up to and including 30 years
 
3,163,062

 
2,861,028

> 30 years
 
104,695

 
453,055

Total
 
$
3,581,597

 
$
3,503,326

(1) 
Actual maturities of RMBS are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal, and the payment priority structure of the security; therefore actual maturities are generally shorter than the stated contractual maturities of the underlying mortgages.


22

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(h) Components of Discount on Non-Agency RMBS
The following table presents the changes in the components of our purchase discount on non-Agency RMBS between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented:
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
Discount
Designated as
Credit Reserve
and OTTI
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI (1)
 
Accretable Discount
Balance at beginning of period
 
$
(87,011
)
 
$
(206,429
)
 
$
(109,299
)
 
$
(193,647
)
Accretion of discount
 
—

 
14,837

 
—

 
29,059

Realized credit losses
 
1,125

 
—

 
2,305

 
—

Purchases
 
(29,499
)
 
(2,916
)
 
(31,538
)
 
(10,858
)
Sales and other
 
2,485

 
(470
)
 
8,998

 
(1,727
)
OTTI recognized in earnings
 
(1,462
)
 
—

 
(2,633
)
 
—

Transfers/release of credit reserve
 
3,278

 
(3,278
)
 
21,083

 
(21,083
)
Balance at end of period
 
$
(111,084
)
 
$
(198,256
)
 
$
(111,084
)
 
$
(198,256
)
(1)
At June 30, 2014, our non-Agency RMBS had gross discounts of $309,340, which included credit discounts of $99,231 and OTTI of $11,853. At December 31, 2013, our non-Agency RMBS had gross discounts of $302,946, which included credit discounts of $100,080 and OTTI of $9,219.
(i) Other Investment Securities
To date, our other investment securities have been comprised of STACR Notes. STACR Notes represent an unsecured general obligation of Freddie Mac and are structured to be subject to the performance of a certain pool of residential mortgage loans. STACR Notes pay interest monthly at a rate of one-month London Interbank Offer Rate (or, LIBOR) plus 3.4%. We recognized interest income of $103 and $204 on our STACR Notes for the three months and six months ended June 30, 2014, respectively. At June 30, 2014, our STACR Notes had a coupon rate of 3.55%, an amortized cost of $11,335 and an estimated fair value of $11,846.
Note 5 – Securitized Mortgage Loans
In February 2013, we purchased a pool of 755 mortgage loans with an unpaid principal balance of $155,001 for $113,038, which we simultaneously securitized. At June 30, 2014, our securitized mortgage loans were carried at their fair value of $109,712, comprised of an amortized cost of $99,704 and unrealized gains of $10,008. Amortized cost reflects the principal balance of the securitized mortgage loans less purchase discounts and OTTI recognized plus accretion of discount. Our securitized mortgage loan pool at June 30, 2014 was comprised of seasoned, fully amortizing, negatively amortizing and balloon, fixed-rate and adjustable-rate mortgage loans, secured by first liens on one-to-four family residential properties. We appointed the servicer who is responsible for servicing our securitized mortgage loans, which servicer may, over time, modify certain provisions of the loans in order to mitigate losses. (See Note 13.)
The following table presents a summary of the changes in the carrying value of securitized mortgage loans held for investment for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Balance beginning of period
 
$
110,307

 
$
114,881

 
$
110,984

 
$
—

Purchases during the period
 
—

 
—

 
—

 
113,038

Principal repayments
 
(2,414
)
 
(1,054
)
 
(3,913
)
 
(2,051
)
Discount accretion and other adjustments
 
(223
)
 
(76
)
 
(264
)
 
(84
)
Unrealized gain/(loss) during the period, net (1)
 
2,042

 
(3,473
)
 
3,096

 
(625
)
Transfer to REO
 
—

 
—

 
(191
)
 
—

Balance at end of period
 
$
109,712

 
$
110,278

 
$
109,712

 
$
110,278

(1) 
Amount is net of losses recognized as OTTI of $782 and $0 for the three months ended June 30, 2014 and June 30, 2013, respectively, and $2,967 and $0 for the six months ended June 30, 2014 and June 30, 2013, respectively.


23

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


The following table presents the five largest U.S. states represented in our securitized mortgage loans at June 30, 2014 based on principal balance:
Property Location
 
State Concentration
 
Principal Balance
California
 
21.1
%
 
$
30,432

Florida
 
13.8

 
19,929

Maryland
 
12.0

 
17,355

Texas
 
7.5

 
10,869

New Jersey
 
7.2

 
10,433

Other
 
38.4

 
55,127

Total
 
100.0
%
 
$
144,145

Note 6 – Receivables
(a) Interest Receivable
The following table presents our interest receivable by investment category at June 30, 2014 and December 31, 2013:
Investment Category
 
June 30, 2014
 
December 31, 2013
Agency RMBS - Fannie Mae
 
$
3,747

 
$
4,537

Agency RMBS - Freddie Mac
 
4,503

 
4,274

Non-Agency RMBS
 
971

 
902

Total RMBS interest receivable
 
9,221

 
9,713

Securitized mortgage loans
 
736

 
676

Other investment securities
 
7

 
7

Warehouse line receivable
 
123

 
—

Total interest receivable
 
$
10,087

 
$
10,396

(b) Investment Related Receivables
The following table presents the components of our investment related receivables at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Unsettled sales of Agency RMBS
 
$
—

 
$
21,978

Principal payments due from broker for non-Agency RMBS
 
3,136

 
2,909

Total investment related receivables
 
$
3,136

 
$
24,887

Note 7 – Borrowings Under Repurchase Agreements
As of June 30, 2014, we had master repurchase agreements with 24 counterparties and had outstanding borrowings of $2,991,989 with 17 counterparties. At June 30, 2014 and December 31, 2013, we had approximately $817 and $882, respectively, of deferred financing costs, net of amortization, included in “Deferred financing costs, net” on our consolidated balance sheet.


24

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Our repurchase agreements bear interest at a contractually agreed-upon rate and typically have initial terms of one to six months, but in some cases may have initial terms that are shorter or longer, up to 18 months. The following table presents certain characteristics of our repurchase agreements at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
 
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
Securities Financed:
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,905,783

 
0.35
%
 
22
 
$
2,082,447

 
0.42
%
 
19
Non-Agency RMBS (1)
 
1,075,603

 
1.99

 
174
 
942,091

 
2.00

 
94
Other investment securities
 
10,603

 
1.83

 
24
 
9,520

 
1.74

 
24
Total
 
$
2,991,989

 
0.94
%
 
77
 
$
3,034,058

 
0.91
%
 
42
(1) 
Includes $28,569 and $27,014 of repurchase borrowings collateralized by non-Agency RMBS of $48,638 and $47,057 at June 30, 2014 and December 31, 2013, respectively, that were eliminated from our balance sheet in consolidation with the VIE associated with our securitization transaction.
The following table presents repricing information about our borrowings under repurchase agreements, at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Time Until Interest Rate Reset:
 
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
30 days or less
 
$
1,972,910

 
0.79
%
 
$
2,349,800

 
0.83
%
> 30 days up to and including 60 days
 
586,467

 
0.67

 
534,487

 
0.95

> 60 days up to and including 90 days
 
47,317

 
1.83

 
55,950

 
2.06

> 90 days up to and including 120 days
 
88,657

 
1.63

 
13,406

 
2.05

> 120 days up to and including 360 days
 
296,638

 
2.20

 
74,682

 
2.21

> 360 days
 
—

 
—

 
5,733

 
2.59

Total
 
$
2,991,989

 
0.94
%
 
$
3,034,058

 
0.91
%
The following table presents the contractual maturity of our repurchase agreements at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Time Until Contractual Maturity:
 
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
30 days or less
 
$
1,777,077

 
0.64
%
 
$
2,181,208

 
0.70
%
> 30 days up to and including 60 days
 
586,467

 
0.67

 
534,487

 
0.95

> 60 days up to and including 90 days
 
47,317

 
1.83

 
55,950

 
2.06

> 90 days up to and including 120 days
 
88,657

 
1.63

 
13,406

 
2.05

> 120 days up to and including 360 days
 
296,639

 
2.20

 
243,274

 
2.36

> 360 days
 
195,832

 
2.16

 
5,733

 
2.59

Total
 
$
2,991,989

 
0.94
%
 
$
3,034,058

 
0.91
%



25

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Note 8 – Collateral Positions
The following table presents the fair value of our collateral positions, reflecting assets pledged and collateral we held, with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
 
 
Assets Pledged as Collateral
 
Collateral Held
 
Assets Pledged as Collateral
 
Collateral Held
Derivatives:
 
 
 
 
 
 
 
 
Restricted cash/cash (1)
 
$
11,743

 
$
11,426

 
$
2,550

 
$
38,654

Repurchase agreement borrowings:
 
 
 
 
 
 
 
 
Agency RMBS 
 
1,996,566

 
—

 
2,125,767

 
—

Non-Agency RMBS (2)
 
1,427,238

 
—

 
1,256,250

 
—

Other investment securities
 
11,846

 
—

 
11,515

 
—

Restricted cash
 
33,349

 
—

 
64,908

 
—

 
 
3,468,999

 
—

 
3,458,440

 
—

Clearing margin:
 
 
 
 
 
 
 
 
Agency RMBS
 
4,069

 
—

 
4,059

 
—

Total
 
$
3,484,811

 
$
11,426

 
$
3,465,049

 
$
38,654

(1) 
Cash pledged as collateral is reported as “Restricted cash” on our consolidated balance sheet. Cash held as collateral is unrestricted in use and therefore is included in cash with a corresponding liability on our consolidated balance sheet.
(2) 
Includes non-Agency RMBS of $48,638 and $47,057 at June 30, 2014 and December 31, 2013, respectively, that were eliminated from our balance sheet in consolidation with the VIE associated with our securitization transaction.
The following tables present our collateral positions, reflecting assets pledged with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
 
Assets Pledged at
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS (1)
 
$
1,996,566

 
$
2,011,426

 
$
6,382

 
$
2,002,948

Non-Agency RMBS (2)
 
1,427,238

 
1,333,410

 
1,059

 
1,428,297

Other investment securities
 
11,846

 
11,335

 
7

 
11,853

Cash
 
33,349

 
—

 
—

 
33,349

 
 
3,468,999

 
3,356,171

 
7,448

 
3,476,447

Cash pledged for derivatives
 
11,743

 
—

 
—

 
11,743

Agency RMBS pledged for clearing margin
 
4,069

 
4,014

 
13

 
4,082

Total
 
$
3,484,811

 
$
3,360,185

 
$
7,461

 
$
3,492,272

(Tables and notes continued on next page.)



26

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(Continued.)
 
 
December 31, 2013
 
 
Assets Pledged-
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS (1)
 
$
2,125,767

 
$
2,225,769

 
$
6,850

 
$
2,132,617

Non-Agency RMBS (3)
 
1,256,250

 
1,174,007

 
1,150

 
1,257,400

Other investment securities
 
11,515

 
11,180

 
7

 
11,522

Cash
 
64,908

 
—

 
—

 
64,908

 
 
3,458,440

 
3,410,956

 
8,007

 
3,466,447

Cash pledged for Swaps and Swaptions
 
2,550

 
—

 
—

 
2,550

Agency RMBS pledged for clearing margin
 
4,059

 
4,331

 
12

 
4,071

Total
 
$
3,465,049

 
$
3,415,287

 
$
8,019

 
$
3,473,068

 
(1) 
There were no unsettled trades at June 30, 2014. Includes Agency RMBS of $21,959 that were sold but unsettled at December 31, 2013.
(2) 
Includes a non-Agency RMBS with a fair value of $48,638, an amortized cost of $45,896 and the associated interest receivable of $124, all of which were eliminated in consolidation with a VIE.
(3) 
Includes a non-Agency RMBS with a fair value of $47,057, an amortized cost of $42,400 and the associated interest receivable of $141, all of which were eliminated in consolidation with a VIE.
In February 2013, we engaged in a securitization transaction that resulted in us consolidating, as a VIE, the trust that was created to facilitate the transaction and to which the underlying mortgage loans in connection with the securitization were transferred. As a part of the securitization transaction, the most senior security created was sold to a third-party investor and as such, this senior security is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value.” The securitized mortgage loans held by the securitization trust are restricted in that they can only be used to fulfill the obligations of the securitization trust. As such, the fair value of the securitized mortgage loans is effectively viewed as collateralizing the non-recourse securitized debt on our consolidated balance sheet at June 30, 2014. (See Note 13.)
A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and other financial instruments are subject to financial covenants, which if breached could cause an event of default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such agreements would be immediately payable by us. Through June 30, 2014, we remained in compliance with all of our financial covenants. (See Note 10.)



27

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Note 9 – Offsetting Assets and Liabilities
All balances associated with the repurchase agreements and derivatives transactions are presented on a gross basis in our consolidated balance sheets. Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of set-off in the event of default or in the event of a bankruptcy of either party to the transaction.
The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset on our consolidated balance sheet at June 30, 2014 and December 31, 2013:
Offsetting of Financial Assets and Derivative Assets
 
 
 
 
 
 
 
 
Gross Amounts Not Offset
in the Consolidated
Balance Sheet
 
 
Gross
Amounts of
Recognized
Assets
 
Gross Amounts
Offset in  the
Consolidated
Balance Sheet
 
Net Amounts
 of Assets  Presented
in the
Consolidated
Balance Sheet
 
Financial
Instruments (1)
 
Cash
Collateral
Received
 
Net
Amount
June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
20,942

 
$
—

 
$
20,942

 
$
(4,805
)
 
$
(11,426
)
 
$
4,711

December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
52,565

 
$
—

 
$
52,565

 
$
(2,643
)
 
$
(38,016
)
 
$
11,906

Short TBA Contracts, at fair value
 
750


—


750


—


(638
)

112

 
 
$
53,315

 
$
—

 
$
53,315

 
$
(2,643
)
 
$
(38,654
)
 
$
12,018

Offsetting of Financial Liabilities and Derivative Liabilities
 
 
 
 
 
 
 
 
Gross Amounts Not Offset
in the Consolidated
Balance Sheet
 
 
Gross
Amounts of
Recognized
Liabilities
 
Gross Amounts
Offset in the
Consolidated
Balance Sheet
 
Net Amounts of
Liabilities
Presented in the
Consolidated
Balance Sheet
 
Financial Instruments (2) (3)
 
Cash
Collateral
Pledged  (2) (4)
 
Net
Amount
June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
8,729

 
$
—

 
$
8,729

 
$
(4,805
)
 
$
(3,924
)
 
$
—

Repurchase agreements
 
2,991,989

 
—

 
2,991,989

 
(2,991,989
)
 
—

 
—

 
 
$
3,000,718

 
$
—

 
$
3,000,718

 
$
(2,996,794
)
 
$
(3,924
)
 
$
—

December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
4,610

 
$
—

 
$
4,610

 
$
(2,643
)
 
$
(1,967
)
 
$
—

Repurchase agreements
 
3,034,058

 
—

 
3,034,058

 
(3,034,058
)
 
—

 
—

 
 
$
3,038,668

 
$
—

 
$
3,038,668

 
$
(3,036,701
)
 
$
(1,967
)
 
$
—

(1) 
Amounts represent derivative instruments in an asset position which could potentially be offset against interest rate derivatives in a liability position at June 30, 2014 and December 31, 2013, subject to a netting arrangement.
(2) 
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements and interest rate derivatives.
(3) 
The fair value of securities pledged against our borrowings under repurchase agreements was $3,435,650 (which includes $48,638 of RMBS that are not included in our consolidated balance sheet, as such assets were eliminated in consolidation with a VIE) and $3,393,532 at June 30, 2014 and December 31, 2013, respectively.
(4) 
Total cash pledged against our derivatives was $11,743 and $2,550 at June 30, 2014 and December 31, 2013, respectively. Total cash collateral pledged against our borrowings under repurchase agreements was $33,349 and $64,908 at June 30, 2014 and December 31, 2013, respectively.



