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EX-32.1 - EXHIBIT 32.1 - NEW YORK MORTGAGE TRUST INCex32-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q   

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2015

 

OR

 

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 001-32216

 

NEW YORK MORTGAGE TRUST, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Maryland 

47-0934168 

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

275 Madison Avenue, New York, New York 10016

(Address of Principal Executive Office) (Zip Code)

 

(212) 792-0107

(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     No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes     No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large Accelerated Filer

Accelerated Filer

Non-Accelerated Filer

Smaller Reporting Company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes     No

 

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding on August 1, 2015 was 109,401,721.

 

 
 

 

 

NEW YORK MORTGAGE TRUST, INC.

 

FORM 10-Q

 

PART I. Financial Information

 

 

Item 1. Condensed Consolidated Financial Statements

2

 

Condensed Consolidated Balance Sheets as of June 30, 2015 (Unaudited) and December 31, 2014

2

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2015 and 2014

3

 

Unaudited Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended  June 30, 2015 and 2014

4

 

Unaudited Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2015

5

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2015 and 2014

6

 

Unaudited Notes to the Condensed Consolidated Financial Statements

7

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

46

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

71

 

Item 4. Controls and Procedures

76

PART II. OTHER INFORMATION

 

 

Item 1A. Risk Factors

76

 

Item 6. Exhibits

77

     

SIGNATURES

78

 

 
 

 

 

 PART I.  FINANCIAL INFORMATION

 

Item 1.  Condensed Consolidated Financial Statements

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollar amounts in thousands, except share data)

 

   

June 30,

   

December 31,

 
   

2015

   

2014

 
    (unaudited)          

ASSETS

 

 

         

 

               

Investment securities, available for sale, at fair value (including pledged securities of $644,787 and $702,684, respectively)

  $ 735,320     $ 816,647  

Investment securities, available for sale, at fair value held in securitization trusts

    40,217       38,594  

Residential mortgage loans held in securitization trusts (net)

    137,440       149,614  

Distressed residential mortgage loans held in securitization trusts (net)

    201,392       221,591  

Distressed residential mortgage loans

    379,148       361,106  

Multi-family loans held in securitization trusts, at fair value

    7,235,328       8,365,514  

Derivative assets

    302,817       288,850  

Receivables for securities sold

    34,733        

Cash and cash equivalents

    106,461       75,598  

Receivables and other assets

    232,588       222,491  

Total Assets (1)

  $ 9,405,444     $ 10,540,005  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Liabilities:

               

Financing arrangements, portfolio investments

  585,492     651,965  

Financing arrangements, distressed residential mortgage loans

    236,908       238,949  

Residential collateralized debt obligations

    133,258       145,542  

Multi-family collateralized debt obligations, at fair value

    6,932,092       8,048,053  

Securitized debt

    191,689       232,877  

Derivative liabilities

    4,411       1,463  

Payable for securities purchased

    302,322       283,537  

Accrued expenses and other liabilities (including $461 and $6,317 to related parties, respectively)

    62,823       74,692  

Subordinated debentures

    45,000       45,000  

Total liabilities (1)

    8,493,995       9,722,078  
                 

Commitments and Contingencies

               
                 

Stockholders' Equity:

               

Preferred stock, $0.01 par value, 7.75% Series B cumulative redeemable, $25 liquidation preference per share, 6,000,000 and 3,450,000 shares authorized as of June 30, 2015 and December 31, 2014 respectively, 3,000,000 shares issued and outstanding as of June 30,2015 and December 31, 2014

    72,397       72,397  

Preferred stock, $0.01 par value, 7.875% Series C cumulative redeemable, $25 liquidation preference per share, 4,140,000 shares authorized, 3,600,000 and 0 shares issued and outstanding as of June 30, 2015 and December 31, 2014

    86,862        

Common stock, $0.01 par value, 400,000,000 shares authorized, 109,401,721 and 105,094,565 shares issued and outstanding as of June 30, 2015 and December 31, 2014, respectively

    1,094       1,051  

Additional paid-in capital

    734,118       701,871  

Accumulated other comprehensive (loss)income

    (563 )     10,015  

Retained earnings

    17,541       32,593  

Total stockholders' equity

    911,449       817,927  

Total Liabilities and Stockholders' Equity

  $ 9,405,444     $ 10,540,005  

 

 

(1) Our consolidated balance sheets include assets and liabilities of consolidated variable interest entities ("VIEs") as the Company is the primary beneficiary of these VIEs. As of June 30, 2015 and December 31, 2014, assets of consolidated VIEs totaled $7,663,228 and $8,847,078, respectively, and the liabilities of consolidated VIEs totaled $7,281,234 and $8,457,034, respectively. See Note 7 for further discussion.

 

 
2

 

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollar amounts in thousands, except per share data)

(unaudited)

 

   

For the Three Months

   

For the Six Months

 
   

Ended June 30,

   

Ended June 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 

INTEREST INCOME:

                               

Investment securities and other

  $ 10,196     $ 14,193     $ 21,540     $ 29,157  

Multi-family loans held in securitization trusts

    62,984       75,501       129,284       150,445  

Residential mortgage loans held in securitization trusts

    895       1,005       2,075       1,983  

Distressed residential mortgage loans

    10,325       4,849       20,486       9,201  

Total interest income

    84,400       95,548       173,385       190,786  
                                 

INTEREST EXPENSE:

                               

Investment securities and other

    3,442       1,402       6,905       2,872  

Multi-family collateralized debt obligations

    56,992       69,110       117,087       137,857  

Residential collateralized debt obligations

    221       228       460       463  

Securitized debt

    2,974       4,459       6,101       8,961  

Subordinated debentures

    468       466       928       925  

Total interest expense

    64,097       75,665       131,481       151,078  
                                 

NET INTEREST INCOME

    20,303       19,883       41,904       39,708  
                                 

OTHER INCOME (EXPENSE):

                               

Provision for loan losses

    (112 )     (663 )     (548 )     (1,152 )

Realized (loss) gain on investment securities and related hedges, net

    (1,291 )     1,325       (167 )     3,364  

Gain on de-consolidation of multi-family loans held in securitization trust and multi-family collateralized debt obligations

                1,483        

Realized gain on distressed residential mortgage loans

    3,614       418       4,290       8,643  

Unrealized gain (loss) on investment securities and related hedges, net

    4,716       (1,291 )     (1,012 )     (3,027 )

Unrealized gain on multi-family loans and debt held in securitization trusts, net

    5,418       20,019       19,046       24,945  

Other income (including $1,712, $121, $3,588 and $263 from related parties, respectively)

    2,300       203       4,586       713  

Total other income

    14,645       20,011       27,678       33,486  
                                 

Base management and incentive fees (including $3,917, $1,129, $4,822 and $2,219 to related parties, respectively)

    4,141       3,866       11,011       7,644  

Expenses related to distressed residential mortgage loans

    2,682       1,217       4,566       2,429  

Other general and administrative expenses (including $0, $80, $0 and $80 to related parties, respectively)

    2,316       2,494       4,408       5,063  

Total general, administrative and other expenses

    9,139       7,577       19,985       15,136  
                                 

INCOME FROM OPERATIONS BEFORE INCOME TAXES

    25,809       32,317       49,597       58,058  

Income tax expense

    1,178       538       1,423       3,568  

NET INCOME

    24,631       31,779       48,174       54,490  

Preferred stock dividends

    (3,087 )     (1,453 )     (4,540 )     (2,906 )

NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS

  21,544     30,326     43,634     51,584  
                                 

Basic income per common share

  $ 0.20     $ 0.34     $ 0.41     $ 0.63  

Diluted income per common share

  $ 0.20     $ 0.34     $ 0.41     $ 0.63  

Weighted average shares outstanding-basic

    109,252       89,686       107,380       82,137  

Weighted average shares outstanding-diluted

    109,252       89,686       107,380       82,137  

 

 
3

 

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

(unaudited)

 

 

   

For the Three Months

   

For the Six Months

 
   

Ended June 30,

   

Ended June 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 
                                 

NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS

  $ 21,544     $ 30,326     $ 43,634     $ 51,584  
                                 

OTHER COMPREHENSIVE INCOME (LOSS)

