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EX-32.1 - EXHIBIT 32.1 - Apollo Residential Mortgage, Inc.a09302015exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - Apollo Residential Mortgage, Inc.a09302015exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - Apollo Residential Mortgage, Inc.a09302015exhibit311.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________
        
FORM 10-Q
_________________________________________
  (Mark One)
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2015
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 001-35246
____________________________________________________ 
Apollo Residential Mortgage, Inc.
(Exact name of Registrant as specified in its charter)
____________________________________________________
Maryland
 
45-0679215
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
Apollo Residential Mortgage, Inc.
c/o Apollo Global Management, LLC
9 West 57th Street, 43rd Floor
New York, New York 10019
(Address of Registrant’s principal executive offices)
(212) 515–3200
(Registrant’s telephone number, including area code)
  ____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer
 
o
 
Accelerated filer
 
þ
 
 
 
 
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934).    Yes  o    No  þ
As of November 6, 2015, there were 31,741,881 shares, par value $0.01, of the registrant’s common stock issued and outstanding.





TABLE OF CONTENTS


2

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands—except share and per share data)


 
 
September 30, 2015
 
December 31, 2014
 
 
(Unaudited)
 
 
Assets:
 
 
 
 
Cash and cash equivalents
 
$
101,852

 
$
114,443

Restricted cash
 
69,662

 
69,006

Residential mortgage-backed securities, at fair value ($3,149,183 and $3,583,853 pledged as collateral, respectively)
 
3,271,629

 
3,755,632

Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value
 
173,322

 
104,438

Other investment securities, at fair value ($155,109 and $34,228 pledged as collateral, respectively)
 
162,722

 
34,228

Other investments
 
44,768

 
40,561

Mortgage loans, at fair value ($0 and $13,602 pledged as collateral, respectively)
 

 
14,120

Investment related receivable ($1,702 and $168,705 pledged as collateral, respectively)
 
6,225

 
191,455

Interest receivable
 
10,108

 
10,455

Derivative instruments, at fair value
 
1,633

 
11,642

Other assets
 
1,583

 
2,073

Total Assets
 
$
3,843,504

 
$
4,348,053

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
Liabilities:
 
 
 
 
Borrowings under repurchase agreements
 
$
3,011,025

 
$
3,402,327

Non-recourse securitized debt, at fair value
 
21,243

 
34,176

Investment related payable
 
36,516

 
76,105

Obligation to return cash held as collateral
 
280

 
2,546

Accrued interest payable
 
7,255

 
13,026

Derivative instruments, at fair value
 
26,415

 
8,949

Payable to related party
 
5,271

 
4,968

Dividends and dividend equivalents payable
 
19,067

 
18,305

Accounts payable, accrued expenses and other liabilities
 
1,745

 
1,699

Total Liabilities
 
$
3,128,817

 
$
3,562,101

 
 
 
 
 
Commitments and Contingencies (Note 13)
 

 

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

 
$
69

Common stock, $0.01 par value, 450,000,000 shares authorized, 31,741,881 and 32,088,045 shares issued and outstanding, respectively
 
317

 
321

Additional paid-in capital
 
789,245

 
793,274

Accumulated deficit
 
(74,944
)
 
(7,712
)
Total Stockholders’ Equity
 
714,687

 
785,952

Total Liabilities and Stockholders’ Equity
 
$
3,843,504

 
$
4,348,053


See notes to unaudited consolidated financial statements.

3

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(in thousands—except per share data)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Interest Income:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
 
$
34,321

 
$
36,277

 
$
105,753

 
$
108,093

Securitized mortgage loans and mortgage loans
 
3,832

 
1,871

 
9,805

 
6,044

Other
 
2,861

 
394

 
6,369

 
726

Total Interest Income
 
41,014


38,542


121,927

 
114,863

Interest Expense:
 
 
 
 
 
 
 
 
Repurchase agreements
 
(7,814
)
 
(7,310
)
 
(23,181
)
 
(21,214
)
Securitized debt
 
(394
)
 
(398
)
 
(1,092
)
 
(1,272
)
Total Interest Expense
 
(8,208
)
 
(7,708
)
 
(24,273
)
 
(22,486
)
 
 
 
 
 
 
 
 
 
Net Interest Income
 
32,806

 
30,834

 
97,654

 
92,377

 
 
 
 
 
 
 
 
 
Other Income/(Loss), net:
 
 
 
 
 
 
 
 
Realized gain/(loss) on sale of residential mortgage-backed securities, net
 
3,331

 
2,581

 
7,340

 
(16,301
)
Other-than-temporary impairments recognized
 
(7,088
)
 
(3,817
)
 
(9,860
)
 
(8,933
)
Gain/(loss) on derivative instruments, net (includes $(31,882), $12,434, (24,047) and ($20,751) of unrealized gains/(losses), respectively)
 
(41,145
)
 
801

 
(55,203
)
 
(63,522
)
Realized gain on sale of other investment securities, net
 

 

 
102

 

Unrealized gain/(loss) on residential mortgage-backed securities, net
 
161

 
(13,154
)
 
(26,325
)
 
94,199

Unrealized gain/(loss) on securitized debt
 
172

 
67

 
1,186

 
(287
)
Unrealized gain/(loss) on securitized mortgage loans and mortgage loans, net
 
(576
)
 
(650
)
 
(110
)
 
2,440

Unrealized gain/(loss) on other investment securities
 
(3,014
)
 
(101
)
 
(5,583
)
 
75

Other, net
 
(52
)
 
39

 
(43
)
 
14

Other Income/(Loss), net
 
(48,211
)
 
(14,234
)
 
(88,496
)
 
7,685

 
 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
 
General and administrative (includes ($171), ($144), ($967) and ($1,011) of stock based compensation, respectively)
 
(3,705
)
 
(2,925
)
 
(11,210
)
 
(8,941
)
Management fee - related party
 
(2,667
)
 
(2,800
)
 
(8,349
)
 
(8,360
)
Total Operating Expenses
 
(6,372
)
 
(5,725
)
 
(19,559
)

(17,301
)
 
 
 
 
 
 
 
 
 
Net Income/(Loss)
 
$
(21,777
)
 
$
10,875


$
(10,401
)

$
82,761

Preferred Stock Dividends Declared
 
(3,450
)
 
(3,450
)
 
(10,350
)
 
(10,350
)
Net Income/(Loss) Allocable to Common Stock and Participating Securities*
 
$
(25,227
)
 
$
7,425

 
$
(20,751
)
 
$
72,411

 
 
 
 
 
 
 
 
 
Earnings/(Loss) per Common Share - Basic and Diluted
 
$
(0.79
)
 
$
0.23

 
$
(0.65
)
 
$
2.25

 
 
 
 
 
 
 
 
 
Dividends Declared per Share of Common Stock
 
$
0.48

 
$
0.44

 
$
1.44

 
$
1.26

* Losses are not allocated to participating securities.

See notes to unaudited consolidated financial statements.

4

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
(in thousands—except share data)


 
 
Preferred Stock
 
Common Stock
 
Additional
Paid- In
Capital
 
Accumulated Deficit
 
Total
 
 
Shares
 
Par
 
Shares
 
Par
 
Balance at December 31, 2014
 
6,900,000

 
$
69

 
32,088,045

 
$
321

 
$
793,274

 
$
(7,712
)
 
$
785,952

Restricted stock grants
 

 

 
9,332

 

 

 

 

Repurchases of common stock
 

 

 
(360,800
)
 
(4
)
 
(4,996
)
 

 
(5,000
)
Capital increase related to equity compensation
 

 

 
5,304

 

 
967

 

 
967

Net income/(loss)
 

 

 

 

 

 
(10,401
)
 
(10,401
)
Dividends declared on preferred stock
 

 

 

 

 

 
(10,350
)
 
(10,350
)
Dividends declared on common stock, restricted stock and restricted stock units
 

 

 

 

 

 
(46,481
)
 
(46,481
)
Balance at September 30, 2015
 
6,900,000

 
$
69

 
31,741,881

 
$
317

 
$
789,245

 
$
(74,944
)
 
$
714,687



See notes to unaudited consolidated financial statements.

5

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash Flows from Operating Activities:
 
 
 
 
Net income/(loss)
 
$
(10,401
)
 
$
82,761

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Premium amortization/(discount accretion), net
 
(25,421
)
 
(17,455
)
Amortization of deferred financing costs
 
440

 
333

Equity based compensation expense
 
967

 
976

Unrealized (gain)/loss on mortgage-backed securities, net
 
26,325

 
(94,199
)
Unrealized (gain)/loss on securitized mortgage loans and mortgage loans, net
 
110

 
(2,440
)
Unrealized loss on derivative instruments, net
 
24,047

 
20,751

Unrealized (gain)/loss on securitized debt
 
(1,186
)
 
287

Other-than-temporary impairments recognized
 
9,860

 
8,933

Unrealized (gain)/loss on other investment securities
 
5,583

 
(75
)
Realized (gain) on sales of mortgage-backed securities
 
(19,914
)
 
(7,642
)
Realized loss on sales of mortgage-backed securities
 
12,574

 
23,943

Realized loss on derivative instruments
 
16,398

 
27,773

Realized loss on real estate owned, net
 
208

 
50

Realized (gain) on sale of other investment securities, net
 
(102
)
 

Depreciation on bond for title contracts
 
323

 

Changes in operating assets and liabilities:
 

 
 
Decrease in accrued interest receivable, less purchased interest
 
397

 
396

(Increase)/decrease in other assets
 
337

 
(363
)
Increase/(decrease) in accrued interest payable
 
(5,771
)
 
1,624

Increase/(decrease) in accounts payable and accrued expenses
 
(89
)
 
96

Decrease in payable to related party
 
(13
)
 
(1,645
)
Increase in other liabilities
 
135

 
6

Net cash provided by operating activities
 
34,807

 
44,110

Cash Flows from Investing Activities:
 
 
 
 
Purchases of mortgage-backed securities
 
(1,732,023
)
 
(981,875
)
Proceeds from sales of mortgage-backed securities
 
2,034,858

 
777,730

Purchases of mortgage loans, simultaneously securitized
 
(67,357
)
 

Purchase of other investment securities
 
(157,330
)
 
(20,752
)
Proceeds from sales of other investment securities
 
17,679

 

Purchases of other investments
 
(25,131
)
 
(27,697
)
Proceeds from other investments
 
20,519

 
2,481

Purchase of mortgage loans
 

 
(295
)
Proceeds from sales of real estate owned
 
1,188

 
168

Increase in restricted cash related to investing activities
 
(21,930
)
 
(6,356
)
Decrease in cash collateral held related to investing activities
 
(2,266
)
 
(23,998
)
Principal payments received on mortgage-backed securities
 
317,787

 
232,748

Principal payments received on securitized mortgage loans and mortgage loans, net
 
10,960

 
5,736

Principal payments received on other investment securities
 
11,768

 
1,686

Payments made for termination of derivative instruments
 
(4,503
)
 
(6,424
)
Purchase of interest rate swaptions
 
(10,560
)
 
(13,400
)
Sale of interest rate swaptions
 
2,093

 

Other, net
 

 
1

Net cash provided/(used) by investing activities
 
395,752

 
(60,247
)
(Continued on next page.)


6

Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

(Continued.)
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash Flows from Financing Activities:
 
 
 
 
Proceeds from repurchase agreement borrowings
 
13,820,515

 
8,453,547

Repayments of repurchase agreement borrowings
 
(14,211,817
)
 
(8,409,336
)
Increase in restricted cash related to financing activities
 
21,274

 
7,415

Principal payments on securitized debt
 
(11,747
)
 
(7,453
)
Dividends paid on preferred stock
 
(10,350
)
 
(10,350
)
Dividends paid on common stock and dividend equivalent rights
 
(45,595
)
 
(39,569
)
Repurchases of common stock
 
(5,000
)
 

Payments related to delivery of common stock for settlement of restricted stock units
 
(42
)
 
36

Deferred financing costs/offering costs expensed/(incurred) net
 
(388
)
 
(208
)
Net cash used by financing activities
 
(443,150
)
 
(5,918
)
Net decrease in cash
 
(12,591
)
 
(22,055
)
Cash and cash equivalents at beginning of period
 
114,443

 
127,959

Cash and cash equivalents at end of period
 
$
101,852

 
$
105,904

Supplemental disclosure of non-cash financing/investing activities:
 
 
 
 
Residential mortgage-backed securities (purchased)/sold not settled, net
 
$
(34,331
)
 
$
(7,790
)
Dividends and dividend equivalent rights declared, not yet paid
 
$
19,067

 
$
17,558

Deferred financing costs not yet paid
 
$
171

 
$
14



See notes to unaudited consolidated financial statements.

7

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


Unless the context requires otherwise, references to “we,” “us,” “our,” “AMTG” or “Company” refer to Apollo Residential Mortgage, Inc., as consolidated with its subsidiaries and variable interest entities (or, VIEs) in which we are the primary beneficiary. The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” refers to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the United States (or, U.S.) Government, such as Ginnie Mae or the U.S. Small Business Administration; “Agency Inverse Floater” refers to securities that have a floating interest rate with coupons that reset periodically based on an index and which coupon varies inversely with changes in index, which index is typically the one month LIBOR; “Agency IO” and “Agency Inverse IO” refers to Agency interest-only and Agency inverse interest-only securities, respectively, which receive some or all of the interest payments, but no principal payments, made on a related series of Agency RMBS, based on a notional principal balance; “Agency RMBS” refer to RMBS issued or guaranteed by an Agency; “Alt-A” refers to residential mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to Agency underwriting guidelines and generally allow homeowners to qualify for a mortgage loan with reduced or alternate forms of documentation; “ARMs” refer to adjustable rate mortgages; “ARM RMBS” refer to RMBS collateralized by ARMs; “BFT Contracts” refer to bond for title contracts which are agreements to sell real estate; “CMOs” refer to collateralized mortgage obligation bonds; “December 2014 Pool” refers to the loan pool we purchased in December 2014; “Fannie Mae” refers to the Federal National Mortgage Association; “February 2013 Pool” refers to the loan pool we purchased in February 2013; “February 2013 Securitization” refers to the securitization that we transacted in February 2013 simultaneously with the purchase of the February 2013 Pool; “Freddie Mac” refers to the Federal Home Loan Mortgage Corporation; “Hybrids” refer to mortgage loans that have fixed interest rates for a period of time and, thereafter, generally adjust annually based on an increment over a specified interest rate index; “IO” refers to securities that have no principal balance and bear interest based on a notional balance; “LIBOR” refers to the London Interbank Offered Rate; “Long TBA Contracts” refer to TBA Contracts for which we would be required to buy certain Agency RMBS on a forward basis; “March 2015 Pool” refers to the loan pool we purchased in March 2015; “March 2015 Securitization” refers to the securitization that we transacted in March 2015, combining the December 2014 Pool with the March 2015 Pool, for which we retained the security issued in the securitization; “non-Agency RMBS” refer to RMBS that are not issued or guaranteed by an Agency; “Option ARMs” refer to mortgages that provide the mortgagee payment options, which may initially include a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment or a 30-year fully amortizing payment; “REO” refers to real estate owned as a result of foreclosure on mortgage loans; “Risk Sharing Securities” refer to securities issued by Fannie Mae and/or Freddie Mac which are structured to be subject to the performance of referenced pools of residential mortgage loans and represent unsecured general obligations of the issuing Agency; “RMBS” refer to residential mortgage-backed securities; “SBA” refers to the U.S. Small Business Administration; “SBA-IO” refers to IO securities issued by the SBA; “SBC-MBS” refer to small balance commercial-mortgage-backed securities; “Seller Financing Program” refers to our initiative whereby we provide advances through a warehouse line to a third party to finance the acquisition and improvement of single family homes and, once the homes are improved, they are marketed for sale, with the seller providing financing to the buyer in the form of a mortgage loan or a BFT Contract; “Short TBA Contracts” refer to TBA Contracts for which we would be required to sell certain Agency RMBS on a forward basis; “Subprime” refers to mortgage loans that have been originated using underwriting standards that are less restrictive than those used to originate prime mortgage loans; “Swaps” refer to interest rate swap contracts where we agree to pay a fixed rate of interest and receive a variable rate of interest based on the notional amount of the interest rate swap contract; “Swaptions” refer to option contracts that allow the option holder to enter into a Swap with a specified fixed rate at the expiration of the option period; “TBA Contracts” refer to to-be-announced contracts to purchase or sell certain Agency RMBS on a forward basis and “VIE” refers to a variable interest entity.
Note 1– Organization
We were incorporated as a Maryland corporation on March 15, 2011 and commenced operations on July 27, 2011. We are externally managed and advised by ARM Manager, LLC (or, Manager), an indirect subsidiary of Apollo Global Management, LLC (together with its subsidiaries,Apollo).
We operate and have elected to qualify as a real estate investment trust (or, REIT) under the Internal Revenue Code of 1986, as amended (or, Internal Revenue Code), commencing with the taxable year ended December 31, 2011. We also operate our business in a manner that allows us not to register as an investment company as defined under the Investment Company Act of 1940 (or, 1940 Act).
We invest on a levered basis in residential mortgage and mortgage-related assets in the U.S. At September 30, 2015, our portfolio was comprised of: (i) Agency RMBS, (which include pass-through securities whose underlying collateral primarily includes 30 year fixed-rate mortgages), Agency IO, Agency Inverse IO and Agency Inverse Floater securities; (ii) non-Agency RMBS; (iii) securitized mortgage loans; (iv) other mortgage-related securities; (v) mortgage loans; and (vi) other real estate related investments associated with our Seller Financing Program. Over time, we may invest in a broader range of other residential mortgage and mortgage-related assets.