28

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Note 10 – Derivative Instruments
We enter into derivative contracts, which through June 30, 2014 have from time to time been comprised of Swaps, Swaptions, and Short TBA Contracts. We use derivative instruments to manage interest rate risk and, as such, view them as economic hedges. We have not elected hedge accounting for any of our derivative instruments and, as a result, the fair value adjustments on such instruments are recorded in earnings. The fair value adjustments for our derivatives, along with the related interest income, interest expense and gains/(losses) on termination of such instruments, are reported as a net gain/(loss) on derivative instruments on our consolidated statements of operations.
Pursuant to our Swaps, we agree to pay a fixed rate of interest and receive a variable rate of interest based on the notional amount of the Swap. The variable amount that we receive from our Swap counterparties is typically based on three-month LIBOR. We pay a premium to our Swaption counterparties to purchase a Swaption. Each of our Swaptions gives us the right, at the expiration of the option period, to either: (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money, as prescribed in the Swaption confirmation.
We had no TBA Contracts at June 30, 2014. At December 2013, we had four Short TBA Contracts with a weighted average sale price of 102.93% for $400,000 of 4.0% coupon, Fannie Mae 30-Year RMBS. These Short TBA Contracts settled in February 2014, resulting in a net realized loss of $7,156.
Information with respect to our derivative instruments as presented on our consolidated balance sheets at June 30, 2014 and December 31, 2013 was as follows:
 
 
June 30, 2014
 
December 31, 2013
 
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Swaps - assets
 
$
957,000

 
$
18,087

 
$
1,007,000

 
$
40,135

Swaptions - assets
 
1,335,000

 
2,855

 
1,375,000

 
12,430

Swaps - (liabilities)
 
730,000

 
(8,729
)
 
580,000

 
(4,610
)
Short TBA Contracts - assets
 
—

 
—

 
400,000

 
750

Total Derivative Instruments
 
$
3,022,000

 
$
12,213

 
$
3,362,000

 
$
48,705

The following table summarizes the average fixed-pay rate and average maturity for our Swaps as of June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Term to Maturity
 
Notional
Amount
 
Average
Fixed-Pay
Rate
 
Average
Maturity
(Years)
 
Notional
Amount
 
Average
Fixed-Pay
Rate
 
Average
Maturity
(Years)
> One year up to and including three years
 
$
580,000

 
1.20
%
 
2.7
 
$
110,000

 
1.38
%
 
2.8
> Three years up to and including five years
 
529,000

 
0.90

 
3.4
 
999,000

 
1.02

 
3.7
> Five years
 
578,000

 
2.13

 
8.4
 
478,000

 
1.98

 
8.7
Total
 
$
1,687,000

 
1.43
%
 
4.9
 
$
1,587,000

 
1.34
%
 
5.1
At June 30, 2014, the Swaps underlying our Swaptions had a weighted average fixed-pay rate of 3.72%. The following table presents information about our Swaptions at June 30, 2014:
 
 
Option
 
Underlying Swap
Fixed-Pay Rate for Underlying Swap
 
Fair Value
 
Weighted Average Months Until Option Expiration
 
Notional
Amount
 
Weighted Average Swap Term (Years)
 
Weighted Average Fixed-Pay Rate
2.50 - 3.00%
 
$
879

 
11
 
$
160,000

 
5.0
 
2.77
%
3.50 - 4.00%
 
1,976

 
6
 
1,075,000

 
10.0
 
3.79

4.00 - 4.50%
 
—

 
2
 
100,000

 
10.0
 
4.41

 
 
$
2,855

 
6
 
$
1,335,000

 
9.4
 
3.72
%
 


29

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


The following table summarizes the amounts recognized on our consolidated statements of operations related to our derivative instruments for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Character of Gain/(Loss) on Derivative Instruments
 
2014
 
2013
 
2014
 
2013
Net interest payments/accruals on Swaps (1)
 
$
(5,081
)
 
$
(6,437
)
 
$
(9,870
)
 
$
(10,576
)
Gains on the termination of Swaps, net (1)
 
—

 
8,589

 
—

 
8,589

Gain/(losses) on the termination and expiration of Swaptions, net (1)
 
(7,585
)
 
1,439

 
(14,112
)
 
1,439

Losses on settlement of Short TBA Contracts (1)
 
—

 
—

 
(7,156
)
 
—

Change in fair value of Swaps (2)
 
(15,244
)
 
71,713

 
(26,168
)
 
70,793

Change in fair value of Swaptions (2)
 
777

 
8,888

 
(6,267
)
 
8,149

Change in fair value of Short TBA Contracts (2)
 
—

 
(823
)
 
(750
)
 
(823
)
Total
 
$
(27,133
)
 
$
83,369

 
$
(64,323
)
 
$
77,571

Note: Each of the items presented is included as a component of “Gain/(loss) on derivative instruments, net” on our consolidated statements of operations for the periods presented.
(1) 
Amounts are realized.
(2) 
Amounts are unrealized.
The following table provides information with respect to our use of derivative instruments for the periods presented:
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
Swaps
 
Swaptions
 
Short TBA Contracts
 
Swaps
 
Swaptions
Beginning Notional Balance
 
$
1,687,000

 
$
1,275,000

 
$
400,000

 
$
1,587,000

 
$
1,375,000

Notional amount of contracts entered
 
—

 
560,000

 
—

 
100,000

 
1,010,000

Notional amount of contracts terminated and expired
 
—

 
(500,000
)
 
(400,000
)
 
—

 
(1,050,000
)
Ending Notional Balance
 
$
1,687,000

 
$
1,335,000

 
$
—

 
$
1,687,000

 
$
1,335,000

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
Swaps
 
Swaptions
 
Short TBA Contracts
 
Swaps
 
Swaptions
Beginning Notional Balance
 
$
2,207,000

 
$
225,000

 
$
—

 
$
1,500,000

 
$
75,000

Notional amount of contracts entered
 
175,000

 
625,000

 
—

 
882,000

 
775,000

Notional amount of contracts terminated and expired
 
(350,000
)
 
(75,000
)
 
—

 
(350,000
)
 
(75,000
)
Ending Notional Balance
 
$
2,032,000

 
$
775,000

 
$
—

 
$
2,032,000

 
$
775,000

Financial Covenants
Our agreements with certain of our derivative counterparties contain financial covenants; through June 30, 2014, we were in compliance with the terms of all such covenants. We have minimum collateral posting thresholds with certain of our Swap counterparties, for which we typically pledge cash. (See Notes 8 and 9.) If we had breached any of these provisions at June 30, 2014, we could have been required to settle our obligations under our Swaps at their termination value of $11,187, which amount reflects the estimated fair value of our Swaps that were in a liability position, plus accrued interest.



30

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Note 11 – Interest Payable
The following table presents the components of our interest payable at June 30, 2014 and December 31, 2013: 
 
 
June 30, 2014
 
December 31, 2013
Repurchase borrowings collateralized by Agency RMBS
 
$
1,380

 
$
2,091

Repurchase borrowings collateralized by non-Agency RMBS (1)
 
6,554

 
4,637

Repurchase borrowings collateralized by other investment securities
 
83

 
31

Securitized debt
 
124

 
141

Swaps
 
2,936

 
1,808

Total interest payable
 
$
11,077

 
$
8,708

(1) 
Includes $125 of interest payable on repurchase borrowings collateralized by a non-Agency RMBS issued by a consolidated VIE at June 30, 2014, which security was eliminated from our balance sheet in consolidation.
Note 12 – Commitments and Contingencies
(a) Management Agreement – Related Party Transactions
In connection with our initial public offering (or, IPO) in July 2011, we entered into a management agreement with our Manager (or, Management Agreement), which describes the services to be provided for us by our Manager and compensation for such services. Our Manager is responsible for managing our day-to-day operations, subject to the direction and oversight of our board of directors.
Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of adjusted stockholders’ equity (as defined in the Management Agreement), calculated and payable quarterly in arrears.
The initial term of the Management Agreement expired on July 27, 2014 and was automatically renewed for a one-year term until July 27, 2015. Absent certain action by the independent directors of our board of directors, as described below, the Management Agreement will continue to automatically renew on each anniversary for a one year term. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors, based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us; or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
We incurred management fees of $2,774 and $2,921 for the three months ended June 30, 2014 and 2013, respectively, and $5,560 and $5,710 for the six months ended June 30, 2014 and 2013, respectively. In addition to the management fee, we are responsible for reimbursing our Manager, or any of its affiliates, for certain expenses paid by such parties on our behalf and for certain services provided for us by our Manager or any of its affiliates. We recorded expenses of $2,553 and $1,953 for the three months ended June 30, 2014 and 2013, respectively, and $4,490 and $4,317 for the six months ended June 30, 2014 and 2013, respectively, related to reimbursements for certain expenses incurred by our Manager or its affiliates on our behalf. Expenses incurred by our Manager or its affiliates and reimbursed by us are typically included in our general and administrative expense on our consolidated statements of operations, or may be reflected on our consolidated balance sheet and associated consolidated statement of changes in stockholders’ equity, based on the nature of the item. At June 30, 2014 and December 31, 2013, $2,774 and $2,928, respectively, for management fees incurred but not yet paid were included in payable to related party on our consolidated balance sheet.
(b) Representations and Warranties in Connection with Securitization
In connection with our securitization transaction, we have the obligation under certain circumstances to repurchase assets from the VIE upon breach of certain representations and warranties. In February 2014, the substantial majority of these obligations expired, with only the representations and warranties surviving such obligations, which may expose us to losses, being that the loans transferred to the VIE are qualified mortgages under Section 860G(a)(3) of the Internal Revenue Code. Through June 30, 2014, no repurchase claims had been made against us, and we do not believe that the amount of any future


31

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


potential liability with respect to such item (the maximum of which would be the current unpaid principal balance of any such loan plus accrued interest, unreimbursed advances and any expenses) is material to us. At June 30, 2014, we had no reserve established for repurchases of loans and were not aware of any repurchase claims that would require the establishment of such a reserve. (See Note 13.)
Note 13 – Use of Special Purpose Entities
Special purpose entities (or, SPEs) are entities designed to fulfill a specific limited need of the entity that organizes it. SPEs are often used to facilitate transactions that involve securitizing financial assets. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis. Securitization involves transferring assets to an SPE to convert all or a portion of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of debt or equity instruments. Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall structure of the transaction, may benefit from various forms of credit enhancement, such as over-collateralization in the form of excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement.
(a) Securitization Transaction
In February 2013, we engaged in a securitization transaction that resulted in us consolidating, as a VIE, the SPE/trust that was created to facilitate the transaction and to which the underlying mortgage loans in connection with the securitization were transferred. (See Note 2(g) for a discussion of our accounting policies applied to the consolidation of the VIE and transfer of the financial assets in connection with the securitization.)
The mortgage loans in the securitization trust are comprised of performing and re-performing mortgage loans with characteristics similar to the mortgage loans underlying our non-Agency RMBS.
The following table presents certain information about our securitization transaction at the time of securitization unless otherwise indicated:
Principal value of mortgage loans sold into the securitization trust
 
$
155,001

Face amount of senior security issued by the VIE and sold to a third-party investor
 
$
50,375

Outstanding balance of senior security at June 30, 2014
 
$
37,348

Face/Par value of certificates received by us (1)
 
$
104,626

Cash received from sale of the senior security sold
 
$
50,375

Gross securitization expenses incurred ($615 net of amortization as of June 30, 2014) (2)
 
$
829

Pass-through interest rate for senior security issued - fixed rate
 
4.00
%
(1) 
The certificates we received are subordinate to and provide credit support for the sequential senior security sold to a third-party investor in the securitization transaction. While the RMBS that we retained in connection with our securitization transaction do not appear on our balance sheet, as they were eliminated in consolidation with the VIE/securitization trust, we legally own such securities and therefore are legally permitted to pledge such securities as collateral.
(2) 
Securitization expenses incurred were capitalized as deferred charges and are amortized to interest expense based upon the actual repayments of the associated senior security sold to a third party.
On a quarterly basis, we complete an analysis to determine whether the VIE should be consolidated by us. As part of this analysis, we consider our involvement in the creation of the VIE, including the design and purpose of the VIE and whether our involvement reflects a controlling financial interest that results in us being deemed the primary beneficiary of the VIE. In determining whether we would be considered the primary beneficiary, we consider: (i) whether we have both the power to direct the activities that most significantly impact the economic performance of the VIE; and (ii) whether we have a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. Based on our evaluation of these factors, including our involvement in the design of the VIE, we determined that we were required to consolidate the VIE created to facilitate the securitization transaction for each reporting period from inception through June 30, 2014.
For financial statement reporting purposes, given that we consolidate the securitization trust, no gain or loss was reported on the sale of the mortgage loans to the securitization trust. Since the underlying trust is consolidated, the securitization is


32



Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


effectively viewed as a financing of the mortgage loans that were “sold” to enable the senior security to be created and sold to a third-party investor. As such, the senior security is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value.” The third-party beneficial interest holders in the VIE have no recourse against us, except that we have an obligation to repurchase assets from the VIE in the event that we breach certain representations and warranties in relation to the mortgage loans sold to the VIE. In the absence of such a breach, we have no obligation to provide any other explicit or implicit support to any VIE. As previously stated, we are not obligated to provide, nor have we provided, any financial support to these consolidated securitization vehicles.
As of June 30, 2014, the aggregate fair value of our securitized mortgage loans was $109,712, and are presented on our consolidated balance sheet as “Securitized mortgage loans (transferred to a consolidated variable interest entity), at fair value.”
The securitization trust receives principal and interest on the underlying mortgage loans and distributes those payments to the certificate holders. The assets and other instruments held by the securitization trust are restricted in that they can only be used to fulfill the obligations of the securitization trust. The risks associated with our involvement with the VIE is limited to the risks and rights as a certificate holder of the securities we retained.  
The activities of the trust are substantially set forth in the securitization transaction documents, primarily the mortgage loan trust agreement, the trust agreement, the indenture and the securitization servicing agreement (collectively, the “Securitization Agreements”). Neither the trust nor any other entity may sell or replace any assets of the trust except in connection with: (i) certain loan defects or breaches of certain representations and warranties which have a material adverse effect on the value of the related assets; (ii) loan defaults; (iii) certain trust events of default or (iv) an optional termination of the trust, each as specifically permitted under the Securitization Agreements.
(b) Securitized Debt
We consolidated the VIE created as a result of our securitization transaction in February 2013. As a result, on our consolidated balance sheet we report: (i) “Non-recourse securitized debt, at fair value” which reflects the senior security sold to third-party investors and (ii) “Securitized mortgage loans (transferred to a consolidated VIE), at fair value” which reflects the residential mortgage loans held by the trust that collateralize all of the securities issued from the trust.
At June 30, 2014, the securitized debt collateralized by residential mortgage loans had a principal balance of $37,348. The senior security, which has a final contractual maturity in 2047, has a fixed coupon rate of 4.00%. The 4.00% rate reflects the coupon rate on the senior security held by third-party investors. In addition, we capitalized (as deferred financing costs) expenses associated with the securitization transaction and amortize such costs to interest expense over the life of the securitized debt.
Our securitized debt is carried at fair value, which is based on the fair value of the senior security held by third parties. The following table presents the estimated principal repayment schedule of the par value of the securitized debt at June 30, 2014, based on expected cash flows of the securitized mortgage loans, as adjusted for projected losses on such loans.
Estimated Maturity
 
June 30, 2014
One year or less
 
$
7,391

> One year up to and including three years
 
18,726

> Three years up to and including five years
 
11,231

Total
 
$
37,348

Repayment of our securitized debt will be dependent upon the cash flows generated by the mortgage loans in the securitization trust that collateralize such debt. The actual cash flows from the securitized mortgage loans are comprised of coupon interest, scheduled principal payments, prepayments and liquidations of the underlying mortgage loans. The actual term of the securitized debt may differ significantly from our estimate given that actual interest collections, mortgage prepayments and/or losses on liquidation of mortgages may differ significantly from those expected. (See Note 5, for more information about the mortgage loans collateralizing our securitized debt.)


33

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


(c) VIE Impact on the Consolidated Financial Statements
The following table reflects the assets and liabilities recorded in our consolidated balance sheet related to our consolidated VIE as of June 30, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Assets:
 
 
 
 
Securitized mortgage loans, at fair value
 
$
109,712

 
$
110,984

Interest receivable
 
$
736

 
$
676

Liabilities:
 
 
 
 
Non-recourse securitized debt, at fair value
 
$
38,656

 
$
43,354

Accrued interest payable
 
$
124

 
$
141

The following table reflects the income and expense amounts recorded in our consolidated statements of operations related to our consolidated VIE for the period presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Interest income - securitized mortgage loans
 
$
1,927

 
$
2,297

 
$
4,173

 
$
3,630

Interest expense - securitized debt
 
$
(432
)
 
$
(508
)
 
$
(874
)
 
$
(818
)
Unrealized gain/(loss) on securitized mortgage loans, net
 
$
2,042

 
$
(3,473
)
 
$
3,096

 
$
(625
)
Unrealized gain/(loss) on securitized debt
 
$
(364
)
 
$
887

 
$
(354
)
 
$
15

Other, net
 
$
(68
)
 
$
—

 
$
(68
)
 
$
—

The following table reflects the amounts included on our consolidated statements of cash flows related to our consolidated VIE for the period presented:
 
 
Six Months Ended June 30,
 
 
2014
 
2013
Net income
 
$
5,973

 
$
2,202

Premium amortization/(discount accretion), net
 
$
263

 
$
51

Amortization of deferred financing costs
 
$
83

 
$
50

Unrealized (gain)/loss on securitized mortgage loans, net
 
$
(3,096
)
 
$
625

Unrealized (gain)/loss on securitized debt
 
$
354

 
$
(15
)
Realized loss on real estate owned, net
 
$
68

 
$
—

(Increase) in accrued interest receivable, less purchased interest
 
$
(60
)
 
$
(753
)
Increase/(decrease) in accrued interest payable
 
$
(17
)
 
$
158

Purchase of mortgage loans, simultaneously securitized
 
$
—

 
$
(113,038
)
Proceeds from sales of real estate owned
 
$
30

 
$
—

Other, net
 
$
1

 
$
33

Principal payments received on securitized mortgage loans
 
$
3,913

 
$
2,051

Proceeds from issuance of securitized debt
 
$
—

 
$
50,375

Principal payments on securitized debt
 
$
(5,052
)
 
$
(3,022
)
Note 14 – Equity Award Plan
On July 21, 2011, our board of directors approved the Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan (or, LTIP). The LTIP provides for grants of restricted common stock, RSUs and other equity-based awards up to an aggregate of 5% of the issued and outstanding shares of our common stock (on a fully diluted basis). The LTIP is administered by the compensation committee of our board of directors, which also must approve grants made under the LTIP. At June 30, 2014, 1,338,893 awards were available for grant under the LTIP. To date, all awards made pursuant to the LTIP vest over a three year period in either quarterly or annual installments, provided that there has not been a termination of service of the grantee.


34

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


The following table presents expenses related to our equity-based compensation awards for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Restricted Common Stock
 
$
103

 
$
91

 
$
193

 
$
168

RSUs
 
305

 
55

 
674

 
377

Total
 
$
408

 
$
146

 
$
867

 
$
545

At June 30, 2014, we had estimated unrecognized compensation expense of $1,304 and $462 related to RSUs and restricted common stock, respectively. The unrecognized compensation expense at June 30, 2014 is expected to be recognized over a weighted average period of 1.0 year. As of June 30, 2014, we had an expected average forfeiture rate of 0% with respect to restricted common stock and 4.2% with respect to RSUs. Through June 30, 2014, no cash was used in the settlement of awards issued pursuant to the LTIP.
The following table presents information about our equity awards for the periods presented:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
RSUs outstanding at beginning of period
 
182,359

 
$
19.48

 
165,119

 
$
20.16

 
183,922

 
$
19.47

 
166,682

 
$
20.14

RSUs granted
 
—

 
—

 
6,250

 
18.09

 
—

 
—

 
6,250

 
18.09

RSUs canceled upon delivery of common stock
 
(1,562
)
 
17.95

 
(1,562
)
 
17.95

 
(3,125
)
 
17.95

 
(3,125
)
 
17.95

RSUs outstanding at end of period
 
180,797

 
$
19.50

 
169,807

 
$
20.10

 
180,797

 
$
19.50

 
169,807

 
$
20.10

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested RSUs
 
62,160

 
$
19.76

 
9,110

 
$
16.94

 
62,160

 
$
19.76

 
9,110

 
$
16.94

Unvested RSUs
 
118,637

 
$
19.36

 
162,021

 
$
20.24

 
118,637

 
$
19.36

 
162,021

 
$
20.24

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Restricted common stock awards outstanding at beginning of period
 
25,140

 
$
20.52

 
36,120

 
$
19.79

 
28,040

 
$
20.37

 
38,468

 
$
19.69

Restricted common stock granted
 
9,208

 
16.29

 
6,748

 
22.22

 
9,208

 
16.29

 
6,748

 
22.22

Restricted common stock vested
 
(2,908
)
 
19.03

 
(2,344
)
 
18.27

 
(5,808
)
 
19.03

 
(4,692
)
 
18.29

Restricted common stock outstanding at end of period
 
31,440

 
$
19.42

 
40,524

 
$
20.28

 
31,440

 
$
19.42

 
40,524

 
$
20.28

(1) 
Amounts are not in thousands.
The following table presents information about our unvested RSUs for the periods presented:
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards
 
Weighted Average Grant Date Fair Value (1)
Unvested RSUs at beginning of period
 
124,688

 
$
19.30

 
127,241

 
$
19.26

RSUs granted
 
—

 
—

 
—

 
—

RSUs vested
 
(6,051
)
 
18.16

 
(8,604
)
 
17.94

RSUs cancelled, forfeited or expired
 
—

 
—

 
—

 
—

Unvested RSUs at end of period
 
118,637

 
$
19.36

 
118,637

 
$
19.36

(1) 
Amounts are not in thousands.