                               
                                 

(Decrease) increase in net unrealized gain on available for sale securities

    (3,490 )     13,427       (353 )     21,877  

Reclassification adjustment for net gain included in net income

    (9,063 )           (9,063 )      

Increase(decrease) in fair value of derivative instruments utilized for cash flow hedges

    99       (1,201 )     (1,162 )     (1,330 )
                                 

OTHER COMPREHENSIVE (LOSS) INCOME

    (12,454 )     12,226       (10,578 )     20,547  
                                 

COMPREHENSIVE INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS

  $ 9,090     $ 42,552     $ 33,056     $ 72,131  

 

 
4

 

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

(Dollar amounts in thousands)

(unaudited)

 

                                   

Accumulated

         
                   

Additional

           

Other

         
   

Common

   

Preferred

   

Paid-In

   

Retained

   

Comprehensive

         
   

Stock

   

Stock

   

Capital

   

Earnings

   

(Loss) Income

   

Total

 

Balance, December 31, 2014

  $ 1,051     $ 72,397     $ 701,871     $ 32,593     $ 10,015     $ 817,927  

Net income

                      48,174             48,174  

Stock issuance, net

    43       86,862       32,247                   119,152  

Dividends declared

                      (63,226 )           (63,226 )

Reclassification adjustment for net gain included in net income

                            (9,063 )     (9,063 )

Increase in net unrealized loss on available for sale securities

                            (353 )     (353 )

Decrease in fair value of derivative instruments utilized for cash flow hedges

                            (1,162 )     (1,162 )

Balance, June 30, 2015

  $ 1,094     $ 159,259     $ 734,118     $ 17,541     $ (563 )   $ 911,449  

 

 
5

 

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

(unaudited)

 

   

For the Six Months Ended

 
   

June 30

 
   

2015

   

2014

 

Cash Flows from Operating Activities:

               

Net income

  $ 48,174     $ 54,490  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Net amortization

    (1,298 )     (1,617 )

Realized loss on investment securities and related hedges, net

    167       (3,364 )

Realized gain on distressed residential mortgage loans

    (4,290 )     (8,643 )

Unrealized loss on investment securities and related hedges, net

    1,012       3,027  

Gain on de-consolidation of multi-family loans held in securitization trusts and multi-family collateralized debt obligations

    (1,483 )      

Unrealized gain on loans and debt held in multi-family securitization trusts

    (19,046 )     (24,945 )

Net decrease in loans held for sale

    10       24  

Provision for loan losses

    548       1,152  

Proceeds from sale of real estate owned

    547        

Income from investments in limited partnerships and limited liability companies

    (5,856 )     (727 )

Distributions of income from investments in limited partnership and limited liability companies

    3,924       859  

Amortization of stock based compensation, net

    458       667  

Changes in operating assets and liabilities:

               

Receivables and other assets

    6,919       (5,585 )

Accrued expenses and other liabilities and accrued expenses, related parties

    (14,667 )     1,159  

Net cash provided by operating activities

    15,119       16,497  
                 

Cash Flows from Investing Activities:

               

Restricted cash

    3,167       (32,665 )

Purchases of investment securities

    (5,265 )     (20,273 )

Purchases of FHLBI stock

    (5,445 )      

Purchases of other assets

    (6 )     (77 )

Funding of mezzanine loans, equity and preferred equity investments

    (25,101 )     (12,543 )

Net proceeds on other derivative instruments settled during the period

    (2,178 )     3,688  

Principal repayments received on residential mortgage loans held in securitization trusts

    11,634       7,212  

Principal repayments and proceeds from sales and refinancing of distressed residential mortgage loans

    51,115       48,088  

Principal repayments received on multi-family loans held in securitization trusts

    37,701       33,669  

Principal paydowns on investment securities - available for sale

    37,748       45,488  

Purchases of residential mortgage loans and distressed residential mortgage loans

    (30,038 )     (20,107 )

Sales of loans held in multi-family securitization trusts

    44,261        

Net cash provided by investing activities

    117,593       52,480  
                 

Cash Flows from Financing Activities:

               

Payments made on financing arrangements, net of FHLBI advances

    (68,514 )     (122,697 )

Common stock issuance, net

    31,832       185,710  

Preferred stock issuance, net

    86,862        

Dividends paid on common stock

    (57,523 )     (37,736 )

Dividends paid on preferred stock

    (2,906 )     (2,906 )

Payments made on residential collateralized debt obligations

    (12,334 )     (7,340 )

Payments made on multi-family collateralized debt obligations

    (37,694 )     (33,669 )

Payments made on securitized debt

    (41,572 )     (11,004 )

Net cash used in financing activities

    (101,849 )     (29,642 )

Net Increase in Cash and Cash Equivalents

    30,863       39,335  

Cash and Cash Equivalents - Beginning of Period

    75,598       31,798  

Cash and Cash Equivalents - End of Period

  $ 106,461     $ 71,133  
                 

Supplemental Disclosure:

               

Cash paid for interest

  $ 157,462     $ 176,893  

Cash paid for income taxes

  $ 2,300     $ 4,519  
                 

Non-Cash Investment Activities:

               

Sales of investment securities not yet settled

  $ 121,508     $  

Purchase of investment securities not yet settled

  $ 389,097     $ 204,580  

Deconsolidation of multi-family loans held in securitization trusts

  $ 1,075,529     $  

Deconsolidation of multi-family collateralized debt obligations

  $ 1,031,268     $  
                 

Non-Cash Financing Activities:

               

Dividends declared on common stock to be paid in subsequent period

  $ 29,538     $ 24,485  

Dividends declared on preferred stock to be paid in subsequent period

  $ 3,087     $ 1,453  

 

 
6

 

 

NEW YORK MORTGAGE TRUST, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2015

 (unaudited)

 

1.             Organization

 

New York Mortgage Trust, Inc., together with its consolidated subsidiaries (“NYMT,” or the “Company), is a real estate investment trust, or REIT, in the business of acquiring, investing in, financing and managing primarily mortgage-related assets and financial assets. Our objective is to manage a portfolio of investments that will deliver stable distributions to our stockholders over diverse economic conditions. We intend to achieve this objective through a combination of net interest margin and net realized capital gains from our investment portfolio. Our portfolio includes investments in mortgage-related and financial assets, residential mortgage loans, including loans sourced from distressed markets, multi-family CMBS, direct financing to owners of multi-family properties through mezzanine loans and preferred equity investments, equity and debt securities issued by entities that invest in commercial real estate-related debt investments, Agency RMBS consisting of fixed-rate, adjustable-rate and hybrid adjustable-rate RMBS and Agency IOs consisting of interest only and inverse interest-only RMBS that represent the right to the interest component of the cash flow from a pool of mortgage loans.

 

The Company conducts its business through the parent company, NYMT, and several subsidiaries, including special purpose subsidiaries established for residential loan and CMBS securitization purposes, taxable REIT subsidiaries ("TRSs") and qualified REIT subsidiaries ("QRSs"). The Company consolidates all of its subsidiaries under generally accepted accounting principles in the United States of America (“GAAP”).

 

The Company is organized and conducts its operations to qualify as a REIT for federal income tax purposes. As such, the Company will generally not be subject to federal income tax on that portion of its income that is distributed to stockholders if it distributes at least 90% of its REIT taxable income to its stockholders by the due date of its federal income tax return and complies with various other requirements.