8

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


Note 2 – Summary of Significant Accounting Policies
(a)
Basis of Presentation and Consolidation
The interim unaudited consolidated financial statements include our accounts and those of our consolidated subsidiaries and a VIE in which we are the primary beneficiary. All intercompany amounts have been eliminated in consolidation. We currently operate as one business segment.
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (or, GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
In the opinion of management, all adjustments have been made (which include only normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014, which was filed with the Securities and Exchange Commission (or, the SEC) on February 19, 2015. Our results of operations for the quarterly period ended September 30, 2015 are not necessarily indicative of the results to be expected for the full year or any other future period.
(b)
Cash and Cash Equivalents
We consider all highly liquid short term investments with original maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. We deposit our cash with what we believe to be high credit quality institutions. From time to time, our cash may include amounts pledged to us by our counterparties as collateral for our derivative instruments. At September 30, 2015 and December 31, 2014, our cash and cash equivalents were primarily comprised of cash on deposit with our prime broker (which is domiciled in the U.S.); substantially all of which was in excess of applicable insurance limits and, we had $40,009 and $40,000 invested in a money market fund at September 30, 2015 and December 31, 2014, respectively. Included in cash and cash equivalents was cash pledged by our counterparties to us of $280 and $2,546 at September 30, 2015 and December 31, 2014, respectively.
(c)
Obligation to Return Cash Held as Collateral
From time to time, we may hold cash pledged as collateral to us by certain of our derivative counterparties as a result of margin calls made by us. Cash pledged to us is unrestricted in use and, accordingly, is included as a component of cash on our consolidated balance sheets. In addition, a corresponding liability is reported as an obligation to return cash held as collateral.
(d)
Restricted Cash
Restricted cash represents cash held by our counterparties as collateral against our repurchase agreement borrowings, Swaps or other derivative instruments. Restricted cash is not available for general corporate purposes, but may be applied against amounts due to counterparties under our repurchase agreement borrowings and Swaps, or returned to us when our collateral requirements are exceeded or at the maturity or termination of the derivative instrument or repurchase agreement.
(e) Investment Securities and Securitized Mortgage Loans
Our investment securities, which are comprised of RMBS and other investment securities, are designated as available for sale. Our RMBS portfolio is comprised of mortgage pass-through certificates, CMOs, including Agency IO and Agency Inverse IO representing interests in or obligations backed by pools of mortgage loans. Our securitized mortgage loans, which are designated as held for investment, are presented on our balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” These mortgage loans are comprised of pools of performing, re-performing and non-performing mortgage loans that we purchased at a discount to principal balance.
At September 30, 2015, our other investment securities were comprised of investments in Risk Sharing Securities issued by Freddie Mac and Fannie Mae and SBC-MBS. Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property.  In some instances, certain of the mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principals of the related business and/or borrowing entity. Our investments in Risk Sharing Securities and SBC-MBS are included in “Other investment securities, at fair value” on our consolidated balance sheet. Interest income on our Risk Sharing Securities is included in “Interest Income - Other” and


9

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


changes in the estimated fair value of such securities is included in “Unrealized gain/(loss) on other investment securities” on our consolidated statements of operations.
Balance Sheet Presentation
Purchases and sales of our investment securities are recorded on the trade date. Our RMBS and other investment securities pledged as collateral against borrowings under repurchase agreements are included in “Residential mortgage-backed securities, at fair value” and “Other investment securities, at fair value” on our consolidated balance sheet, respectively, with the fair value of securities pledged disclosed parenthetically. Amounts receivable/payable associated with sales/purchases of securities at the balance sheet date are reflected on our consolidated balance sheet as “Investment related receivable” and “Investment related payable,” respectively.
For purposes of determining the applicable accounting policy with respect to our investment securities, we review credit ratings available from each of the three major credit rating agencies (i.e. Moody’s Investors Services, Inc., Standard & Poor’s Ratings Services and Fitch, Inc.) for each investment security at the time of purchase and apply the lowest rating.
The aggregate fair value of the mortgage loans associated with our securitization transactions are presented on our consolidated balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” (See Notes 5 and 14.)
Impairments
Investment Securities: We have elected the fair value option of accounting for our investment securities and, as such, all changes in the market value of our investment securities are recorded through earnings, including other-than-temporary impairments (or, OTTI), if any. When the fair value of an investment security is less than its amortized cost at the balance sheet date, the security is considered impaired. We assess our impaired securities on at least a quarterly basis and designate such impairments as either “temporary” or “other-than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell an impaired security before its anticipated recovery, then we recognize an OTTI, which reduces the amortized cost basis of the impaired security. Following the recognition of an OTTI, a new cost basis is established for the security. Changes in the fair value of the security on which an OTTI charge was made will be reflected in unrealized gains/(losses) but will not result in a change to the amortized cost of the impaired security. Increases in interest income may be recognized on a security that an OTTI charge was taken, if the performance of such security subsequently improves. The determination as to whether an OTTI exists is subjective, given that such determination is based on information available at the time of assessment as well as our Manager’s estimate of the future performance and cash flow projections for the individual security. (See Notes 4 and 6.)
Securitized Mortgage Loans: We have elected the fair value option of accounting for our securitized mortgage loans and, as such, all changes in the estimated fair value of our securitized mortgage loans are recorded through earnings, including a provision for loan losses, if any. Our securitized mortgage loans had evidence of deterioration of credit quality at the time of acquisition. We analyze our securitized mortgage loan pool at least quarterly to assess the actual performance compared to the expected performance. If the revised cash flow estimates on our securitized mortgage loans provide a lower yield than the previous yield, we recognize a provision to loan losses (i.e., a reduction in the amortized cost of the securitized mortgage loans that is recorded in earnings) in an amount such that the yield will remain unchanged. If cash flow estimates on our securitized mortgage loans increase subsequent to recording a provision to loan losses, we will reverse previously recognized provision for loan losses before any increase to the yield is made. (See Note 5.)
(f) Designation and Fair Value Option Election
To date, we have elected the fair value option of accounting for all of our investment securities, at the time of purchase, and our securitized debt, when initially incurred. As a result of the fair value election on such assets/liabilities, we record the change in the estimated fair value of such assets and liabilities in earnings as unrealized gains/(losses). We generally intend to hold our investment securities to generate interest income; however, we have and may continue to sell certain of our investment securities as part of the overall management of our assets and liabilities and operating our business. Realized gains/(losses) on the sale of investment securities are recorded in earnings using the specific identification method.
Our securitized mortgage loans are considered held for investment purposes, as we expect that we will be required to continue to consolidate the VIEs in which such loans are held and generally do not have the authority to sell the mortgage loans held in such VIEs. Consistent with our investments in RMBS, we have elected the fair value option for our securitized mortgage loans and, as a result, we record changes in the estimated fair value of such assets in earnings as unrealized gains/(losses).


10

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


We believe that our election of the fair value option for our investment securities, securitized mortgage loans and securitized debt improves financial reporting, as such treatment is consistent with how we present the changes in the fair value of our Swaps, Swaptions and TBA Contracts, all of which are derivative instruments, through earnings.
(g)
Interest Income Recognition
Investment Securities
Interest income on investment securities is accrued based on the outstanding principal balance and the current coupon interest rate on each security. In addition, premiums and discounts associated with Agency RMBS, non-Agency RMBS and other investment securities rated AA and higher by a nationally recognized statistical rating organization at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. In order to determine the effective yield, we estimate prepayments for each security. For those securities, if prepayment levels differ, or are expected to differ in the future from our previous assessment, we adjust the amount of premium amortization recognized in the period that such change is made, applying the retrospective method, resulting in a cumulative catch-up reflecting such change. To the extent that prepayment activity varies significantly from our previous prepayment estimates, we may experience volatility in our interest income. For Agency pass-through RMBS that we acquired subsequent to June 30, 2013, we do not estimate prepayments to determine premium amortization or discount accretion on such securities. Instead, the amount of premium amortization/discount accretion on Agency pass-through RMBS acquired subsequent to June 30, 2013 is based upon actual prepayment experience, which may vary significantly over time. Substantially all the Agency RMBS we held at September 30, 2015 were acquired subsequent to June 30, 2013.
For Agency IO, Agency Inverse IO and Agency Inverse Floaters, income is accrued based on the amortized cost and the effective yield. Cash received on Agency IO and Agency Inverse IO is first applied to accrued interest and then to reduce the amortized cost. At each reporting date, the effective yield is adjusted prospectively based on the current cash flow projections, which reflect prepayment estimates and the contractual terms of the security.
Interest income on non-Agency RMBS and other investment securities rated below AA or not rated by a nationally recognized statistical rating organization is recognized based on the effective yield method of accounting. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on our observation of current information and events and include assumptions related to the future path of interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models and our judgment about interest rates, prepayment speeds, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and the payment priority structure of the security; therefore, actual maturities are generally shorter than the stated contractual maturities of the underlying mortgages. Based on the projected cash flows for our non-Agency RMBS, we generally expect that a portion of the purchase discount on such securities will not be recognized as interest income and is instead viewed as a credit discount. The credit discount mitigates our risk of loss on our non-Agency securities. The amount considered to be credit discount may change over time, based on the actual performance of the underlying mortgage collateral, actual and projected cash flows from such collateral, economic conditions and other factors. If the performance of a non-Agency RMBS with a credit discount is more favorable than forecasted, we may accrete more discount into interest income than expected at the time of purchase or when performance was last assessed. Conversely, if the performance of a non-Agency RMBS with a credit discount is less favorable than forecasted, the amount of discount accreted into income may be less than expected at the time of purchase or when performance was last assessed and/or impairment and write-downs of such securities to a new lower cost basis could result.
Securitized Mortgage Loans and Mortgage Loans
Application of the interest method of accounting for our pools of securitized mortgage loans and mortgage loans requires the use of estimates to calculate a projected yield. We calculate the yield based on the projected cash flows for each pool of mortgage loans. To the extent the actual performance of a loan pool is better than last expected, the yield is adjusted upward prospectively to reflect the revised estimate of cash flows over the remaining life of such mortgage pool. However, if the revised cash flow estimates on a loan pool provides a lower yield than the original or the last calculated yield, we recognize an OTTI (i.e., a reduction in the amortized cost of the loan pool that is recorded in earnings) such that the yield will remain unchanged. Decreasing yields arising solely from a change in the contractual interest rate on variable rate loans are not treated as an OTTI. If future cash collections are materially different in amount or timing than projected cash collections, earnings could be affected, either positively or negatively.


11

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


On at least a quarterly basis, our Manager reviews and, if appropriate, makes adjustments to cash flow projections based on input and analysis received from external sources, internal models and our Manager’s judgment about interest rates, prepayment speeds, home prices, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such loans and/or the recognition of an OTTI.
Warehouse Line Receivable
We accrue interest income on our warehouse line receivable, which is included as a component of our “Interest income-other” and “Other investments,” on our consolidated financial statements, based on the contractual terms governing the warehouse line receivable agreement. We assess the collectability of the warehouse receivable and associated income on at least a quarterly basis.
(h)
Investment Consolidation and Transfers of Financial Assets
We evaluate the underlying entity that issues securities we acquire or to which we make a loan to determine the appropriate accounting methods.
In VIEs, an entity is subject to consolidation if the equity investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities or are not exposed to the entity’s losses or entitled to its residual returns. VIEs that meet certain scope characteristics are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This determination can sometimes involve complex and subjective analysis. We are required on an ongoing basis to assess whether we are the primary beneficiary of a VIE.
With respect to our securitizations, we consolidate the VIEs/securitization trusts that were created to facilitate the transactions and to which the underlying assets in connection with the securitizations were transferred. In determining the accounting treatment to be applied to securitization transactions, we evaluate whether the entity used to facilitate the transactions was a VIE and, if so, whether it should be consolidated. Based on our evaluations, we have concluded since inception of our securitizations that the VIEs should be consolidated. If we determine in the future that consolidation is not required for a securitization, we would have to assess whether the transfer of the underlying assets qualify as a sale or should be accounted for as secured financings under GAAP.
We may periodically enter into transactions in which we sell assets. Upon a transfer of financial assets, we may sometimes retain or acquire senior or subordinated interests in the related assets. In connection with such transactions, a determination must be made as to whether we, as the transferor, have surrendered control over transferred financial assets. That determination must consider our continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. The financial components approach under applicable GAAP limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. It defines the term “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale.
From time to time, we may securitize mortgage loans we hold if such securitization allows us access to better financing terms. Depending upon the structure of the securitization transaction these transactions will be accounted for as either a “sale” and the loans will be removed from the consolidated balance sheet or, as a “financing” with the loans remaining on our consolidated balance sheet. Significant judgment may be exercised by us in determining whether a transaction should be recorded as a “sale” or a “financing.”
(i)
Deferred Financing Costs
Costs incurred in connection with securing our financings are capitalized and amortized using the effective interest rate method over the respective financing term with such amortization reflected on our consolidated statements of operations as a component of interest expense. Our deferred financing costs may include legal, accounting and other related fees. These deferred charges are included on our consolidated balance sheet as a component of “Other assets.” The amortization of deferred charges associated with our securitized debt is adjusted to reflect actual repayments of the securitized debt.


12

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


(j)
Earnings Per Share
Earnings per share (or, EPS) is computed using the two-class method of accounting, which includes the weighted-average number of shares of common stock outstanding during the period and other securities that participate in dividends, such as our unvested restricted stock and restricted stock units (or, RSUs), to arrive at total common equivalent shares. In applying the two-class method, earnings are allocated to both shares of common stock and securities that participate in dividends based on their respective weighted-average shares outstanding for the period. During periods of net loss, losses are allocated only to the extent that the participating securities are required to absorb such losses. (See Note 17.)
(k)
Derivative Instruments
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments, currently comprised of Swaps, Swaptions and, from time to time, TBA Contracts as part of our interest rate risk management. We view our derivative instruments as economic hedges, which we believe mitigate interest rate risk associated with our borrowings under repurchase agreements and/or the fair value of our RMBS portfolio. We do not enter into derivative instruments for speculative purposes.
All derivatives are reported as either assets or liabilities on the balance sheet at estimated fair value. We have not elected hedge accounting for our derivative instruments and, as a result, changes in the fair value for our derivatives are recorded in earnings. The fair value adjustments, along with the related interest income or interest expense, are recognized in the consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”
To-Be-Announced Securities
TBA Contracts are forward contracts for the purchase or sale of Agency RMBS by a specified issuer and for a specified face amount, coupon and stated term, at a predetermined price on the date stated in the contract. The particular Agency RMBS as identified by a Committee on Uniform Securities Identification Procedures number (known as a CUSIP) delivered into the contract upon the settlement date are not known at the time of the transaction. We recognize in earnings unrealized gains and losses associated with TBA Contracts that are not subject to the regular-way exception, which applies: (i) when there is no other way to purchase or sell that security; (ii) if delivery of that security and settlement will occur within the shortest period possible for that type of security and (iii) if it is probable at inception and throughout the term of the individual contract that physical delivery of the security will occur. Changes in the value of our TBA Contracts and realized gains or losses on settlement are recognized in our consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”
(l)
Repurchase Agreements
Investment securities financed under repurchase agreements are treated as collateralized borrowings, unless they meet sale treatment or are deemed to be linked transactions. As of September 30, 2015, none of our repurchase agreements had been accounted for as linked transactions. As of September 30, 2015, all securities financed through a repurchase agreement have remained on our consolidated balance sheet as an asset (with the fair value of the securities pledged as collateral disclosed parenthetically) and cash received from the lender was recorded on our consolidated balance sheet as a liability. However, securities associated with the February 2013 Securitization are eliminated in consolidation with the VIE. Interest paid and accrued in connection with our repurchase agreements is recorded as interest expense.
(m)
Stock-based Payments
We account for stock-based awards granted to our independent directors, to our Manager and to employees of our Manager and its affiliates using the fair value based methodology prescribed by GAAP. Expense related to restricted common stock issued to our independent directors is based on the fair value of our common stock on the grant date, and amortized into expense over the award vesting period on a straight-line basis. Expense related to RSUs issued to our Manager and to employees of our Manager and its affiliates are based on the estimated fair value of such award at the grant date and are remeasured quarterly for unvested awards. We measure the fair value of our RSUs using the price of our common stock and other measurement assumptions, including implied volatility and discount rates. We use the graded vesting attribution method of accounting to amortize expense related to RSUs granted to our Manager and its affiliates.
(n)
Income Taxes (Dollar amounts in this Note 2(n) are not presented in thousands.)
We elected to be taxed as a REIT for U.S. Federal income tax purposes, commencing with our taxable year ended December 31, 2011. Pursuant to the Internal Revenue Code, a REIT that distributes at least 90% of its net taxable income, excluding net capital gains, as a dividend to its stockholders each year and which meets certain other conditions, will not be taxed on the portion of its taxable income that is distributed to its stockholders. We expect to meet the conditions required to


13

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


enable us to continue to operate as a REIT and to distribute all of our taxable income, including net capital gains for the periods presented and therefore we have not recorded any provisions for income taxes on our consolidated statements of operations through September 30, 2015.
As of December 31, 2014, we had net capital loss carryforward amounts of $84.0 million which may be carried forward and applied against future net capital gains. Our capital loss carryforward amounts will reduce the amount of future capital gains, if any, that we would otherwise expect to distribute, since capital gains would first be reduced by the capital loss carryforward. In addition, as of December 31, 2014, we had net deferred tax gains from terminated Swaps of $18.3 million and net deferred tax losses from terminated Swaption contracts of $14.9 million. These deferred gains/losses are expected to be amortized into future ordinary taxable income over the remaining terms of the underlying Swaps.
We have elected to treat a wholly owned subsidiary as a taxable REIT subsidiary (or, TRS). A TRS may participate in activities that would otherwise not be allowed to be carried on in a REIT. A TRS is subject to U.S. Federal, state and local income tax at regular corporate tax rates.
As of December 31, 2014, our TRS and its subsidiaries, which are not consolidated with the Company for income tax purposes, had a net operating loss carryforward of $1.1 million and a capital loss carryforward of $0.1 million. Given the limited operating history of our TRS and its subsidiaries, there can be no assurance that such entities will generate taxable income in the future. As a result, the deferred tax asset of approximately $0.6 million and $0.06 million, associated with our net operating loss carryforward and capital loss carryforward, respectively, have been offset by a valuation allowance, such that we had no net deferred tax asset or liability at December 31, 2014, and had not recorded any tax benefits through September 30, 2015.
Under GAAP, a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Based upon review of our federal, state and local income tax returns and tax filing positions, we determined that no unrecognized tax benefits for uncertain tax positions were required to be recorded. In addition, we do not believe that we have any tax positions for which it is reasonably possible that we will be required to record significant amounts of unrecognized tax benefits within the next twelve months.
Our capital loss carryforward amounts expire in 2018 and 2019. Our major tax jurisdictions are U.S. Federal, New York State and New York City. The statute of limitations is open for all jurisdictions for tax years beginning 2011.
(o) Variable Interest Entities
     We consolidate a VIE when we have 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.   We are required to reconsider our evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE. (See Note 2(h).)
Prior to the completion of our initial securitization transaction in February 2013, we had not transferred assets to VIEs or Qualifying Special Purpose Entities (or, QSPEs) and other than acquiring RMBS issued by such entities, had no other involvement with VIEs or QSPEs.  (See Note 14.)