35

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Restricted stock granted in the three and six months ended June 30, 2014, all of which were granted in April 2014, had a grant date fair value of $150.  We did not grant any RSUs during the six months ended June 30, 2014. The grant date fair value of restricted stock that vested during the three and six months ended June 30, 2014 was $55 and $110, respectively. The grant date fair value of the RSUs that vested during the three and six months ended June 30. 2014 was $110 and $154, respectively.
Note 15 – Stockholders’ Equity
(a) Common Stock Dividends
The following table presents cash dividends declared by our board of directors on our common stock from January 1, 2013 through June 30, 2014:
Declaration Date
 
Record Date
 
Payment Date
 
Dividend Per Share
June 19, 2014
 
June 30, 2014
 
July 31, 2014
 
$
0.42

March 13, 2014
 
March 31, 2014
 
April 30, 2014
 
$
0.40

December 18, 2013
 
December 31, 2013
 
January 31, 2014
 
$
0.40

September 19, 2013
 
September 30, 2013
 
October 31, 2013
 
$
0.40

June 17, 2013
 
June 28, 2013
 
July 31, 2013
 
$
0.70

March 18, 2013
 
March 28, 2013
 
April 30, 2013
 
$
0.70

(b) Common Stock
The following table presents information with respect to shares of our common stock issued through public offerings from January 1, 2013 through June 30, 2014:
Share Settlement Date
 
Shares Issued
 
Gross Proceeds  Per
Share
 
Gross Proceeds (1)
March 25, 2013
 
1,020,000

 
$
22.00

 
$
22,440

March 13, 2013
 
6,800,000

 
$
22.00

 
$
149,600

(1) 
We raised net equity capital of $22,421 and $149,221 after offering costs of $19 and $379 for the shares issued on March 25, 2013 and March 13, 2013, respectively.
(c) Preferred Stock
At June 30, 2014 and December 31, 2013, we had outstanding 6,900,000 shares of 8.0% Series A Cumulative Redeemable Perpetual Preferred Stock (or, Preferred Stock) with a liquidation preference of $25.00 per share and a par value $0.01 per share. Holders of our Preferred Stock are entitled to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. These dividends are cumulative and payable quarterly in arrears. Generally, we may not redeem the Preferred Stock until September 20, 2017, except under certain limited circumstances intended to preserve our qualification as a REIT and upon the occurrence of a change in control as defined in the final prospectus supplement related to the Preferred Stock filed with the SEC on September 17, 2012. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. Upon assessing the characteristics of the Preferred Stock, we determined that such instruments are characterized as equity instruments.
The Preferred Stock generally has no voting rights. However, if dividends on the Preferred Stock are in arrears for six quarterly dividend periods, whether or not consecutive, the holders of the Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) will have the right to elect two additional directors to our board until we pay (or declare and set aside for payment) all dividends that are then in arrears. In addition, the affirmative vote of at least two-thirds of the votes entitled to be cast by holders of outstanding shares of Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) is required for us to authorize, create or increase the number of any class or series of senior equity securities or to amend our charter (including the Articles


36

Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share amounts)
 


Supplementary designating the Preferred Stock, or the Articles Supplementary) in a manner that materially and adversely affects the rights of the Preferred Stock.
(d) Shelf Registration
On July 23, 2012, we filed a shelf registration statement on Form S-3 with the SEC under the Securities Act of 1933, as amended (or, the Securities Act), with respect to up to $750,000 of common stock, preferred stock, depositary shares, warrants and/or rights that may be sold by us from time to time pursuant to Rule 415 of the Securities Act. This registration statement was declared effective by the SEC on August 10, 2012. At June 30, 2014, we had $405,460 available under this shelf registration statement.
(e) Direct Stock Purchase and Dividend Reinvestment Plan
On November 13, 2012, we filed a Registration Statement on Form S-3 with the SEC under the Securities Act reserving 2,000,000 shares of common stock available under the terms of our Direct Stock Purchase and Dividend Reinvestment Plan (or, Stock Purchase Plan). Under the Stock Purchase Plan, stockholders who participate may purchase shares of our common stock directly from us. Stockholders may also automatically reinvest all or a portion of their dividends for additional shares of our stock. Through June 30, 2014, all shares issued pursuant to the Stock Purchase Plan were issued from shares purchased on the open market.
(f) Stock Repurchase Program
On November 6, 2013, our Board of Directors authorized a stock repurchase program (or, the Repurchase Program), to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program, if any, will be cancelled and, until reissued by us, will be deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior notice. Through June 30, 2014, we had not repurchased any shares of common stock under the Repurchase Program.
Note 16 – Earnings per Common Share
The following table presents basic and diluted net EPS of common stock using the two-class method for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
 
Net Income/(loss)
 
$
44,004

 
$
(72,767
)
 
$
71,886

 
$
(67,427
)
Less:
 
 
 
 
 
 
 
 
Dividends declared on Preferred Stock
 
3,450

 
3,450

 
6,900

 
6,900

Dividends, dividend equivalents and undistributed earnings allocated to participating securities
 
263

 
139

 
416

 
273

Net income/(loss) allocable to common stock – basic and diluted
 
$
40,291

 
$
(76,356
)
 
$
64,570

 
$
(74,600
)
Denominator:
 
 
 
 
 
 
 
 
Weighted average common shares - basic
 
32,019,863

 
31,995,321

 
32,017,640

 
28,858,241

Weighted average common shares - diluted (1)
 
32,105,666

 
31,995,321

 
32,084,993

 
28,858,241

Earnings/(loss) per common share - basic
 
$
1.26

 
$
(2.39
)
 
$
2.02

 
$
(2.59
)
Earnings/(loss) per common share - diluted
 
$
1.25

 
$
(2.39
)
 
$
2.01

 
$
(2.59
)
(1) 
For the three and six months ended June 30, 2014, we had an aggregate of 0 and 4,063 RSUs and 22,232 and 22,232 shares of restricted common stock outstanding, respectively, which were not included in the calculation of EPS, as their inclusion would have been anti-dilutive. These instruments may have a dilutive impact on future EPS.


37




ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(Dollars in thousands, except share and per share data or as otherwise noted, by use of the word “million” or “billion.”)
FORWARD-LOOKING INFORMATION
We make forward-looking statements in this Quarterly Report on Form 10-Q and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (or, the Exchange Act). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may,” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in our industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; our business and investment strategy; our operating results and potential asset performance; 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; our 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 we participate; changes in the value of our assets; our expected portfolio of assets; our expected investment and underwriting process; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; prepayment speeds on our target assets; effects of hedging instruments on our target assets; rates of default or decreased recovery rates on our target assets; the degree to which our hedging strategies may or may not protect us from interest rate volatility; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; our ability to maintain our qualification as a REIT for U.S. Federal income tax purposes; our ability to maintain our exclusion from registration as an investment company under 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 our ability to make distributions to our stockholders in the future; and our understanding of our competition.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. See “Part I, Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2013. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in our Annual Report on Form 10-K filed for the year ended December 31, 2013.
General
We were incorporated in Maryland on March 15, 2011 and began operations on July 27, 2011. We are structured as a holding company and conduct our business primarily through ARM Operating, LLC and our other operating subsidiaries. We have elected and operate to qualify as a REIT for U.S. Federal income tax purposes commencing with our taxable year ended December 31, 2011. We also operate our business in a manner that we believe will allow us to remain excluded from registration as an investment company under the 1940 Act. We are externally managed and advised by our Manager, an indirect subsidiary of Apollo Global Management, LLC.
At June 30, 2014, our portfolio was comprised of: (i) Agency RMBS (which include pass-through securities whose underlying collateral primarily includes fixed-rate mortgages), Agency IO and Agency Inverse IO; (ii) non-Agency RMBS; (iii) securitized mortgage loans; (iv) other mortgage-related securities and (v) a warehouse line receivable.


38


Over time, we expect that we may invest in a broader range of other residential mortgage and mortgage-related assets. (See “Target Assets,” below.)
We use leverage as part of our business strategy in order to increase potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon our Manager’s assessment of a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties.
We use derivatives to hedge a portion of our interest rate risk and not for speculative purposes. As of June 30, 2014, our derivatives included Swaps and Swaptions.
Factors Impacting Our Operating Results
Our results of operations are driven by, among other things, our net interest income, changes in the market value of our investments and derivative instruments and, from time to time, realized gains and losses on the sale of our investments and termination of our derivative instruments. The supply and demand for RMBS in the market place, the terms and availability of financing for our RMBS, general economic and real estate conditions, the impact of U.S. Government actions that impact the real estate and mortgage sector, and the credit performance of our non-Agency RMBS impact our overall performance. Our net interest income varies primarily as a result of changes in market interest rates and the slope of the yield curve (i.e., the differential between long-term and short-term interest rates) and the constant prepayment rate (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on RMBS as a percentage of the principal balance, and includes the conditional repayment rate (or, CRR), which measures voluntary prepayments of mortgages collateralizing a particular RMBS and conditional default rates (or, CDR), which measures involuntary prepayments resulting from defaults of the underlying mortgage loans. Prepayments vary according to the type of investment, interest rates, conditions in the financial and housing markets, new government regulations, government and private sector initiatives, availability of credit to home borrowers, underwriting standards, the economy in general, competition and other factors, none of which can be predicted with any certainty. In addition, our borrowing costs and available credit are further affected by the collateral pledged and general conditions in the credit market. Interest rate spread measures the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities, while net interest margin reflects net interest income divided by average interest-earning assets. Our net interest income and our net interest margin are significantly impacted by the amount of leverage we use.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our Agency pass-through RMBS and Agency Inverse IO to decline; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS; (v) the value of our Agency IO to increase; (vi) the value of our Short TBA Contracts, if any, Swaps and Swaptions to improve; and (vii) the value of our Long TBA Contracts, if any, to decline. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs as well as other conditions in the market place will further impact our results of operations and financial condition. In addition, in periods with low interest rates, such as the current environment, the impact of decreases in interest rates may be limited, given that we do not expect that interest rates will decrease to zero.
Premiums arise when we purchase securities at prices in excess of their par value and discounts arise when we purchase securities at prices below their par value. Premiums on our RMBS are amortized against interest income over the life of the security, while discounts (excluding credit discounts, as discussed below) are accreted to income over the life of the security. The speeds at which premiums are amortized and discounts are accreted are significantly impacted by the CPR for each security.
We are exposed to credit risk with respect to our non-Agency RMBS, other investment securities, securitized mortgage loans associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such assets. The credit risk on our non-Agency RMBS is generally mitigated by the credit support built into non-Agency RMBS structures and the purchase discounts on such securities, which provides a level of credit protection in the event that we receive less than 100% of the par value of these securities. In addition, we are exposed to credit risk associated with our warehouse line receivable, which is secured by a pledge of substantially all the assets of the third-party borrower and guarantor which owns the homes during the time they are pledged on the warehouse line. To date we purchased substantially all of our non-Agency RMBS at a discount to par value; a portion of such discount may be viewed as a credit discount, which is not expected to be amortized into interest income. The amount designated as a credit discount on a security may change over time based on the security’s performance and its anticipated future performance. (See “Credit Risk,” included under Item 3 of this Quarterly Report on Form 10-Q.)


39


Interest income on our non-Agency RMBS is recorded at an effective yield, which reflects an estimate of expected cash flows for each security. In forecasting cash flows on our non-Agency RMBS, our Manager makes certain assumptions about the underlying mortgage loans, which assumptions include, but are not limited to, future interest rates, voluntary prepayment rates, default rates, modifications and loss severities. As part of our non-Agency RMBS surveillance, we review, on at least a quarterly basis, each security’s performance. To the extent that actual performance and our current assessment of future performance differs from our prior assessment, such changes are reflected in the yield/income recognized on such securities prospectively. Credit losses greater than those anticipated, or in excess of purchase discount on a given security, could materially adversely impact our operating results.
We receive interest payments only with respect to the notional amount of Agency IO and Agency Inverse IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency pass-through RMBS, the market prices of Agency IO generally have a positive correlation to increases in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO are expected to decrease, which in turn is expected to extend/increase the cash flow and the value of such securities; we expect the inverse to occur with respect to decreases in market interest rates. In addition to viewing Agency IO as investments, we also note that such instruments serve as a partial economic hedge against the impact that an increase in market interest rates would have on the value of our Agency pass-through RMBS in the marketplace. While Agency IO and Agency Inverse IO comprised a relatively small portion of our investments at June 30, 2014, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments.
In the fourth quarter of 2013, we entered into an agreement whereby we provide funding through a warehouse line to a third-party to finance the acquisition and improvement of single-family homes. Once the homes are improved, they will be marketed for sale with the seller providing financing to the buyer in the form of a mortgage loan or a bond-for-title contract (or, BFT Contract). We refer to this initiative, whereby we make warehouse advances and purchase BFT Contracts and mortgage loans as our “BFT Program.” BFT Contracts are legal agreements to finance the purchase of real property in which the seller provides the buyer with financing to purchase the property for an agreed-upon purchase price, and the buyer repays the loan in installments over the ensuing 20 to 30 years, depending on the term of the loan. Pursuant to a BFT Contract, unlike a mortgage loan, the seller retains the legal title to the property, granting the buyer complete use of the property and requiring the buyer to maintain the property, including the payment of property taxes. Pursuant to a BFT Contract, the seller generally conveys legal title of the property to the buyer when the full purchase price set forth in the contract has been paid, including all interest incurred through the date of final payment.



40


Target Assets
As of June 30, 2014, we held investments in Agency RMBS, including Agency IO and Agency Inverse IO, non-Agency RMBS and, to a lesser extent, securitized mortgage loans, other investment securities and a warehouse line receivable. We believe that the continued diversification of our portfolio of assets, our expertise within our target asset classes and the flexibility of our strategy will enable us to achieve attractive risk-adjusted returns under a variety of market conditions and economic cycles over time. In the future, we may invest in assets other than our target assets listed below, in each case subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes and our exclusion from registration as an investment company under the 1940 Act. Our board of directors may, without stockholder approval, amend our investment strategy at any time. The following is a summary of our target assets at June 30, 2014:
Asset Classes
 
Principal Assets
 
 
Agency RMBS
 
Agency RMBS, primarily comprised of whole-pool pass-through securities, CMOs, Agency IO, Agency Inverse IO and Agency principal-only (or, Agency PO) securities.
 
 
Non-Agency RMBS
 
Non-Agency RMBS, including highly-rated, as well as non-investment grade and unrated, tranches backed by Alt-A mortgage loans, Option ARMs, Subprime mortgage loans and prime mortgage loans.
 
 
Residential Mortgage Loans
 
Prime mortgage loans, jumbo mortgage loans, Alt-A mortgage loans, Option ARMs, Subprime mortgage loans or other mortgage-like financing arrangements, including, but not limited to, BFT Contracts. These investments may be performing, sub-performing or non-performing.
 