 

2.             Summary of Significant Accounting Policies 

 

Definitions – The following defines certain of the commonly used terms in these financial statements: “RMBS” refers to residential adjustable-rate, hybrid adjustable-rate, fixed-rate, interest only and inverse interest only and principal only mortgage-backed securities; “Agency RMBS” refers to RMBS representing interests in or obligations backed by pools of mortgage loans issued or guaranteed by a federally chartered corporation (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. government, such as the Government National Mortgage Association (“Ginnie Mae”); “non-Agency RMBS” refers to RMBS backed by prime jumbo mortgage loans; “IOs” refers collectively to interest only and inverse interest only mortgage-backed securities that represent the right to the interest component of the cash flow from a pool of mortgage loans; “POs” refers to mortgage-backed securities that represent the right to the principal component of the cash flow from a pool of mortgage loans; “Agency IOs” refers to an IO that represents the right to the interest component of the cash flows from a pool of residential mortgage loans issued or guaranteed by a GSE or an agency of the U.S. government; “ARMs” refers to adjustable-rate residential mortgage loans; “Prime ARM loans” and “residential securitized loans” each refer to prime credit quality residential ARM loans (“prime ARM loans”) held in securitization trusts; “Agency ARMs” refers to Agency RMBS comprised of adjustable-rate and hybrid adjustable-rate RMBS; “CMBS” refers to commercial mortgage-backed securities comprised of commercial mortgage pass-through securities, as well as IO or PO securities that represent the right to a specific component of the cash flow from a pool of commercial mortgage loans; “multi-family CMBS” refers to CMBS backed by commercial mortgage loans on multi-family properties; “CDOs” refers to collateralized debt obligations; and “CLO” refers to collateralized loan obligations.

 

 
7

 

 

Basis of Presentation – The accompanying condensed consolidated balance sheet as of December 31, 2014 has been derived from audited financial statements.  The accompanying condensed consolidated balance sheet as of June 30, 2015, the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2015 and 2014, the accompanying condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2015 and 2014, the accompanying condensed consolidated statement of changes in stockholders’ equity for the six months ended June 30, 2015 and the accompanying condensed consolidated statements of cash flows for the six months ended June 30, 2015 and 2014 are unaudited.  In our opinion, all adjustments (which include only normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations and cash flows have been made.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q.  These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the U.S. Securities and Exchange Commission (“SEC”).  The results of operations for the three and six months ended June 30, 2015 are not necessarily indicative of the operating results for the full year. 

 

The accompanying condensed consolidated financial statements have been prepared on the accrual basis of accounting in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could be different than anticipated in those estimates, which could materially impact the Company’s results of operations and its financial condition. Management has made significant estimates in several areas, including valuation of its CMBS investments, multi-family loans held in securitization trusts and multi-family CDOs, as well as, income recognition on distressed residential mortgage loans purchased at a discount. 

 

Principles of Consolidation and Variable Interest Entities – The accompanying condensed consolidated financial statements of the Company include the accounts of all its subsidiaries which are majority-owned, controlled by the Company or a VIE where the Company is the primary beneficiary.  All significant intercompany accounts and transactions have been eliminated in consolidation.

 

A VIE is an entity that lacks one or more of the characteristics of a voting interest entity.  A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.  The Company consolidates a VIE when it is the primary beneficiary of such VIE. As primary beneficiary, it has both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.

 

Investment Securities Available for Sale – The Company's investment securities, where the fair value option has not been elected and which are reported at fair value with unrealized gains and losses reported in Other Comprehensive Income (“OCI”), include Agency RMBS, non-Agency RMBS and CLOs.  The Company has elected the fair value option for its Agency IOs, U.S. Treasury securities, certain Agency ARMs and Agency Fixed Securities within the Agency IO portfolio, which measures unrealized gains and losses through earnings in the accompanying condensed consolidated statements of operations. The fair value option was elected for these investment securities to mitigate earnings volatility by better matching the accounting for these investment securities with the related derivative instruments within the Agency IO portfolio. The derivative instruments within the Agency IO portfolio are not designated as hedging instruments for accounting purposes.

 

The Company generally intends to hold its investment securities until maturity; however, from time to time, it may sell any of its securities as part of the overall management of its business. As a result, our investment securities are classified as available for sale securities.

 

Realized gains and losses recorded on the sale of investment securities available for sale are based on the specific identification method and included in realized gain (loss) on investment securities and related hedges in the accompanying condensed consolidated statements of operations. Purchase premiums or discounts on investment securities are amortized or accreted to interest income over the estimated life of the investment securities using the effective yield method. Adjustments to amortization are made for actual prepayment activity.

 

 
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The Company accounts for debt securities that are of high credit quality (generally those rated AA or better by a Nationally Recognized Statistical Rating Organization, or NRSRO), at date of acquisition in accordance with Accounting Standards Codification (“ASC”) 320-10. The Company accounts for debt securities that are not of high credit quality (i.e., those whose risk of loss is less than remote) or securities that can be contractually prepaid such that we would not recover our initial investment at the date of acquisition in accordance with ASC 325-40. The Company considers credit ratings, the underlying credit risk and other market factors in determining whether the debt securities are of high credit quality; however, securities rated lower than AA or an equivalent rating are not considered of high credit quality and are accounted for in accordance with ASC 325-40. If ratings are inconsistent among NRSROs, the Company uses the lower rating in determining whether the securities are of high credit quality.

 

The Company assesses its impaired securities on at least a quarterly basis and designates such impairments as either “temporary” or “other-than-temporary” by applying the guidance prescribed in ASC Topic 320-10. When the fair value of an investment security is less than its amortized cost as of the reporting balance sheet date, the security is considered impaired.  If the Company intends to sell an impaired security, or it is more likely than not that it will be required to sell the impaired security before its anticipated recovery, then it must recognize an other-than-temporary impairment through earnings equal to the entire difference between the investment’s amortized cost and its fair value as of the balance sheet date. If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the other-than-temporary impairment related to credit losses is recognized through earnings with the remainder recognized as a component of other comprehensive income (loss) on the accompanying condensed consolidated balance sheets. Impairments recognized through other comprehensive income (loss) do not impact earnings. Following the recognition of an other-than-temporary impairment through earnings, a new cost basis is established for the security, which may not be adjusted for subsequent recoveries in fair value through earnings. However, other-than-temporary impairments recognized through earnings may be accreted back to the amortized cost basis of the security on a prospective basis through interest income. The determination as to whether an other-than-temporary impairment exists and, if so, the amount considered other-than-temporarily impaired is subjective, as such determinations are based on both factual and subjective information available at the time of assessment as well the Company’s estimates of the future performance and cash flow projections. As a result, the timing and amount of other-than-temporary impairments constitute material estimates that are susceptible to significant change.

 

In determining the other-than temporary impairment related to credit losses for securities that are not of high credit quality, the Company compares the present value of the remaining cash flows expected to be collected at the purchase date (or last date previously revised) against the present value of the cash flows expected to be collected at the current financial reporting date.  The Company considers information available about the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities and delinquency rates.

 

Investment Securities Available for Sale Held in Securitization Trusts – The Company’s investment securities available for sale held in securitization trusts as of June 30, 2015 and December 31, 2014 are comprised of multi-family CMBS consisting of PO securities that represent the first loss tranche of the securitizations from which they were issued, or “first loss tranche”, and certain IOs issued from two Freddie Mac-sponsored multi-family K-Series securitizations. These securities are reported at fair value with unrealized gains and losses reported in OCI. Realized gains and losses recorded on the sale of investment securities available for sale held in securitization trusts are based on the specific identification method and included in realized gain (loss) on sale of securities and related hedges in the accompanying condensed consolidated statements of operations. Purchase premiums or discounts are amortized or accreted to interest income over the estimated life of the investment securities using the effective yield method.

 

Residential Mortgage Loans Held in Securitization Trusts – Residential mortgage loans held in securitization trusts are comprised of certain ARM loans transferred to Consolidated VIEs that have been securitized into sequentially rated classes of beneficial interests. The Company accounted for these securitization trusts as financings which are consolidated into the Company’s financial statements. Residential mortgage loans held in securitization trusts are carried at their unpaid principal balances, net of unamortized premium or discount, unamortized loan origination costs and allowance for loan losses.  Interest income is accrued and recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectible. The accrual of interest on loans is discontinued when, in management’s opinion, the interest is not collectible in the normal course of business, but in no case when payment becomes greater than 90 days delinquent. Loans return to accrual status when principal and interest become current and are anticipated to be fully collectible.