14

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


(p)
Recent Accounting Pronouncements
Accounting Standards Adopted
In January 2014, the Financial Accounting Standards Board (or, FASB) issued guidance in order to help determine when a creditor should derecognize a loan receivable and recognize the real estate property by clarifying when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. The guidance is effective for public business entities for fiscal years beginning after December 15, 2014. The adoption of this guidance did not have a material impact on our consolidated financial statements.
In April 2014, the FASB issued guidance to improve the definition of discontinued operations and to enhance convergence between the FASB’s and International Accounting Standard Board’s reporting requirements for discontinued operations. The new definition of discontinued operations limits discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity’s operations and financial results. The new guidance affects entities that have either of the following: (1) a component of an entity that either is disposed of or meets the criteria under current guidance to be classified as held-for-sale or (2) a business or nonprofit activity that, on acquisition, meets the criteria under current guidance to be classified as held-for-sale. The guidance is effective for all disposals (or classifications as held-for-sale) of components of an entity and all businesses or nonprofit activities that, on acquisition, are classified as held-for-sale that occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. Early adoption is permitted, but only for disposals (or classifications as held-for-sale) that have not been reported in financial statements previously issued or available for issuance. The adoption of this guidance did not impact our consolidated financial statements.
In June 2014, the FASB issued guidance that requires repurchase-to-maturity transactions to be accounted for as secured borrowings rather than as sales with a forward repurchase commitment. The new guidance eliminated existing guidance on repurchase financings and requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty. If derecognition criteria are met, the initial transfer will generally be accounted for as a sale and the repurchase agreement will generally be accounted for as a secured borrowing. Under prior guidance, there was a rebuttable presumption that the two parts of the repurchase financing are linked, meaning that the transactions should be combined and accounted for as a forward agreement to sell (purchase) a financial asset. The new guidance requires new disclosures for repurchase agreements, securities lending transactions and repurchase-to-maturity transactions that are accounted for as secured borrowings. These disclosures include information about the types of assets pledged and the relationship between those assets and the related obligation to return the proceeds. The new standard also requires new disclosures for transfers of financial assets that are accounted for as sales that involve an agreement with the transferee entered into in contemplation of the initial transfer that result in the transferor retaining substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. The disclosures include information about the nature of the transactions, the transferor’s continuing exposure to the financial assets it derecognized and the components of the transactions presented in the financial statements. The guidance is effective for the first interim or annual period beginning after December 15, 2014, except for the disclosures related to transactions accounted for as secured borrowings, which are effective for periods beginning on or after March 15, 2015; earlier application of this guidance was not permitted. The adoption of this guidance did not have a material impact on our consolidated financial statements, but resulted in additional disclosures with respect to our repurchase borrowings, as presented in Note 8.
In August 2014, the FASB issued guidance to eliminate diversity in practice in the accounting for measurement differences in both the initial consolidation and subsequent measurement of the financial assets and the financial liabilities of a collateralized financing entity. A reporting entity that consolidates a collateralized financing entity within the scope of the new guidance may elect to measure the financial assets and the financial liabilities of that collateralized financing entity using either the measurement alternative included in the new guidance or the existing guidance on fair value measurement. When the measurement alternative is not elected for a consolidated collateralized financing entity within the scope of the new guidance, the new guidance clarifies that (1) the fair value of the financial assets and the fair value of the financial liabilities of the consolidated collateralized financing entity should be measured using the requirements of the existing guidance on fair value measurement and (2) any differences in the fair value of the financial assets and the fair value of the financial liabilities of that consolidated collateralized financing entity should be reflected in earnings and attributed to the reporting entity in the consolidated statement of income (loss). When a reporting entity elects the measurement alternative included in the new guidance for a collateralized financing entity, the reporting entity should measure both the financial assets and the financial liabilities of that collateralized financing entity in its consolidated financial statements using the more observable of the fair value of the financial assets and the fair value of the financial liabilities. The guidance applies to a reporting entity that is required to consolidate a collateralized financing entity under the existing variable interest entity guidance when (1) the reporting entity measures all of the financial assets and the financial liabilities of that consolidated collateralized financing entity at fair value in the consolidated financial statements based on other guidance and (2) the changes in the fair values of


15

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


those financial assets and financial liabilities are reflected in earnings. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2015. Early adoption of this guidance is permitted as of the beginning of an annual period. Our early adoption of this guidance during the period ended March 31, 2015 did not have a material impact our consolidated financial statements. (See Note 3(b).)
In February 2015, the FASB issued guidance affecting reporting entities that are required to evaluate whether they should consolidate certain legal entities, particularly those that have fee arrangements and related party relationships. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2015. Early adoption is permitted as of the beginning of an annual period. The amendments found in this accounting update do not affect the criteria within the Company’s VIE analysis related to its securitization trusts, which are currently consolidated. As such, our adoption of this guidance during the period ended March 31, 2015 did not have an impact on our consolidated financial statements.
Accounting Standards Issued but Not Yet Adopted
In May 2014, the FASB issued guidance to establish a comprehensive and converged standard on revenue recognition to enable financial statement users to better understand and consistently analyze an entity’s revenue across industries, transactions, and geographies. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance also specifies the accounting for certain costs to obtain or fulfill a contract with a customer. The new guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. Qualitative and quantitative information is required to be disclosed about: (1) contracts with customers, (2) significant judgments and changes in judgments, and (3) assets recognized from costs to obtain or fulfill a contract. The new guidance will apply to all entities. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017; early application is not permitted. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In August 2014, the FASB issued guidance regarding management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related financial statement note disclosures. The new guidance requires that management evaluate each annual and interim reporting period whether conditions exist that give rise to substantial doubt about the entity’s ability to continue as a going concern within one year from the financial statement issuance date, and if so, provide related disclosures. Disclosures are only required if conditions give rise to substantial doubt, whether or not the substantial doubt is alleviated by management’s plans. No disclosures are required specific to going concern uncertainties if an assessment of the conditions does not give rise to substantial doubt. Substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable that a company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. If substantial doubt is alleviated as a result of the consideration of management’s plans, a company should disclose information that enables users of financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the financial statement notes): (1) principal conditions that initially give rise to substantial doubt, (2) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (3) management’s plans that alleviated substantial doubt. If substantial doubt is not alleviated after considering management’s plans, disclosures should enable investors to understand the underlying conditions, and include the following: (1) a statement indicating that there is substantial doubt about the company’s ability to continue as a going concern within one year after the issuance date, (2) the principal conditions that give rise to substantial doubt, (3) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (4) management’s plans that are intended to mitigate the adverse conditions. The new guidance applies to all companies. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2016, with early adoption permitted. Based on our current financial condition, we do not expect this guidance will have a material impact on our consolidated financial statements.
In November 2014, the FASB issued guidance to clarify how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the new guidance clarifies that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Further, the new guidance clarifies that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument. The new guidance applies to all entities that are issuers of, or investors in, hybrid financial instruments that are issued in the form of a share. The guidance is effective for interim and annual reporting periods in fiscal years beginning after


16

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


December 15, 2015, with early adoption permitted. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In April 2015, the FASB issued guidance on the presentation of debt issuance costs. This guidance requires 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. This guidance is effective for fiscal years and interim periods beginning after December 15, 2015, and requires retrospective application. We expect to adopt this guidance when effective, and do not expect this guidance to have a significant impact on our financial statements, although it will change the financial statement classification of our deferred financing costs. As of September 30, 2015, we had $718 of net deferred financing costs which are included as a component of Other assets on our consolidated balance sheet. Under the new guidance, these net deferred financing costs will reduce the carrying value of the associated borrowings/debt. In August 2015, the FASB expanded its April 2015 guidance associated with the presentation of debt issue costs, to address costs related to line-of-credit arrangements. In this update, the FASB noted that the Securities Exchange Commission (or, SEC) staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowing on the line-of-credit arrangement. We do not expect this clarification will have a material impact on our consolidated financial statements.
In June 2015, the FASB issued guidance providing for technical corrections and improvements to existing accounting standards. The amendments in this update represent changes to clarify, correct unintended application of guidance, or make minor improvements to existing accounting standards that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this guidance. The amendments that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon the issuance of this accounting guidance.  We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.

(q)    Reclassifications
Certain prior period amounts have been reclassified to conform to the current presentation.
Note 3 – Fair Value of Financial Instruments
(a) General
We disclose the estimated fair value of our financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). We are required to provide enhanced disclosures regarding instruments in the Level III category, including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP provides a framework for measuring estimated fair value and for providing financial statement disclosure requirements for fair value measurements. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level I - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level II - Fair values are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These inputs may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.
Level III - Fair values are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.
The level in the fair value hierarchy, within which a fair measurement falls in its entirety, is based on the lowest level input that is significant to the fair value measurement. When available, we use quoted market prices to determine the estimated fair value of an asset or liability.
Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices received for such assets could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold are also subject to significant judgment, particularly in times of market illiquidity.


17

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


We have controls over our valuation processes that are intended to ensure that the valuations for our financial instruments are fairly presented in accordance with GAAP on a consistent basis. Our Manager and our chief executive officer oversee our valuation process, which is carried out by our Manager and Apollo’s pricing group. Our audit committee has final oversight for the valuation process for all of our financial instruments and, on a quarterly basis, reviews and provides final approval for such process.
Any changes to our valuation methodology will be reviewed by our Manager and audit committee to ensure the changes are appropriate. We may refine our valuation methodologies as markets and products develop. The methods used by us may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we anticipate that our valuation methods are appropriate and are believed to result in valuations consistent with other market participants, the use of different methodologies, or assumptions, to determine the estimated fair value of certain financial instruments could result in a different estimate of estimated fair value at the reporting date. We use inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.
The following describes the valuation methodologies used for our financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
(b) Agency RMBS, non-Agency RMBS, TBA Contracts, Securitized Mortgage Loans, Non-Recourse Securitized Debt and Other Investment Securities
To determine the fair value of our Agency RMBS, non-Agency RMBS, TBA Contracts, other investment securities, securitized mortgage loans and non-recourse securitized debt, we obtain third party broker quotes which, while non-binding, are indicative of fair value. To validate the reasonableness of the broker quotes, we obtain and compare the broker quotes to valuations received from a third party pricing service and review the range of quotes received for outliers, compare quotes to recent market activity observed for similar securities and review significant changes in quarterly price levels. We generally do not adjust the prices we obtain from brokers; however, adjustments to valuations may be made as deemed appropriate to capture observable market information at the valuation date. Further, broker quotes are used provided that there is not an ongoing material event that affects the issuer of the securities being valued or the market thereof. If there is such an ongoing event, we will determine the estimated fair value of the securities using valuation techniques that use, when possible, current market-based or independently-sourced market parameters, such as interest rates and prepayment rates and, with respect to non-Agency RMBS, default rates and loss severities. Valuation techniques for RMBS may be based on models that consider the estimated cash flows of each debt tranche of the issuer, establish a benchmark yield, and develop an estimated tranche-specific spread to the benchmark yield based on the unique attributes of the tranche including, but not limited to, assumptions related to prepayment speed, the frequency and severity of defaults and attributes of the collateral underlying such securities. To the extent the inputs are observable and timely, the values would be categorized in Level II of the fair value hierarchy; otherwise they would be categorized as Level III. There were no events that resulted in us using internal models to value our Agency and non-Agency RMBS or other investment securities in our consolidated financial statements for the periods presented. Given the high level of liquidity and price transparency for our Agency RMBS, Risk Sharing Securities and TBA Contracts prices obtained from brokers and pricing services are readily verifiable to observable market transactions; as such, we categorize Agency RMBS, TBA Contracts and Risk Sharing Securities as Level II valuations. While market liquidity exists for non-Agency RMBS, securities underlying our securitized mortgage loans, securitized debt and SBC-MBS, periods of less liquidity or even illiquidity may also occur periodically for certain of these assets. As a result of this market dynamic and that observable market transactions may or may not exist from time to time, such instruments are categorized as Level III.
(c) Swaps and Swaptions
We determine the estimated fair value of our Swaps and Swaptions based on market valuations obtained from a third party with expertise in valuing such instruments. With respect to Swap valuations, the expected future cash flows are determined for the fixed and floating rate leg of the Swap. To arrive at the expected cash flows for the fixed leg of a Swap, the coupon rate stated in the Swap agreement is used and to arrive at the expected cash flows for the floating leg, the forward rates derived from raw yield curve data are used. Finally, both the fixed and floating legs’ cash flows are discounted using the calculated discount factors and the fixed and floating leg valuations are netted to arrive at a single valuation for the Swap at the valuation date. Swaptions require the same market inputs as Swaps with the addition of implied Swaption volatilities quoted by the market. The valuation inputs for Swaps and Swaptions are observable and, as such, their valuations are categorized as Level II in the fair value hierarchy.


18

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


(d) Fair Value Hierarchy
The following tables present our financial instruments carried at estimated fair value as of September 30, 2015 and December 31, 2014 based upon our consolidated balance sheet by the valuation hierarchy:
 
 
Estimated Fair Value at September 30, 2015
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$

 
$
2,031,441

 
$
1,240,188

 
$
3,271,629

Securitized mortgage loans (transferred to consolidated variable interest entities)
 

 

 
173,322

 
173,322

Other investment securities
 

 
99,737

 
62,985

 
162,722

Swaps/Swaptions
 

 
1,633

 

 
1,633

Total
 
$

 
$
2,132,811

 
$
1,476,495

 
$
3,609,306

Liabilities:
 
 
 
 
 
 
 
 
Swaps/Swaptions
 
$

 
$
25,595

 
$

 
25,595

Non-recourse securitized debt
 

 

 
21,243

 
21,243

Short TBA Contracts
 

 
820

 

 
820

Total
 
$

 
$
26,415

 
$
21,243

 
$
47,658

 
 
Estimated Fair Value at December 31, 2014
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$

 
$
2,287,523

 
$
1,468,109

 
$
3,755,632

Securitized mortgage loans (transferred to consolidated variable interest entity)
 

 

 
104,438

 
104,438

Other investment securities
 

 
10,395

 
23,833

 
34,228

Mortgage Loans
 

 

 
14,120

 
14,120

Long TBA Contracts
 

 
544

 

 
544

Swaps/Swaptions
 

 
11,098

 

 
11,098

Total
 
$

 
$
2,309,560

 
$
1,610,500

 
$
3,920,060

Liabilities:
 
 
 
 
 
 
 
 
Swaps
 

 
8,949

 

 
8,949

Non-recourse securitized debt
 

 

 
34,176

 
34,176

Total
 
$

 
$
8,949

 
$
34,176

 
$
43,125

(e) Level III Fair Value Measurement Disclosures
Our non-Agency RMBS, other investment securities, securitized mortgage loans and securitized debt are measured at fair value and are considered to be Level III measurements of fair value.


19

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


The following table presents a summary of changes in the fair value of our non-Agency RMBS for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning balance
 
$
1,378,265

 
$
1,413,194

 
$
1,468,109

 
$
1,212,789

Purchases
 
21,249

 
72,511

 
205,086

 
304,388

Sales
 
(100,384
)
 
(2,253
)
 
(273,316
)
 
(13,562
)
Principal repayments
 
(55,937
)
 
(45,671
)
 
(175,321
)
 
(108,661
)
Total net gains/(losses) included in net income:
 


 
 
 
 
 
 
         Realized gains/(losses), net
 
4,058

 
531

 
7,882

 
2,965

         Unrealized gains/(losses), net
 
(15,072
)
 
(4,403
)
 
(25,822
)
 
9,515

         Other-than-temporary impairment
 
(5,879
)
 
(3,426
)
 
(7,758
)
 
(6,059
)
Discount accretion
 
13,888

 
14,533

 
41,328

 
43,641

Ending balance
 
$
1,240,188

 
$
1,445,016

 
$
1,240,188

 
$
1,445,016

 
The following table presents a summary of the changes in the fair value of our securitized mortgage loan pools associated with our securitizations for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning balance
 
$
178,904

 
$
109,712

 
$
104,438

 
$
110,984

Mortgage loans securitized
 

 

 
81,093

 

Principal repayments
 
(5,238
)
 
(1,823
)
 
(10,750
)
 
(5,736
)
Discount accretion and other adjustments
 
261

 
(247
)
 
(495
)
 
(511
)
Unrealized gain/(loss) during the period, net (1)
 
(605
)
 
(650
)
 
97

 
2,440

Loans transferred to REO
 

 
(45
)
 
(1,061
)
 
(230
)
Ending balance
 
$
173,322


$
106,947

 
$
173,322

 
$
106,947

(1) 
Amount is net of a provision for loan losses of $0 and $1,241 for the three months ended September 30, 2015 and September 30, 2014, respectively, and $0 and $1,726 for the nine months ended September 30, 2015 and September 30, 2014, respectively.
The following table presents a summary of the changes in fair value of our Level III other investment securities for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning balance
 
$
58,890

 
$

 
$
23,833

 
$
11,515

Transferred out of Level III fair values (1)
 

 

 

 
(11,515
)
Purchases
 
8,175

 
19,799

 
47,776

 
19,799

Principal repayments
 
(3,582
)
 
(224
)
 
(8,134
)
 
(224
)
Discount accretion
 
657

 
27

 
1,473

 
27

Unrealized gain/(loss)
 
(1,155
)
 
8

 
(1,963
)
 
8

Ending balance
 
$
62,985

 
$
19,610

 
$
62,985

 
$
19,610

(1)
During the three and nine months ended September 30, 2015, we did not transfer any investments into or out of the Level III category of the fair value hierarchy. During the nine months ended September 30, 2014, we transferred an investment in Risk Sharing Securities from Level III to Level II, all which occurred during the three months ended March 31, 2014. The Risk Sharing Securities were transferred to Level II measurements of fair value based on the availability of significant observable market inputs which are used to estimate the fair value of these securities. Transfers between levels are deemed to take place on the first day of the reporting period in which the transfer occurred.


20

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


The following table presents a summary of the changes in fair value of our securitized debt for the periods presented: 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning balance
 
$
25,893

 
$
38,656

 
$
34,176

 
$
43,354

Principal paid
 
(4,478
)
 
(2,401
)
 
(11,747
)
 
(7,453
)
Unrealized gain/(loss)
 
(172
)
 
(67
)
 
(1,186
)
 
287

Ending balance
 
$
21,243

 
$
36,188

 
$
21,243

 
$
36,188

(f) Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on our consolidated balance sheet, at September 30, 2015 and December 31, 2014: 
 
 
September 30, 2015
 
December 31, 2014
 
 
Carrying Value
 
Estimated  Fair
Value
 
Carrying Value
 
Estimated  Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
Investment related receivable (1)
 
$
6,225

 
$
6,225

 
$
191,455

 
$
191,455

Warehouse line receivable (2) (3)
 
$
12,424

 
$
12,424

 
$
28,639

 
$
28,639

Mortgage loans (3)
 
$
7,391

 
$
7,391

 
$
2,306

 
$
2,306

Real estate subject to BFT Contracts (3)
 
$
24,953

 
$
24,953

 
$
9,616

 
$
9,616

Financial liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
$
3,011,025

 
$
3,011,216

 
$
3,402,327

 
$
3,402,237

Investment related payable (1)
 
$
36,516

 
$
36,516

 
$
76,105

 
$
76,105

(1) 
Carrying value approximates fair value due to the short-term nature of the item.
(2) 
Carrying value approximates fair value as such investment is variable rate.
(3)    This item is included as a component of “Other investments” on our consolidated balance sheet.

To determine the estimated fair value of our borrowings under repurchase agreements, contractual cash flows from such borrowings are discounted at estimated market interest rates, which rates may be based upon actual transactions executed by us or indicative rates quoted by brokers. The estimated fair values are not necessarily indicative of the amount we would realize on disposition of the financial instruments. Our borrowings under repurchase agreements had a weighted average remaining term to maturity of 63 days and 65 days at September 30, 2015 and December 31, 2014, respectively. Adjustments to valuations may be made as deemed appropriate to capture market information at the valuation date. Inputs used to arrive at the fair value of our repurchase agreement borrowings are generally observable and therefore the fair value of our repurchase agreement borrowings are classified as Level II valuations in the fair value hierarchy.



21

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


Note 4 – Residential Mortgage-Backed Securities
(a) RMBS Portfolio Components
The following tables present certain information about our RMBS portfolio at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
 
Principal
Balance
 
Premium/
(Discount)and OTTI, Net (1)
 
Amortized
Cost (2) 
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Weighted Average Coupon
Agency pass-through RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
284,721

 
$
20,098

 
$
304,819

 
$
303,121

 
$

 
$
(1,698
)
 
2.44
%
3.5% coupon
 
487,485

 
23,854

 
511,339

 
509,008

 
1,150

 
(3,481
)
 
3.50
%
4.0% coupon
 
1,078,684

 
69,056

 
1,147,740

 
1,157,162

 
10,436

 
(1,014
)
 
4.00
%
 
 
1,850,890

 
113,008

 
1,963,898

 
1,969,291

 
11,586

 
(6,193
)
 
3.63
%
Agency IO (2) 
 

 

 
55,880

 
54,579

 
4

 
(1,305
)
 
2.25
%
Agency Inverse IO (2)
 

 

 
7,304

 
7,571

 
312

 
(45
)
 
6.81
%
Total Agency securities
 
1,850,890

 
113,008

 
2,027,082

 
2,031,441

 
11,902

 
(7,543
)
 
3.37
%
Non-Agency RMBS
 
1,438,932

 
(247,517
)
 
1,191,415

 
1,240,188

 
59,242

 
(10,469
)
 
1.48
%
Total RMBS
 
$
3,289,822

 
$
(134,509
)
 
$
3,218,497

 
$
3,271,629

 
$
71,144

 
$
(18,012
)
 
2.67
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
 
 
Principal
Balance
 
Premium/
(Discount)and OTTI, Net (1)
 
Amortized
Cost (2) 
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Weighted Average Coupon
Agency pass-through RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
98,079

 
$
7,196

 
$
105,275

 
$
105,122

 
$
6

 
$
(159
)
 
2.36
%
3.5% coupon
 
495,214

 
20,245

 
515,459

 
515,628

 
1,536

 
(1,367
)
 
3.50
%
4.0% coupon
 
1,173,972

 
82,353

 
1,256,325

 
1,256,724

 
8,357

 
(7,958
)
 
4.00
%
4.5% coupon
 
336,353

 
25,863

 
362,216

 
366,472

 
4,256

 

 
4.50
%
 
 
2,103,618

 
135,657

 
2,239,275

 
2,243,946

 
14,155

 
(9,484
)
 
3.89
%
Agency Inverse Floater
 
1,359

 
3,590

 
4,949

 
5,094

 
145

 

 
81.76
%
Agency IO (2)
 

 

 
11,948

 
11,941

 
62

 
(69
)
 
2.24
%
Agency Inverse IO (2)
 

 

 
26,489

 
26,542

 
306

 
(253
)
 
6.30
%
Total Agency securities
 
2,104,977

 
139,247

 
2,282,661

 
2,287,523

 
14,668

 
(9,806
)
 
3.93
%
Non-Agency RMBS
 
1,682,858

 
(289,345
)
 
1,393,513

 
1,468,109

 
78,434

 
(3,838
)
 
1.46
%
Total RMBS
 
$
3,787,835

 
$
(150,098
)
 
$
3,676,174

 
$
3,755,632

 
$
93,102

 
$
(13,644
)
 
2.91
%
Note: We apply trade-date accounting. Included in the above table are unsettled purchases with an aggregate cost of $32,073 and $76,009 at September 30, 2015 and December 31, 2014 respectively, with an estimated fair value of $32,068 and $75,990, respectively, at such dates.
(1) 
A portion of the purchase discount on non-Agency RMBS is not expected to be recognized as interest income, and is instead viewed as a credit discount. See Notes 4(h) and 4(f).
(2) 
Agency IO and Agency Inverse IO have no principal balance and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on such securities. At September 30, 2015 and December 31, 2014, our Agency IO had a notional balance of $565,199 and $133,924, respectively, and our Agency Inverse IO had a notional balance of $41,145 and $138,293, respectively.