 
Other Residential Mortgage-Related Assets
 
Non-Agency RMBS comprised of interest-only securities (or, non-Agency IO), principal-only securities (or, non-Agency PO), floating rate inverse interest-only securities (or, non-Agency Inverse IO), and floating rate securities, and other Agency and non-Agency RMBS derivative securities, as well as other financial assets, including, but not limited to, common stock, preferred stock and debt of other real estate-related entities, mortgage servicing rights, excess servicing spreads, advances on our warehouse line and mortgage loans to investors in residential properties. In addition, we may own real estate incidental to our financing arrangements associated with such properties.
We rely on our Manager’s expertise in identifying assets within our target asset classes and to efficiently finance those assets. We expect that our Manager will make decisions based on a variety of factors, including expected risk-adjusted returns on our assets, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our qualification as a REIT and our exclusion from registration as an investment company under the 1940 Act.
Financing Strategy
We use leverage primarily for the purpose of financing our investment portfolio and increasing potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We had an aggregate debt-to-equity multiple of 3.8 times at June 30, 2014. Our debt-to-equity multiple reflects the aggregate of our borrowings under repurchase agreements and securitized debt (based upon fair value) to our total stockholders’ equity.
We continue to have available capacity under our master repurchase agreements. However, such agreements are generally uncommitted and are renewable at the discretion of our lenders. We finance our Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity ratio of approximately eight-to-one leverage and finance our non-Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity ratio of approximately three-to-one leverage. Our target and actual leverage may vary from time to time based on our assessment of market conditions. The terms of our repurchase agreements are typically one to six months at inception, but in some cases may have initial terms that are shorter or longer, up to 18 months. At June 30, 2014, we had master repurchase agreements with 24 counterparties. As a matter of routine business, we may have discussions with additional financial institutions with respect to expanding our repurchase agreement borrowing capacity. As of June 30, 2014, we had $2,991,989 of borrowings outstanding under our repurchase agreements with 17 counterparties collateralized by $1,996,566 of Agency RMBS, $1,427,238 of non-


41


Agency RMBS (which included $48,638 of non-Agency RMBS that were eliminated from our balance sheet in consolidation with a VIE) and $11,846 of other investment securities. (See Notes 7, 8 and 9 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
In addition to repurchase borrowings and securitized debt, subject to market conditions, we may utilize other sources of leverage in the future, including, but not limited to, securitized debt associated with resecuritizations, warehouse facilities, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. Our future use of these alternative forms of financing is subject to market conditions.
Hedging Strategy
Subject to maintaining our qualification as a REIT for U.S. Federal income purposes, we pursue various hedging strategies with the objective of reducing our exposure to increases in interest rates. The U.S. Federal income tax rules applicable to REITs may necessitate that we implement certain of these techniques through a TRS that will generally be subject to U.S. Federal and state income taxation. Our hedging activity may vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions.
Our Swaps and Swaptions are intended to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings; in addition, these derivative instruments may also mitigate the impact of increases in interest rates on the value of our Agency RMBS portfolio.
At June 30, 2014, our Swaps had an aggregate notional of $1,687,000 with a weighted average fixed-pay rate of 1.43% and a weighted average term to maturity of 4.9 years. Our Swaps have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of the Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. Our Swaptions provide that at the expiration of the option period, we: (i) may enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money. The method of settlement at expiration of the option period is prescribed in each Swaption confirmation. At June 30, 2014, our Swaptions had an aggregate notional of $1,335,000 and a weighted average term of six months until expiration. At June 30, 2014, the Swaps underlying our Swaptions had a weighted average fixed-pay rate of 3.72% and a weighted average term of 9.4 years.
In addition to Swaps and Swaptions, from time to time we also enter into TBA Contracts. Short TBA Contracts may serve as an economic hedge against decreases in the value of Agency RMBS held in our portfolio, in an amount equivalent to the TBA Contract notional balance, with the same characteristics as those stipulated in the TBA Contract, or may serve as an economic hedge of indebtedness incurred or to be incurred to acquire real estate assets. At June 30, 2014, we were not a party to any TBA Contracts. (See Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.) For U.S. Federal income tax purposes, although the law is not clear with respect to TBA Contracts, we intend to take the position that settling Short TBA Contracts that hedge Agency RMBS results in a gain or loss on the disposition of the securities delivered for the purpose of the REIT 75% and 95% gross income tests as described in the Internal Revenue Code. We expect that any gains recognized in connection with the settlement of Short TBA Contracts or other derivative transactions that we may identify to hedge indebtedness incurred or to be incurred to acquire real estate assets would not constitute gross income for purposes of the REIT 75% and 95% gross income tests.
To date, we have not elected to apply hedge accounting pursuant to GAAP for our derivatives and, as a result, we record changes in the estimated fair value of such instruments, along with the associated net Swap interest in earnings, as a component of the net gain/(loss) on derivatives instruments in our consolidated statements of operations.
Certain Swap trades are required to be cleared through a clearinghouse, in accordance with the Commodities Futures Trading Commission (or, CFTC) Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties. The change in Swap margin collateral requirements generally increases the inherent cost of cleared Swaps, as higher amounts of cash are required to be pledged to meet the initial margin requirement on such transactions. For additional information about our derivative instruments, see Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.
Variances between GAAP Income and Taxable Income
Our net income for financial reporting purposes differs from our taxable income. The differences are the result of the use of different methods prescribed by GAAP and the Internal Revenue Code for recognizing certain items of income and expense. Certain of these differences give rise to “timing differences” between GAAP net income and taxable income while other variations cause “permanent differences” between GAAP net income and taxable net income. Timing differences reverse over


42


time and may cause significant periodic variances between GAAP and taxable net income; permanent differences do not reverse over time.
Timing differences between GAAP net income and taxable net income with respect to the amount of amortization of purchase premiums, accretion of purchase discounts and original issue discount (or, OID) on our Agency and non-Agency RMBS will also cause GAAP to tax differences to arise in the amount of gains/losses we recognize on sales of securities.
For the three and six months ended June 30, 2014, the most significant differences between our GAAP and taxable net income arose from the following: (1) net unrealized gains/(losses) which are recognized under GAAP but are not recognized for tax purposes; (2) accretion of purchase discounts on non-Agency RMBS were recognized more slowly for tax purposes than for GAAP; (3) net losses on Swaps and Swaptions terminated and expired during the quarter were recognized currently for GAAP purposes; for tax purposes, gains/losses on terminations of our Swaps and Swaptions are recognized over the remaining term of the Swap or the term of the Swap underlying the Swaption; and (4) differences in the recognition of income from our February 2013 securitization transaction.
The timing of accretion of purchase discount into income on our non-Agency RMBS and the amortization of purchase premiums on Agency RMBS may differ significantly for GAAP and tax purposes. Currently, this timing difference is most significant with respect to our non-Agency RMBS that are “locked-out” from receiving principal payments (until the more senior bonds in the securitization structure are repaid) and on which we receive only interest payments. During the period that non-Agency RMBS that we purchase at a discount are locked-out from receiving principal payments, the amount of taxable income recognized on these bonds will generally be significantly lower than income recognized under GAAP. This timing difference is expected to begin to reverse as the bonds that are locked-out begin to receive principal payments. The ultimate performance of our non-Agency RMBS will impact the aggregate income recognized over the life of the bonds under both GAAP and tax.
The determination of taxable income attributable to non-Agency RMBS is dependent on a number of factors, including principal payments, defaults and loss severities. Such estimates require significant judgment and actual results may differ from these estimates. Moreover, the deductibility of realized losses from non-Agency RMBS and their effect on market discount accretion is analyzed on an asset-by-asset basis and while they will result in a reduction of taxable income, this reduction tends to occur gradually and primarily in periods after the realized losses are reported.
We hold certain securities that were issued with OID. For tax purposes, we generally recognize OID accretion as interest income over the life of the applicable securities, using a constant yield to maturity, without any loss assumptions. As a result, for tax purposes, REIT taxable income may be recognized in excess of GAAP income or in advance of the corresponding cash flow from securities that have OID. OID does not impact the amount of income recognized under GAAP, unless we purchased such securities at original issue.
As of June 30, 2014, for tax purposes we had estimated non-deductible net capital losses from the prior year of $95.3 million which will be carried forward and offset against future net capital gains for up to five years. This capital loss carry-forward will reduce the amount of future dividends designated as capital gains, if any, that we would otherwise expect to distribute, since capital gains would first be reduced by capital loss carry-forwards. In addition, as of June 30, 2014, we had estimated net deferred tax gains from terminated Swaps of $19.1 million and estimated net tax deferred losses from terminated and expired Swaptions of $7.2 million which will be accreted into future ordinary taxable income over the remaining terms of the underlying Swaps. At June 30, 2014, the weighted average remaining amortization period for Swap gains was 4.7 years and for Swaps underlying Swaptions was 5.0 years.
Depending on the structure of a particular securitization or resecuritization transaction, for tax purposes, such transactions may be treated either as a sale or a financing of the underlying assets. Income recognized from securitization and resecuritization transactions will generally differ for tax and GAAP purposes. In February 2013, we purchased a pool of mortgage loans and concurrently executed a securitization transaction. This securitization was treated as a sale for tax purposes and, effectively, treated as financing for GAAP purposes, whereby we consolidate the securitization trust under GAAP. As a result of these differences, for tax purposes, no interest income is recognized on our securitized mortgage loans and no interest expense is recognized for our securitized debt; instead, interest income is recognized on the subordinated bonds we retained.
Critical Accounting Policies and Use of Estimates
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q. A summary of our critical accounting policies is set forth in our Annual Report on Form 10-K for the year ended December 31, 2013 under “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Use of Estimates.”



43


Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2014
General:
During the second quarter of 2014, interest rates declined marginally, with U.S. Treasury and swap rates remaining in a tight range. Despite the decline in interest rates during the second quarter of 2014, mortgage prepayments remained benign as mortgage rates had not fallen enough to spark refinancing activity. The U.S. Federal Reserve Open Market Committee (or, FOMC) continued to taper bond purchases of Agency RMBS and U.S. Treasury securities under its quantitative easing policy (or, QE3) during the second quarter of 2014. As a result of this tapering, FOMC monthly purchases of U.S. Treasury securities and Agency RMBS were reduced to $25 billion and $20 billion beginning in May 2014, respectively, from $45 billion and $40 billion for December 2013, respectively. Beginning in July 2014, the FOMC further reduced its purchases to $20 billion per month and $15 billion per month of U.S. Treasury securities and Agency RMBS, respectively. In July 2014, the FOMC announced that it expects to conclude its monthly Agency RMBS and U.S. Treasury purchase program in October 2014. We expect increased volatility in interest rates and Agency RMBS spreads as the FOMC, the largest buyer in the sector, steps away from the market, which we believe will impact Agency RMBS valuations.
The table below presents rates for ten-year U.S. Treasuries and ten-year Swap rates at the dates indicated during the six months ended June 30, 2014:
Table 1
 
Ten-Year Treasury Rate
 
Ten-Year Swap Rate
Month Ended
 
High
 
Low
 
Month End
 
High
 
Low
 
Month End
June 30, 2014
 
2.65
%
 
2.53
%
 
2.53
%
 
2.76
%
 
2.63
%
 
2.63
%
May 31, 2014
 
2.66
%
 
2.44
%
 
2.48
%
 
2.74
%
 
2.54
%
 
2.59
%
April 30, 2014
 
2.81
%
 
2.63
%
 
2.65
%
 
2.92
%
 
2.74
%
 
2.75
%
March 31, 2014
 
2.79
%
 
2.60
%
 
2.72
%
 
2.89
%
 
2.73
%
 
2.84
%
February 28, 2014
 
2.76
%
 
2.58
%
 
2.65
%
 
2.89
%
 
2.72
%
 
2.76
%
January 31, 2014
 
3.03
%
 
2.64
%
 
2.64
%
 
3.09
%
 
2.79
%
 
2.79
%
Agency RMBS Portfolio/Interest Rate Hedges:
As rates drifted lower, the market showed renewed demand for prepayment protection in higher coupon Agency pass-through RMBS. Accordingly, prices on Agency RMBS with attributes that mitigate prepayments expanded relative to generic Agency RMBS during the second quarter of 2014. In addition, market valuations of Agency RMBS increased during the second quarter of 2014 as net Agency RMBS supply remained consistently at or below zero during the second quarter of 2014, as FOMC purchases continued to absorb new production.
We expect that as long as mortgage rates to the consumer remain above 4.0%, prepayments will remain contained and support fundamental valuations. At the end of the second quarter, 30-year fixed-rate conforming mortgage rates hovered around 4.25%.
During the second quarter of 2014, valuations on our Agency pass-through RMBS investments improved, contributing to the 3.5% increase in our Agency RMBS portfolio at June 30, 2014, compared to March 31, 2014. At June 30, 2014, we had Agency RMBS of $2,168,403 and Agency repurchase borrowings of $1,905,783, compared to Agency RMBS of $2,094,671 and Agency repurchase borrowings of $1,861,066 at March 31, 2014.
For the second quarter of 2014, our Agency RMBS portfolio experienced a fair value weighted CPR of 6.7% comprised of 6.6% CPR on Agency pass-through securities and 8.5% on Agency IO and Agency Inverse IO in the aggregate. During the quarter, the maximum average monthly CPR of our Agency RMBS was experienced in June 2014, with an overall Agency CPR of 7.5% comprised of 7.4% on Agency pass-through securities and 8.7% on Agency IO and Agency Inverse IO in the aggregate.


44


The following table presents the estimated fair value and net unrealized gain/(loss) position with respect to our Agency RMBS portfolio at June 30, 2014 compared to March 31, 2014:
Table 2
 
June 30, 2014
 
March 31, 2014
Collateral
 
Estimated Fair Value
 
Unrealized Gain/(Loss), net
 
Estimated Fair Value
 
Unrealized Gain/(Loss), net
30-Year Mortgages:
 
 
 
 
 
 
 
 
3.5% Coupon
 
$
91,263

 
$
(2,639
)
 
$
184,027

 
$
(10,578
)
4.0% Coupon
 
1,372,490

 
(17,711
)
 
1,461,460

 
(48,867
)
4.5% Coupon
 
584,812

 
7,130

 
333,498

 
(968
)
 
 
2,048,565

 
(13,220
)
 
1,978,985

 
(60,413
)
15 Year Mortgages:
 
 
 
 
 
 
 
 
3.0% Coupon
 
52,309

 
522

 
53,016

 
42

Agency IO
 
42,368

 
3,224

 
47,959

 
3,945

Agency Inverse IO
 
25,161

 
91

 
14,711

 
(489
)
Total Agency RMBS
 
$
2,168,403

 
$
(9,383
)
 
$
2,094,671

 
$
(56,915
)
During the three months ended June 30, 2014, we increased our hedge position by increasing our Swaption notional amount by $60,000. This net increase reflects the expiration of $500,000 notional amount of Swaptions with ten-year underlying Swaps and purchases of $560,000 notional amount of Swaptions, of which $400,000 had ten-year underlying Swaps and $160,000 had five-year underlying Swaps.
The following table presents information with respect to our Swaps and Swaptions at June 30, 2014 compared to March 31, 2014:
Table 3
 
June 30, 2014
 
March 31, 2014
Swaps:
 
 
 
 
Notional amount
 
$
1,687,000

 
$
1,687,000

Estimated fair value
 
$
9,358

 
$
24,601

Unrealized gain/(loss), net
 
(26,168
)
 
(10,924
)
Weighted average fixed-pay rate
 
1.43
%
 
1.43
%
Weighted average months to maturity
 
58

 
61

 
 
 
 
 
Swaptions:
 
 
 
 
Notional amount
 
$
1,335,000

 
$
1,275,000

Estimated fair value
 
$
2,855

 
$
3,494

Unrealized gain/(loss), net
 
(6,267
)
 
(7,044
)
Weighted average months to expiration
 
6
 
5
Weighted average underlying Swap months
 
113
 
120
Weighted average underlying Swap fixed-pay rate
 
3.72
%
 
3.73
%
Credit Investments
Market yields available on non-Agency RMBS generally continued to trend lower during the second quarter of 2014, as market prices for such bonds generally continued to increase. We believe non-Agency valuations continue to be driven by technicals, such as the continued lack of supply of newly issued non-Agency securities, as well as fundamentals, such as the recovering housing market, which should lead to better performance with respect to borrower defaults and loss severities in the future. Our non-Agency RMBS performed well over the second quarter of 2014, with stable voluntary prepayments and loss severities and continued decreases in defaults. During the quarter, we transferred $1.8 million, net from credit reserve to accretable discount on our non-Agency RMBS, which is net of OTTI recognized. These transfers reflect the positive impact on our non-Agency RMBS from home price appreciation, as reflected by lower default levels across our non-Agency portfolio. We expect the impact of this transfer to be reflected in future interest income on non-Agency RMBS.
During the second quarter of 2014, we invested $134,285 in non-Agency RMBS with a weighted average purchase price of 80.6% of par value and a weighted average unlevered yield of 4.60%. At June 30, 2014, 59.6% of our non-Agency portfolio was comprised of securities on which we receive both principal and interest on a monthly basis, compared with 50.0% of such


45


securities at March 31, 2014. The remaining non-Agency RMBS are comprised of securities on which we currently receive only interest payments and will receive principal after the more senior securities in the capital structure are paid off. (See Table 20 below.)
We believe that the migration in our portfolio from Agency RMBS to non-Agency RMBS has reduced our exposure to changes in interest rates and increased our sensitivity to credit risk. Our average debt-to-equity multiple for the second quarter of 2014 remained at 3.7 times, effectively unchanged from the quarter ended March 31, 2014.
The following table presents the composition of our investment portfolio as a percentage of total investments as of June 30, 2014 compared to March 31, 2014:
Table 4
 
June 30, 2014
 
March 31, 2014
Agency pass-through RMBS
 
56.5
%
 
57.8
%
Agency IO and Agency Inverse IO
 
1.8
%
 
1.8
%
Total Agency RMBS
 
58.3
%
 
59.6
%
 
 
 
 
 
Non-Agency RMBS
 
38.0
%
 
36.9
%
Securitized Mortgage Loans
 
3.0
%
 
3.1
%
Warehouse Line Receivable
 
0.4
%
 
0.1
%
Other Investment Securities (1)
 
0.3
%
 
0.3
%
(1) 
Other investment securities are comprised of STACR Notes.
Credit Initiatives
During the second quarter of 2014, we advanced $10,445 under our BFT Program warehouse line to fund the acquisition by a third-party of single-family homes in the southeastern U.S. We view our BFT Program as a novel way to gain exposure to rising real estate values and as a complement to our strategy of acquiring non-Agency RMBS.
We anticipate that we will purchase BFT Contracts and/or mortgage loans originated in connection with the BFT Program over time. This investment strategy is in its early stages, and our ultimate investment in BFT Contracts and/or mortgage loans will be dependent on, among other things, market conditions and the ability of one or more third parties to efficiently and economically purchase, rehabilitate and sell or convert such properties to individuals. In addition, given that such investments are less liquid than non-Agency securities, we are proceeding thoughtfully with this program. As of June 30, 2014, we had $13,462 outstanding on our BFT Program warehouse line which was used by a third-party to fund the acquisition and improvement of 220 properties and to make earnest money deposits on 29 properties.
Borrowings and Borrowing Facilities:
Borrowings under repurchase agreements collateralized by Agency and non-Agency RMBS remained readily available from our counterparties. Financing rates on repurchase agreements collateralized by Agency RMBS declined by approximately one to two basis points during the second quarter of 2014. During this time, more counterparties offered non-Agency financing, resulting in a competitive environment that caused haircuts, or the percentage by which the collateral value is discounted to determine the loan amount, and funding rates for repurchase borrowings collateralized by such securities to generally decline as well.
Regulatory Updates:
Bipartisan efforts by the U.S. Congress to wind down Government Sponsored Entities (or, the GSEs), Fannie Mae and Freddie Mac, and return the nation's housing finance system to more private capital advanced in July 2014, with the introduction of the “Partnership to Strengthen Homeownership” bill, which provides for winding down the GSEs and replacing them with a new system based on private capital. This bill provides for a defined government backstop to ensure credit is available for stable mortgages, but would require private investors to take the first loss if mortgages faltered. The Partnership to Strengthen Homeownership bill shares some of the key reform principles contained in the bipartisan GSE reform legislation previously proposed.
It remains unclear which, if any, of the currently proposed legislation will be enacted, and, if any legislation is enacted, what the impact of such legislation will be. For a discussion of additional risks relating to our business, see “Part I, Item 1A- Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.