 

We establish an allowance for loan losses based on management's judgment and estimate of credit losses inherent in our portfolio of residential mortgage loans held in securitization trusts. Estimation involves the consideration of various credit-related factors, including but not limited to, macro-economic conditions, current housing market conditions, loan-to-value ratios, delinquency status, historical credit loss severity rates, purchased mortgage insurance, the borrower's current economic condition and other factors deemed to warrant consideration. Additionally, we look at the balance of any delinquent loan and compare that to the current value of the collateralizing property. We utilize various home valuation methodologies including appraisals, broker pricing opinions, internet-based property data services to review comparable properties in the same area or consult with a real estate agent in the property's area. 

 

 
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Acquired Distressed Residential Mortgage Loans – Distressed residential mortgage loans held in securitization trusts are comprised of pools of fixed and adjustable rate residential mortgage loans acquired by the Company at a discount (that is due, in part, to the credit quality of the borrower). Distressed residential mortgage loans held in securitization trusts are distressed residential mortgage loans transferred to Consolidated VIEs that have been securitized into beneficial interests. The Company accounted for these securitization trusts as financings which are consolidated into the Company’s financial statements.  

 

The Company considers the purchase price for the acquired distressed residential mortgage loans to be at fair value at the date of acquisition. These acquired distressed residential mortgage loans were initially recorded at fair value with no allowance for loan losses.

 

Acquired distressed residential mortgage loans that have evidence of deteriorated credit quality at acquisition are accounted for under ASC Subtopic 310-30, "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"). Under ASC 310-30, the acquired loans may be accounted for individually or aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Once a pool is assembled, it is treated as if it was one loan for purposes of applying the accounting guidance

 

Under ASC 310-30, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield,” is accreted into interest income over the life of the loans in each pool or individually using a level yield methodology. Accordingly, our acquired distressed residential mortgage loans accounted for under ASC 310-30 are not subject to classification as nonaccrual classification in the same manner as our residential mortgage loans that were not distressed when acquired by us. Rather, interest income on acquired distressed residential mortgage loans relates to the accretable yield recognized at the pool level or on an individual loan basis, and not to contractual interest payments received at the loan level. The difference between contractually required principal and interest payments and the cash flows expected to be collected, referred to as the “nonaccretable difference,” includes estimates of both the impact of prepayments and expected credit losses over the life of the individual loan, or the pool (for loans grouped into a pool).

 

The Company monitors actual cash collections against its expectations, and revised cash flow estimates are prepared as necessary. These estimates incorporate assumptions regarding default rates, loss severities, value of the underlying real estate securing the loans, the amounts and timing of prepayments and other factors that reflect then-current market conditions. A decrease in expected cash flows in subsequent periods may indicate that the loan pool or individual loan, as applicable, is impaired thus requiring the establishment of an allowance for loan losses by a charge to the provision for loan losses. An increase in expected cash flows in subsequent periods initially reduces any previously established allowance for loan losses by the increase in the present value of cash flows expected to be collected, and results in a recalculation of the amount of accretable yield for the loan pool. The adjustment of accretable yield due to an increase in expected cash flows is accounted for prospectively as a change in estimate. The additional cash flows expected to be collected are reclassified from the nonaccretable difference to the accretable yield, and the amount of periodic accretion is adjusted accordingly over the remaining life of the loans in the pool or individual loan, as applicable. The impacts of (i) prepayments, (ii) changes in variable interest rates, and (iii) any other changes in the timing of expected cash flows are recognized prospectively as adjustments to interest income.

 

An acquired distressed residential mortgage loan may be resolved either through receipt of payment (in full or in part) from the borrower, the sale of the loan to a third party, or foreclosure of the collateral. For acquired distressed residential mortgage loans held in pools, in the event of a sale of the loan, a gain or loss on sale is recognized and reported based on the difference between the sales proceeds and the carrying amount of the acquired distressed residential mortgage loan. In the case of a foreclosure, an individual loan is removed from the pool at the fair value of the underlying collateral less costs to sell. For loans satisfied by payment in full, the loan is removed from the pool. The Company uses the specific allocation method for the removal of loans as the estimated cash flows and related carrying amount for each individual loan are known. In these cases, the remaining accretable yield is unaffected and any material change in remaining effective yield caused by the removal of the loan from the pool is addressed by the re-assessment of the estimate of cash flows for the pool prospectively. Acquired distressed residential mortgage loans subject to modification are not removed from the pool even if those loans would otherwise be considered troubled debt restructurings because the pool, and not the individual loan, represents the unit of account.

 

For individual loans not accounted for in pools that are sold or satisfied by payment in full, a gain or loss on sale is recognized and reported based on the difference between the sales proceeds and the carrying amount of the acquired distressed residential mortgage loan. In the case of a foreclosure, the loss is recognized if the carrying value exceeds the fair value of the collateral (less costs to sell). A gain is not recognized if the fair value of collateral (less costs to sell) exceeds the carrying value.

 

 
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Multi-Family Loans Held in Securitization Trusts – Multi-family loans held in securitization trusts are comprised of multi-family mortgage loans held in five and six Freddie Mac-sponsored multi-family K-Series securitizations (the “Consolidated K-Series”) as of June 30, 2015 and December 31, 2014, respectively. Based on a number of factors, we determined that we were the primary beneficiary of each VIE within the Consolidated K-Series, met the criteria for consolidation and, accordingly, have consolidated these Freddie Mac-sponsored multi-family K-Series securitizations, including their assets, liabilities, income and expenses in our financial statements. The Company has elected the fair value option on each of the assets and liabilities held within the Consolidated K-Series, which requires that changes in valuations in the assets and liabilities of the Consolidated K-Series be reflected in the Company's accompanying condensed consolidated statement of operations, as the Company believes this accounting treatment more accurately and consistently reflects its results of operations.

 

Interest income is accrued and recognized as revenue when earned according to the terms of the mortgage loans and when, in the opinion of management, it is collectible. The accrual of interest on loans is discontinued when, in management’s opinion, the interest is not collectible in the normal course of business, but in no case when payment becomes greater than 90 days delinquent. Loans return to accrual status when principal and interest become current and are anticipated to be fully collectible.

 

Mezzanine Loan and Preferred Equity Investments The Company invests in mezzanine loans and preferred equity of entities that have significant real estate assets. The mezzanine loan is secured by a pledge of the borrower’s equity ownership in the property. Unlike a mortgage, this loan does not represent a lien on the property. Therefore, it is always junior and subordinate to any first-lien as well as second liens, if applicable, on the property.  These loans are senior to any preferred equity or common equity interests.  Purchasers of mezzanine loans benefit from a right to foreclose on the ownership equity in a more efficient manner than senior mortgage debt.  

 

A preferred equity investment is an equity investment in the entity that owns the underlying property.  Preferred equity is not secured by the underlying property, but holders have priority relative to common equity holders on cash flow distributions and proceeds from capital events. In addition, preferred equity holders may be able to enhance their position and protect their equity position with covenants that limit the entity’s activities and grant the holder the exclusive right to control the property after an event of default.

 

Mezzanine loans and preferred equity investments, where the risks and payment characteristics are equivalent to mezzanine loans, are accounted for as loans held for investment and are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, net of valuation allowances, and are included in receivables and other assets.   We accrete or amortize any discounts or premiums over the life of the related loan receivable utilizing the effective interest method or straight line-method, if the result is not materially different. We evaluate the collectability of both interest and principal of each of our loans, if circumstances warrant, to determine whether they are impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the existing contractual terms. When a loan is impaired, the amount of the loss accrual is calculated by comparing the carrying amount of the investment to the estimated fair value of the loan or, as a practical expedient, to the value of the collateral if the loan is collateral dependent.

 

Mezzanine loans and preferred equity investments where the risks and payment characteristics are equivalent to an equity investment are accounted for using the equity method of accounting. See “Investment in Limited Partnership and Limited Liability Companies” for a description of our accounting policy for Investments in Limited Partnerships and Limited Liability Companies. The mezzanine loans and preferred equity investments are included in receivables and other assets.