22

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


(b) Agency Pass-through RMBS
The following tables present certain information about our Agency pass-through RMBS by issuer at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Fannie Mae:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
268,526

 
$
18,995

 
$
287,521

 
$
285,970

 
$

 
$
(1,551
)
3.5% Coupon
 
127,109

 
6,419

 
133,528

 
132,939

 
273

 
(862
)
4.0% Coupon
 
360,334

 
23,255

 
383,589

 
386,469

 
2,907

 
(27
)
 
 
755,969

 
48,669

 
804,638

 
805,378

 
3,180

 
(2,440
)
Freddie Mac:
 
 
 


 
 
 
 
 
 
 
 
ARMs
 
16,195

 
1,103

 
17,298

 
17,151

 

 
(147
)
3.5% Coupon
 
360,376

 
17,435

 
377,811

 
376,069

 
877

 
(2,619
)
4.0% Coupon
 
718,350

 
45,801

 
764,151

 
770,693

 
7,529

 
(987
)
 
 
1,094,921

 
64,339

 
1,159,260

 
1,163,913

 
8,406

 
(3,753
)
Total Agency pass-through RMBS
 
$
1,850,890

 
$
113,008

 
$
1,963,898

 
$
1,969,291

 
$
11,586

 
$
(6,193
)
 
 
December 31, 2014
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Fannie Mae:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
78,731

 
$
5,878

 
$
84,609

 
$
84,537

 
$
6

 
$
(78
)
3.5% Coupon
 
149,436

 
6,200

 
155,636

 
155,895

 
417

 
(158
)
4.0% Coupon
 
271,031

 
19,397

 
290,428

 
289,903

 
1,531

 
(2,056
)
4.5% Coupon
 
294,177

 
22,712

 
316,889

 
320,653

 
3,764

 

 
 
793,375

 
54,187

 
847,562

 
850,988

 
5,718

 
(2,292
)
Freddie Mac:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
19,348

 
1,318

 
20,666

 
20,585

 

 
(81
)
3.5% Coupon
 
345,778

 
14,045

 
359,823

 
359,733

 
1,119

 
(1,209
)
4.0% Coupon
 
902,941

 
62,956

 
965,897

 
966,821

 
6,826

 
(5,902
)
4.5% Coupon
 
42,176

 
3,151

 
45,327

 
45,819

 
492

 

 
 
1,310,243

 
81,470

 
1,391,713

 
1,392,958

 
8,437

 
(7,192
)
Total Agency pass-through RMBS
 
$
2,103,618

 
$
135,657

 
$
2,239,275

 
$
2,243,946

 
$
14,155

 
$
(9,484
)


23

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


(c) Non-Agency RMBS
The following tables present certain information about our non-Agency RMBS by type of underlying mortgage loan collateral type at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
Underlying Loan Characteristics:
 
Principal
Balance
 
Unamortized Premium/
(Discount) and OTTI, Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Subprime
 
$
991,480

 
$
(143,784
)
 
$
847,696

 
$
884,211

 
$
42,667

 
$
(6,152
)
Alt-A
 
193,202

 
(47,151
)
 
146,051

 
156,128

 
11,722

 
(1,645
)
Option ARMs
 
254,250

 
(56,582
)
 
197,668

 
199,849

 
4,853

 
(2,672
)
Total Non-Agency RMBS
 
$
1,438,932

 
$
(247,517
)
 
$
1,191,415

 
$
1,240,188

 
$
59,242

 
$
(10,469
)
 
 
December 31, 2014
Underlying Loan Characteristics:
 
Principal
Balance
 
Unamortized Premium/
(Discount) and OTTI, Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Subprime
 
$
1,257,231

 
$
(184,851
)
 
$
1,072,380

 
$
1,129,045

 
$
59,350

 
$
(2,685
)
Alt-A
 
220,220

 
(53,283
)
 
166,937

 
179,767

 
13,329

 
(499
)
Option ARMs
 
205,407

 
(51,211
)
 
154,196

 
159,297

 
5,755

 
(654
)
Total Non-Agency RMBS
 
$
1,682,858

 
$
(289,345
)
 
$
1,393,513

 
$
1,468,109

 
$
78,434

 
$
(3,838
)
(d) Unrealized Loss Positions on RMBS
The following table presents information about our RMBS that were in an unrealized loss position at September 30, 2015:
 
 
Unrealized Loss Position for Less than
12 Months
 
Unrealized Loss Position for 12
Months or More
 
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
Agency RMBS
 
$
658,318

 
$
(5,065
)
 
23
 
$
129,804

 
$
(1,128
)
 
4
Agency IO
 
37,397

 
(1,305
)
 
11
 

 

 
0
Agency Inverse IO
 
1,342

 
(45
)
 
1
 

 

 
0
Total Agency Securities
 
697,057

 
(6,415
)
 
35
 
129,804

 
(1,128
)
 
4
Non-Agency RMBS
 
474,161

 
(7,945
)
 
90
 
87,770

 
(2,523
)
 
31
Total RMBS
 
$
1,171,218

 
$
(14,360
)
 
125
 
$
217,574

 
$
(3,651
)
 
35


24

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


(e) Interest Income on RMBS
The following tables present components of interest income on our Agency RMBS and non-Agency RMBS for the periods presented:
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
Agency RMBS
 
$
20,606

 
$
(5,783
)
 
$
14,823

 
$
64,645

 
$
(17,472
)
 
$
47,173

Non-Agency RMBS
 
5,610

 
13,888

 
19,498

 
17,252

 
41,328

 
58,580

Total
 
$
26,216

 
$
8,105

 
$
34,321

 
$
81,897

 
$
23,856

 
$
105,753

 
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
Agency RMBS
 
$
25,261

 
$
(8,698
)
 
$
16,563

 
$
75,784

 
$
(25,707
)
 
$
50,077

Non-Agency RMBS
 
5,181

 
14,533

 
19,714

 
14,375

 
43,641

 
58,016

Total
 
$
30,442

 
$
5,835

 
$
36,277

 
$
90,159

 
$
17,934

 
$
108,093

(f) Realized and Unrealized Gains, Losses and OTTI on RMBS
The following tables present components of net realized gains/(losses), changes in net unrealized gains/(losses) and OTTI recognized on our RMBS for the periods presented:
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
RMBS Type
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairments
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairments
Agency fixed-rate
 
$
(806
)
 
$
18,827

 
$

 
$
(863
)
 
$
2,267

 
$

Agency ARM
 

 
(720
)
 

 
15

 
(1,545
)
 

Agency Inverse
 

 

 

 
43

 
(145
)
 

Agency IO
 
407

 
(3,182
)
 
(14
)
 
280

 
(1,293
)
 
(627
)
Agency Inverse IO
 
(328
)
 
308

 
(745
)
 
(17
)
 
213

 
(917
)
Non-Agency
 
4,058

 
(15,072
)
 
(5,879
)
 
7,882

 
(25,822
)
 
(7,758
)
Total
 
$
3,331

 
$
161

 
$
(6,638
)
 
$
7,340

 
$
(26,325
)
 
$
(9,302
)
 
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
RMBS Type
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairment
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairment
Agency-fixed
 
$
(560
)
 
$
(6,161
)
 
$

 
$
(22,027
)
 
$
84,180

 
$

Agency Inverse
 

 
18

 
 
 

 
18

 
 
Agency IO
 
2,714

 
(2,440
)
 
(105
)
 
2,775

 
(2,120
)
 
(719
)
Agency Inverse IO
 
(104
)
 
(168
)
 
(286
)
 
45

 
818

 
(429
)
Agency ARM
 

 

 

 
(59
)
 
62

 

Non-Agency
 
531

 
(4,403
)
 
(3,426
)
 
2,965

 
9,515

 
(6,059
)
Total
 
$
2,581

 
$
(13,154
)
 
$
(3,817
)
 
$
(16,301
)
 
$
92,473

 
$
(7,207
)


25

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


(g) Contractual Maturities of RMBS
The following table presents the maturities of our RMBS, based on the contractual maturities of the underlying mortgages at September 30, 2015 and December 31, 2014:
Contractual Maturities of RMBS (1)
 
September 30, 2015
 
December 31, 2014
10 years or less
 
$
85,780

 
$

> 10 years and < or equal to 20 years
 
376,836

 
628,787

> 20 years and < or equal to 30 years
 
2,491,110

 
2,977,089

> 30 years
 
317,903

 
149,756

Total
 
$
3,271,629

 
$
3,755,632

(1) 
Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal, and the payment priority structure of the security; therefore actual maturities are generally shorter than the stated contractual maturities of the underlying or referenced mortgages.
(h) Non-Agency RMBS Discounts and OTTI
The following tables present the changes in the components of our purchase discount on non-Agency RMBS between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented:
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
 
Discount
Designated as
Credit Reserve
and OTTI
(1)
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI
(1)
 
Accretable Discount
Balance at beginning of period
 
$
(70,185
)
 
$
(189,888
)
 
$
(95,504
)
 
$
(194,451
)
Accretion of discount
 

 
13,888

 

 
41,328

Realized credit losses
 
1,320

 

 
1,809

 

Purchases
 
(5,205
)
 
(1,201
)
 
(6,675
)
 
(11,995
)
Sales and other
 
2,098

 
7,330

 
8,181

 
17,343

OTTI recognized
 
(5,879
)
 

 
(7,758
)
 

Transfers/release of credit reserve
 
(13,147
)
 
13,147

 
8,949

 
(8,949
)
Balance at end of period
 
$
(90,998
)
 
$
(156,724
)
 
$
(90,998
)
 
$
(156,724
)
(1)
At September 30, 2015, our non-Agency RMBS had gross discounts of $247,722, which included credit discounts of $67,775 and OTTI of $23,223. At December 31, 2014, our non-Agency RMBS had gross discounts of $289,955, which included credit discounts of $76,914 and OTTI of $18,590.


26

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


 
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
 
 
Discount
Designated as
Credit Reserve
and OTTI
(1)
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI
(1)
 
Accretable Discount
Balance at beginning of period
 
$
(111,084
)
 
$
(198,256
)
 
$
(109,299
)
 
$
(193,647
)
Accretion of discount
 

 
14,533

 

 
43,592

Realized credit losses
 
697

 

 
3,002

 

Purchases
 
(4,520
)
 
(7,367
)
 
(36,058
)
 
(18,225
)
Sales and other
 
476

 
(250
)
 
9,474

 
(1,977
)
OTTI recognized in earnings
 
(3,426
)
 

 
(6,059
)
 

Transfers/release of credit reserve
 
4,621

 
(4,621
)
 
25,704

 
(25,704
)
Balance at end of period
 
$
(113,236
)
 
$
(195,961
)
 
$
(113,236
)
 
$
(195,961
)
(1) 
At September 30, 2014, our non-Agency RMBS had gross discounts of $309,197, which included credit discounts of $97,958 and OTTI of $15,278.
The following table presents a roll-forward of the credit loss component of OTTI on our Agency IO and Inverse IO securities:
 
 
Three Months September 30, 2015
 
Nine Months September 30, 2015
OTTI at beginning of period
 
$
738

 
$
1,106

Additions to OTTI
 
759

 
1,544

Sale of securities with OTTI
 
(563
)
 
(1,716
)
OTTI at end of period
 
$
934

 
$
934

Note 5 – Securitized Mortgage Loans
Our investments in residential mortgage loans, which are held in securitization trusts that we consolidate, are presented at fair value on our consolidated balance sheets. (See Note 14.)
The following table presents a summary of the changes in the carrying value of our securitized mortgage loans for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning balance
 
$
178,904

 
$
109,712

 
$
104,438

 
$
110,984

Securitization of March 2015 Pool
 

 

 
81,093

 

Principal repayments
 
(5,238
)
 
(1,823
)
 
(10,750
)
 
(5,736
)
Discount accretion and other adjustments
 
261

 
(247
)
 
(495
)
 
(511
)
Unrealized gain/(loss) during the period, net (1)
 
(605
)
 
(650
)
 
97

 
2,440

Loans transferred to REO
 

 
(45
)
 
(1,061
)
 
(230
)
Ending balance
 
$
173,322

 
$
106,947

 
$
173,322

 
$
106,947

(1) 
Amount is net of the recognition of provision for loan losses of $0 and $1,241 for the three months ended September 30, 2015 and September 30, 2014, respectively, and $0 and $1,726 for the nine months ended September 30, 2015 and September 30, 2014, respectively, which are included with “Other-than-temporary impairments recognized” on our consolidated statements of operations.


27

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


The following table presents certain information about mortgage loans underlying our securitized mortgage loans at September 30, 2015:
Securitized Mortgage Loans
 
September 30, 2015
Performing (1)
 
$
75,539

Re-performing (1)
 
108,667

Non-performing (1)
 
31,854

Purchase discount
 
(47,017
)
Loan loss provision
 
(3,130
)
Fair value adjustment
 
7,409

Total
 
$
173,322

(1) 
We consider loans that are no more than 60 days delinquent as “performing,” loans that have had their initial terms modified and are no more than 60 days delinquent as “re-performing” and loans that are more than 60 days past due as “non-performing.”
At September 30, 2015, $6,906 of our securitized mortgage loans were in the process of foreclosure, and we did not hold any positions classified as REO. The following table presents the five largest state concentrations, in the aggregate, for our securitized mortgage loans based on principal balance at September 30, 2015:
Property Location
 
Principal Balance
 
Total Concentration
Florida
 
$
39,417

 
18.2
%
California
 
37,835

 
17.5

Maryland
 
17,931

 
8.3

Texas
 
13,824

 
6.4

New York
 
12,200

 
5.6

Other states and the District of Columbia
 
94,854

 
44.0

Total
 
$
216,061

 
100.0
%



28

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


Note 6 – Other Investment Securities and Other Investments
(a) Other Investment Securities
The following table presents certain information about our other investment securities portfolio at September 30, 2015 and December 31, 2014:
 
 
Principal
Balance
 
Premium/
(Discount), Net
 
Amortized Cost (1)
 
Estimated Fair Value
 
Gross Unrealized Gain
 
Gross Unrealized Losses
 
Weighted Average Coupon
 
 
September 30, 2015
Risk Sharing Securities - Freddie Mac
 
$
49,242

 
$
304

 
$
49,546

 
$
48,206

 
$
220

 
$
(1,560
)
 
3.69
%
Risk Sharing Securities - Fannie Mae
 
55,287

 
(1,716
)
 
53,571

 
51,531

 

 
(2,040
)
 
3.77
%
SBC-MBS
 
70,032

 
(8,081
)
 
61,951

 
59,986

 
2

 
(1,967
)
 
0.75
%
SBA-IO (2)
 

 

 
2,998

 
2,999

 
1

 

 
2.36
%
Total
 
$
174,561

 
$
(9,493
)
 
$
168,066

 
$
162,722

 
$
223

 
$
(5,567
)
 
2.51
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2014
Risk Sharing Securities - Freddie Mac
 
$
10,082

 
$
38

 
$
10,120

 
$
10,395

 
$
288

 
$
(13
)
 
3.56
%
SBC-MBS
 
27,136

 
(3,268
)
 
23,868

 
23,833

 

 
(35
)
 
0.90

Total
 
$
37,218

 
$
(3,230
)
 
$
33,988

 
$
34,228

 
$
288

 
$
(48
)
 
1.62
%
(1) 
Amortized cost is reduced by unrealized losses that are classified as OTTI, which was $668 and $109 at September 30, 2015 and December 31, 2014, respectively.
(2) 
SBA-IO have no principal balance and bear interest based on a notional balance. At September 30. 2015 our SBA-IO had a notional balance of $27,900.
(b) Income on Other Investment Securities
The following tables present components of interest income on our other investment securities for the periods presented:
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
Risk Sharing Securities - Freddie Mac
 
$
405

 
$
157

 
$
562

 
4.97
%
 
$
942

 
$
297

 
$
1,239

 
4.11
%
Risk Sharing Securities - Fannie Mae
 
510

 
211

 
721

 
5.57

 
797

 
300

 
1,097

 
4.85

SBC-MBS
 
117

 
659

 
776

 
5.21

 
278

 
1,440

 
1,718

 
5.06

SBA-IO
 
2

 
(1
)
 
1

 
12.82

 
2

 
(1
)
 
1

 
12.82

Total
 
$
1,034

 
$
1,026

 
$
2,060

 
5.26
%
 
$
2,019

 
$
2,036

 
$
4,055

 
4.64
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2014
 
Nine Months Ended September 30, 2014
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
Risk Sharing Securities - Freddie Mac
 
$
100

 
$
1

 
$
101

 
4.52
%
 
$
305

 
$
4

 
$
309

 
4.90
%
SBC-MBS
 
4

 
27

 
31

 
4.85

 
4

 
27

 
31

 
4.85

Total
 
$
104

 
$
28

 
$
132

 
4.60
%
 
$
309

 
$
31

 
$
340

 
4.88
%


29

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


(c) Other Investment Securities Discounts and OTTI
The following table presents the changes in the components of our purchase discount on other investment securities between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented.
 