46


Results of Operations
Three Months Ended June 30, 2014 compared to the Three Months Ended June 30, 2013
For the three months ended June 30, 2014, we had net income allocable to common stock and participating securities of $40,554, or $1.26 per basic share and $1.25 per diluted share, compared to net loss allocable to common stock and participating securities of $76,217, or $2.39 per basic and diluted share for the three months ended June 30, 2013. Our results of operations for the three months ended June 30, 2013 were significantly impacted by steep declines in the value of our Agency RMBS portfolio, some of which were realized through sales, which were partially offset by increases in the value of our derivative instruments.
Net Interest Income
Our net interest income was $30,631 for the three months ended June 30, 2014, compared to $34,092 for the comparative period in 2013. For the three months ended June 30, 2014 and June 30, 2013, we earned interest income of $38,141 and $41,329, respectively, and incurred interest expense of approximately $7,510 and $7,237, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher borrowing expense reflects our increase in non-Agency RMBS and associated repurchase borrowings, which borrowings have higher interest rates than repurchase agreements on Agency RMBS. We had securitized debt with a contractual balance of $37,348 and $47,353 at June 30, 2014 and June 30, 2013, respectively, with a fixed stated interest rate of 4.00%. Costs associated with our securitized debt are amortized as a component of interest expense; as a result, our securitized debt had a cost of 4.36% for the three months ended June 30, 2014 and 4.22% for the three months ended June 30, 2013.
For the three months ended June 30, 2014, we had average debt-to-equity of 3.7 times, compared to 5.0 times for the three months ended June 30, 2013. This reduction in leverage reflects the use of less leverage on Agency RMBS and our migration from Agency RMBS to non-Agency RMBS. Non-Agency RMBS generate higher yields, have higher borrowing costs and are less leveraged than Agency RMBS. Our interest rate spread and net interest margin were 3.32% and 3.44% for the three months ended June 30, 2014, respectively, compared to 2.69% and 2.77%, respectively, for the three months ended June 30, 2013. The increase in our net interest rate spread during the three months ended June 30, 2014 reflects our portfolio shift into non-Agency RMBS and a slight improvement in our net interest spread on our Agency RMBS portfolio resulting from the rebalancing of our Agency pass-through RMBS portfolio that began in the last three months of 2013.
The impact of our Swaps is not reflected in our net interest rate spread and net interest margin. However, when making investment decisions, we consider our effective cost of borrowings, which includes the net interest component of our Swaps. (See Tables 6, 16 and 17 below.)
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the three months ended June 30, 2014 and 2013:
Table 5
 
 
 
 
Three Months Ended June 30, 2014
Collateral
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,150,645

 
$
1,273,563

 
$
102,062

 
$
3,526,270

Total interest income
 
$
16,356

 
$
19,858

 
$
1,927

 
$
38,141

Yield on average assets
 
3.04
%
 
6.24
%
 
7.55
%
 
4.33
%
Average balance of associated repurchase agreements
 
$
1,866,797

 
$
1,004,942

 
$
28,543

 
$
2,900,282

Average balance of securitized debt
 
$
—

 
$
—

 
$
39,133

 
$
39,133

Total interest expense
 
$
1,688

 
$
5,254

 
$
568

 
$
7,510

Average cost of funds (3) (4)
 
0.36
%
 
2.07
%
 
3.32
%
(5) 
1.01
%
Net interest income
 
$
14,668

 
$
14,604

 
$
1,359

 
$
30,631

Net interest rate spread
 
2.68
%
 
4.17
%
 
4.23
%
 
3.32
%
Total interest expense including net interest cost of Swaps (5)
 
$
6,631

 
$
5,254

 
$
706

 
$
12,591

Effective cost of funds (5)
 
1.41
%
 
2.07
%
 
4.13
%
 
1.69
%
Net interest income including net interest cost of Swaps
 
$
9,725

 
$
14,604

 
$
1,221

 
$
25,550

Effective net interest rate spread (5)
 
1.63
%
 
4.17
%
 
3.42
%
 
2.64
%
(Tables and notes continued on next page.)


47


(Continued.)
 
 
Three Months Ended June 30, 2013
Collateral
 
Agency
 
Non-Agency (6)
 
Securitized
Mortgage

Loans (6)
 
Total
Average balance (2)
 
$
4,167,139

 
$
589,969

 
$
111,257

 
$
4,868,365

Total interest income
 
$
28,388

 
$
10,644

 
$
2,297

 
$
41,329

Yield on average assets
 
2.69
%
 
7.14
%
 
8.16
%
 
3.36
%
Average balance of associated repurchase agreements
 
$
3,762,949

 
$
470,514

 
$
27,136

 
$
4,260,599

Average balance of securitized debt
 
$
—

 
$
—

 
$
48,271

 
$
48,271

Total interest expense
 
$
4,048

 
$
2,541

 
$
648

 
$
7,237

Average cost of funds (3) (4)
 
0.43
%
 
2.17
%
 
3.45
%
(5) 
0.67
%
Net interest income
 
$
24,340

 
$
8,103

 
$
1,649

 
$
34,092

Net interest rate spread
 
2.26
%
 
4.97
%
 
4.71
%
 
2.69
%
Total interest expense including net interest cost of Swaps (5)
 
$
10,352

 
$
2,541

 
$
781

 
$
13,674

Effective cost of funds (5)
 
1.10
%
 
2.17
%
 
4.15
%
 
1.27
%
Net interest income including net interest cost of Swaps
 
$
18,036

 
$
8,103

 
$
1,516

 
$
27,655

Effective net interest rate spread (5)
 
1.59
%
 
4.97
%
 
4.01
%
 
2.09
%
(1) 
Other credit investments were comprised of STACR Notes and a warehouse line receivable.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(4) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, such costs are included in "Gain/(loss) on derivative instruments, net" in our consolidated statements of operations.
(5) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
(6) 
Amounts have been conformed to the current presentation, which reflects the allocation of certain repurchase agreements and Swaps to such investments.
As of June 30, 2014, our repurchase agreement borrowings collateralized by Agency RMBS had initial terms of up to six months with haircut requirements ranging from 3.00% to 5.25% and financing rates from 0.31% to 0.42%; our repurchase agreement borrowings collateralized by non-Agency RMBS had initial terms of up to 18 months with haircut requirements ranging from 10.00% to 45.00% and financing rates from 1.15% to 2.59%.
Swaps and Swaptions
Our Swaps are intended to mitigate the impact of increases in interest rates on a portion of our repurchase agreement borrowings, as they have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of our Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. In addition, we purchase Swaptions, each of which provides that at the expiration of the option period, we: (i) may enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money. The method of settlement at expiration of the option period is prescribed in each Swaption confirmation. (See Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
While we view our Swaps and Swaptions as an economic hedge against increases in future market interest rates associated with our repurchase agreement borrowings, we have not elected hedge accounting for such instruments under GAAP. Alternatively, we present the “effective cost of funds” to reflect our interest expense adjusted to include the interest component for our Swaps that would be reported had we elected and qualified for hedge accounting for such instruments. We believe that the presentation of our effective cost of funds, which is a non-GAAP financial measure, is useful for investors as it presents our borrowing costs as viewed by management. (See Table 6 and “Non-GAAP Financial Measures,” below and Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)


48


The following table presents our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the three months ended June 30, 2014 and June 30, 2013. (See Tables 16 and 17, included under “Non-GAAP Financial Measures” below.)
Table 6
 
Agency
 
Non-Agency and Other Credit Investments (1) (2)
 
Securitized
Mortgage
Loans (2)
 
Total
Three Months Ended June 30, 2014
 
 
 
 
 
 
 
 
Effective interest expense
 
$
6,631

 
$
5,254

 
$
706

 
$
12,591

Effective cost of funds
 
1.41
%
 
2.07
%
 
4.13
%
 
1.69
%
Effective net interest income
 
$
9,725

 
$
14,604

 
$
1,221

 
$
25,550

Effective net interest rate spread
 
1.63
%
 
4.17
%
 
3.42
%
 
2.64
%
Three Months Ended June 30, 2013
 
 
 
 
 
 
 
 
Effective interest expense
 
$
10,352

 
$
2,541

 
$
781

 
$
13,674

Effective cost of funds
 
1.10
%
 
2.17
%
 
4.15
%
 
1.27
%
Effective net interest income
 
$
18,036

 
$
8,103

 
$
1,516

 
$
27,655

Effective net interest rate spread
 
1.59
%
 
4.97
%
 
4.01
%
 
2.09
%
(1) 
At June 30, 2014, other credit investments were comprised of STACR Notes and a warehouse line receivable. We had no items included in other credit investments during the three months ended June 30, 2013.
(2) 
Amounts for the three months ended June 30, 2013 have been conformed to the current presentation, which reflects the allocation of associated repurchase agreements and Swaps to such investments.
Realized and Unrealized Gain/(Loss)
From time to time we sell RMBS as part of managing our portfolio. During the three months ended June 30, 2014 and 2013, we sold Agency RMBS of $248,122 and $2,210,911, respectively, realizing net losses of $7,370 and $48,950, respectively, and sold non-Agency RMBS of $4,742 and $7,574, realizing net gains of $298 and $1,442, respectively. The Agency RMBS we sold during the three months ended June 30, 2014 generally reflect our continued migration to higher coupon securities. As we find attractive investment opportunities in non-Agency RMBS, whole loans and other mortgage-related securities, we may sell certain Agency and non-Agency RMBS to fund such purchases. (See Table 2 above and Note 4 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q for information with respect to our unrealized gain/(loss) positions on our RMBS portfolio at June 30, 2014 and December 31, 2013.) With respect to non-Agency RMBS, we continue to emphasize investments in seasoned securities, backed by Subprime mortgage loans, targeting securities at or near the top of the capital structure.


49


The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS, securitized mortgage loans, securitized debt, derivative instruments and other investment securities, for the three months ended June 30, 2014 and June 30, 2013:
Table 7
 
Three Months Ended
 
 
June 30, 2014
 
June 30, 2013
Realized (loss) on sale of Agency RMBS, net
 
(7,370
)
 
(48,950
)
Realized gain on sale of Non-Agency RMBS, net
 
298

 
1,442

Unrealized gain/(loss) on Agency RMBS, net
 
46,775

 
(126,786
)
Unrealized gain/(loss) on Non-Agency RMBS, net
 
4,815

 
(8,036
)
Realized gain/(loss) on derivatives, net (1)
 
(12,666
)
 
3,591

Unrealized gain/(loss) on derivatives, net (2)
 
(14,467
)
 
79,778

Unrealized gain on other investment securities
 
54

 
—

Unrealized gain/(loss) on securitized mortgage loans, net
 
2,042

 
(3,473
)
Unrealized gain/(loss) on securitized debt
 
(364
)
 
887

Total
 
$
19,117

 
$
(101,547
)
 
(1) 
For the three months ended June 30, 2014 and June 30, 2013, amounts include net interest payments (made), including accrued amounts, of ($5,081) and ($6,437) associated with our Swaps, $0 and $8,589 of realized gain on termination of Swaps, and ($7,585) and $1,439 of realized gains/(losses) on terminations and expirations of Swaptions, respectively.
(2) 
For the three months ended June 30, 2014 and June 30, 2013, we recognized net unrealized gain/(loss) of ($15,244) and $71,713 related to the change in fair value of our Swaps, $777 and $8,888 related to the change in fair value of our Swaptions and $0 and ($823) related to the change in fair value of our Short TBA Contracts, respectively.
At June 30, 2014, we had Swaps with an aggregate notional amount of $1,687,000, a weighted average fixed-pay rate of 1.43% and a weighted average term to maturity of 4.9 years. At June 30, 2014, our Swaptions had an aggregate notional balance of $1,335,000 and a weighted average term of six months until expiration of the option period. At June 30, 2014, the Swaps underlying our Swaptions had a weighted average fixed-pay rate of 3.72% and a weighted average term of 9.4 years. At June 30, 2014, we had gross unrealized gains of $18,087 and $0 on our Swaps and Swaptions, respectively, and had gross unrealized losses of $8,729 and $15,567 on our Swaps and Swaptions, respectively.
Expenses
General and Administrative Expenses: We are responsible for our operating expenses, which include the cost of data and analytical systems, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance, and other miscellaneous operating costs. We reimburse our Manager, or its affiliates, for our allocable share of the compensation of our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. Costs we incur for our third-party accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $2,921 and $2,434 for the three months ended June 30, 2014 and June 30, 2013, respectively. The increase in our general and administrative expenses was primarily driven by an increase in the cost of our non-cash equity based compensation, increases in our data services as we expanded our analytical tools and an increase in our legal fees and other costs associated with our new business development.
Management Fee: Under the terms of the Management Agreement, our Manager is entitled to a management fee, calculated and payable quarterly in arrears, in an amount equal to 1.5% of adjusted stockholders’ equity (as defined in the Management Agreement), per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fee expenses of $2,774 and $2,921 for the three months ended June 30, 2014 and June 30, 2013, respectively.
Management fees, expense reimbursements and the relationship with our Manager are discussed further in Note 12 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.



50


Results of Operations
Six Months Ended June 30, 2014 compared to the Six Months Ended June 30, 2013
For the six months ended June 30, 2014, we had net income allocable to common stock and participating securities of $64,986, or $2.02 per basic share and $2.01 per diluted share, compared to net loss allocable to common and participating securities of $74,327, or $2.59 per basic and diluted share for the six months ended June 30, 2013. Our results of operations for the six months ended June 30, 2013 were significantly impacted by steep declines in the value of our Agency RMBS portfolio, some of which were realized through sales, which were partially offset by increases in the value of our derivative instruments.
Net Interest Income
Our net interest income was $61,543 for the six months ended June 30, 2014 compared to $66,122 for the comparative period in 2013. For the six months ended June 30, 2014 and June 30, 2013, we earned interest income of $76,321 and $79,576, respectively, and incurred interest expense of approximately $14,778 and $13,454, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher borrowing expense reflects our increase in non-Agency RMBS and associated repurchase borrowings, which borrowings have higher interest rates than repurchase agreements on Agency RMBS. We had securitized debt with a contractual balance of $37,348 at June 30, 2014 and a fixed stated interest rate of 4.00%. Costs associated with our securitization transaction are amortized as a component of interest expense; as a result, our securitized debt had a cost of 4.29% for the six months ended June 30, 2014 and 4.28% for the six months ended June 30, 2013.
For the six months ended June 30, 2014, we had average debt-to-equity of 3.8 times, compared to 5.0 times for the six months ended June 30, 2013. This reduction in leverage reflects the use of less leverage on Agency RMBS and our migration from Agency RMBS to non-Agency RMBS. Non-Agency RMBS generate higher yields, have higher borrowing costs and are less leveraged than Agency RMBS. Our interest rate spread and net interest margin were 3.34% and 3.48% for the six months ended June 30, 2014, respectively, compared to 2.80% and 2.89%, respectively, for the six months ended June 30, 2013. The increase in our net interest rate spread during the six months ended June 30, 2014 reflects our portfolio shift into non-Agency RMBS and a slight improvement in our net interest spread on our Agency RMBS portfolio resulting from the rebalancing of our Agency pass-through RMBS portfolio that began in the last three months of 2013. (See Table 8 below.)
The impact of our Swaps is not reflected in our net interest rate spread and net interest margin. However, when making investment decisions, we consider our effective cost of borrowings, which includes the net interest component of our Swaps. (See Tables 9, 16 and 17 below.)
Our interest income on Agency RMBS was positively impacted by slower prepayment speeds on Agency RMBS during the first six months of 2014 compared to the first six months of 2013, which improved yields and increased interest income on such portfolio. Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income recognized in future periods on such investments.


51


The following table presents certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the six months ended June 30, 2014 and 2013:
Table 8
 
 
 
 
Six Months Ended June 30, 2014
Collateral
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,213,781

 
$
1,201,487

 
$
104,169

 
$
3,519,437

Total interest income
 
$
33,514

 
$
38,634

 
$
4,173

 
$
76,321

Yield on average assets
 
3.03
%
 
6.43
%
 
8.01
%
 
4.34
%
Average balance of associated repurchase agreements
 
$
1,905,722

 
$
959,665

 
$
28,329

 
$
2,893,716

Average balance of securitized debt
 
$
—

 
$
—

 
$
40,477

 
$
40,477

Total interest expense
 
$
3,575

 
$
10,048

 
$
1,155

 
$
14,778

Average cost of funds (3) (4)
 
0.37
%
 
2.08
%
 
3.34
%
(5) 
1.00
%
Net interest income
 
$
29,939

 
$
28,586

 
$
3,018

 
$
61,543

Net interest rate spread
 
2.66
%
 
4.35
%
 
4.67
%
 
3.34
%
Total interest expense including net interest cost of Swaps (5)
 
$
13,171

 
$
10,048

 
$
1,429

 
$
24,648

Effective cost of funds (5)
 
1.37
%
 
2.08
%
 
4.19
%
 
1.67
%
Net interest income including net interest cost of Swaps
 
$
20,343

 
$
28,586

 
$
2,744

 
$
51,673

Effective net interest rate spread (5)
 
1.66
%
 
4.35
%
 
3.82
%
 
2.67
%
 
 
Six Months Ended June 30, 2013
Collateral
 
Agency
 
Non-Agency (6)
 
Securitized
Mortgage

Loans (6)
 
Total
Average balance (2)
 
$
3,895,942

 
$
562,181

 
$
88,306

 
$
4,546,429

Total interest income
 
$
55,241

 
$
20,705

 
$
3,630

 
$
79,576

Yield on average assets
 
2.82
%
 
7.33
%
 
8.17
%
 
3.48
%
Average balance of associated repurchase agreements
 
$
3,496,161

 
$
449,128

 
$
21,458

 
$
3,966,747

Average balance of securitized debt
 
$
—

 
$
—

 
$
38,556

 
$
38,556

Total interest expense
 
$
7,606

 
$
4,812

 
$
1,036

 
$
13,454

Average cost of funds (3) (4)
 
0.44
%
 
2.16
%
 
3.48
%
(5) 
0.68
%
Net interest income
 
$
47,635

 
$
15,893

 
$
2,594

 
$
66,122

Net interest rate spread
 
2.38
%
 
5.17
%
 
4.69
%
 
2.80
%
Total interest expense including net interest cost of Swaps (5)
 
$
17,999

 
$
4,812

 
$
1,219

 
$
24,030

Effective cost of funds (5)
 