 

Mortgage Loans Held for Investment – Mortgage loans held for investment are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, net of valuation allowances, and are included in receivables and other assets.  Interest income is accrued on the principal amount of the loan based on the loan’s contractual interest rate. Amortization of premiums and discounts is recorded using the effective yield method. Interest income, amortization of premiums and discounts and prepayment fees are reported in interest income. A loan is considered to be impaired when it is probable that based upon current information and events, the Company will be unable to collect all amounts due under the contractual terms of the loan agreement. Based on the facts and circumstances of the individual loans being impaired, loan specific valuation allowances are established for the excess carrying value of the loan over either: (i) the present value of expected future cash flows discounted at the loan’s original effective interest rate, (ii) the estimated fair value of the loan’s underlying collateral if the loan is in the process of foreclosure or otherwise collateral dependent, or (iii) the loan’s observable market price.

 

 
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Investments in Limited Partnership and Limited Liability Companies – In circumstances where the Company has a non-controlling interest but either owns a significant interest or is able to exert influence over the affairs of the enterprise, the Company utilizes the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity’s earnings or preferred return and decreased for cash distributions and a proportionate share of the entity’s losses. Where the Company is not required to fund additional losses, the Company does not continue to record its proportionate share of the entity’s losses such that its investment balance would go below zero.

 

Management periodically reviews its investments for impairment based on projected cash flows from the entity over the holding period. When any impairment is identified, the investments are written down to recoverable amounts.

 

Cash and Cash Equivalents – Cash and cash equivalents include cash on hand, amounts due from banks and overnight deposits. The Company maintains its cash and cash equivalents in highly rated financial institutions, and at times these balances exceed insurable amounts. 

 

Receivables and Other Assets – Receivables and other assets as of June 30, 2015 and December 31, 2014 include restricted cash held by third parties of $51.1 million and $54.2 million, respectively. Included in restricted cash is $38.4 million and $40.6 million held in our Agency IO portfolio to be used for trading purposes and $10.8 million and $11.4 million held by counterparties as collateral for hedging instruments as of June 30, 2015 and December 31, 2014, respectively. Interest receivable on multi-family loans held in securitization trusts is also included in the amounts of $24.0 million and $29.8 million as of June 30, 2015 and December 31, 2014, respectively.

 

Financing Arrangements, Portfolio Investments – The Company finances its Agency RMBS using repurchase agreements and Federal Home Loan Bank Advances.  Under a repurchase agreement, an asset is sold to a counterparty to be repurchased at a future date at a predetermined price, which represents the original sales price plus interest.  The Company accounts for these repurchase agreements as financings under ASC 860, Transfers and Servicing.  Under ASC 860, for these transactions to be treated as financings, they must be separate transactions and not linked.  If the Company finances the purchase of its securities with repurchase agreements with the same counterparty from which the securities are purchased and both transactions are entered into contemporaneously or in contemplation of each other, the transactions are presumed under GAAP to be part of the same arrangement, or a "Linked Transaction," unless certain criteria are met.  None of the Company’s repurchase agreements are accounted for as linked transactions because they met the applicable criteria in accordance with ASC 860-10-40.

 

On February 20, 2015, our wholly-owned subsidiary, Great Lakes Insurance Holdings LLC (“GLIH”), became a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”). As a member of the FHLBI, GLIH will have access to a variety of products and services offered by the FHLBI, including secured advances. As of June 30, 2015, GLIH had $121 million in outstanding secured advances from FHLBI, which are included on the Company’s accompanying condensed balance sheet in financing arrangement, portfolio investments.

 

Financing Arrangements, Distressed Residential Mortgage Loans – The Company finances a portion of its distressed residential mortgage loans through a repurchase agreement, expiring within one year. The borrowing under the repurchase agreement bears an interest rate of a specified margin over one-month LIBOR. The repurchase agreement is treated as a collateralized financing transaction and is carried at the contractual amounts, as specified in the respective agreement. Costs related to the establishment of the repurchase agreement which include underwriting, legal, accounting and other fees are reflected as deferred charges. Such costs are included on the Company’s accompanying condensed consolidated balance sheets in receivables and other assets in the amount of $0.9 million as of June 30, 2015 and $1.7 million as of December 31, 2014, respectively. These deferred charges are amortized as an adjustment to interest expense using the effective interest method, or straight line-method, if the result is not materially different.

 

Residential Collateralized Debt Obligations (“Residential CDOs”) – We use Residential CDOs to permanently finance our residential mortgage loans held in securitization trusts. For financial reporting purposes, the ARM loans held as collateral are recorded as assets of the Company and the Residential CDOs are recorded as the Company’s debt. The Company has completed four residential mortgage loan securitizations since inception. The first three were accounted for as a permanent financing while the fourth was accounted for as a sale and accordingly, is not included in the Company’s accompanying condensed consolidated financial statements.

 

 
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Multi-Family Collateralized Debt Obligations (“Multi-Family CDOs”) – We consolidated the Consolidated K-Series including their debt, referred to as Multi-Family CDOs, in our financial statements. The Multi-Family CDOs permanently finance the multi-family mortgage loans held in the Consolidated K-Series securitizations. For financial reporting purposes, the loans held as collateral are recorded as assets of the Company and the Multi-Family CDOs are recorded as the Company’s debt. We refer to both the Residential CDOs and Multi-Family CDOs as CDOs in this report.

 

Securitized Debt – Securitized Debt represents third-party liabilities of Consolidated VIEs and excludes liabilities of the VIEs acquired by the Company that are eliminated on consolidation. The Company has entered into several financing transactions that resulted in the Company consolidating as VIEs the special purpose entities (the “SPEs”) that were created to facilitate the transactions and to which underlying assets in connection with the financing were transferred. The Company engaged in these transactions primarily to obtain permanent or longer term financing on a portion of its multi-family CMBS and acquired distressed residential mortgage loans.

 

Costs related to issuance of securitized debt which include underwriting, rating agency, legal, accounting and other fees are reflected as deferred charges.  Such costs are included on the Company’s accompanying condensed consolidated balance sheets in receivables and other assets in the amount of $1.6 million and $2.2 million as of June 30, 2015 and December 31, 2014, respectively. These deferred charges are amortized as an adjustment to interest expense using the effective interest method, or straight line-method, if the result is not materially different.

 

Derivative Financial Instruments – The Company has developed risk management programs and processes, which include investments in derivative financial instruments designed to manage interest rate and prepayment risk associated with its securities investment activities. 

 

Derivative instruments contain an element of risk in the event that the counterparties may be unable to meet the terms of such agreements. The Company minimizes its risk exposure by limiting the counterparties with which it enters into contracts to banks and investment banks who meet established credit and capital guidelines.

 

The Company invests in To-Be-Announced securities (“TBAs”) through its Agency IO portfolio. TBAs are forward-settling purchases and sales of Agency RMBS where the underlying pools of mortgage loans are “To-Be-Announced.”  Pursuant to these TBA transactions, we agree to purchase or sell, for future settlement, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. For TBA contracts that we have entered into, we have not asserted that physical settlement is probable, therefore we have not designated these forward commitments as hedging instruments. Realized and unrealized gains and losses associated with these TBAs are recognized through earnings as other income (expense) in the condensed consolidated statements of operations.  

 

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of OCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instruments in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change.  

 

For instruments that are not designated or qualify as a cash flow hedge, such as our use of U.S. Treasury securities or financial futures and options on financial futures contracts, any realized and unrealized gains and losses associated with these instruments are recognized through earnings as other income (expense) in the condensed consolidated statements of operations.  

 

Termination of Hedging Relationships – The Company employs risk management monitoring procedures to ensure that the designated hedging relationships are demonstrating, and are expected to continue to demonstrate, a high level of effectiveness. Hedge accounting is discontinued on a prospective basis if it is determined that the hedging relationship is no longer highly effective or expected to be highly effective in offsetting changes in fair value of the hedged item.

 

Additionally, the Company may elect to un-designate a hedge relationship during an interim period and re-designate upon the rebalancing of a hedge profile and the corresponding hedge relationship. When hedge accounting is discontinued, the Company continues to carry the derivative instruments at fair value with changes recorded in current earnings.

 

Revenue Recognition – Interest income on our investment securities and on our mortgage loans is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with investment securities and mortgage loans at the time of purchase or origination are amortized into interest income over the life of such securities using the effective yield method. Adjustments to amortization are made for actual prepayment activity.