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
 
Discount
Designated as
Credit Reserve
and OTTI
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI
 
Accretable Discount
Balance at beginning of period
 
$
(217
)
 
$
(9,574
)
 
$
(364
)
 
$
(2,904
)
Accretion of discount
 

 
1,026

 

 
2,036

Realized credit losses
 

 

 

 

Purchases
 
(15
)
 
(722
)
 
(15
)
 
(8,183
)
Sales and other
 

 

 

 
36

OTTI recognized
 
(450
)
 

 
(558
)
 

Transfers/release of credit reserve
 

 

 
255

 
(255
)
Balance at end of period
 
$
(682
)
 
$
(9,270
)
 
$
(682
)
 
$
(9,270
)
Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property. In some instances, certain mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principal(s) of the related business and/or borrowing entity. As part of underwriting small balance commercial loans, real estate appraisals of the underlying real estate are generally obtained at origination of the mortgage assets underlying the SBC-MBS.
(d) Other Investment Securities Unrealized Losses
The following table presents information about our Other Investment Securities that were in an unrealized loss position at September 30, 2015:
 
 
Unrealized Loss Position for Less than
12 Months
 
Unrealized Loss Position for 12
Months or More
 
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
Risk Sharing Securities - Freddie Mac
 
$
27,293

 
$
(1,547
)
 
4

 
$
634

 
$
(14
)
 
1

Risk Sharing Securities - Fannie Mae
 
51,531

 
(2,040
)
 
3

 

 

 

SBC-MBS
 
52,729

 
(1,804
)
 
6

 
4,200

 
(162
)
 
1

Total Other Investment Securities
 
$
131,553

 
$
(5,391
)
 
13

 
$
4,834

 
$
(176
)
 
2

(e) Other Investments
Our other investments are comprised of our warehouse line, real estate subject to BFT Contracts and mortgage loans, all of which are associated with our Seller Financing Program.
BFT Contracts are agreements to finance the purchase of real property in which the seller provides the buyer with financing to purchase the property for an agreed-upon purchase price, and the buyer repays the loan in installments over the ensuing 20 to 30 years, depending on the term of the financing agreement. Pursuant to a BFT Contract, unlike a mortgage loan, the seller retains the legal title to the property, granting the buyer complete use of the property and requiring the buyer to maintain the property and bear the cost of property taxes. Pursuant to a BFT Contract, the seller generally conveys legal title of the property to the buyer when the full purchase price set forth in the contract has been paid, including all interest incurred through the date of final payment.
Our warehouse line receivable is secured by a pledge of substantially all the assets of the third-party borrower that owns the homes, BFT Contracts and mortgage loans during the time they are pledged on the warehouse line. All BFT Contracts purchased by us through September 30, 2015 are designated as “real estate subject to BFT Contracts,” which real estate is depreciated until such time that the criteria for sale have been met. With respect to payments we receive under BFT Contracts,


30

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


we record the principal component of the buyer’s monthly payment as a deposit liability and record the interest payment in interest income as received.
The following table presents components of the carrying value of our other investments at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
Warehouse line receivable
 
$
12,424

 
$
28,639

Real estate subject to BFT Contracts, net of accumulated depreciation (1) (2)
 
24,953

 
9,616

Mortgage loans purchased through Seller Financing Program
 
7,391

 
2,306

Total
 
$
44,768

 
$
40,561

(1) 
BFT Contracts at September 30, 2015 had an aggregate principal balance of $25,321 with a weighted average contractual interest rate of 8.22% and BFT Contracts at December 31, 2014 had an aggregate principal balance of $9,655 with a weighted average stated interest rate of 8.88%.
(2) 
Net of $368 and $48 of accumulated depreciation at September 30, 2015 and December 31, 2014, respectively.
(f) Income on Other Investments
The following table presents components of income on our other investments during the three and nine months ended September 30, 2015 and September 30, 2014:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Warehouse line interest

 
$
233

 
$
249

 
$
913

 
$
373

Real estate subject to BFT Contracts

 
419

 
11

 
1,063

 
11

Mortgage loans purchased through Seller Financing Program

 
149

 
2

 
338

 
2

Total
 
$
801

 
$
262

 
$
2,314

 
$
386




31

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


Note 7 – Receivables
(a) Interest Receivable
The following table presents our interest receivable by investment category at September 30, 2015 and December 31, 2014:
Investment Category
 
September 30, 2015
 
December 31, 2014
Agency RMBS - Fannie Mae (1)
 
$
2,789

 
$
3,101

Agency RMBS - Freddie Mac (1)
 
4,040

 
4,798

Agency RMBS - Ginnie Mae (1)
 
115

 
30

Non-Agency RMBS
 
1,027

 
1,068

Securitized mortgage loans
 
943

 
719

Other investment securities
 
255

 
10

Other investments
 
939

 
729

Total
 
$
10,108

 
$
10,455

(1) 
Includes interest income receivable on pass-through, IO, Inverse IO and Inverse Floater securities issued by an Agency, as applicable.
(b) Investment Related Receivables
The following table presents the components of our investment related receivables at September 30, 2015 and December 31, 2014:
Investment Related Receivables
 
September 30, 2015
 
December 31, 2014
Unsettled sales of Agency RMBS
 
$

 
$
188,527

Unsettled sales non-Agency RMBS
 
1,702

 

Principal payments due from broker
 
4,523

 
2,928

Total investment related receivables
 
$
6,225

 
$
191,455


Note 8 – Borrowings Under Repurchase Agreements
As of September 30, 2015, we had master repurchase agreements with 24 counterparties and had outstanding borrowings of $3,011,025 with 18 counterparties.
Our repurchase agreements bear interest at a contractually agreed-upon rate and typically have initial terms of one to six months, but in some cases may have initial terms that are shorter or longer, up to 24 months.
The following table presents certain characteristics of our repurchase agreements at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
 
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
Securities Financed:
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,809,868

 
0.44
%
 
16
 
$
2,205,082

 
0.34
%
 
16
Non-Agency RMBS (1)
 
1,078,703

 
1.89

 
130
 
1,159,698

 
1.95

 
160
Other investment securities
 
122,454

 
1.80

 
155
 
28,805

 
1.74

 
13
Mortgage loans
 

 

 
 
8,742

 
2.79

 
120
Total
 
$
3,011,025

 
1.02
%
 
63
 
$
3,402,327

 
0.91
%
 
65
(1) 
Includes $91,758 and $33,153 of repurchase borrowings collateralized by non-Agency RMBS of $125,948 and $47,786 at September 30, 2015 and December 31, 2014, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with securitization transactions.


32



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


A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and derivative contracts are subject to financial covenants, which if breached could cause an event of default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such agreements would be immediately payable by us. Through September 30, 2015, we remained in compliance with all of our financial covenants. (See Notes 9 and 10.)
The following table presents repricing information about our borrowings under repurchase agreements at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
Time Until Interest Rate Reset:
 
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
Within 30 days
 
$
2,363,040

 
0.92
%
 
$
2,658,515

 
0.73
%
Over 30 days to 60 days
 
336,990

 
0.78

 
501,291

 
1.34

Over 60 days to 90 days
 
16,611

 
1.73

 
116,196

 
1.92

Over 90 days to 120 days
 
222,022

 
1.88

 
35,668

 
1.94

Over 120 days to 360 days
 
72,362

 
2.58

 
90,657

 
2.01

Total
 
$
3,011,025

 
1.02
%
 
$
3,402,327

 
0.91
%
     
The following table presents the contractual maturity of our repurchase agreements at September 30, 2015 and December 31, 2014:
 
September 30, 2015
 
December 31, 2014
Time Until Contractual Maturity:
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
Within 30 days
$
2,080,295

 
0.77
%
 
$
2,461,835

 
0.61
%
Over 30 days to 60 days
336,990

 
0.78

 
393,555

 
1.10

Over 60 days to 90 days
16,611

 
1.73

 
116,196

 
1.92

Over 90 days to 120 days
222,022

 
1.88

 
35,668

 
1.56

Over 120 days to 360 days
136,884

 
2.46

 
287,337

 
2.18

Over 360 days
218,223

 
1.94

 
107,736

 
2.23

Total
$
3,011,025

 
1.02
%
 
$
3,402,327

 
0.91
%



33

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


Note 9 – Collateral Positions
(a) Collateral Pledged and Collateral Held
The following table presents the fair value of our collateral positions, reflecting assets pledged and collateral we held, with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
 
 
Assets Pledged as Collateral
 
Collateral Held
 
Assets Pledged as Collateral
 
Collateral Held
Derivatives:
 
 
 
 
 
 
 
 
Restricted cash/cash (1)
 
$
36,105

 
$
280

 
$
14,176

 
$
2,546

Repurchase agreement borrowings:
 
 
 
 
 
 
 
 
Agency RMBS (2)
 
1,891,077

 

 
2,297,050

 

Non-Agency RMBS (3)(4)
 
1,381,541

 

 
1,499,296

 

Other investment securities
 
155,109

 

 
34,228

 

Mortgage loans
 

 
 
 
13,602

 
 
Restricted cash
 
33,557

 

 
54,830

 

 
 
3,461,284

 

 
3,899,006

 

Clearing margin:
 
 
 
 
 
 
 
 
Agency RMBS
 
4,215

 

 
3,998

 

Total
 
$
3,501,604

 
$
280

 
$
3,917,180

 
$
2,546

(1) 
Cash pledged as collateral is reported as “Restricted cash” on our consolidated balance sheet. Cash held by us as collateral is unrestricted in use and therefore is included with “Cash and cash equivalents” with a corresponding liability, “Obligation to return cash held as collateral” on our consolidated balance sheet.
(2) 
Includes Agency RMBS of $0 and $168,705 that were sold but unsettled at September 30, 2015 and December 31, 2014, respectively.
(3) 
Includes non-Agency RMBS of $125,948 and $47,786 at September 30, 2015 and December 31, 2014, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with our securitizations. Our securitized mortgage loans collateralize the securities pledged.
(4) 
Includes non-Agency RMBS of $1,702 and $0 that were sold but unsettled at September 30, 2015 and December 31, 2014, respectively.


34

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


(b) Collateral Pledged Components
The following tables present our collateral positions, reflecting assets pledged with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
 
Assets Pledged at
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,891,077

 
$
1,887,580

 
$
5,396

 
$
1,896,473

 Non-Agency RMBS (1)(2)
 
1,381,541

 
1,331,696

 
1,532

 
1,383,073

Other investment securities
 
155,109

 
160,454

 
253

 
155,362

Cash
 
33,557

 

 

 
33,557

 
 
3,461,284

 
3,379,730

 
7,181

 
3,468,465

Cash pledged for derivatives contracts
 
36,105

 

 

 
36,105

Agency RMBS pledged for clearing margin
 
4,215

 
4,078

 
13

 
4,228

Total
 
$
3,501,604

 
$
3,383,808

 
$
7,194

 
$
3,508,798

 
 
December 31, 2014
 
 
Assets Pledged-
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS (3)
 
$
2,297,050

 
$
2,287,498

 
$
7,015

 
$
2,304,065

Non-Agency RMBS (4)
 
1,499,296

 
1,423,853

 
1,144

 
1,500,440

Other investment securities
 
34,228

 
33,988

 
10

 
34,238

Mortgage loans
 
13,602

 
13,602

 
116

 
13,718

Cash
 
54,830

 

 

 
54,830

 
 
3,899,006

 
3,758,941

 
8,285

 
3,907,291

Cash pledged for derivative contracts
 
14,176

 

 

 
14,176

Agency RMBS pledged for clearing margin
 
3,998

 
3,907

 
12

 
4,010

Total
 
$
3,917,180

 
$
3,762,848

 
$
8,297

 
$
3,925,477

 
(1) 
Includes a non-Agency RMBS with a fair value of $125,948, an amortized cost of $125,434 and the associated interest receivable of $462, all of which were eliminated in consolidation with VIEs at September 30, 2015.
(2) 
Includes non-Agency RMBS of $1,702 and $0 that were sold but unsettled at September 30, 2015 and December 31, 2014, respectively.
(3) 
Includes Agency RMBS $168,705 that were sold but unsettled at December 31, 2014.
(4) 
Includes a non-Agency RMBS with a fair value of $47,786, an amortized cost of $46,319 and the associated interest receivable of $110, all of which were eliminated in consolidation with a VIE at December 31, 2014.
We consolidate the securitization trusts associated with our securitizations, each of which is a VIE, that were created to facilitate our securitization transactions. As part of the February 2013 Securitization, the most senior security created was sold to a third-party investor and as such, when we consolidate this securitization trust, this senior security is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value.” Our securitized mortgage loans are restricted in that they can only be used to fulfill the obligations of their associated securitization trust. (See Note 14.)
A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and other financial instruments are subject to financial covenants, which if breached could cause an event of default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such


35

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


agreements would be immediately payable by us. Through September 30, 2015, we remained in compliance with all of our financial covenants. (See Notes 9 and 10.)
Note 10 – Offsetting Assets and Liabilities
All balances associated with the repurchase agreements and derivatives transactions are presented on a gross basis in our consolidated balance sheets. Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of set-off in the event of default or in the event of a bankruptcy of either party to the transaction.
The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset on our consolidated balance sheet at September 30, 2015 and December 31, 2014:
Offsetting of Financial Assets and Derivative Assets
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Assets
 
Gross Amounts
Offset in  the
Consolidated
Balance Sheet
 
Net Amounts
 of Assets  Presented
in the
Consolidated
Balance Sheet
 
Financial
Instruments (1)
 
Cash
Collateral
Received
 
Net
Amount
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
1,633

 
$

 
$
1,633

 
$
(1,603
)
 
$
(280
)
 
$
(250
)
Total
 
$
1,633

 
$

 
$
1,633

 
$
(1,603
)
 
$
(280
)
 
$
(250
)
December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
11,098

 
$

 
$
11,098

 
$
(3,711
)
 
$
(2,516
)
 
$
4,871

Long TBA Contracts, at fair value
 
544

 

 
544

 

 
(30
)
 
514

Total
 
$
11,642

 
$

 
$
11,642

 
$
(3,711
)
 
$
(2,546
)
 
$
5,385

Offsetting of Financial Liabilities and Derivative Liabilities
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Liabilities
 
Gross Amounts
Offset in the
Consolidated
Balance Sheet
 
Net Amounts of
Liabilities
Presented in the
Consolidated
Balance Sheet
 
Financial
Instruments (2) (3)
 
Cash
Collateral
Pledged  (2) (4)
 
Net
Amount
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
25,595

 
$

 
$
25,595

 
$
(1,603
)
 
$
(23,992
)
 
$

Short TBA contracts, at fair value
 
820

 

 
820

 

 
744

 
1,564

Repurchase agreements
 
3,011,025

 

 
3,011,025

 
(3,011,025
)
 

 

Total
 
$
3,037,440

 
$

 
$
3,037,440

 
$
(3,012,628
)
 
$
(23,248
)
 
$
1,564

December 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
8,949

 
$

 
$
8,949

 
$
(3,711
)
 
$
(5,238
)
 
$

Repurchase agreements
 
3,402,327

 

 
3,402,327

 
(3,402,327
)
 

 

Total
 
$
3,411,276

 
$

 
$
3,411,276

 
$
(3,406,038
)
 
$
(5,238
)
 
$

(1) 
Amounts represent derivative instruments in an asset position which could potentially be offset against interest rate derivatives in a liability position at September 30, 2015 and December 31, 2014, subject to a netting arrangement.
(2) 
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, and interest rate derivatives.
(3) 
The fair value of securities pledged against our borrowings under repurchase agreements was $3,427,727 and $3,830,574 at September 30, 2015 and December 31, 2014, respectively. The amounts pledged include $125,948 and $47,786 of RMBS that are not included in our consolidated balance sheet at September 30, 2015 and December 31, 2014, respectively, as such assets were eliminated in consolidation with a VIE.                            
(Notes continued on next page.)


36

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


(Notes continued.)
(4) 
Total cash pledged against our derivative instruments was $36,105 and $14,176 at September 30, 2015 and December 31, 2014, respectively. Total cash collateral pledged against our borrowings under repurchase agreements was $33,557 and $54,830 at September 30, 2015 and December 31, 2014, respectively.
Note 11 – Derivative Instruments
We enter into derivative contracts, which through September 30, 2015 have from time to time been comprised of Swaps, Swaptions, and TBA Contracts. We use derivative instruments to manage interest rate risk and, as such, view them as economic hedges. We have not elected hedge accounting under GAAP for any of our derivative instruments and, as a result, the fair value adjustments on such instruments are recorded in earnings. The fair value adjustments for our derivatives, along with the related interest income, interest expense and gains/(losses) on termination of such instruments, are reported as Realized and unrealized gain/(loss) on derivative instruments, net on our consolidated statements of operations.
(a) Derivative Instruments Summary
Information with respect to our derivative instruments as presented on our consolidated balance sheets at September 30, 2015 and December 31, 2014 was as follows:
 
 
September 30, 2015
 
December 31, 2014
 
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Swaps - assets
 
$

 
$

 
$
957,000

 
$
9,543

Swaptions - assets
 
1,100,000

 
1,633

 
1,250,000

 
1,555

Swaps - (liabilities)
 
1,687,000

 
(21,671
)
 
730,000

 
(8,949
)
Swaptions - (liabilities)
 
200,000

 
(3,924
)
 

 

Short TBA Contracts - (liabilities)
 
125,000

 
(820
)
 

 

Long TBA Contracts - assets
 

 

 
100,000

 
544

Total
 
$
3,112,000

 
$
(24,782
)
 
$
3,037,000

 
$
2,693

(b) Swaps
The variable amount that we receive from our Swap counterparties is typically based on three-month LIBOR. The following table summarizes the average fixed-pay rate and average maturity for our Swaps as of September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
Term to Maturity
 
Notional
Amount
 
Weighted Average
Fixed-Pay
Rate
 
Weighted Average
Maturity
(Years)
 
Notional
Amount
 
Weighted Average
Fixed-Pay
Rate
 
Weighted Average
Maturity
(Years)
Less than one year
 
$
45,000

 
1.33
%
 
0.9
 
$

 
%
 

More than one year up to and including three years
 
1,064,000

 
1.05

 
1.9
 
920,000

 
1.07

 
2.4

More than three years up to and including five years
 
64,000

 
2.28

 
4.8
 
189,000

 
1.02

 
3.2

More than five years
 
514,000

 
2.11

 
7.5
 
578,000

 
2.13

 
7.9

Total
 
$
1,687,000

 
1.43
%
 
3.6
 
$
1,687,000

 
1.43
%
 
4.4




37

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


(c) Swaptions
We pay a premium to our Swaption counterparties to purchase a Swaption and receive a premium when we sell a Swaption. At the expiration of the option period our Swaption purchase contracts give us the right, to either: (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money, as prescribed in the Swaption confirmation. Our Swaption sale contracts give the counterparty to such agreements the right to either: (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money, as prescribed in the Swaption confirmation.
The following table presents information about our Swaptions at September 30, 2015:
 
 
 
 
 
 
Underlying Swap
Purchase Contracts: Fixed-Pay Rate for Underlying Swap
 
Premium Cost
 
Fair
Value
 
Weighted Average Months Until Option Expiration
 
Notional
Amount
 
Weighted Average Swap Term (Years)
 
Weighted Average Fixed-Pay Rate
2.34% - 2.50%
 
$
854

 
$
30

 
3.7
 
100,000

 
5.0
 
2.34
%
2.51% - 2.75%
 
553

 
145

 
9.9
 
75,000

 
5.0
 
2.72

2.76% - 3.00%
 
6,360

 
882

 
3.5
 
475,000

 
10.0
 
2.94

3.01% - 3.25%
 
2,794

 
576

 
8.9
 
200,000

 
10.0
 
3.20

3.26% - 3.50%
 
3,201

 

 
1.4
 
250,000

 
10.0
 
3.31

Total
 
$
13,762

 
$
1,633

 
5.1
 
1,100,000

 
9.2
 
3.00
%
 
 
 
 
 
 
 
Underlying Swap
Sale Contracts: Fixed-Pay Rate for Underlying Swap
 
Premium (Received)
 
Fair
Value
 
Weighted Average Months Until Option Expiration
 
Notional
Amount
 
Weighted Average Swap Term (Years)
 
Weighted Average Fixed-Pay Rate
1.72%
 
$
(500
)
 
$
(1,090
)
 
9.9

 
75,000

 
5.0
 
1.72
%
1.99%
 
(640
)
 
(1,001
)
 
11.7

 
50,000

 
10.0
 
1.99

2.14%
 
(953
)
 
(1,833
)
 
9.9

 
75,000

 
10.0
 
2.14

Total
 
$
(2,093
)
 
$
(3,924
)
 
10.4

 
200,000

 
8.1
 
1.95
%
(d) Gains/(Losses) on Derivatives
The following table summarizes the amounts recognized on our consolidated statements of operations related to our derivative instruments for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
Character of Gain/(Loss) on Derivative Instruments
 
2015
 
2014
 
2015
 
2014
Net interest payments/accruals on Swaps (1)
 
$
(4,874
)
 
$
(5,128
)
 
$
(14,758
)
 
$
(14,998
)
Losses on terminations and expirations of Swaptions, net (1)
 
(1,863
)
 
(6,505
)
 
(11,895
)
 
(20,617
)
Losses on settlement of TBA Contracts, net (1)
 
(2,526
)
 

 
(4,503
)
 
(7,156
)
Change in fair value of Swaps (2)
 
(21,558
)
 
8,055

 
(22,265
)
 
(18,113
)
Change in fair value of Swaptions, net (2)
 
(9,598
)
 
4,379

 
(417
)
 
(1,888
)
Change in fair value of TBA Contracts (2)
 
(726
)
 

 
(1,365
)
 
(750
)
Total
 
$
(41,145
)
 
$
801

 
$
(55,203
)
 
$
(63,522
)
Note: Each of the items presented is included as a component of “Realized and unrealized gain/(loss) on derivative instruments, net” on our consolidated statements of operations for the periods presented.
(1) 
Amounts are realized.
(2) 
Amounts are unrealized and reflect the net change in fair value.