1.04
%
 
2.16
%
 
4.10
%
 
1.21
%
Net interest income including net interest cost of Swaps
 
$
37,242

 
$
15,893

 
$
2,411

 
$
55,546

Effective net interest rate spread (5)
 
1.78
%
 
5.17
%
 
4.08
%
 
2.27
%
(1) 
Other credit investments were comprised of STACR Notes and a warehouse line receivable.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(4) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, such costs are included in "Gain/(loss) on derivative instruments, net" in our consolidated statements of operations.
(5) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction as well as the associated net interest component of Swaps. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
(6) 
Amounts have been conformed to the current presentation, which reflects the allocation of certain repurchase agreements and Swaps to such investments.
Swaps and Swaptions
While we view our Swaps and Swaptions as an economic hedge against increases in future market interest rates associated with our repurchase agreement borrowings, we have not elected hedge accounting under GAAP. Alternatively, we present the “effective cost of funds” to reflect our interest expense adjusted to include the interest component for our Swaps that


52


would be reported had we elected and qualified for hedge accounting for such instruments. We believe that the presentation of our effective cost of funds, which is a non-GAAP financial measure, is useful for investors as it presents our borrowing costs as viewed by us. (See Table 9 and “Non-GAAP Financial Measures,” below and Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
The following table presents our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the six months ended June 30, 2014 and June 30, 2013. (See Tables 16 and 17, included under “Non-GAAP Financial Measures” below.)
Table 9
 
Agency
 
Non-Agency and Other Credit Investments (1) (2)
 
Securitized
Mortgage
Loans (2)
 
Total
Six months ended June 30, 2014
 
 
 
 
 
 
 
 
Effective interest expense
 
$
13,171

 
$
10,048

 
$
1,429

 
$
24,648

Effective cost of funds
 
1.37
%
 
2.08
%
 
4.19
%
 
1.67
%
Effective net interest income
 
$
20,343

 
$
28,586

 
$
2,744

 
$
51,673

Effective net interest rate spread
 
1.66
%
 
4.35
%
 
3.82
%
 
2.67
%
Six months ended June 30, 2013
 
 
 
 
 
 
 
 
Effective interest expense
 
$
17,999

 
$
4,812

 
$
1,219

 
$
24,030

Effective cost of funds
 
1.04
%
 
2.16
%
 
4.10
%
 
1.21
%
Effective net interest income
 
$
37,242

 
$
15,893

 
$
2,411

 
$
55,546

Effective net interest rate spread
 
1.78
%
 
5.17
%
 
4.08
%
 
2.27
%
(1) 
At June 30, 2014, other credit investments were comprised of STACR Notes and a warehouse line receivable. We had no items included in other credit investments during the six months ended June 30, 2013.
(2) 
Amounts for the six months ended June 30, 2013 have been conformed to the current presentation, which reflects the allocation of associated repurchase agreements and Swaps to such investments.
Realized and Unrealized Gain/(Loss)
During the six months ended June 30, 2014 and 2013, we sold Agency RMBS of $614,566 and $2,742,431, respectively, realizing net losses of $21,316 and $41,443, respectively, and sold non-Agency RMBS of $11,309 and $65,562, respectively, realizing net gains of $2,434 and $9,730, respectively (some of which may have settled in a subsequent period). As we find attractive investment opportunities in non-Agency RMBS and whole loans and mortgage-related assets, we may sell additional Agency RMBS to fund such purchases. With respect to non-Agency RMBS, we continue to emphasize investment in seasoned securities, backed by subprime mortgage loans, targeting securities at or near the top of the capital structure.


53


We have elected the fair value option for all of our RMBS, securitized mortgage loans, other investment securities and securitized debt and given that we do not apply hedge accounting, our derivatives are carried at fair value. As a result, we record the change in estimated fair value of each of these instruments in earnings. The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS, securitized mortgage loans, securitized debt, other investment securities and derivative instruments, all of which are included in our consolidated statements of operations, for the six months ended June 30, 2014 and June 30, 2013:
Table 10
 
Six Months Ended
 
 
June 30, 2014
 
June 30, 2013
Realized (loss) on sale of Agency RMBS, net
 
(21,316
)
 
(41,443
)
Realized gain on sale of Non-Agency RMBS, net
 
2,434

 
9,730

Unrealized gain/(loss) on Agency RMBS, net
 
90,952

 
(170,785
)
Unrealized gain on Non-Agency RMBS, net
 
11,285

 
2,915

Realized (loss) on derivatives, net (1)
 
(31,138
)
 
(548
)
Unrealized gain/(loss) on derivatives, net (2)
 
(33,185
)
 
78,119

Unrealized gain on other investment securities
 
176

 
—

Unrealized gain/(loss) on securitized mortgage loans, net
 
3,096

 
(625
)
Unrealized gain/(loss) on securitized debt
 
(354
)
 
15

Total
 
$
21,950

 
$
(122,622
)
(1) 
For the six months ended June 30, 2014 and June 30, 2013, amounts include net interest payments (made)/received, including accrued amounts, of ($9,870) and ($10,576) associated with our Swaps, $0 and $8,589 of gains realized on terminations of Swaps, ($14,112) and $1,439 of realized gains/(losses) on terminations and expirations of Swaptions and $(7,156) and $0 of (losses) on settlement of Short TBA Contracts, respectively.
(2) 
For the six months ended June 30, 2014 and June 30, 2013, we recognized net unrealized gains/(losses) of ($26,168) and $70,793 related to the change in fair value of our Swaps, ($6,267) and $8,149 related to the change in fair value of our Swaptions and ($750) and $0 related to the change in fair value of our Short TBA Contracts, respectively.
At June 30, 2014, we had Swaps with an aggregate notional amount of $1,687,000, a weighted average fixed pay rate of 1.43% and a weighted average term to maturity of 4.9 years. At June 30, 2014, our Swaptions had an aggregate notional balance of $1,335,000 and a weighted average term of six months until expiration. At June 30, 2014, the Swaps underlying our Swaptions had a weighted average fixed pay rate of 3.72% and a weighted average term of 9.4 years. At June 30, 2014, we had gross unrealized gains of $18,087 and $0 on Swaps and Swaptions, respectively, and gross unrealized losses of $8,729 and $15,567 on Swaps and Swaptions, respectively.
Expenses
General and Administrative Expenses: We are responsible for our operating expenses, which include the cost of data and analytical systems, outsourced accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. We reimburse our Manager, or its affiliates, for our allocable share of the compensation of our Chief Financial Officer based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. Costs we incur for our third-party accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $6,016 and $5,285 for the six months ended June 30, 2014 and June 30, 2013, respectively. The increase in our general and administrative expenses was primarily driven by an increase in the cost of our non-cash equity based compensation, increases in our data services as we expanded our analytical tools and an increase in our legal fees and other costs associated with our new business development.
Management Fee: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement), per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fee expenses of $5,560 and $5,710 for the six months ended June 30, 2014 and June 30, 2013, respectively.
The management fees, expense reimbursements and the relationship with our Manager are discussed further in Note 12 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.


54


Dividends
We have had 6,900,000 shares of Preferred Stock outstanding since September 20, 2012. No dividends may be paid on our common stock unless full cumulative dividends have been paid on our Preferred Stock, all of which have been paid to date. The following table presents cash dividends we have declared on our Preferred Stock from January 1, 2013 through June 30, 2014:
Table 11
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
June 19, 2014
 
June 30, 2014
 
July 30, 2014
 
$
0.50

March 13, 2014
 
March 31, 2014
 
April 30, 2014
 
$
0.50

December 18, 2013
 
December 31, 2013
 
January 31, 2014
 
$
0.50

September 19, 2013
 
September 30, 2013
 
October 31, 2013
 
$
0.50

June 17, 2013
 
June 28, 2013
 
July 31, 2013
 
$
0.50

March 18, 2013
 
March 28, 2013
 
April 30, 2013
 
$
0.50

As a REIT we are required to distribute at least 90% of our annual net taxable income, excluding net capital gains. As of June 30, 2014, we had estimated non-deductible net capital losses from the prior year of approximately $95.3 million which will be carried forward and offset against future net capital gains for up to five years. Our capital loss carryforward will reduce the amount of future dividends designated as capital gains, if any, that we would otherwise expect to distribute, since capital gains would first be reduced by the capital loss carryforwards. In addition, as of June 30, 2014, we had estimated net deferred tax gains from terminated Swaps of $19.1 million and estimated net deferred tax losses from terminated and expired Swaptions of $7.2 million. These deferred gains and losses will be accreted into future ordinary taxable income over the remaining terms of the underlying Swaps.
The following table presents cash dividends we declared on our common stock for the quarterly periods presented:
Table 12
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
June 19, 2014
 
June 30, 2014
 
July 30, 2014
 
$
0.42

March 13, 2014
 
March 31, 2014
 
April 30, 2014
 
$
0.40

December 18, 2013
 
December 31, 2013
 
January 31, 2014
 
$
0.40

September 19, 2013
 
September 30, 2013
 
October 31, 2013
 
$
0.40

June 17, 2013
 
June 28, 2013
 
July 31, 2013
 
$
0.70

March 18, 2013
 
March 28, 2013
 
April 30, 2013
 
$
0.70

Liquidity and Capital Resources
General
To maintain our qualification as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our net taxable income, excluding net capital gains. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations.
Our principal sources of cash generally consist of borrowings under repurchase agreements, payments of principal and interest received on our RMBS portfolios, cash generated from operating results and, depending on market conditions, proceeds from capital market transactions, which to date have reflected issuances of our capital stock. As part of managing our investment portfolio, we may also generate cash through sales of RMBS. Cash is needed to fund our ongoing obligations, make payments of principal and interest on repurchase agreement borrowings, purchase our target assets, meet margin calls, make distributions to stockholders and for other general business and operating purposes.
As of June 30, 2014, we had a $200,000 repurchase borrowing facility with a counterparty to finance residential mortgage loans that we may acquire. The facility matures on April 30, 2015; however, extensions of up to one year may be granted at the discretion of our counterparty at our request, which requests may be made at specified times. We may use the facility to finance current and non-performing residential whole loans and properties subject to various haircuts and rates based on product type.
Under our repurchase agreements, lenders retain the right to mark the collateral pledged to estimated fair value. A reduction in the value of the collateral pledged will require us to provide additional securities or cash as collateral. As part of


55


our risk management process, our Manager closely monitors our liquidity position and subjects our balance sheet to scenario testing designed to assess our liquidity in the face of different economic and market developments.
We believe we have adequate financial resources to meet our obligations, including margin calls, as they come due, to actively hold and acquire our target assets, to fund dividends we declare on our capital stock and to pay our operating expenses. However, should the value of our RMBS suddenly decrease, significant margin calls on repurchase agreement borrowings could result and our liquidity position could be materially and adversely affected. Further, should market liquidity tighten, our repurchase agreement counterparties could increase the percentage by which the collateral value is required to exceed the loan amount on new financings, reducing our ability to use leverage. Access to financing may also be negatively impacted by the ongoing volatility in the global financial markets, potentially adversely impacting our current or potential lenders’ ability to provide us with financing.
Investing Activity
During the six months ended June 30, 2014, we: (i) invested $492,228 in Agency pass-through RMBS, at a weighted average purchase price of 106.8% of par value, $6,160 in Agency IO, $15,959 in Agency Inverse IO, $231,877 in non-Agency RMBS, with a weighted average purchase price of 84.6% of par value, $953 in other investment securities and $13,462 for advances on a warehouse line; (ii) received prepayments and scheduled amortization of $74,544 for Agency RMBS, $62,990 for non-Agency RMBS, $3,913 on our securitized mortgage loans and $802 for other investment securities; and (iii) sold Agency RMBS of $614,566, realizing aggregate net losses of $21,316, and sold $11,309 of non-Agency RMBS, realizing gains of $2,434. As of June 30, 2014, we had investment related payables of $13,299 with respect to unsettled purchases of non-Agency RMBS and had $3,136 of principal receivable from brokers on non-Agency RMBS. All investment related payables and receivables at June 30, 2014 were settled in July 2014.
We receive interest-only payments with respect to the notional amount of Agency IO and Agency Inverse IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency RMBS, the market prices of Agency IO generally have a positive correlation to changes in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO will decrease, which in turn is expected to increase the cash flow and the value of such securities; inverse results are expected with respect to decreases in market interest rates. In addition to viewing Agency IO as attractive investments, we also view such instruments as an economic hedge, in part, against the impact that an increase in market interest rates would have on our Agency RMBS. However, given that we had Agency IO of $42,368 with an aggregate notional balance of $401,322, the overall impact of Agency IO in off-setting the impact of increases in interest rates on the value of our Agency RMBS portfolio is limited. During the six months ended June 30, 2014, we sold $18,148 of Agency IO and Agency Inverse IO, realizing aggregate net gains of $210.
Financing Activity
We use repurchase agreements to finance a substantial majority of our Agency RMBS and non-Agency RMBS with such securities pledged as collateral to secure such borrowings. At June 30, 2014, we had outstanding repurchase agreement borrowings with 17 counterparties totaling $2,991,989. We continue to have available capacity under our repurchase agreements; however, our repurchase agreements are generally uncommitted and renewable at the discretion of our lenders. As of June 30, 2014, we had master repurchase agreements with 24 counterparties. As a matter of routine business, we may have discussions with other financial institutions regarding potentially providing us with additional repurchase agreement borrowing capacity.
 


56


The table below presents certain information about our borrowings for the periods presented:
Table 13
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase Agreements
 
Securitized Debt (1)
Quarter Ended
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
June 30, 2014
 
$
2,900,282

 
$
2,991,989

 
$
2,991,989

 
$
39,133

 
$
37,348

 
$
39,066

March 31, 2014
 
$
2,887,060

 
$
2,859,344

 
$
2,956,389

 
$
41,835

 
$
40,281

 
$
41,292

December 31, 2013
 
$
2,951,265

 
$
3,034,058

 
$
3,034,058

 
$
44,268

 
$
42,400

 
$
44,567

September 30, 2013
 
$
2,967,123

 
$
2,881,680

 
$
3,045,769

 
$
46,249

 
$
45,590

 
$
46,776

June 30, 2013 (2)
 
$
4,260,599

 
$
3,945,097

 
$
4,516,604

 
$
48,271

 
$
47,353

 
$
48,572

March 31, 2013 (3)
 
$
3,669,629

 
$
4,343,341

 
$
4,343,341

 
$
28,742

 
$
48,980

 
$
49,525

(1) 
The balances presented for securitized debt reflect the balance of such debt, which does not reflect the impact of changes in the fair value of such liability.
(2) 
The end-of-period balance at June 30, 2013 includes repurchase agreement borrowings of $990,973, which amount was repaid in July 2013 upon settlement of Agency RMBS sold in June 2013.
(3) 
On March 25, 2013 and March 13, 2013, we raised net equity of approximately $22,421 and $149,221, respectively, which was invested on a levered basis and, as a result, increased our borrowings under repurchase agreements at the period end relative to the average balance during the quarterly period.
The following table presents information about our borrowings by type of collateral pledged, and the fair value of collateral pledged as of the dates presented and the weighted average interest rate, the cost of funds and effective cost of funds for the quarterly periods then ended:
Table 14
 
 
 
 
 
 
 
 
Quarterly Period Ended:
 
Principal Balance  of Borrowing
 
Fair Value of Collateral Pledged (1)
 
Average Cost of Funds
 
Effective Cost of Funds (2)
June 30, 2014:
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,905,783

 
$
2,029,915

 
0.36
%
 
1.41
%
Non-Agency RMBS and STACR Notes repurchase borrowings
 
1,057,637

 
1,390,446

 
2.07

 
2.07

Securitized Mortgage Loans repurchase borrowings (3)
 
28,569

 
48,638

 
1.88

 
3.80

Total repurchase borrowings
 
2,991,989

 
3,468,999

 
0.97
%
 
1.66
%
Securitized debt
 
37,348

 
109,712

 
4.36

 
4.36

Total
 
$
3,029,337

 
$
3,578,711

 
1.01
%
 
1.69
%
March 31, 2014:
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,861,066

 
$
1,962,536

 
0.39
%
 
1.34
%
Non-Agency RMBS and STACR Notes repurchase borrowings
 
970,044

 
1,303,098

 
2.10

 
2.10

Securitized Mortgage Loans repurchase borrowings (3)
 
28,234

 
47,614

 
2.06

 
4.00

Total repurchase borrowings
 
2,859,344

 
3,313,248

 
0.95
%
 
1.61
%
Securitized debt
 
40,281

 
110,307

 
4.23

 
4.23

Total
 
$
2,899,625

 
$
3,423,555

 
0.99
%
 
1.65
%
December 31, 2013:
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
2,082,447

 
$
2,175,114

 
0.43
%
 
1.28
%
Non-Agency RMBS and STACR Notes repurchase borrowings
 
924,597

 
1,236,269

 
1.99

 
1.99

Securitized Mortgage Loans repurchase borrowings (3)
 
27,014

 
47,057

 
2.14

 
4.13

Total repurchase borrowings
 
3,034,058

 
3,458,440

 
0.91
%
 
1.52
%
Securitized debt
 
42,400

 
110,984

 
4.30

 
4.30

Total
 
$
3,076,458

 
$
3,569,424

 
0.96
%
 
1.56
%
(Tables and notes continued on next page.)