 

 
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 Interest income on our credit sensitive securities, such as our CLOs and certain of our CMBS that were purchased at a discount to par value, is recognized based on the security’s effective interest rate. The effective interest rate on these securities is based on management’s estimate from each security of the projected cash flows, which are estimated based on the Company’s assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on these securities.

 

Based on the projected cash flows from the Company’s first loss tranche PO multi-family CMBS purchased at a discount to par value, a portion of the purchase discount is designated as non-accretable purchase discount or credit reserve, which partially mitigates the Company’s risk of loss on the mortgages collateralizing such multi-family CMBS, and is not expected to be accreted into interest income. The amount designated as a credit reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a credit reserve is more favorable than forecasted, a portion of the amount designated as credit reserve may be accreted into interest income over time. Conversely, if the performance of a security with a credit reserve is less favorable than forecasted, the amount designated as credit reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.

 

With respect to interest rate swaps that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such swaps will be recognized in current earnings.

 

See “Acquired Distressed Residential Mortgage Loans” for a description of our revenue recognition policy for acquired distressed residential mortgage loans.

 

Manager Compensation - We are a party to separate investment management agreements with Headlands Asset Management LLC (“Headlands”), The Midway Group, LP (“Midway”) and RiverBanc LLC (“RiverBanc”), with Headlands providing investment management services with respect to our investments in certain distressed residential mortgage loans, Midway providing investment management services with respect to our investments in Agency IOs, and RiverBanc providing investment management services with respect to our investments in multifamily CMBS and certain commercial real estate-related debt investments. These investment management agreements provide for the payment to our investment managers of a management fee, incentive fee and reimbursement of certain operating expenses, which are accrued and expensed during the period for which they are earned or incurred.

 

Other Comprehensive Income (Loss) – The Company’s comprehensive income/(loss) available to common stockholders includes net income, the change in net unrealized gains/(losses) on its available for sale securities and its derivative hedging instruments, currently comprised of interest rate swaps, (to the extent that such changes are not recorded in earnings), adjusted by realized net gains/(losses) reclassified out of accumulated other comprehensive income/(loss) for available for sale securities and is reduced by dividends declared on the Company’s preferred stock.

 

Employee Benefits Plans – The Company sponsors a defined contribution plan (the “Plan”) for all eligible domestic employees. The Plan qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). The Company made no contributions to the Plan for the three and six months ended June 30, 2015 and 2014.

 

Stock Based Compensation – Compensation expense for equity based awards and stock issued for services are recognized over the vesting period of such awards and services based upon the fair value of the award at the grant date.

 

The Company has awarded restricted stock to eligible employees and officers as part of their compensation. Compensation expense for awarded restricted stock is based on the grant date fair value of the stock and is recognized over the vesting period.

 

In May 2015, the Company granted certain Performance Share Awards (“PSAs”) which cliff vest after a three-year period, subject to the achievement of certain performance criteria based on a formula tied to the Company’s achievement of three-year total stockholder return (“TSR”) and the Company’s TSR relative to the TSR of certain peer companies. The feature in this award constitutes a “market condition” which impacts the amount of compensation expense recognized for these awards.  The grant date fair values of PSAs were determined through Monte-Carlo simulation analysis.

 

 
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Income Taxes – The Company operates in such a manner so as to qualify as a REIT under the requirements of the Internal Revenue Code. Requirements for qualification as a REIT include various restrictions on ownership of the Company’s stock, requirements concerning distribution of taxable income and certain restrictions on the nature of assets and sources of income. A REIT must distribute at least 90% of its taxable income to its stockholders, of which 85% plus any undistributed amounts from the prior year must be distributed within the taxable year in order to avoid the imposition of an excise tax. Distribution of the remaining balance may extend until timely filing of the Company’s tax return in the subsequent taxable year. Qualifying distributions of taxable income are deductible by a REIT in computing taxable income.

  

Certain activities of the Company are conducted through TRSs and therefore are subject to federal and various state and local income taxes. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

 

ASC 740, Income Taxes, provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more-likely-than-not” of being sustained by the applicable tax authority. In situations involving uncertain tax positions related to income tax matters, we do not recognize benefits unless it is more likely than not that they will be sustained. ASC 740 was applied to all open taxable years as of the effective date. Management’s determinations regarding ASC 740 may be subject to review and adjustment at a later date based on factors including, but not limited to, an ongoing analysis of tax laws, regulations and interpretations thereof. The Company will recognize interest and penalties, if any, related to uncertain tax positions as income tax expense.

 

Earnings Per Share – Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company.

 

Segment Reporting – ASC 280, Segment Reporting, is the authoritative guidance for the way public entities report information about operating segments in their annual financial statements. We are a REIT focused on the business of acquiring, investing in, financing and managing primarily mortgage-related and financial assets, and currently operate in only one reportable segment.

 

 
15

 

 

Summary of Recent Accounting Pronouncements

 

Receivables (ASC 310)

 

In April 2014, the FASB issued ASU 2014-04, Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40)—Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (“ASU 2014-04”). The amendments of this ASU are intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. In addition, the amendments clarify that if an in substance repossession or foreclosure occurs, then a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. ASU 2014-04 became effective for the Company beginning January 1, 2015. The adoption of ASU 2014-04 did not have a material effect on our financial condition, results of operations and disclosures.

 

Transfers and Servicing (ASC 860)

 

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing: Repurchase-to-Maturity Transaction, Repurchase Financings, and Disclosures (“ASU 2014-09”).  This guidance requires repurchase-to-maturity transactions to be accounted for as secured borrowings as if the transferor retains effective control, even though the transferred financial assets are not returned to the transferor at settlement. ASU 2014-09 also eliminates existing guidance for repurchase financings and requires instead that entities consider the initial transfer and the related repurchase agreement separately when applying the derecognition requirements of ASC 860, Transfers and Servicing. New disclosures will be required for (1) certain transactions accounted for as secured borrowings, and (2) transfers accounted for as sales when the transferor also retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. ASU 2014-09 became effective for the Company beginning January 1, 2015. The adoption of ASU 2014-11 did not have a significant effect on our financial condition, results of operations and disclosures.

 

Revenue Recognition (Topic 606)

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). This guidance creates a new, principle-based revenue recognition framework that will affect nearly every revenue-generating entity. ASU 2014-09 also creates a new topic in the Codification, Topic 606 (“ASC 606”). In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASC 606 does the following: (1) establishes a new control-based revenue recognition model; (2) changes the basis for deciding when revenue is recognized over time or at a point in time; (3) provides new and more detailed guidance on specific aspects of revenue recognition; and (4) expands and improves disclosures about revenue. ASC 606 is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods therein. Early application is not permitted for public business entities. The Company is currently assessing the impact of this guidance.

 

Consolidation (Topic 810)

 

In August 2014, the FASB issued ASU 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity (“ASU 2014-13”). For entities that consolidate a collateralized financing entity within the scope of this update, an option to elect to measure the financial assets and the financial liabilities of that collateralized financing entity using either the measurement alternative included in this Update or Topic 820 on fair value measurement is provided. The guidance is effective for fiscal years beginning after December 15, 2015, and the interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual period. We do not expect the adoption of ASU 2014-13 to have a significant effect on our financial condition, results of operations and disclosures.

 

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (“ASU 2015-02”). The update is intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The guidance is effective for fiscal years beginning after December 15, 2015, and the interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual period. The Company is currently assessing the impact of this guidance.

 

 
16

 

 

Interest - Imputation of Interest (Topic 835)

 

In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”). The amendments in ASU 2015-03 are intended to simplify the presentation of debt issuance costs. These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. We do not expect the adoption of ASU 2015-03 to have a significant effect on our financial condition, results of operations and disclosures.