38

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


(e) Derivative Activity
The following table provides information with respect to our use of derivative instruments during the periods presented:
 
 
Three Months Ended September 30, 2015
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
(200,000
)
 
$

 
$
1,687,000

 
$
1,065,000

 
$

Notional amount of contracts entered
 
(300,000
)
 

 

 
200,000

 
200,000

Notional amount of contracts terminated
 
375,000

 

 

 
(165,000
)
 

Ending Notional Balance
 
$
(125,000
)
 
$

 
$
1,687,000

 
$
1,100,000

 
$
200,000

 
 
Nine Months Ended September 30, 2015
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$

 
$
100,000

 
$
1,687,000

 
$
1,250,000

 
$

Notional amount of contracts entered
 
(500,000
)
 
500,000

 

 
850,000

 
200,000

Notional amount of contracts terminated
 
375,000

 
(600,000
)
 

 
(1,000,000
)
 

Ending Notional Balance
 
$
(125,000
)
 
$

 
$
1,687,000

 
$
1,100,000

 
$
200,000

 
 
Three Months Ended September 30, 2014
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$

 
$

 
$
1,687,000

 
$
1,335,000

 
$

Notional amount of contracts entered
 

 

 

 
165,000

 

Notional amount of contracts terminated
 

 

 

 
(400,000
)
 

Ending Notional Balance
 
$

 
$

 
$
1,687,000

 
$
1,100,000

 
$

 
 
Nine Months Ended September 30, 2014
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
400,000

 
$

 
$
1,587,000

 
$
1,375,000

 
$

Notional amount of contracts entered
 

 

 
100,000

 
1,175,000

 

Notional amount of contracts terminated
 
(400,000
)
 

 
 
 
(1,450,000
)
 

Ending Notional Balance
 
$

 
$

 
$
1,687,000

 
$
1,100,000

 
$

(f) Financial Covenants
Our agreements with certain of our derivative counterparties contain financial covenants; through September 30, 2015 we were in compliance with the terms of all such covenants. We have minimum collateral posting thresholds with certain of our Swap counterparties, for which we typically pledge cash. (See Notes 10 and 11.) If we had breached any of these financial covenants at September 30, 2015, we could have been required to settle our obligations under our Swaps at their termination value. At September 30, 2015, the estimated termination value of our Swaps was $23,494, which amount reflects the estimated fair value of our Swaps that were in a liability position, plus accrued interest payable.



39

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


Note 12 – Interest Payable
The following table presents the components of our interest payable at September 30, 2015 and December 31, 2014: 
 
 
September 30, 2015
 
December 31, 2014
Repurchase borrowings collateralized by Agency RMBS
 
$
1,109

 
$
1,569

Repurchase borrowings collateralized by non-Agency RMBS (1)
 
4,028

 
8,234

Repurchase borrowings collateralized by other investment securities
 
196

 
127

Repurchase borrowings collateralized by mortgage loans
 

 
9

Securitized debt
 
98

 
110

Swaps
 
1,824

 
2,977

Total
 
$
7,255

 
$
13,026

(1) 
Includes $71 and $103 of interest payable on repurchase borrowings collateralized by non-Agency RMBS issued by consolidated VIEs at September 30, 2015 and December 31, 2014, respectively, which securities were eliminated from our balance sheet in consolidation.
Note 13 – Commitments and Contingencies
(a) Management Agreement – Related Party Transactions
In connection with our initial public offering in July 2011, we entered into a management agreement with our Manager (or, Management Agreement), which describes the services to be provided for us by our Manager and compensation for such services. Our Manager is responsible for managing our day-to-day operations, subject to the direction and oversight of our board of directors.
Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of adjusted stockholders’ equity (as defined in the Management Agreement), calculated and payable quarterly in arrears.
The term of our Management Agreement currently runs through July 27, 2016. Absent certain action by the independent directors of our board of directors, as described below, the Management Agreement will automatically renew on each anniversary for a one year term. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors, based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us; or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
We incurred management fees of $2,667 and $2,800 for the three months ended September 30, 2015 and 2014 and $8,349 and $8,360 for the nine months ended September 30, 2015 and 2014, respectively. In addition to the management fee, we are responsible for reimbursing our Manager for certain expenses paid by our Manager on behalf of us and for certain services provided by our Manager to us. Expenses incurred by our Manager and reimbursed by us are typically included in our general and administrative expense on the consolidated statement of operations, or may be reflected on the consolidated balance sheet and associated consolidated statement of changes in stockholders’ equity, based on the nature of the item. Included in “Payable to related party” on our consolidated balance sheet at September 30, 2015 and December 31, 2014, was $2,667 and $2,840, respectively, for management fees payable to our Manager, with the remainder of such payable reflecting reimbursements due to Apollo for our general and administrative expenses paid or incurred by them on our behalf.
(b) Representations and Warranties in Connection with Securitization
In connection with our February 2013 Securitization, we have the obligation under certain circumstances to repurchase assets from the VIE upon breach of certain representations and warranties. In February 2014, the substantial majority of these obligations expired, with only the representations and warranties surviving such obligations, which may expose us to losses, being that the loans transferred to the VIE are qualified mortgages under Section 860G(a)(3) of the Internal Revenue Code. Through September 30, 2015, no repurchase claims had been made against us, and we do not believe that the amount of any future potential liability with respect to such item (the maximum of which would be the current unpaid principal balance of any such loan plus accrued interest, unreimbursed advances and any expenses) is material to us. At September 30, 2015, we had no


40

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


reserve established for repurchases of loans and were not aware of any repurchase claims that would require the establishment of such a reserve. (See Note 14.)
Note 14 – Use of Special Purpose Entities and Variable Interest Entities
Special purpose entities (or, SPEs) are entities designed to fulfill a specific limited need of the entity that organizes it. SPEs are often used to facilitate transactions that involve securitizing financial assets. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis. Securitization involves transferring assets to an SPE to convert all or a portion of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of debt or equity instruments. Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall structure of the transaction, may benefit from various forms of credit enhancement, such as over-collateralization in the form of excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement.
(a) Securitization Transactions
We have entered into two securitization transactions for which we consolidate the associated trusts, as VIEs, that were created to facilitate the transactions and to which the underlying assets in connection with the securitizations were transferred. (See Note 2(o) for a discussion of the accounting policies applied to the consolidation of VIEs and transfers of financial assets in connection with securitization transactions.)
As of September 30, 2015 and December 31, 2014, the aggregate fair value of securitized mortgage loans underlying our securitizations was $173,322 and $104,438, respectively, and are included in “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value,” on our consolidated balance sheet.
The mortgage loans in our securitizations are comprised of performing, re-performing and non-performing mortgage loans with characteristics similar to the mortgage loans underlying our non-Agency RMBS.
The following table summarizes the key details of our securitization transactions as of September 30, 2015:
 
 
March 2015 Securitization
 
February 2013 Securitization
 
Total
Name of securitization trust consolidated as a VIE
 
AMST 2015-1
 
AMST 2013-1
 
 
Principal value of mortgage loans sold into the securitization trust
 
$
90,802

 
$
155,001

 
$
245,803

Current principal value of mortgage loan in securitization trust
 
$
87,425

 
$
128,636

 
$
216,061

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

 
$
50,375

 
$
50,375

Outstanding balance of senior security at September 30, 2015 (1)
 
$
78,860

 
$
21,351

 
$
100,211

Year of final contractual maturity of senior debt
 
2054

 
2047

 
 
Face/Par value of certificates received by us (2)
 
$
82,287

 
$
104,626

 
$
186,913

Cash received upon sale of the senior security sold to third-party investor
 
$

 
$
50,375

 
$
50,375

Gross securitization expenses incurred (net of amortization of $87 and $425, respectively, as of September 30, 2015) (3)
 
$
174

 
$
829

 
$
1,003

Stated interest rate for senior security issued
 
5.75
%
 
4.00
%
 
 
(1) 
With respect to the March 2015 Securitization, amount reflects 100% of the single security issued, which we retained. The stated rate is presented for informational purposes only, as such certificate is eliminated in consolidation with the associated trust.
(2) 
With respect to our February 2013 Securitization, the certificates we received are subordinate to and provide credit support for the sequential senior security sold to a third-party investor. While the RMBS that we retained in connection with February 2013 Securitization do not appear on our balance sheet, as they are eliminated in consolidation with the VIE/securitization trust, we legally own such securities and we, as legally permitted, pledge such securities as collateral.
(3) 
Certain expenses incurred in connection with our securitizations were capitalized as deferred charges and are amortized to interest expense based upon the actual repayments of the associated senior security sold to a third party, or the initial term of the associated borrowing facility.


41



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


(b) Consolidation Assessment
On a quarterly basis, we complete an analysis to determine whether the VIEs associated with our securitizations should be consolidated by us. As part of this analysis, we consider our involvement in the creation of the VIE, including the design and purpose of the VIE and whether our involvement reflects a controlling financial interest that results in us being deemed the primary beneficiary of the VIE. In determining whether we would be considered the primary beneficiary, we consider: (i) whether we have both the power to direct the activities that most significantly impact the economic performance of the VIE; and (ii) whether we have a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. Based on our evaluation of these factors, including our involvement in the design of the VIE, we determined that we were required to consolidate the VIE created to facilitate the March 2015 Securitization and February 2013 Securitization for each reporting period from inception through September 30, 2015.
(c) Activities of Securitization Trusts
The securitization trusts receive principal and interest on the underlying mortgage loans and distribute those payments to the certificate holders. The assets and other instruments held by the securitization trusts are restricted in that they can only be used to fulfill the obligations of their respective securitization trust. The risks associated with our involvement with the VIEs are limited to the risks and rights as a certificate holder of the securities we retained.  
The activities of the securitization trusts are substantially set forth in the securitization transaction documents, primarily the mortgage loan trust agreements, the trust agreements, the indenture and the securitization servicing agreements (or collectively, the Securitization Agreements). Neither the trusts nor any other entity may sell or replace any assets of the trust except in connection with: (i) certain loan defects or breaches of certain representations and warranties which have a material adverse effect on the value of the related assets; (ii) loan defaults; (iii) certain trust events of default or (iv) an optional termination of the trust, each as specifically permitted under the Securitization Agreements.
Prior to the completion of our first securitization transaction in February 2013, we had not transferred assets to VIEs or QSPEs and other than acquiring RMBS issued by such entities, had no other involvement with VIEs or QSPEs.

(d) Securitized Debt
We consolidate the underlying trust associated with our February 2013 Securitization. As a result, the senior security that was sold to a third-party investor is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value” and the residential mortgage loans held by the trust that collateralize the securities issued by the trust are included as a component of “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value” on our consolidated balance sheet. The third-party beneficial interest holders in the VIE have no recourse against us, except that we may have an obligation to repurchase assets from the VIE in the event that we breach certain representations and warranties in relation to the mortgage loans sold to the VIE. Other than the foregoing, we have no obligation to provide, nor have we provided, any other explicit or implicit support to this or any other VIE that we consolidate.
Our securitized debt is carried at fair value, which is based on the fair value of the senior security held by third parties. The following table presents the estimated principal repayment schedule of the par value of the securitized debt at September 30, 2015, based on expected cash flows of the securitized residential mortgage loans, as adjusted for projected losses on such loans.
Estimated Maturity
 
September 30, 2015
One year or less
 
$
8,594

More than one year, up to and including three years
 
12,757

More than three years, up to and including five years
 

Total
 
$
21,351

Repayment of our securitized debt will be dependent upon the cash flows generated by the mortgage loans in the February 2013 Securitization trust that collateralize such debt. The actual cash flows from the securitized mortgage loans are comprised of coupon interest, scheduled principal payments, prepayments and liquidations of the underlying mortgage loans. The actual term of the securitized debt may differ significantly from our estimate given that actual interest collections, mortgage prepayments and/or losses on liquidation of mortgages may differ significantly from those expected. (See Note 5 for more information about the mortgage loans collateralizing our securitized debt.)


42

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


(e) VIEs - Impact on the Consolidated Financial Statements
The following table reflects the assets and liabilities recorded in our consolidated balance sheet related to our consolidated VIEs at September 30, 2015 and December 31, 2014:
 
 
September 30, 2015
 
December 31, 2014
Assets:
 
 
 
 
Securitized mortgage loans, at fair value
 
$
173,322

 
$
104,438

Interest receivable
 
$
943

 
$
719

Liabilities:
 
 
 
 
Non-recourse securitized debt, at fair value
 
$
21,243

 
$
34,176

Accrued interest payable (1)
 
$
71

 
$
110

(1) 
Prior presentation is conformed to the current presentation.
The following table reflects the income and expense amounts recorded in our consolidated statements of operations related to our consolidated VIEs for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Interest income - securitized mortgage loans
 
$
3,832

 
$
1,871

 
$
9,622

 
$
6,044

Interest expense - securitized debt
 
(393
)
 
(398
)
 
(1,092
)
 
(1,272
)
Unrealized gain/(loss) on securitized mortgage loans, net
 
(576
)
 
(650
)
 
(110
)
 
2,440

Unrealized gain/(loss) on securitized debt
 
172

 
67

 
1,186

 
(287
)
Other, net
 
(727
)
 
13

 
(727
)
 
(50
)
General and Administrative
 
(128
)
 

 
(128
)
 

Net income
 
$
2,180

 
$
903

 
$
8,751

 
$
6,875

The following table reflects the amounts included on our consolidated statements of cash flows related to our consolidated VIEs for the periods presented:
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
8,751

 
$
6,875

Premium amortization/(discount accretion), net
 
$
369

 
$
510

Amortization of deferred financing costs
 
$
(280
)
 
$
123

Unrealized (gain) on securitized mortgage loans, net
 
$
(110
)
 
$
(2,440
)
Unrealized loss on securitized debt
 
$
1,186

 
$
287

Realized loss on real estate owned, net
 
$
208

 
$
50

Changes in operating assets and liabilities:
 
 
 
 
(Increase) in accrued interest receivable, less purchased interest
 
$
(223
)
 
$
(48
)
(Decrease) in accrued interest payable
 
$
(39
)
 
$
(25
)
Cash Flows from Investing Activities:
 


 


Purchase of mortgage loans, simultaneously securitized
 
$
(67,357
)
 
$

Proceeds from sales of real estate owned
 
$
1,188

 
$
168

Other, net
 
$

 
$
1

Principal payments received on securitized mortgage loans
 
$
10,750

 
$
5,736

Cash Flows from Financing Activities:
 
 
 
 
Principal payments on securitized debt
 
$
(11,747
)
 
$
(7,453
)



43

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



Note 15 – Equity Award Plan
On July 21, 2011, our board of directors approved the Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan (or, LTIP). The LTIP provides for grants of restricted common stock, RSUs and other equity-based awards up to an aggregate of 5% of the issued and outstanding shares of our common stock (on a fully diluted basis). The LTIP is administered by the compensation committee of our board of directors, which also must approve grants made under the LTIP. At September 30, 2015, 1,264,339 awards were available for grant under the LTIP.
The following table presents expenses related to our equity-based compensation awards for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Restricted Common Stock
 
$
106

 
$
103

 
$
317

 
$
296

RSUs
 
65

 
41

 
650

 
715

Total
 
$
171

 
$
144

 
$
967

 
$
1,011

At September 30, 2015, we had estimated unrecognized compensation expense of $1,327 and $589 related to RSUs and restricted common stock, respectively. The unrecognized compensation expense at September 30, 2015 is expected to be recognized over a weighted average period of 1.7 years. As of September 30, 2015, we had an expected average forfeiture rate of 5% with respect to restricted common stock and 5% with respect to RSUs.
Through September 30, 2015, we have not settled RSUs in cash. However, the LTIP provides that we may allow RSU recipients to elect to settle their tax liabilities with a reduction of their share delivery from the originally granted and vested RSUs, which is referred to herein as “net share settlement.” Net share settlement results in us making a cash payment to an affiliate of our Manager related to this tax liability and a corresponding adjustment to additional paid-in-capital.
The following table presents information about our equity awards for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value(1)
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value (1)
RSUs outstanding at beginning of period
 
284,488

 
$
18.27

 
180,797

 
$
19.50

 
292,088

 
$
18.05

 
183,922

 
$
19.47

RSUs canceled upon delivery of common stock (2)
 
(3,333
)
 
20.04

 
(11,837
)
 
16.70

 
(8,333
)
 
19.58

 
(14,962
)
 
16.96

RSUs canceled or forfeited
 

 

 
(3,330
)
 
18.10

 
(2,600
)
 
18.60

 
(3,330
)
 
18.10

RSUs outstanding at end of period
 
281,155

 
$
18.25

 
165,630

 
$
19.72

 
281,155

 
$
18.25

 
165,630

 
$
19.72

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Vested RSUs at end of period
 
136,061

 
$
19.88

 
53,579

 
$
20.37

 
136,061

 
$
19.88

 
53,579

 
$
20.37

Unvested RSUs at end of period
 
145,093

 
$
16.72

 
112,051

 
$
19.41

 
145,093

 
$
16.72

 
112,051

 
$
19.41

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unvested restricted common stock awards outstanding at beginning of period
 
49,304

 
$
17.02

 
31,440

 
$
19.42

 
43,992

 
$
17.39

 
28,040

 
$
20.37

Restricted common stock granted
 

 

 

 

 
9,332

 
16.07

 
9,208

 
16.29

Restricted common stock vested
 
(2,108
)
 
17.80

 
(3,676
)
 
18.46

 
(6,128
)
 
14.29

 
(9,484
)
 
18.81

Unvested restricted common stock at end of period
 
47,196

 
$
16.98

 
27,764

 
$
19.55

 
47,196

 
$
16.98

 
27,764

 
$
19.55

(1) 
Amounts are not in thousands.
(2) 
Includes amounts deemed issued in connection with payment of grantee’s tax liability.