57


(Continued.)
Table 14
 
 
 
 
 
 
 
 
Quarterly Period Ended:
 
Principal Balance  of Borrowing
 
Fair Value of Collateral Pledged (1)
 
Average Cost of Funds
 
Effective Cost of Funds (2)
September 30, 2013
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,989,518

 
$
2,102,874

 
0.42
%
 
1.64
%
Non-Agency RMBS and STACR Notes repurchase borrowings (3)
 
865,148

 
1,148,085

 
2.04

 
2.04

Securitized Mortgage Loans repurchase borrowings (4)
 
27,014

 
45,023

 
2.11

 
4.07

Total repurchase borrowings
 
2,881,680

 
3,295,982

 
0.84
%
 
1.76
%
Securitized Debt
 
45,590

 
109,586

 
4.19

 
4.19

Total
 
$
2,927,270

 
$
3,405,568

 
0.89
%
 
1.80
%
June 30, 2013
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
3,367,445

 
$
3,533,248

 
0.43
%
 
1.10
%
Non-Agency RMBS repurchase borrowings
 
550,752

 
747,666

 
2.17

 
2.17

Securitized Mortgage Loans repurchase borrowings
 
26,900

 
44,834

 
2.07

 
4.04

Total repurchase borrowings
 
3,945,097

 
4,325,748

 
0.63
%
 
1.24
%
Securitized Debt
 
47,353

 
110,278

 
4.22

 
4.22

Total
 
$
3,992,450

 
$
4,436,026

 
0.67
%
 
1.27
%
(1) 
May include cash collateral pledged for Agency RMBS and non-Agency RMBS. (See Note 8 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
(2) 
The effective cost of funds for the quarterly periods presented is calculated on an annualized basis and includes the net interest component for Swaps of $5,081, $4,789, $4,564, $6,894 and $6,437 for the quarterly periods presented, respectively. While Swaps are not accounted for using GAAP hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates.
(3) 
Repurchase agreements collateralized by securitized mortgage loans represent borrowings associated with non-Agency RMBS acquired in connection with our February 2013 securitization transaction. Such non-Agency RMBS were eliminated in consolidation with the VIE associated with the securitization and as a result are not included in our consolidated balance sheet. (See Notes 5 and 13 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
(4) 
Amounts have been conformed to the current presentation, which reflects the allocation of certain repurchase agreements and Swaps to such investments.
With respect to our repurchase agreement borrowings, the haircut represents the percentage by which the collateral value is discounted to determine the loan amount. At June 30, 2014, haircuts ranged from a low of 3.00% to a high of 5.25% for our repurchase borrowings secured by Agency RMBS and a low of 10.00% to a high of 45.00% for repurchase borrowings secured by non-Agency RMBS. Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call. Margin calls are satisfied when we pledge additional collateral in the form of securities and/or cash to the lender. We have met all margin calls to date.
Certain repurchase agreements subject us to financial covenants. An event of default or termination event would give certain of our counterparties the option to terminate all existing repurchase transactions with us and require amounts due to the counterparties by us to be payable immediately. We were in compliance with all of our financial covenants through June 30, 2014. At June 30, 2014, we had RMBS of $3,423,804, and cash of $33,349 pledged as collateral to lenders as security for repurchase agreements. The total of the RMBS pledged for repurchase borrowings included non-Agency RMBS with a fair value of $48,638 that is not included on our consolidated balance sheet, as such RMBS are eliminated in consolidation with the securitization trust. Cash collateral held by counterparties is reported on our balance sheet as “Restricted cash” and was comprised of $33,349 pledged in connection with repurchase borrowings and $11,743 pledged in connection with derivatives.
Stock Repurchase Plan
Since November 6, 2013, we have had in place a Repurchase Program which allows us to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program are canceled and, until reissued by us, are deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be


58


suspended or discontinued by us at any time and without prior notice. We have not repurchased any shares of common stock under the Repurchase Program through June 30, 2014.
Collateral Requirement Updates
In 2013, the Treasury Market Practices Group (or, TMPG), a private-sector organization sponsored by the Federal Reserve Bank of New York, published guidelines recommending that broker dealers begin margining counterparties for certain types of collateral on the trade date as opposed to the settlement/financing date. As part of these guidelines, the TMPG recommended that, at a minimum, margining apply to the following four broad categories of forward-settling Agency RMBS transactions: TBA transactions; specified pool transactions; ARM transactions; and CMO transactions. We are in the process of negotiating the relevant legal documentation with our counterparties as a result of these TMPG guidelines. We do not currently anticipate that these new margin requirements will have a material impact on our ability to manage our liquidity.
Cash Flows and Liquidity for the Six Months Ended June 30, 2014
Our cash and cash equivalents decreased by $29,945 during the six months ended June 30, 2014, reflecting $48,738 used by financing activities, $11,838 used by investing activities and $30,631 provided by operating activities. We held cash of $98,014 at June 30, 2014. (For detailed information with respect to our operating, investing and financing activities, see “Consolidated Statements of Cash Flows,” included with our consolidated Financial Statements in this Quarterly Report on Form 10-Q.)
Contractual Obligations and Commitments
The following table summarizes the future effect on our liquidity and cash flows of our contractual obligations for principal and interest as of June 30, 2014:
Table 15
 
 
 
 
 
 
 
 
 
 
  
 
Less than  1
year
 
1 to 3
years
 
3 to 5
years
 
More than
5 years
 
Total
Borrowings under repurchase agreements
 
$
2,796,157

 
195,832

 
—

 
—

 
$
2,991,989

Interest on repurchase agreements borrowings (1) 
 
13,228

 
6,345

 
—

 
—

 
19,573

Total
 
$
2,809,385

 
202,177

 
—

 
—

 
$
3,011,562

(1) 
Interest expense is calculated based on the interest rate in effect at June 30, 2014 and includes all interest expense incurred and expected to be incurred in the future through the contractual maturity of the associated repurchase agreement.
The table above does not include amounts due under the Management Agreement as such obligations, discussed below, do not have fixed and determinable payments, or our anticipated dividend on our Preferred Stock. (See Notes 12 and 15 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q for a discussion with respect to our obligations pursuant to the Management Agreement and our Preferred Stock.) At June 30, 2014, we had securitized debt with a balance of $37,348 (and a fair value of $38,656) with a contractual interest rate of 4.00%. Our securitized debt is not included in the table above, as such debt is non-recourse to us and is only paid to the extent that the mortgage loans (in the securitization trust) collateralizing the debt pay.
Management Agreement
Pursuant to the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of adjusted stockholders’ equity, as defined in the Management Agreement, per annum. Our management fee is used, in part, to pay compensation to officers and personnel of the Manager who may also be our officers, but receive no cash compensation directly from us. We reimburse our Manager and/or its affiliates for the allocable share of the compensation of (1) our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and (2) other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs based on the percentage of time devoted by such personnel to our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. To the extent that our Manager or its affiliates pay for services provided on our behalf, we are required to reimburse our Manager and/or its affiliates for such items. Expense reimbursements to our Manager and/or its affiliates are made in cash generally on a monthly basis in arrears. Our reimbursement obligation is not subject to any dollar limitation.


59


On July 27, 2014, the third anniversary of the closing of our IPO, our Management Agreement was automatically renewed for a one-year term until July 27, 2015. This renewal followed a meeting of the independent members of our board of directors on January 27, 2014 with respect to the Management Agreement, which included a discussion of our Manager’s performance and the level of the management fees thereunder, at which meeting such members determined not to terminate the Management Agreement on July 27, 2014. Absent certain actions by the independent directors of our board of directors as described below, the Management Agreement will continue to automatically renew on each anniversary for a one year term. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment to provide additional funding to any such entities.
Dividends on Our Capital Stock
We have outstanding 6,900,000 shares of Preferred Stock, which entitles holders to receive dividends at an annual rate of 8.00% (paid quarterly, in arrears) based on the liquidation preference of $25.00 per share, or $2.00 per share per annum. The dividends on the Preferred Stock are cumulative and payable quarterly in arrears. Except under certain limited circumstances, the Preferred Stock is generally not convertible into or exchangeable for any other property or any other of our securities at the election of the holders. After September 20, 2017, we may, at our option, redeem the shares at $25.00 per share, plus any accrued unpaid distribution through the date of the redemption.
We intend to make regular quarterly dividend distributions to holders of our common stock. U.S. Federal income tax law generally requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains and without regard to the deduction for dividends paid and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our common stockholders in an amount equal to our net taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. Federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other contractual obligations. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.
Non-GAAP Financial Measures
We have included in this Form 10-Q disclosures about our “operating earnings,” “operating earnings per common share,” “effective cost of funds,” “effective interest expense,” “effective interest income” and “effective net interest rate spread” which disclosures constitute non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. We believe that the non-GAAP financial measures presented, when considered together with GAAP financial measures, provide information that is useful to investors in understanding our operating results. An analysis of any non-GAAP financial measures should be made in conjunction with results presented in accordance with GAAP.
Operating earnings and operating earnings per common share presented exclude, as applicable: (i) certain realized and unrealized gains and losses recognized through earnings; (ii) non-cash equity compensation; (iii) one-time events pursuant to changes in GAAP; and (iv) certain other non-cash charges. Operating earnings is a non-GAAP financial measure that is used by our Manager to assess our business results.
While we have not elected hedge accounting under GAAP for our Swaps, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates. To present for investors how we view our Swaps, we provide the “effective cost of funds” which is comprised of GAAP interest expense plus the interest expense component for our Swaps. The interest expense component of our Swaps reflects the net interest payments made or accrued on our Swaps.
We believe that the non-GAAP measures we present provide investors and other readers of this Quarterly Report on Form 10-Q with a useful measure to assess the performance of our ongoing business and useful supplemental information to both


60


management and investors in evaluating our financial results. The primary limitation associated with operating earnings as a measure of our financial performance over any period is that it excludes the effects of net realized and unrealized gains/(losses) from investments and Swaps. In addition, our presentation of operating earnings may not be comparable to similarly-titled measures of other companies, who may use different definitions or calculations for such term. As a result, operating earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP.
A reconciliation of the GAAP items discussed above to their non-GAAP measures presented in this Quarterly Report on Form 10-Q are as follows:
Table 16
 
Three Months Ended
 
 
June 30, 2014
 
June 30, 2013
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
7,510

 
1.01
%
 
$
7,237

 
0.67
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest paid for Swaps
 
5,081

 
0.68
%
 
6,437

 
0.60
%
Effective interest expense/effective cost of funds
 
$
12,591

 
1.69
%
 
$
13,674

 
1.27
%
Weighted average balance of borrowings
 
$
2,939,415

 
 
 
$
4,308,870

 
 
 
 
 
Six Months Ended
 
 
June 30, 2014
 
June 30, 2013
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
14,778

 
1.00
%
 
$
13,454

 
0.68
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest paid for Swaps
 
9,870

 
0.67
%
 
10,576

 
0.53
%
Effective interest expense/effective cost of funds
 
$
24,648

 
1.67
%
 
$
24,030

 
1.21
%
Weighted average balance of borrowings
 
$
2,934,193

 
 
 
$
4,005,303

 
 
Table 17
 
Three Months Ended
 
 
June 30, 2014
 
June 30, 2013
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
38,141

 
4.33
%
 
$
41,329

 
3.36
%
Less: effective interest expense/effective cost of funds (1)
 
12,591

 
1.69
%
 
13,674

 
1.27
%
Effective net interest income
 
$
25,550

 
2.64
%
 
$
27,655

 
2.09
%
Weighted average balance of interest-earning assets
 
$
3,526,270

 
 
 
$
4,868,365

 
 
 
 
 
Six Months Ended
 
 
June 30, 2014
 
June 30, 2013
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
76,321

 
4.34
%
 
$
79,576

 
3.48
%
Less: effective interest expense/effective cost of funds (1)
 
24,648

 
1.67
%
 
24,030

 
1.21
%
Effective net interest income
 
$
51,673

 
2.67
%
 
$
55,546

 
2.27
%
Weighted average balance of interest-earning assets
 
$
3,519,437

 
 
 
$
4,546,429

 
 
(1) 
As reconciled in Table 16, above.


61


The following table presents the reconciliation from net income allocable to common stockholders to operating earnings:
Table 18
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Net income/(loss) allocable to common stockholders (1)
 
$
40,291

 
$
(76,356
)
 
$
64,570

 
$
(74,600
)
Adjustments to arrive at operating earnings:
 
 
 
 
 
 
 
 
Realized loss on sale of RMBS, net
 
7,072

 
47,508

 
18,882

 
31,713

Unrealized (gain)/loss on RMBS, net
 
(51,590
)
 
134,822

 
(102,237
)
 
167,870

Unrealized (gain)/loss on derivatives, net
 
14,467

 
(79,778
)
 
33,185

 
(78,119
)
Unrealized (gain)/loss on securitized mortgage loans, net
 
(2,042
)
 
3,473

 
(3,096
)
 
625

Unrealized (gain)/loss on securitized debt
 
364

 
(887
)
 
354

 
(15
)
Unrealized (gain) on other investment securities
 
(54
)
 
—

 
(176
)
 
—

Non-cash stock-based compensation expense
 
408

 
146

 
867

 
545

Realized (gain)/loss on Swap/Swaption terminations and expirations, net
 
7,585

 
(10,028
)
 
14,112

 
(10,028
)
Realized loss on Short TBA Contracts, net
 
—

 
—

 
7,156

 
—

Other
 
68

 
—

 
68

 
—

Tax amortization of gain/(loss) on Swaption terminations and expirations, net
 
(48
)
 
—

 
(92
)
 
—

Total adjustments to arrive at operating earnings
 
(23,770
)
 
95,256

 
(30,977
)
 
112,591

Operating earnings
 
$
16,521

 
$
18,900

 
$
33,593

 
$
37,991

Operating earnings per common share
 
$
0.52

 
$
0.59

 
$
1.05

 
$
1.32

Weighted average common shares
 
32,019,863

 
31,995,321

 
32,017,640

 
28,858,241

(1) 
See Note 16 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.



62


ITEM 3.
Quantitative and Qualitative Disclosures about Market Risk.
(Dollar amounts in thousands – except per share data.)
We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from our assets through ownership of our capital stock. While we do not seek to avoid risk completely, we believe that risk can be quantified from historical experience and seek to actively manage risk, to earn sufficient returns to justify taking such risks and to maintain capital levels consistent with the risks we undertake.
Credit Risk
We are subject to varying degrees of credit risk in connection with our assets. Although we do not expect to encounter credit risk in our Agency RMBS, we do expect to encounter credit risk related to our non-Agency RMBS, residential mortgage loans, warehouse line receivable and other mortgage related assets we may acquire. The credit support built into non-Agency RMBS transaction structures is designed to mitigate credit losses. In addition, to date, we have purchased the substantial majority of our non-Agency RMBS at a discount to par value, which is expected to further mitigate our risk of loss in the event that less than 100% of the par value of such securities is received. However, credit losses greater than those anticipated or in excess of the recorded purchase discount could occur, which could materially adversely impact our operating results. With respect to our securitized mortgage loans, we retain the risk of potential credit losses. Our Manager seeks to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and overseeing the servicer.
Investment decisions are made following a bottom-up credit analysis and specific risk assumptions. As part of the risk management process our Manager uses detailed proprietary models to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure frequency, cost and timing.
The following table presents certain characteristics about our securitized mortgage loans, all of which are first liens, at June 30, 2014. Information presented with respect to weighted average loan-to-value, weighted average Fair Isaac Corporation (or, FICO) score (which is a credit score used by major credit bureaus to indicate a borrower’s credit worthiness), and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 19
 
Year of Origination
 
 
2008
 
2007
 
2006
 
2005
 
2004 & Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
Number of loans
 
65

 
628

 
13

 
6

 
2

 
714

Current unpaid principal balance
 
$
13,572

 
$
126,678

 
$
2,587

 
$
1,169

 
$
139

 
$
144,145

Loan Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average loan age
 
75

 
84

 
90

 
107

 
119

 
83

Weighted average original loan-to-value
 
74.60
%
 
79.84
%
 
82.55
%
 
80.60
%
 
100.00
%
 
79.42
%
Weighted average original FICO
 
602

 
632

 
624

 
610

 
668

 
629

Net weighted average coupon rate
 
6.84
%
 
5.68
%
 
5.59
%
 
5.39
%
 
7.83
%
 
5.79
%
Current Performance:
 
 
 
 
 
 
 
 
 
 
 
 
Current
 
59.50
%
 
74.30
%
 
69.60
%
 
100.00
%
 
—
%
 
72.95
%
30 days delinquent
 
19.66
%
 
8.68
%
 
2.56
%
 
—
%
 
—
%
 
9.53
%
60 days delinquent
 
1.73
%
 
4.76
%
 
16.14
%
 
—
%
 
—
%
 
4.63
%
90+ days delinquent
 
15.13
%
 
8.15
%
 
11.70
%
 
—
%
 
100.00
%
 
8.89
%
Bankruptcy/foreclosure
 
3.98
%
 
4.12
%
 
—
%
 
—
%
 
—
%
 
3.99
%


63


The following table presents information about our non-Agency RMBS and the mortgages underlying such securities at June 30, 2014. Information presented with respect to weighted average loan-to-value, weighted average FICO score and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 20
 
Year of Securitization (1)
 
 
2014
 
2007
 
2006
 
2005
 
2004
 
2003 & Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of securities
 
2

 
17

 
35

 
72

 
74

 
49

 
249

Carrying value/estimated fair value
 
$
20,253

 
$
122,298

 
$
233,933

 
$
425,727

 
$
440,411

 
$
170,572

 
$
1,413,194

Amortized cost
 
$
20,131

 
$
107,593

 
$
206,481

 
$
401,112

 
$
423,338

 
$
163,013

 
$
1,321,668

Current par value
 
$
20,131

 
$
156,040

 
$
287,569

 
$
507,974

 
$
477,038

 
$
182,072

 
$
1,630,824

Carrying value to current par
 
100.61
%
 
78.38
%
 
81.35
%
 
83.81
%
 
92.32
%
 
93.68
%
 
86.66
%
Amortized cost to current par
 
100.00
%
 
68.95
%
 
71.80
%
 
78.96
%
 
88.74
%
 
89.53
%
 
81.04
%
Net weighted average security coupon
 
3.35
%
 
1.43
%
 
0.64
%
 
1.04
%
 
1.32
%
 
2.03
%
 
1.23
%
Loan Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average loan age (months)
 
88

 
90

 
99

 
110

 
120

 
137

 
113

Weighted average original loan-to-value
 
95.03
%
 
77.48
%
 
78.48
%
 
80.24
%
 
79.76
%
 
80.25
%
 
79.78
%
Weighted average original FICO
 
609

 
666

 
653

 
648

 
622

 
616

 
638

Current Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
60+ day delinquencies
 
72.93
%
 
31.58
%
 
30.88
%
 
31.16
%
 
25.70
%
 
26.47
%
 
29.48
%
Average credit enhancement (2)
 
57.49
%
 
17.81
%
 
23.33
%
 
36.02
%
 
41.64
%
 
27.08
%
 
33.32
%
3 month CRR (3)
 
0.92
%
 
2.75
%
 
3.71
%
 
4.20
%
 
5.13
%
 
4.06
%
 
4.22
%
(1) 
Certain of our non-Agency RMBS have been resecuritized; however, the vintage and information presented is based on the initial year of securitization and the data available at that time.
(2) 
Credit enhancement is expressed as a percentage of all outstanding mortgage loan collateral. Our RMBS may incur losses if credit enhancement is reduced to zero. Information is based on loans for individual groups owned by us.
(3) 
Amounts presented reflect the weighted average monthly performance for the three months ended June 30, 2014. Information is based on loans for individual groups owned by us.
The following table presents the fair value of our non-Agency RMBS at June 30, 2014, by original purchase price as a percentage of our par value by year of acquisition:
Table 21
 
Year of Acquisition
 
 
Acquisition Price (1)
 
2014
 
2013
 
2012
 
2011
 
Total
 
Percent of Total
>100%
 
$
5,892

 
$
15,449

 
$
—

 
$
—

 
$
21,341

 
1.5
%
95% to 100%
 
65,305

 
41,922

 
533

 
—

 
107,760

 
7.6

85% to <95%
 
74,099

 
379,272

 
48,563

 
4,549

 
506,483

 
35.8

75% to <85%
 
67,531

 
189,176

 
113,434

 
15,092

 
385,233

 
27.3

65% to <75%
 
6,158

 
72,460

 
92,142

 
18,164

 
188,924

 
13.4

<65%
 
8,941

 
8,638

 
161,384

 
24,490

 
203,453

 
14.4

Total
 
$
227,926

 
$
706,917

 
$
416,056

 
$
62,295

 
$
1,413,194

 
100.0
%
(1) 
Prices are expressed as a percentage of par value.