 

 

3.                Investment Securities Available For Sale

 

Investment securities available for sale consist of the following as of June 30, 2015 and December 31, 2014 (dollar amounts in thousands):

 

   

June 30, 2015

   

December 31, 2014

 
            Unrealized                     Unrealized          
   

 

Amortized    

 

   

 

Fair    

 

Amortized     

 

   

 

Fair  
       Cost    

Gains

   

Losses

      Value        Cost     

Gains

   

Losses

       Value  

Agency RMBS (1):

                                                               

Agency ARMs

                                                               

Freddie Mac

  $ 54,997     $ 57     $ (436

)

  $ 54,618     $ 57,597     $ 55     $ (488

)

  $ 57,164  

Fannie Mae

    106,211       137       (849

)

    105,499       113,192       81       (1,037

)

    112,236  

Ginnie Mae

    10,606       1       (159

)

    10,448       12,552             (259

)

    12,293  

Total Agency ARMs

    171,814       195       (1,444

)

    170,565       183,341       136       (1,784

)

    181,693  
                                                                 

Agency Fixed Rate

                                                               

Freddie Mac

    34,729             (660

)

    34,069       37,800             (629

)

    37,171  

Fannie Mae

    416,011             (11,282

)

    404,729       451,694             (10,184

)

    441,510  

Ginnie Mae

    219       1             220                          

Total Agency Fixed Rate

    450,959       1       (11,942

)

    439,018       489,494             (10,813

)

    478,681  
                                                                 

Agency IOs (1)

                                                               

Freddie Mac

    36,805       827       (4,871

)

    32,761       38,844       273       (5,779

)

    33,338  

Fannie Mae

    48,122       1,259       (5,101

)

    44,280       53,666       741       (6,388

)

    48,019  

Ginnie Mae

    41,217       721       (4,962

)

    36,976       42,991       310       (5,527

)

    37,774  

Total Agency IOs

    126,144       2,807       (14,934

)

    114,017       135,501       1,324       (17,694

)

    119,131  
                                                                 

Total Agency RMBS

    748,917       3,003       (28,320

)

    723,600       808,336       1,460       (30,291

)

    779,505  

Non-Agency RMBS

    1,886       67       (233

)

    1,720       2,061       69       (191

)

    1,939  

U.S. Treasury securities

    9,999       1             10,000                          

CLOs

                            26,140       9,063             35,203  

Total investment securities available for sale

  $ 760,802     $ 3,071     $ (28,553

)

  $ 735,320     $ 836,537     $ 10,592     $ (30,482

)

  $ 816,647  
                                                                 

CMBS

  $ 27,394     $ 12,823     $     $ 40,217     $ 26,193     $ 12,401     $     $ 38,594  

Total investment securities available for sale held in securitization trusts

  $ 27,394     $ 12,823     $     $ 40,217     $ 26,193     $ 12,401     $     $ 38,594  

 

 

(1) Included in investment securities available for sale are Agency IOs, Agency Fixed Rate, Agency ARM and U.S. Treasury securities managed by Midway that are measured at fair value through earnings.

 

During the three and six months ended June 30, 2015, the Company received proceeds of approximately $34.5 million, realizing approximately $3.2 million of net gains, from the sale of investment securities available for sale. There were no sales of investment securities available for sale during the three months and six months ended June 30, 2014.

 

 
17

 

 

 Actual maturities of our available for sale securities are generally shorter than stated contractual maturities (which range up to 30 years), as they are affected by the contractual lives of the underlying mortgages, periodic payments and prepayments of principal. As of June 30, 2015 and December 31, 2014, based on management’s estimates using three month historical Constant Prepayment Rate (“CPR”), the weighted average life of the Company’s available for sale securities portfolio was approximately 4.45 and 4.95 years, respectively.

 

The following table sets forth the weighted average lives our investment securities available for sale as of June 30, 2015 and December 31, 2014 (dollar amounts in thousands):

 

Weighted Average Life

 

June 30,

2015

   

December 31,

2014

 

0 to 5 years

  $ 489,511     $ 393,080  

Over 5 to 10 years

    172,357       365,386  

10+ years

    73,452       58,181  

Total

  $ 735,320     $ 816,647  

 

The following tables set forth the stated reset periods of our investment securities available for sale and investment securities available for sale held in securitization trusts at June 30, 2015 and December 31, 2014 at carrying value (dollar amounts in thousands):

 

   

June 30, 2015

   

December 31, 2014

 
   

Less than 6

months

   

6 to 24

months

   

More than

24 months

   

Total

   

Less than

6 months

   

6 to 24

months

   

More than

24 months

   

Total

 

Agency RMBS

  $ 128,357     $ 14,608     $ 580,635     $ 723,600     $ 89,442     $ 21,746     $ 668,317     $ 779,505  

Non-Agency RMBS

    1,720                   1,720       1,939                   1,939  

U.S. Treasury securities

    10,000                   10,000                          

CLOs

                            35,203                   35,203  

Total investment securities available for sale

  $ 140,077     $ 14,608     $ 580,635     $ 735,320     $ 126,584     $ 21,746     $ 668,317     $ 816,647  
                                                                 

CMBS

  $     $     $ 40,217     $ 40,217     $     $     $ 38,594     $ 38,594  

Total investment securities available for sale held in securitization trusts

  $     $     $ 40,217     $ 40,217     $     $     $ 38,594     $ 38,594  

  

The following tables present the Company's investment securities available for sale in an unrealized loss position reported through OCI, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2015 and December 31, 2014 (dollar amounts in thousands):

 

 

June 30, 2015

 

Less than 12 Months

   

Greater than 12 months

   

Total

 
   

Carrying

Value

   

Gross

Unrealized

Losses

   

Carrying

Value

   

Gross

Unrealized

Losses

   

Carrying

Value

   

Gross

Unrealized

Losses

 

Agency RMBS

  $ 48,748     $ (318

)

  $ 535,697     $ (13,068

)

  $ 584,445     $ (13,386

)

Non-Agency RMBS

                846       (233

)

    846       (233

)

Total investment securities available for sale

  $ 48,748     $ (318

)

  $ 536,543     $ (13,301

)

  $ 585,291     $ (13,619

)

 

 
18

 

  

December 31, 2014

 

Less than 12 Months

   

Greater than 12 months

   

Total

 
   

Carrying

Value

   

Gross

Unrealized

Losses

   

Carrying

Value

   

Gross

Unrealized

Losses

   

Carrying

Value

   

Gross

Unrealized

Losses

 

Agency RMBS

  $     $     $ 638,936     $ (12,597 )   $ 638,936     $ (12,597 )

Non-Agency RMBS

                967       (191 )     967       (191 )

Total investment securities available for sale

  $     $     $ 639,903     $ (12,788 )   $ 639,903     $ (12,788 )

 

 For the three and six months ended June 30, 2015 and 2014, the Company recognized no other-than-temporary impairment through earnings.

 

4.                Residential Mortgage Loans Held in Securitization Trusts (Net) and Real Estate Owned

 

Residential mortgage loans held in securitization trusts (net) consist of the following as of June 30, 2015 and December 31, 2014, respectively (dollar amounts in thousands):

 

   

June 30,

2015

   

December 31,

2014

 

Unpaid principal balance

  $ 140,641     $ 152,277  

Deferred origination costs – net

    891       968  

Reserve for loan losses

    (4,092

)

    (3,631

)

Total

  $ 137,440     $ 149,614  

 

Allowance for Loan Losses - The following table presents the activity in the Company's allowance for loan losses on residential mortgage loans held in securitization trusts for the six months ended June 30, 2015 and 2014, respectively (dollar amounts in thousands):  

 

   

Six months Ended June 30,

 
   

2015

   

2014

 

Balance at beginning of period

  $ 3,631     $ 2,989  

Provisions for loan losses

    656       367  

Transfer to real estate owned

    1       (157

)

Charge-offs

    (196

)

     

Balance at the end of period

  $ 4,092     $ 3,199  

 

On an ongoing basis, the Company evaluates the adequacy of its allowance for loan losses. The Company’s allowance for loan losses as of June 30, 2015 was $4.1 million, representing 291 basis points of the outstanding principal balance of residential loans held in securitization trusts, as compared to 238 basis points as of December 31, 2014. As part of the Company’s allowance for loan loss adequacy analysis, management will assess an overall level of allowances while also assessing credit losses inherent in each non-performing residential mortgage loan held in securitization trusts. These estimates involve the consideration of various credit related factors, including but not limited to, current housing market conditions, current loan to value ratios, delinquency status, the borrower’s current economic and credit status and other relevant factors.