44

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


Note 16 – Stockholders’ Equity
(a) Common Stock Dividends
The following table presents cash dividends declared by our board of directors on our common stock from January 1, 2014 through September 30, 2015:
Declaration Date
 
Record Date
 
Payment Date
 
Dividend Per Share
September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.48

June 17, 2015
 
June 30, 2015
 
July 31, 2015
 
$
0.48

March 19, 2015
 
March 31, 2015
 
April 30, 2015
 
$
0.48

December 18, 2014
 
December 31, 2014
 
January 30, 2015
 
$
0.45

September 17, 2014
 
September 30, 2014
 
October 31, 2014
 
$
0.44

June 19, 2014
 
June 30, 2014
 
July 31, 2014
 
$
0.42

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

(b) Preferred Stock
At September 30, 2015 and December 31, 2014, we had outstanding 6,900,000 shares of 8.0% Series A Cumulative Redeemable Perpetual Preferred Stock (or, Preferred Stock) with a liquidation preference of $25.00 per share and a par value $0.01 per share. Holders of our Preferred Stock are entitled to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. These dividends are cumulative and payable quarterly in arrears. Generally, we may not redeem the Preferred Stock until September 20, 2017, except under certain limited circumstances intended to preserve our qualification as a REIT and upon the occurrence of a change in control as defined in the final prospectus supplement related to the Preferred Stock filed with the SEC on September 17, 2012. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. Based upon the characteristics of the Preferred Stock, such instruments are characterized as equity instruments.
The Preferred Stock generally has no voting rights. However, if dividends on the Preferred Stock are in arrears for six quarterly dividend periods, whether or not consecutive, the holders of the Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) will have the right to elect two additional directors to our board until we pay (or declare and set aside for payment) all dividends that are then in arrears. In addition, the affirmative vote of at least two-thirds of the votes entitled to be cast by holders of outstanding shares of Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) is required for us to authorize, create or increase the number of any class or series of senior equity securities or to amend our charter (including the Articles Supplementary designating the Preferred Stock, or the Articles Supplementary) in a manner that materially and adversely affects the rights of the Preferred Stock.
(c) Shelf Registration
On July 23, 2012, we filed a shelf registration statement on Form S-3 with the SEC under the Securities Act of 1933, as amended (or, the Securities Act), with respect to up to $750,000 of common stock, preferred stock, depositary shares, warrants and/or rights that may be sold by us from time to time pursuant to Rule 415 of the Securities Act. This registration statement was declared effective by the SEC on August 10, 2012 and expired on August 10, 2015.
(d) Direct Stock Purchase and Dividend Reinvestment Plan
On November 13, 2012, we filed a Registration Statement on Form S-3 with the SEC under the Securities Act reserving 2,000,000 shares of common stock available under the terms of our Direct Stock Purchase and Dividend Reinvestment Plan (or, Stock Purchase Plan). Under the Stock Purchase Plan, stockholders who participate may purchase shares of our common stock directly from us. Stockholders may also automatically reinvest all or a portion of their dividends for additional shares of our stock. Through September 30, 2015, all shares issued pursuant to the Stock Purchase Plan were issued from shares purchased on the open market.


45



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


(e) Stock Repurchase Program
On November 6, 2013, our board of directors authorized a stock repurchase program (or, the Repurchase Program), to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program, if any, will be canceled and, until reissued by us, will be deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior notice. Through September 30, 2015, we repurchased 360,800 shares of common stock at an average cost per share of $13.86. At September 30, 2015, $45,000 of common stock remained authorized for future share repurchase under the Repurchase Program.
The following table presents a summary of our common stock repurchases under the Repurchase Program during the three months ended September 30, 2015:
Month Purchased (1)
 
Total Number of Shares Repurchased
 
Weighted Average Price Paid per Share (2)
 
Total Cost of Shares Repurchased
August 2015
 
202,655
 
$
13.86

 
$
2,808

September 2015
 
158,145
 
13.86

 
2,192

Total
 
360,800
 
$
13.86

 
$
5,000

 
 
 
 
 
 
 
(1) 
Based on trade date.
(2) 
Includes brokerage commissions.
Note 17 – Earnings per Common Share
The following table presents basic and diluted net EPS of common stock using the two-class method for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Numerator:
 
 
 
 
 
 
 
 
Net Income/(Loss)
 
$
(21,777
)
 
$
10,875

 
$
(10,401
)
 
$
82,761

Less:
 
 
 
 
 
 
 
 
Dividends declared on Preferred Stock
 
3,450

 
3,450

 
10,350

 
10,350

Dividends, dividend equivalents and undistributed earnings allocated to participating securities (1)
 
157

 
81

 
464

 
451

Net income/(loss) allocable to common stock – basic and diluted
 
$
(25,384
)
 
$
7,344

 
$
(21,215
)
 
$
71,960

Denominator:
 
 
 
 
 
 
 
 
Weighted average common shares - basic and diluted
 
31,947

 
32,035

 
32,013

 
32,024

Earnings per common share - basic and diluted
 
$
(0.79
)
 
$
0.23

 
$
(0.66
)
 
$
2.25

(1) 
At September 30, 2015, 284 RSUs and 47 shares of unvested restricted stock outstanding were not included in the calculation of diluted earnings per common share, as their inclusion would have been anti-dilutive. These instruments may have a dilutive impact on future EPS.


46





ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(All currency figures are presented in thousands, except per share data or as otherwise noted.)
FORWARD-LOOKING INFORMATION
We make forward-looking statements in this Quarterly Report on Form 10-Q and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (or, the Exchange Act). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may,” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in our industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; our business and investment strategy; our operating results and potential asset performance; availability of opportunities to acquire Agency RMBS, non-Agency RMBS, residential mortgage loans and other residential mortgage assets or other real estate related assets; changes in the prepayment rates on the mortgage loans securing our RMBS; management’s assumptions regarding default rates on the mortgage loans securing our non-Agency RMBS and our SBC-MBS; our ability to borrow to finance our assets and the terms, including the cost, maturity and other terms, of any such borrowing; our estimates regarding taxable income, the actual amount of which is dependent on a number of factors, including, but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market discount on non-Agency RMBS, realized losses and changes in the composition of our Agency RMBS and non-Agency RMBS portfolios that may occur during the applicable tax period, including gain or loss on any RMBS disposals; expected leverage; general volatility of the securities markets in which we participate; our expected portfolio and scope of our target assets; our expected investment and underwriting process; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; rates of default or decreased recovery rates on our assets; the degree to which our hedging strategies may or may not protect us from interest rate volatility and the effects of hedging instruments on our assets; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters affecting our business; the timing and amount of distributions to stockholders, which are declared and paid at the discretion of our board of directors and will depend on, among other things, our taxable income, our financial results and overall financial condition and liquidity; maintenance of our qualification as a REIT for U.S. Federal income tax purposes and such other factors as our board of directors deems relevant; our ability to maintain our exclusion from registration as an investment company under the1940 Act; availability of qualified personnel through our Manager; and our understanding of our competition.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. See “Part I, Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2014. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in our Annual Report on Form 10-K filed for the year ended December 31, 2014.
General
We were incorporated in Maryland on March 15, 2011 and commenced operations on July 27, 2011. We are structured as a holding company and conduct our business primarily through ARM Operating, LLC and our other operating subsidiaries. We have elected and operate to qualify as a REIT for U.S. Federal income tax purposes commencing with our taxable year ended December 31, 2011. We also operate our business in a manner that we believe will allow us to remain excluded from


47



registration as an investment company under the 1940 Act. We are externally managed and advised by our Manager, an indirect subsidiary of Apollo Global Management, LLC.
At September 30, 2015, our portfolio was comprised of Agency RMBS (comprised of pass-through, IO and Inverse IO securities), non-Agency RMBS, securitized mortgage loans, and other mortgage and mortgage related assets. Over time, we expect that we may invest in a broader range of other residential mortgage and mortgage-related assets. (See “Target Assets,” below.)
We use leverage as part of our business strategy in order to increase potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon our Manager’s assessment of a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties.
We use derivatives to hedge a portion of our interest rate risk and not for speculative purposes. As of September 30, 2015, our derivatives included Swaps, Swaptions and TBA Contracts.
Factors Impacting Our Operating Results
Our results of operations are driven by, among other things, our net interest income, changes in the market value of our investments and derivative instruments and, from time to time, realized gains and losses on the sale of our investments and termination of our derivative instruments. The supply and demand for RMBS and other mortgage assets in the market place, the terms and availability of financing for such assets, general economic and real estate conditions, the impact of U.S Government actions that impact the real estate and mortgage sector, and the credit performance of our credit sensitive investments impact our overall performance. Our net interest income varies primarily as a result of changes in market interest rates and the slope of the yield curve (i.e., the differential between long-term and short-term interest rates) and constant prepayment rates (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on RMBS as a percentage of the principal balance, and includes the conditional repayment rate (or, CRR), which measures voluntary prepayments of mortgages collateralizing a particular RMBS and conditional default rates (or, CDR), which measures involuntary prepayments resulting from defaults of the underlying mortgage loans. CPRs vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. In addition, our borrowing costs and available credit are further affected by the collateral pledged and general conditions in the credit market.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS, Inverse IO and Inverse Floater securities and Long TBA Contracts to decrease; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts, if any, Swaps and Swaptions contracts to increase. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.
Premiums arise when we purchase a security at a price in excess of the security’s par value and discounts arise when we purchase a security at a price below the security’s par value. Premiums on our RMBS are amortized against interest income over the life of the security, while discounts (excluding credit discounts, as discussed below) are accreted to income over the life of the security. The speeds at which premiums are amortized and discounts are accreted are significantly impacted by the CPR for each security. CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. CPRs on Agency RMBS and non-Agency RMBS may differ significantly.
We are exposed to credit risk with respect to our non-Agency RMBS, other investment securities, securitized mortgage loans, mortgage loans and other investments. Such credit risk is associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such investments. The credit risk on our non-Agency RMBS is generally mitigated by the credit support built into non-Agency RMBS structures and the purchase discounts on such securities, which provides a level of credit protection in the event that we receive less than 100% of the par value of these securities. The credit risk associated with our warehouse line receivable is mitigated by a pledge of substantially all the equity of the third-party borrower/guarantor, which borrower has legal title to the homes, BFT Contracts and mortgage loans that we finance on a


48



warehouse line. To date we purchased substantially all of our non-Agency RMBS at a discount to par value; a portion of such discount may be viewed as a credit discount which is not expected to be amortized into interest income. The amount designated as credit discount on a security may change over time based on the security’s performance and its anticipated future performance. (See “Credit Risk”, included under Item 3 of this Quarterly Report on Form 10-Q.)
Our non-Agency RMBS investment process involves analysis focused primarily on quantifying and pricing credit risk. Interest income on our non-Agency RMBS is recorded at an effective yield, which reflects an estimate of expected cash flows for each security. In forecasting cash flows on our non-Agency RMBS, our Manager makes certain assumptions about the underlying mortgage loans which assumptions include, but are not limited to, future interest rates, voluntary prepayment rates, default rates, modifications and loss severities. As part of our non-Agency RMBS surveillance, we review, on at least a quarterly basis, each security’s performance. To the extent that actual performance and our current assessment of future performance differs from our prior assessment, such changes are reflected in the yield/income recognized on such securities prospectively. Credit losses greater than those anticipated, or in excess of purchase discount on a given security, could materially adversely impact our operating results.
We receive interest payments only with respect to the notional amount of Agency IO and Agency Inverse IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency pass-through RMBS, the market prices of Agency IO generally have a positive correlation to increases in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO are expected to decrease, which in turn is expected to extend/increase the cash flow and the value of such securities; we expect the inverse to occur with respect to decreases in market interest rates. In addition to viewing Agency IO as investments, we also note that such instruments serve as a partial economic hedge against the impact that an increase in market interest rates would have on the value of our Agency RMBS in the marketplace. While Agency IO and Agency Inverse IO comprised a relatively small portion of our investments at September 30, 2015, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments.
Target Assets
We primarily invest in residential mortgage and mortgage related assets throughout the United States. As of September 30, 2015, we held investments in RMBS, including Agency pass-through RMBS (whose underlying collateral is primarily comprised of 30 year fixed-rate mortgages), Agency Inverse Floaters, Agency IO, Agency Inverse IO, non-Agency RMBS, securitized mortgage loans, other mortgage-related securities, mortgage loans and other real estate related investments associated with our Seller Financing Program. The Seller Financing Program refers to our initiative whereby we provide advances through a warehouse line to a third party to finance the acquisition and improvement of single-family homes. Once the homes are improved, they are marketed for sale, with the seller providing financing to the buyer in the form of a mortgage loan or a BFT Contract. We believe that the continued diversification of our portfolio of assets, our expertise within our target asset classes and the flexibility of our strategy will enable us to achieve attractive risk-adjusted returns under a variety of market conditions and economic cycles over time. In the future, we may invest in assets other than our target assets listed below, in each case subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes and our exclusion from registration as an investment company under the 1940 Act. Our board of directors may, without stockholder approval, amend our investment strategy at any time.


49



The following is a summary of our target assets at September 30, 2015:
Asset Classes
 
Principal Assets
 
 
Agency RMBS
 
Agency RMBS, primarily comprised of whole-pool pass-through securities, CMOs,
Agency IO, Agency Inverse IO, Agency Inverse Floater and Agency principal-only
securities.
 
 
Non-Agency RMBS and Real Estate
Related Asset-Backed Securities

 
Non-Agency RMBS, including highly rated, as well as non-investment grade and
unrated, tranches backed by Alt-A mortgage loans, Option ARMs, Subprime
mortgage loans and prime mortgage loans, and other real estate related asset-backed
securities.

 
 
Residential Mortgage Loans
 
Prime mortgage loans, jumbo mortgage loans, Alt-A mortgage loans, Option ARMs,
Subprime mortgage loans or other mortgage-like financing arrangements, including,
but not limited to, BFT Contracts. These investments may be performing, re-performing, sub-performing or non-performing.

 
 
Other Residential Mortgage-Related Assets
 
Non-Agency RMBS comprised of interest-only securities, principal-only securities, floating rate inverse interest-only securities, and floating rate securities, and other Agency and non-Agency RMBS derivative securities, as well as other financial assets, including, but not limited to, common stock, preferred stock and debt of other real estate-related entities, mortgage servicing rights, excess mortgage servicing rights, advances on our warehouse line, mortgage loans to investors in residential properties, and residential real estate. In addition, we may own real estate incidental to our financing arrangements associated with such properties.
 
We rely on our Manager’s expertise in identifying assets within our target asset classes and to efficiently finance those assets. We expect that our Manager will make decisions based on a variety of factors, including expected risk-adjusted returns on our assets, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our qualification as a REIT and our exclusion from registration as an investment company under the 1940 Act.
Financing Strategy
We use leverage primarily for the purpose of financing our investment portfolio and increasing potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We had an aggregate debt-to-equity multiple of 4.24 times at September 30, 2015. Our debt-to-equity multiple reflects the aggregate of our borrowings under repurchase agreements and securitized debt (based upon fair value) to our total stockholders’ equity.
We continue to have available capacity under our master repurchase agreements. However, such agreements are generally uncommitted and are renewable at the discretion of our lenders. We finance our Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio in the range between approximately eight-to-one and ten-to-one and finance our non-Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio of approximately three-to-one. Our target and actual leverage may vary from time to time based on availability of financing and our assessment of market conditions. The terms of our repurchase agreements are typically one to six months at inception, but in some cases may have initial terms that are shorter or longer, up to 24 months. At September 30, 2015, we had master repurchase agreements with 24 counterparties. As a matter of routine business, we may have discussions with additional financial institutions with respect to expanding our repurchase agreement borrowing capacity. As of September 30, 2015, we had $3,011,025 of borrowings outstanding under our repurchase agreements with 18 counterparties collateralized by $1,891,077 of Agency RMBS and $1,381,541 of non-Agency RMBS (which included $125,948 of non-Agency RMBS that were eliminated from our balance sheet in consolidation with a VIE and $1,702 of RMBS that were


50



sold but unsettled at September 30, 2015) and $155,109 of other investment securities. (See Notes 8, 9 and 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
We have engaged in and expect, subject to market conditions, to continue to engage in securitization transactions. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or financing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis.
In addition to repurchase borrowings and securitized debt, subject to market conditions, we may utilize other sources of leverage in the future, including, but not limited to, securitized debt associated with resecuritizations, warehouse facilities, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. Our future use of these alternative forms of financing is subject to market conditions. (See “Recent Market Conditions and Our Strategy” below).
Hedging Strategy
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we pursue various hedging strategies with the objective of reducing our exposure to increases in interest rates. The U.S. Federal income tax rules applicable to REITs may necessitate that we implement certain of these techniques through a TRS that will generally be subject to U.S. Federal and state income taxation. Our hedging activity may vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions.
Our Swaps and Swaptions are intended to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings; in addition, these derivative instruments may also mitigate the impact of increases in interest rates on the value of our Agency RMBS portfolio.
At September 30, 2015, our Swaps had an aggregate notional balance of $1,687,000 with a weighted average fixed-pay rate of 1.43% and a weighted average term to maturity of 3.6 years. Our Swaps have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of our Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. Our Swaption purchase contracts provide that when a Swaption is “in the money” (when the Swaption has intrinsic value) at the expiration of the option period, we may enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount, or receive a cash payment equal to the fair value of the underlying Swap. Our Swaption sale contracts give the counterparty to such agreements the right to either: (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or (ii) cash settle if the Swaption is in-the-money, as prescribed in the Swaption confirmation. The method of settlement at expiration of the option period is prescribed in each Swaption confirmation. (See Note 11 to the consolidated financial statements included under Item 1 in this Quarterly report on Form 10-Q.)
In addition to Swap and Swaptions, we also enter into TBA Contracts from time to time. Short TBA Contracts may serve as an economic hedge against decreases in the value of Agency RMBS held in our portfolio, in an amount equivalent to the TBA Contract notional balance, with the same characteristics as those stipulated in the TBA Contract, or may serve as an economic hedge of indebtedness incurred or to be incurred to acquire real estate assets.
We expect that any gains recognized in connection with the settlement of our derivative transactions that we identify for tax purposes to hedge indebtedness incurred or to be incurred to acquire real estate assets would not constitute gross income for purposes of the REIT 75% and 95% gross income tests. To date, we have identified our Swap and Swaptions as tax hedges.
To date, we have not elected to apply hedge accounting pursuant to GAAP for our derivatives and, as a result, we record changes in the estimated fair value of such instruments, along with the associated net Swap interest in earnings, as a component of the net gain/(loss) on derivatives instruments in our consolidated statements of operations.
Certain Swap trades are required to be cleared through a clearinghouse, in accordance with the Commodities Futures Trading Commission (or, CFTC) Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties. The change in Swap margin collateral requirements generally increases the inherent cost of cleared Swaps, as higher amounts of cash are required to be pledged to meet the initial margin requirement on such transactions. (For additional information about our derivative instruments, see Note 11 to the consolidated financial statements included under Item 1 in this Quarterly report on Form 10-Q.)


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Variances between GAAP Income and Taxable Income
Our net income for financial reporting purposes differs from our taxable income. Certain of the differences between our GAAP net income and our taxable income arise from variations among the methods prescribed under GAAP and the Internal Revenue Code for recognizing certain items of income and/or expense. Certain of these variations give rise to “timing differences” between GAAP net income and taxable income while other variations cause “permanent differences” between GAAP net income and taxable net income. The differences are expected to reverse over time and may cause significant short-term variances between GAAP and taxable net income.
We hold certain securities that were issued with original issue discount (or, OID). We generally recognize OID in our current gross interest income over the term of the applicable securities as the OID accrues. The rate at which the OID is recognized into taxable income is calculated using a constant rate of yield to maturity, without a loss assumption provision. As a result, for tax purposes, REIT taxable income may be recognized in excess of GAAP income or in advance of the corresponding cash flow from these assets. Differences with respect to GAAP versus tax amortization of purchase premiums and accretion of purchase discounts on our Agency and non-Agency RMBS may also impact the difference between net gains we recognized under GAAP compared to tax. In addition, certain permanent differences between our GAAP income and our taxable income arise when items are recognized for GAAP purposes and never affect the calculation of taxable income.
Depending on the structure of securitization/resecuritization transactions, for tax purposes such transactions may be treated either as a sale or a financing of the underlying assets. Income recognized from securitization and resecuritization transactions will generally differ for tax and GAAP purposes.
Critical Accounting Policies and Use of Estimates
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q. A summary of our critical accounting policies is set forth in our Annual Report on Form 10-K for the year ended December 31, 2014 under “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Use of Estimates.”
Recent Market Conditions and Our Strategy during the Quarter Ended September 30, 2015
General:
Despite prior market expectations that the Federal Reserve Open Market committee (or, FOMC) would begin to increase the U.S. Federal Funds interest rate during 2015, such a rate hike was not introduced during the third quarter of 2015, driving long-term interest rates on U.S. Treasury securities and Swaps lower during the quarter. While the U.S. labor market continued to show improvement, economic conditions abroad appear to have kept the FOMC from raising rates. At the same time, yield spreads, versus benchmark rates such as U.S. Treasuries, for fixed income products, including Agency RMBS and non-Agency RMBS, widened during the third quarter of 2015 to levels last seen in mid-2012. During the third quarter, not withstanding the FOMC inaction to date, the market appeared to continue to price in the possibility of the FOMC introducing an interest rate increase in December 2015. The third quarter ended with ten-year U.S. Treasury notes at 2.04% at September 30, 2015, down 31 basis points from 2.35% at June 30, 2015 while two-year U.S. Treasury rates ended the third quarter at 0.63%, down only one basis point from 0.64% at June 30, 2015.