64


The mortgages underlying our non-Agency RMBS are located in various states across the U.S. The following table presents the five largest concentrations by state for the mortgages collateralizing our non-Agency RMBS at June 30, 2014 based on fair value:
Table 22
 
 
Property Location
 
Percent (1)
California
 
25.0
%
New York
 
10.0
%
Florida
 
8.5
%
Texas
 
6.4
%
New Jersey
 
3.7
%
Other (2) 
 
46.4
%
Total
 
100.0
%
(1) 
Percentages are weighted to reflect our proportional share for each of the securities we own.
(2) 
Includes mortgages on properties located in each of the remaining 45 states and the District of Columbia, with no concentration exceeding 3.3% of the total.
The following table presents certain information about the mortgage loans underlying our non-Agency RMBS at June 30, 2014:
Table 23
 
 
 
 
Underlying Mortgage Loan Collateral Type
 
Market Value
 
Percent of Total
Subprime
 
$
1,112,709

 
78.73
%
Alt-A
 
158,942

 
11.25

Option ARMs
 
141,543

 
10.02

Total
 
$
1,413,194

 
100.0
%
To the extent we invest in residential mortgage loans, we may retain the risk of potential credit losses on the mortgage loans that we hold in our portfolio. With respect to any residential mortgage loans in which we may invest, we expect to seek to obtain representations and warranties from each seller stating that each loan was underwritten to our requirements or, in the event underwriting exceptions were made, that we are informed of the exceptions so that we may evaluate whether to accept or reject the loans. A seller who breaches these representations and warranties in making a loan that we purchase may be obligated to repurchase the loan from us. In the event we invest in residential mortgage loans, our Manager will seek to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and will proactively manage positions.
Interest Rate Risk
Interest rates are sensitive to many factors, including fiscal and monetary policies, domestic and international economic and political considerations, as well as other factors, all of which are beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset specific funding arrangements.
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments to mitigate the impact of increases in interest rates. Increases in interest rates may impact the cost of our repurchase borrowings and reduce the value of our Agency RMBS. Our hedges are not designed to protect against market value fluctuations in our assets caused by changes in the spread between our investments and other benchmark rates such as Swaps and Treasury bonds. Therefore, the risk of adverse spread changes is inherent to our business. Our asset composition and general market conditions may cause the amount of interest rate protection provided by our derivatives to vary considerably over time. We also may utilize a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our Agency pass-through RMBS and Agency Inverse IO to decline; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the


65


accretion of purchase discounts on our non-Agency RMBS; (v) the value of our Agency IO to increase; (vi) the value of our Short TBA Contracts, if any, Swaps and Swaptions to improve; and (vii) the value of our Long TBA Contracts, if any, to decline. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs as well as other conditions in the market place will further impact our results of operations and financial condition.
Interest Rate Cap Risk
Certain of our RMBS are collateralized by ARMs, which are generally subject to interest rate caps, which could cause such RMBS to acquire characteristics similar to fixed-rate securities if interest rates were to rise above the cap levels. Interim interest rate caps limit the amount interest rates on a particular ARM can adjust during the next adjustment period. Lifetime interest rate caps limit the amount interest rates can adjust upward from inception through maturity of a particular ARM. These caps could result in us receiving less income on such assets than we would incur for interest expense on borrowings to finance such investments. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under “Interest Rate Risk.”
Interest Rate Effects on Estimated Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease differently from our derivative instruments.
The impact of changing interest rates on estimated fair value can change significantly when interest rates change materially. Accordingly, changes in actual interest rates may have a material adverse effect on us. Therefore, the volatility in the estimated fair value of our assets could increase significantly in the event that interest rates change materially. In addition, other factors impact the estimated fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions.
Our RMBS are carried at their estimated fair value with unrealized gains and losses included in earnings. The estimated fair value of these securities fluctuates primarily due to changes in interest rates and, with respect to our non-Agency RMBS, credit changes, and other factors. Generally, in a rising interest rate environment, the estimated fair value of our RMBS portfolio, on a net basis, would generally be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would generally be expected to increase.
Our securitized mortgage loans are carried at their estimated fair value with unrealized gains and losses included in earnings. Such assets, which are credit sensitive, are comprised of both ARM and fixed-rate mortgage loans. As a result, changes in the fair value of our securitized mortgage loans are expected to be impacted by delinquencies, changes in housing prices, jobless rates and other factors to a greater extent than by changes in interest rates.
Nearly all of our Agency pass-through RMBS, which comprise the substantial majority of our Agency portfolio, are fixed- rate securities. In general, as market interest rates increase the market prices for fixed-rate securities generally decrease; conversely, as market interest rates decrease the market prices for fixed-rate securities generally increase. We monitor the duration of our Agency RMBS and derivatives using empirical data as well as third-party models and may adjust our portfolio to maintain duration at a level that we believe is prudent in the current or anticipated interest rate environment. In a rising interest rate environment, the weighted average life of our Agency RMBS could extend significantly beyond the terms of our Swaps or other hedging instruments. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed beyond the term of the hedging instrument while the income earned on the remaining Agency RMBS would remain fixed for a period of time. This situation may also cause the market value of our Agency RMBS to decline with insufficient or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses. Variations in models and methodologies in measuring duration may produce differing results for the same securities or portfolio.
The value of our non-Agency RMBS and securitized mortgage loans, which may be backed by Hybrid, ARM and fixed-rate mortgage loans, are more significantly impacted by the performance of the underlying collateral (i.e., credit) than by changes in interest rates.
Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call, which we satisfy by pledging additional collateral in the form of securities and/or cash to the lender. In general, decreases in the fair value of our RMBS will reduce the amount we are able to borrow.


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The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including derivative instruments and net interest income at June 30, 2014, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilizes our Manager’s assumptions, models and estimates, which are based on our Manager’s judgment and experience. For example, given the low level of interest rates at June 30, 2014, we have assumed a floor on repurchase agreement borrowing rates of 25 basis points and we have assumed a floor of six basis points with respect to the variable rate that we receive on our Swaps.
Table 24
 
 
 
 
Basis Point Change in Interest Rates
 
Percentage Change in Projected
Portfolio Value
 
Percentage Change in Projected 
Net Interest Income and Periodic Interest Settlements for Swaps
+100
 
1.42%
 
0.01%
+50
 
0.68%
 
(0.24)%
(50)
 
(1.00)%
 
(13.12)%
(100)
 
(1.91)%
 
(20.18)%
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at June 30, 2014. The analysis presented utilizes assumptions and estimates based on our Manager’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.
Prepayment Risk
The value of our assets may be affected by prepayment rates on residential mortgage loans. If we acquire residential mortgage loans and mortgage related securities, we anticipate that the residential mortgage loans or the underlying residential mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated.
Counterparty Risk
We finance the acquisition of a significant portion of our RMBS with repurchase agreements. The aggregate of our repurchase agreement financings are reflected as a liability in our consolidated balance sheet. In connection with these financing arrangements, we pledge our securities as collateral to secure the borrowing. The amount of collateral pledged will typically exceed the amount of the borrowing, as lenders apply a haircut to the collateral value, whereby the haircut reflects the percentage by which the collateral value is discounted to determine the loan amount. As a result, we are exposed to the counterparty if, during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral. For additional information about our assets pledged as collateral as of June 30, 2014, see Note 8 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.
We enter into Swaps, Swaptions, and TBA Contracts to manage our interest rate risk and are required to pledge cash or securities as collateral as part of a margin arrangement in connection with such contracts. The amount of margin that we are required to post will vary by counterparty and generally reflects collateral posted with respect to Swaps and TBA Contracts that are in an unrealized loss position to us and a percentage of the aggregate notional amount of Swaps and Swaptions per counterparty. In the event that a counterparty to one of these contracts were to default on its obligation, we would be exposed to a loss when the amount of cash or securities pledged by us exceeds the unrealized loss on such contracts and to the extent that we are not able to recover our excess collateral. In addition, if a counterparty to a Swap cannot perform under the terms of the Swap, we may not receive payments due under that agreement, and thus, may lose any unrealized gain associated with the Swap or, be unable to collect the cash value, if any, at expiration. Therefore, upon a default by a Swap counterparty, the Swap would no longer mitigate the impact of changes in interest rates as intended. If a counterparty to a Swaption cannot perform


67


under the terms of a Swaption, we would lose our ability to exercise our option to enter into a Swap and could lose the amount by which the Swaption is in-the-money.
During the past several years, certain repurchase agreement and derivative counterparties in the U.S. and Europe have experienced financial difficulty and have been either rescued by government assistance or otherwise benefited from accommodative monetary policy of their respective central banks.
The following table summarizes our exposure to our repurchase agreements and derivative counterparties at June 30, 2014:
Table 25
 
 
 
 
 
 
 
 
 
 
 
 
Number of
Counter-
parties
 
Repurchase
Agreement
Borrowings
 
Derivatives at
Fair Value
 
Exposure (1)
 
Exposure
as Percent
of Total
Assets
North America:
 
 
 
 
 
 
 
 
 
 
United States
 
7

 
$
1,392,781

 
$
9,663

 
$
221,405

 
5.7
%
Canada (2)
 
2

 
507,778

 
—

 
100,234

 
2.6
%
 
 
9

 
1,900,559

 
9,663

 
321,639

 
8.3
%
Europe: (2)
 
 
 
 
 
 
 
 
 
 
Germany
 
1

 
94,740

 
—

 
8,285

 
0.2
%
Switzerland
 
1

 
79,824

 
—

 
36,443

 
0.9
%
United Kingdom
 
2

 
374,524

 
(2,609
)
 
89,084

 
2.3
%
Netherlands
 
1

 
171,132

 
478

 
10,324

 
0.3
%
 
 
5

 
720,220

 
(2,131
)
 
144,136

 
3.7
%
Asia: (2)
 
 
 
 
 
 
 
 
 
 
Japan
 
3

 
371,210

 
4,681

 
26,129

 
0.7
%
Total Counterparty Exposure
 
17

 
$
2,991,989

 
$
12,213

 
$
491,904

 
12.7
%
 
(1) 
Represents the amount of cash and/or securities pledged as collateral to counterparties and associated accrued interest receivable less the aggregate of repurchase agreement borrowings and associated accrued interest payable and unrealized loss on Swaps for each counterparty net of collateral pledged to us, the fair value of our Swaptions.
(2) 
Includes foreign based counterparties as well as U.S. domiciled subsidiaries of such counterparties, as such transactions are generally entered into with a U.S. domiciled subsidiary of such counterparties.
We maintain cash deposits with what we believe to be high credit quality financial institutions. At June 30, 2014, we had cash of $98,014 which was primarily comprised of cash on deposit with our prime broker domiciled in the U.S., substantially all of which was in excess of applicable insurance limits.


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We had outstanding balances under repurchase agreements with 17 counterparties at June 30, 2014. The following table presents information with respect to any counterparty for repurchase agreements for which we had greater than 5% of stockholders’ equity at risk in the aggregate at June 30, 2014:
Table 26
 
 
 
 
 
 
 
 
Counterparty
 
Counterparty Rating (1)
 
Amount of Risk (2)
 
Weighted Average Months to Maturity for Repurchase Agreements
 
Percent of Stockholders’ Equity
J.P. Morgan Securities LLC
 
A+/Aa3/A+
 
$
77,308

 
6

 
9.7
%
Barclays Capital Inc.(3)
 
A/A2/A
 
$
72,545

 
5

 
9.1
%
Royal Bank of Canada (4)
 
AA-/Aa3/AA
 
$
89,426

 
9

 
11.2
%
Wells Fargo (5)
 
AA-/Aa3/AA-
 
$
86,870

 
12

 
10.9
%
(1) 
The counterparty rating presented is the long-term issuer credit rating as rated at June 30, 2014 by Standard & Poor’s Ratings Services, Moody’s Investor Services, Inc. and Fitch, Inc., respectively. 
(2) 
The amount at risk reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities.
(3) 
Counterparty rating is the rating for Barclays Bank PLC, which is the parent entity of Barclays Capital Inc. Barclays Capital Inc. was rated A by Standard & Poor’s Ratings Services as of June 30, 2014.
(4) 
Includes amounts at risk with Royal Bank of Canada and RBC (Barbados) Trading Bank Corporation. Counterparty rating is the rating for Royal Bank of Canada, as RBC (Barbados) Trading Bank Corporation was not rated at June 30, 2014.
(5) 
Includes amounts at risk with Wells Fargo Bank, N.A. and Wells Fargo Securities, LLC. Counterparty rating is the rating for Wells Fargo Bank, N.A. which represents $74,616 of the total exposure. The remaining exposure is to Wells Fargo Securities, LLC which was rated AA- by Standard & Poor’s Ratings Services as of June 30, 2014.
Funding Risk
We have financed a substantial majority of our RMBS with repurchase agreement borrowings. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.
Liquidity Risk
The assets that comprise our asset portfolio are not traded on an exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than exchange-traded securities. Certain of our assets may from time to time become illiquid, making it difficult for us to sell such assets if the need or desire arises, or sell such assets at prices that are detrimental to us, including in response to changes in economic and other conditions.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation. Our financial statements are prepared in accordance with GAAP and dividends are based upon net ordinary income as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.


69


ITEM 4.
Controls and Procedures.
The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as of June 30, 2014, our disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder.
During the period ended June 30, 2014, there was no change in our internal control over financial reporting that has materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.


70


PART II – OTHER INFORMATION
ITEM 1.
Legal Proceedings
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of June 30, 2014, we were not involved in any legal proceedings.

ITEM 1A.
Risk Factors
There were no material changes to the Risk Factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.
ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3.
Defaults Upon Senior Securities
None.
ITEM 4.
Mine Safety Disclosures
Not Applicable.
ITEM 5.
Other Information
None.


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ITEM 6.
Exhibits
Exhibit No.
  
Description
 
 
3.1

  
Articles of Amendment and Restatement of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.1 of the Registrant’s Form S-8 (Registration No. 333-175824).
 
 
3.2

  
Articles Supplementary designating Apollo Residential Mortgage, Inc.’s 8.00% Series A Cumulative Redeemable Perpetual Preferred Stock, liquidation preference $25.00 per share, par value $0.01 per share, incorporated by reference to Exhibit 3.2 of the Registrant’s Form 8-A (File No.: 001-35246), filed on September 19, 2012.
 
 
3.3

  
Amended and Restated Bylaws of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.2 of the Registrant’s Form S-8 (Registration No. 333-175824).
 
 
4.1

  
Specimen Common Stock Certificate of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 4.1 of the Registrant’s Form S-11, as amended (Registration No. 333-172980).
 
 
4.2

  
Specimen Preferred Stock Certificate of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 4.2 of the Registrant’s Form 10-Q for the period ended September 30, 2012.
 
 
 
10.1

 
Registration Rights Agreement, dated as of July 27, 2011, between Apollo Residential Mortgage, Inc. and the parties named therein, incorporated by reference to Exhibit 10.1 of the Registrant’s Form 10-Q for the period ended September 30, 2011.
 
 
 
10.2

 
Management Agreement, dated as of July 21, 2011 and effective as of July 27, 2011, between Apollo Residential Mortgage, Inc., ARM Operating, LLC and ARM Manager, LLC, incorporated by reference to Exhibit 10.2 of the Registrant’s Form 10-Q for the period ended September 30, 2011.
 
 
 
10.3

 
License Agreement, dated as of July 21, 2011, between Apollo Residential Mortgage, Inc. and Apollo Global Management, LLC, incorporated by reference to Exhibit 10.3 of the Registrant’s Form 10-Q for the period ended September 30, 2011.
 
 
 
10.4

 
Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan, incorporated by reference to Exhibit 10.1 of the Registrant’s Form S-8 (Registration No. 333- 175824).
 
 
 
10.5

 
Form of Restricted Stock Award Agreement, incorporated by reference to Exhibit 10.3 of the Registrant’s Form S-11, as amended (Registration No. 333-172980).
 
 
 
10.6

 
Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.4 of the Registrant’s Form S-11, as amended (Registration No. 333-172980).
 
 
 
31.1

  
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
31.2

  
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1

  
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of 18 U.S.C. Section 1350 as adopted pursuant to the Sarbanes-Oxley Act of 2002.
 
 
101.INS*

  
XBRL Instance Document
 
 
101.SCH*

  
XBRL Taxonomy Extension Schema Document
 
 
101.CAL*

  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 


72


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.



73


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
 
 
 
 
 
 
APOLLO RESIDENTIAL MORTGAGE, INC.
 
 
 
 
 
 
 
 
August 6, 2014
 
 
 
 
 
 
 
 
By:
 
/s/ Michael A. Commaroto
 
 
 
 
 Michael A. Commaroto
 
 
 
 
 President and Chief Executive Officer
 
 
 
 
 (Principal Executive Officer)
 
 
 
 
 
 
 
 
By:
 
/s/ Teresa D. Covello
 
 
 
 
 Teresa D. Covello
 
 
 
 
 Chief Financial Officer
 
 
 
 
 (Principal Financial Officer and Principal Accounting Officer)


74

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