 

Real Estate Owned – The following table presents the activity in the Company’s real estate owned held in residential securitization trusts for the six months ended June 30, 2015 and 2014, respectively (dollar amounts in thousands):

 

   

Six months Ended June 30,

 
   

2015

   

2014

 

Balance at beginning of period

  $ 965     $ 1,108  

Write downs

          (53

)

Transfer from/(to) mortgage loans held in securitization trusts

    (192

)

    55  

Disposal

    (362

)

    (577

)

Balance at the end of period

  $ 411     $ 533  

 

 
19

 

 

Real estate owned held in residential securitization trusts are included in receivables and other assets on the accompanying condensed consolidated balance sheets and write downs are included in provision for loan losses in the accompanying condensed consolidated statements of operations for reporting purposes.

    

All of the Company’s mortgage loans and real estate owned held in residential securitization trusts are pledged as collateral for the Residential CDOs issued by the Company.  The Company’s net investment in the residential securitization trusts, which is the maximum amount of the Company’s investment that is at risk to loss and represents the difference between (i) the carrying amount of the mortgage loans and real estate owned held in residential securitization trusts and (ii) the amount of Residential CDOs outstanding, was $5.1 million and $5.6 million as of June 30, 2015 and December 31, 2014, respectively.

 

Delinquency Status of Our Residential Mortgage Loans Held in Securitization Trusts

 

As of June 30, 2015, we had 34 delinquent loans with an aggregate principal amount outstanding of approximately $19.9 million categorized as Residential Mortgage Loans Held in Securitization Trusts (net). Of the $19.9 million in delinquent loans, $12.2 million, or 61%, are under some form of temporary modified payment plan. The table below shows delinquencies in our portfolio of residential mortgage loans held in securitization trusts, including real estate owned (“REO”) through foreclosure, as of June 30, 2015 (dollar amounts in thousands):

 

June 30, 2015

Days Late

 

Number of

Delinquent

Loans

   

Total

Unpaid

Principal

   

% of Loan

Portfolio

 

30 - 60

    4     $ 3,482       2.45 %

61 - 90

        $       0.00 %

90 +

    30     $ 16,384       11.54 %

Real estate owned through foreclosure

    3     $ 1,334       0.94 %

 

As of December 31, 2014, we had 33 delinquent loans with an aggregate principal amount outstanding of approximately $18.5 million categorized as Residential Mortgage Loans Held in Securitization Trusts (net). Of the $18.5 million in delinquent loans, $9.4 million, or 51%, are under some form of modified payment plan. The table below shows delinquencies in our portfolio of residential mortgage loans held in securitization trusts, including real estate owned through foreclosure (REO), as of December 31, 2014 (dollar amounts in thousands):

 

December 31, 2014

Days Late

 

Number of Delinquent

Loans

   

Total

Unpaid Principal

   

% of Loan

Portfolio

 

30 - 60

    4     $ 1,522       0.99 %

61 - 90

        $       0.00 %

90 +

    29     $ 16,997       11.01 %

Real estate owned through foreclosure

    6     $ 2,100       1.36 %

 

 

The geographic concentrations of credit risk exceeding 5% of the total loan balances in our residential mortgage loans held in securitization trusts and real estate owned held in residential securitization trusts as of June 30, 2015 and December 31, 2014 are as follows:

 

   

June 30,

2015

   

December 31,

2014

 

New York

    35.6 %     36.1 %

Massachusetts

    22.9 %     24.0 %

New Jersey

    11.5 %     10.9 %

Florida

    6.7 %     6.2 %

Connecticut

    5.9 %     5.9 %

 

 
20

 

 

5.                Distressed Residential Mortgage Loans

     

 

 As of June 30, 2015 and December 31, 2014, the carrying value of the Company’s distressed residential mortgage loans, including distressed residential mortgage loans held in securitization trusts, amounts to approximately $580.5 million and $582.7 million, respectively.

 

The Company considers its purchase price for the distressed residential mortgage loans, including distressed residential mortgage loans held in securitization trusts, to be at fair value at the date of acquisition. The Company only establishes an allowance for loan losses subsequent to acquisition.

 

The following table presents information regarding the estimates of the contractually required payments, the cash flows expected to be collected, and the estimated fair value of the distressed residential mortgage loans acquired during the six months ended June 30, 2015 (dollar amounts in thousands):

 

   

June 30, 2015

 

Contractually required principal and interest

  $ 70,630  

Non-accretable yield

    (3,997

)

Expected cash flows to be collected

    66,633  

Accretable yield

    (37,225

)

Fair value at the date of acquisition

  $ 29,408  

 

The following table details activity in accretable yield for the distressed residential mortgage loans, including distressed residential mortgage loans held in securitization trusts, for the six months ended June 30, 2015 and 2014, respectively (dollar amounts in thousands):

 

   

June 30, 2015

   

June 30, 2014

 

Balance at beginning of period

  $ 640,416     $ 171,112  

Additions

    44,485       53,395  

Disposals

    (34,897

)

    (54,842

)

Accretion

    (20,486

)

    (9,201

)

Balance at end of period (1)

  $ 629,518     $ 160,464  

(1) 

Accretable yield is the excess of the distressed residential mortgage loans’ cash flows expected to be collected over the purchase price. The cash flows expected to be collected represents the Company’s estimate of the amount and timing of undiscounted principal and interest cash flows. Additions include accretable yield estimates for purchases made during the period and reclassification to accretable yield from nonaccretable yield. Deletions include distressed residential mortgage loan dispositions, which include refinancing, sale and foreclosure of the underlying collateral and resulting removal of the distressed residential mortgage loans from the accretable yield, and reclassifications from accretable to nonaccretable yield. The reclassifications between accretable and nonaccretable yield and the accretion of interest income is based on various estimates regarding loan performance and the value of the underlying real estate securing the loans. As the Company continues to update its estimates regarding the loans and the underlying collateral, the accretable yield may change. Therefore, the amount of accretable income recorded in the six-month period ended June 30, 2015 and 2014 is not necessarily indicative of future results.

 

The geographic concentrations of credit risk exceeding 5% of the unpaid principal balance of our distressed residential mortgage loans, including distressed residential mortgage loans held in securitization trusts, as of June 30, 2015 and December 31, 2014, respectively, are as follows:

 

   

June 30,

2015

   

December 31,

2014

 

Florida

    13.0

%

    12.4

%

North Carolina

    8.2

%

    8.2

%

California

    8.1

%

    8.9

%

Georgia

    6.7

%

    6.9

%

New York

    5.1

%

    5.1

%

 

 
21

 

 

The Company’s distressed residential mortgage loans held in securitization trusts with a carrying value of approximately $201.4 million and $221.6 million at June 30, 2015 and December 31, 2014, respectively, are pledged as collateral for certain of the Securitized Debt issued by the Company (see Note 7). In addition, distressed residential mortgage loans with a carrying value of approximately $321.9 million at June 30, 2015 are pledged as collateral for a Master Repurchase Agreement with Deutsche Bank AG, Cayman Islands Branch (see Note 10). 

 

6.                Consolidated K-Series

 

The Company has elected the fair value option on the assets and liabilities held within the Consolidated K-Series, which requires that changes in valuations in the assets and liabilities of the Consolidated K-Series be reflected in the Company's statements of operations. Our investment in the Consolidated K-Series is limited to the multi-family CMBS comprised of first loss tranche PO securities and/or certain IOs issued by certain K-Series securitizations with an aggregate net carrying value of $303.2 million and $317.5 million at June 30, 2015 and December 31, 2014, respectively (see Note 7).  

  

The condensed consolidated balance sheets of the Consolidated K-Series at June 30, 2015 and December 31, 2014, respectively, are as follows (dollar amounts in thousands):

 

Balance Sheets

 

June 30,

2015

   

December 31,

2014

 

Assets

               

Multi-family loans held in securitization trusts

  $ 7,235,328     $ 8,365,514  

Receivables

    24,012       29,809  

Total Assets

  $ 7,259,340     $ 8,395,323  
                 

Liabilities and Equity