52



The table below presents quarterly information about rates for two and ten-year U.S. Treasuries, ten-year Swap rates and the spread between the two and ten year U.S. Treasury rate for the first nine months of 2015:
Table 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
High
 
Low
 
Average
 
Quarter End
 
High
 
Low
 
Average
 
Quarter End
Quarter Ended
 
Ten-Year U.S. Treasury Rate
 
Ten-Year Swap Rate
September 30, 2015
 
2.45
%
0.0000245

2.00
%
 
2.22
%
 
2.04
%
 
2.52
%
 
2.00
%
 
2.28
%
 
2.00
%
June 30, 2015
 
2.48
%
 
1.84
%
 
2.16
%
 
2.35
%
 
2.56
%
 
1.95
%
 
2.24
%
 
2.43
%
March 31, 2015
 
2.24
%
 
1.64
%
 
1.96
%
 
1.92
%
 
2.36
%
 
1.80
%
 
2.08
%
 
2.04
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Two-Year U.S. Treasury Rate
 
Spread Between Two and Ten Year U.S. Treasury Rate
September 30, 2015
 
0.81
%
 
0.54
%
 
0.68
%
 
0.63
%
 
1.64
%
 
1.46
%
 
1.54
%
 
1.41
%
June 30, 2015
 
0.73
%
 
0.48
%
 
0.60
%
 
0.64
%
 
1.75
%
 
1.36
%
 
1.56
%
 
1.71
%
March 31, 2015
 
0.72
%
 
0.41
%
 
0.59
%
 
0.56
%
 
1.52
%
 
1.23
%
 
1.37
%
 
1.36
%
Our net income for the third quarter of 2015 was negatively impacted by unrealized losses on our non-Agency RMBS and interest rate Swaps and Swaptions reflecting the net impact of the market conditions described above. In addition, our operating earnings (which is a non-GAAP financial measure, see Table 23, below) decreased slightly for the third quarter ended September 30, 2015, compared to the second quarter of 2015, primarily reflecting an increase in interest rates on repurchase agreements and an increase in our Swap costs.
Investment Strategy:
The following table presents the composition of our investment portfolio as a percentage of total investments as of September 30, 2015 and June 30, 2015:
Table 2
 
September 30, 2015
 
June 30, 2015
Rate Investments:
 
 
 
 
Agency pass-through RMBS, at fair value
 
53.9
%
 
51.9
%
Agency IO and Agency Inverse IO, at fair value
 
1.7

 
2.0

Total Agency RMBS, at fair value
 
55.6

 
53.9

Credit Investments:
 
 
 
 
Non-Agency RMBS, at fair value
 
34.0

 
36.3

Securitized mortgage loans (1), at fair value
 
4.7

 
4.7

Other investments, at fair value
 
1.2

 
1.2

Other investment securities (2), at fair value
 
4.5

 
3.9

 
 
44.4

 
46.1

 
 
100.0
%
 
100.0
%
(1) 
Securitized mortgage loans include securitized mortgage loans associated with our February 2013 Securitization and March 2015 Securitization transactions.
(2) 
Other investment securities at September 30, 2015 were comprised of investments in Risk Sharing Securities issued by Freddie Mac, Fannie Mae, SBC-MBS and SBA-IO.
Agency RMBS Portfolio/Interest Rate Hedges:
The FOMC continues to replace the runoff of its Agency RMBS holdings, supporting Agency RMBS valuations and the decrease in market interest rates bolstered the value of our Agency RMBS portfolio. However, market spreads on Agency RMBS, which began to widen in June, continued to widen during the third quarter of 2015, partially off-setting the positive impact that lower market interest rates had on our Agency RMBS.
As expected, prepayments on Agency RMBS slowed during the third quarter of 2015, as mortgage interest rates remained largely unchanged and the market began to experience typical seasonally slower housing turnover. Slower prepayments in the third quarter and the coming months may also reflect the heavy concentration of prepayments during the summer of 2015, when prepayments were primarily driven by increased home turnover, supported by a relatively strong housing market. During the


53



third quarter of 2015, our Agency RMBS portfolio experienced a monthly fair value weighted average CPR of 7.6%, comprised of 7.3% CPR on Agency pass-through securities and 15.8% on Agency IO and Agency Inverse IO securities, in the aggregate. During the third quarter of 2015, the maximum average monthly CPR of our Agency RMBS was experienced in July, with an overall Agency CPR of 7.7% comprised of 7.4% on Agency pass-through securities and 17.5% on Agency IO and Agency Inverse IO securities in the aggregate. Prepayments on Agency RMBS are generally expected to continue to slow as we move into the fall and winter months.
The following table presents the composition and estimated fair value and net unrealized gain/(loss) position with respect to our Agency RMBS portfolio at September 30, 2015 and June 30, 2015:
Table 3
 
September 30, 2015
 
June 30, 2015
Agency RMBS Collateral Type
 
Estimated Fair Value
 
Unrealized Gain/(Loss), net
 
Estimated Fair Value
 
Unrealized Gain/(Loss), net
30-Year Fixed:
 
 
 
 
 
 
 
 
3.5% coupon
 
$
509,008

 
$
(2,331
)
 
$
552,325

 
$
(9,811
)
4.0% coupon
 
1,157,162

 
9,422

 
1,159,433

 
(1,925
)
 
 
1,666,170

 
7,091

 
1,711,758

 
(11,736
)
ARMs
 
303,121

 
(1,698
)
 
258,956

 
(978
)
Agency IO
 
54,579

 
(1,301
)
 
57,218

 
1,830

Agency Inverse IO
 
7,571

 
267

 
17,621

 
11

Total
 
$
2,031,441

 
$
4,359

 
$
2,045,553

 
$
(10,873
)
The following table presents information with respect to our Swaps and Swaptions at September 30, 2015 and June 30, 2015:
Table 4
 
September 30, 2015
 
June 30, 2015
Swaps:
 
 
 
 
Notional amount
 
$
1,687,000

 
$
1,687,000

Estimated fair value
 
$
(21,671
)
 
$
(113
)
Unrealized gain/(loss), net
 
$
(21,557
)
 
$
(707
)
Weighted average fixed pay rate
 
1.43
%
 
1.43
%
Weighted average months to maturity
 
44

 
47

 
 
 
 
 
Swaptions Purchase Contracts:
 
 
 
 
Notional amount
 
$
1,100,000

 
$
1,065,000

Estimated fair value
 
$
1,633

 
$
9,089

Unrealized gain, net
 
$
1,413

 
$
9,181

Weighted average term to expiration (months)
 
5.1

 
6

Weighted average underlying Swap term (months)
 
110

 
114

Weighted average underlying Swap fixed pay rate
 
3.00
%
 
3.11
%
 
 
 
 
 
Swaptions Sale Contracts:
 
 
 
 
Notional amount
 
$
200,000

 
$

Estimated fair value
 
$
(3,924
)
 
$

Unrealized gain/(loss), net
 
$
(1,831
)
 
$

Weighted average term to expiration (months)
 
10.4

 

Weighted average underlying Swap term (months)
 
97.5

 

Weighted average underlying Swap fixed pay rate
 
1.95
%
 
%


54



Credit Investments:
Prices of non-Agency RMBS decreased during the third quarter as all credit markets became more volatile following a sell-off in the U.S. equity markets in August. However, stable credit enhancement and steady home price appreciation provided a level of support for non-Agency valuations, as decreases in valuations of non-Agency RMBS were muted relative to the decline in the fixed income high-yield market.
During the third quarter, as we identified attractive credit investment opportunities, we continued to add to our other investment security holdings, purchasing additional Risk Sharing Securities and SBC-MBS and made an initial investment in SBA-IO. To fund such purchases we sold certain of our non-Agency RMBS and these sales resulted in net realized gains of $4,058. During the third quarter, our unrealized gains on non-Agency RMBS decreased by $15,072, reflecting decreases in market prices, purchase discount accretion (which effectively re-characterizes a portion of our purchase discount to interest income on bonds that are not currently receiving principal payments) and gains realized on sales.
Our credit investments were comprised of the following at September 30, 2015 and June 30, 2015:
Table 5
 
September 30, 2015
 
June 30, 2015
Non-Agency RMBS (at fair value)
 
$
1,240,188

 
$
1,378,265

Securitized mortgage loans (at fair value)
 
173,322

 
178,904

Other investments
 
44,768

 
44,089

Other investment securities:
 
 
 
 
Risk Sharing Securities - Freddie Mac (at fair value)
 
48,206

 
44,976

Risk Sharing Securities - Fannie Mae (at fair value)
 
51,531

 
45,936

SBC-MBS (at fair value)
 
59,986

 
58,889

SBA-IO
2,000

2,999



Total
 
$
1,621,000

 
$
1,751,059

During the three months ended September 30, 2015, performance of our non-Agency RMBS improved with voluntary prepayments remaining relatively high during the summer home-buying season, and the number of borrowers with 12 months of on-time payment history continued to increase. We believe this improvement was bolstered by housing values that continued to trend upward leading to the number of borrowers with negative home equity to decrease.
As of September 30, 2015, we had: (a) $12,424 of advances outstanding under a warehouse line; (b) $24,953 of legal title to real estate associated with BFT Contracts; and (c) $7,391 of mortgage loans, all of which were related to our Seller Financing Program. We provide warehouse advances to our Seller Financing Program counterparty to fund the acquisition of single-family homes primarily located in the southeastern U.S. Given that such investments are less liquid than non-Agency securities, we have grown the program at a measured pace.
Borrowings:
Financing rates on Agency RMBS continued to increase during the third quarter of 2015. We believe that balance sheet tightening at banks, regulatory requirements and interest rate concerns continued to drive increases in interest rates on repurchase borrowings.
With respect to non-Agency funding, dealers continued to offer non-Agency financing on bonds purchased from others at competitive levels. In July 2015, we entered into a $300,000 whole loan repurchase facility which provides for financing of certain residential mortgage loan products. The terms of future borrowings under this facility will vary based on the characteristics of the products pledged as collateral.
Over time, as market conditions change, in addition to repurchase borrowings we may use other forms of leverage, including, but not limited to, warehouse facilities, additional securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances. In the third quarter, our average leverage remained fairly constant at 4.10 times for the quarter ended September 30, 2015, down marginally from 4.12 times for the second quarter of 2015. We ended the quarter at 4.24 times leverage compared to 4.21 times leverage at June 30, 2015.




55



Results of Operations
Three Months Ended September 30, 2015 compared to the Three Months Ended September 30, 2014
For the three months ended September 30, 2015, we had a net loss of $(21,777), or $(0.79) per basic and diluted common share, compared to net income of $10,875, or $0.23 per basic and diluted common share, for the three months ended September 30, 2014. Our results of operations for the three months ended September 30, 2015 were significantly impacted by declines in the value of our non-Agency portfolio and hedging instruments. (See “Recent Market Conditions and Our Strategy during the Quarter Ended September 30, 2015,” above.)
Net Interest Income
Our net interest income is significantly impacted by the amount of leverage we use, our interest rate spread and our net interest margin. Interest rate spread measures the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities, while net interest margin reflects net interest income divided by average interest-earning assets. The $2,472 increase in our net interest income reflects the increase in our leverage and the increase in net interest rate spread and net interest margin for the three months ended September 30, 2015, compared to September 30, 2014. For the three months ended September 30, 2015, we had average debt-to-equity of 4.10 times, compared to 3.75 times for the three months ended September 30, 2014. We had an interest rate spread and net interest margin of 3.46% and 3.54% for the three months ended September 30, 2015, respectively, compared to 3.28% and 3.41%, respectively, for the three months ended September 30, 2014. The increase in our interest rate spread and net interest margin reflects our continued reallocation of capital into our credit investments which generate higher yields and spreads, relative to Agency RMBS.
For the three months ended September 30, 2015 and September 30, 2014, we earned interest income of $41,014 and $38,542, respectively, and incurred interest expense of approximately $8,208 and $7,708, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher borrowing expense reflects: (1) an increase in our average borrowings, (2) an increase in borrowings associated with our non-Agency RMBS, other credit investments and securitized mortgage loans, which borrowings have higher interest rates than repurchase agreements on Agency RMBS and (3) an increase in interest rates on our Agency RMBS repurchase borrowings.
Actual prepayments, may cause future premium amortization on our Agency RMBS and resulting yields to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income and resulting yields recognized on our non-Agency RMBS in future periods on such investments.
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the three months ended September 30, 2015 and 2014:
Table 6
 
Three Months Ended September 30, 2015
 
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average investment balance (2)
 
$
1,993,871

 
$
1,454,870

 
$
169,059

 
$
3,617,800

Total interest income
 
$
14,823

 
$
22,359

 
$
3,832

 
$
41,014

Weighted average CPR
 
7.4
%
 
6.3
%
 
6.5
%
 
5.7
%
Yield on average assets
 
2.97
%
 
6.15
%
 
9.07
%
 
4.53
%
Average balance of associated repurchase agreements
 
$
1,805,455

 
$
1,149,654

 
$
92,702

 
$
3,047,811

Average balance of securitized debt  (3)
 
$

 
$

 
$
24,708

 
$
24,708

Total interest expense
 
$
1,906

 
$
5,347

 
$
955

 
$
8,208

Average cost of funds (4) (5)
 
0.42
%
 
1.86
%
 
3.25
%
 
1.07
%
Net interest income
 
$
12,917

 
$
17,012

 
$
2,877

 
$
32,806

Net interest rate spread
 
2.55
%
 
4.29
%
 
5.82
%
 
3.46
%
Total interest expense including net interest cost of Swaps (6)
 
$
6,649

 
$
5,347

 
$
1,086

 
$
13,082

Effective cost of funds (6)
 
1.47
%
 
1.86
%
 
3.70
%
 
1.70
%
Net interest income including net interest cost of Swaps
 
$
8,174

 
$
17,012

 
$
2,746

 
$
27,932

Effective net interest rate spread (6)
 
1.50
%
 
4.29
%
 
5.37
%
 
2.83
%


56



 
 
Three Months Ended September 30, 2014
 
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,146,535

 
$
1,366,642

 
$
98,978

 
$
3,612,155

Total interest income
 
$
16,563

 
$
20,108

 
$
1,871

 
$
38,542

Yield on average assets
 
3.09
%
 
5.89
%
 
7.56
%
 
4.27
%
Average balance of associated repurchase agreements
 
$
1,890,885

 
$
1,078,454

 
$
29,131

 
$
2,998,470

Average balance of securitized debt  (3)
 
$

 
$

 
$
36,500

 
$
36,500

Total interest expense
 
$
1,629

 
$
5,541

 
$
538

 
$
7,708

Average cost of funds (4) (5)
 
0.34
%
 
2.01
%
 
3.21
%
 
0.99
%
Net interest income
 
$
14,934

 
$
14,567

 
$
1,333

 
$
30,834

Net interest rate spread
 
2.75
%
 
3.88
%
 
4.35
%
 
3.28
%
Total interest expense including net interest cost of Swaps (6)
 
$
6,617

 
$
5,541

 
$
678

 
$
12,836

Effective cost of funds (6)
 
1.37
%
 
2.01
%
 
4.04
%
 
1.65
%
Net interest income including net interest cost of Swaps
 
$
9,946

 
$
14,567

 
$
1,193

 
$
25,706

Effective net interest rate spread (6)
 
1.72
%
 
3.88
%
 
3.52
%
 
2.62
%
(1) 
Other credit investments were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Reflects the average unpaid principal balance.
(4) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(5) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, those costs are included in gain/(loss) on derivative instruments in our consolidated statement of operations.
(6) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
As of September 30, 2015, our repurchase agreement borrowings collateralized by Agency RMBS had initial terms of up to three months with haircut requirements ranging from 3.0% to 5.0% and financing rates from 0.40% to 0.53%; our repurchase agreement borrowings collateralized by non-Agency RMBS and other investment securities had initial terms of up to twenty four months with haircut requirements ranging from 10.0% to 45.0% and financing rates from 1.20% to 2.69%. (The “haircut” represents the percentage by which the collateral value is contractually required to exceed the loan amount.)


57



The following table presents the cost of funds and effective cost of funds for our repurchase agreement borrowings by type of collateral pledged for the periods presented:
Table 7
 
Three Months Ended September 30,
 
 
2015
 
2014
Collateral Pledged:
 
Cost of
Funds
 
Effective
Cost of
Funds(1)
 
Cost of
Funds
 
Effective
Cost of
Funds(1)
Agency RMBS
 
0.42
%
 
1.47
%
 
0.34
%
 
1.37
%
Non-Agency RMBS and other credit investments(2)
 
1.86

 
1.86

 
2.01

 
2.01

Securitized mortgage loans(3)
 
3.25

 
3.70

 
3.21

 
4.04

Total
 
1.07
%
 
1.70
%
 
0.99
%
 
1.65
%
(1) 
The effective cost of funds for the periods presented includes interest expense for the periods and the net interest component for Swaps during the periods of $4,874 and $5,128, respectively. While we have not elected to apply hedge accounting for our Swaps, we view such instruments as an economic hedge against the impact of increases in interest rates on our borrowing costs. (See “Non-GAAP Financial Measures,” below.)
(2) 
For the periods presented, other credit investments were comprised of other investment securities and other investments.
(3) 
The non-Agency RMBS associated with our securitization transactions are eliminated in consolidation with the VIE and the mortgage loans in the VIE are consolidated by us. The interest expense on repurchase agreement borrowings associated with non-Agency RMBS associated with our securitization transactions are included with the cost of funds for our securitized mortgage loans.
Gains/(Losses) on Derivative Instruments
The following table presents components of our gain/(loss) on derivative instruments for the periods presented:
Table 8
 
Three Months Ended September 30,
Components of Gain/(Loss) on Derivative Instruments
 
2015
 
2014
Net interest (payments/accruals) on Swaps(1)
 
$
(4,874
)
 
$
(5,128
)
Losses on the termination and expiration of Swaptions, net(1)
 
(1,863
)
 
(6,505
)
Losses on settlement of TBA Contracts, net(1)
 
(2,526
)
 

Change in fair value of Swaps(2)
 
(21,558
)
 
8,055

Change in fair value of Swaptions, net(2)
 
(9,598
)
 
4,379

Change in fair value of TBA Contracts(2)
 
(726
)
 

Total
 
$
(41,145
)
 
$
801

(1) 
Amounts are realized.
(2) 
Amounts are unrealized.
We expect that changes in the fair value of our net derivative instruments will generally move inversely to changes in the fair value of our Agency pass-through RMBS, however we do not expect that the changes in valuations of such derivatives relative to our Agency pass-through RMBS will off-set entirely. We note that the terms and benchmark interest rates associated with our derivatives are not matched with our investments, that the notional amount of our derivatives is not equal to our investments and the value of our Swaps and Swaptions do not mitigate the impact of spread widening, which occurs when market spreads widen between the yield on RMBS relative to certain benchmark interest rates, which occurred during the three months ended September 30, 2015. The timing and amount of realized and unrealized gains/(losses) associated with our derivative instruments cannot be predicted, as the value of such instruments generally moves inversely with changes in interest rates which cannot be predicted with any certainty. (For more information about derivative instruments we held at September 30, 2015 and December 31, 2014, see Note 11 to the consolidated financial statements included under Item 1 of this quarterly report on Form 10-Q.)


58



The following table presents the notional amount and estimated fair value for each of our derivative instrument types at September 30, 2015 and December 31, 2014:
Table 9
 
September 30, 2015
 
December 31, 2014
 
 
Notional Amount
 
Estimated Fair Value
 
Notional Amount
 
Estimated Fair Value
Swaps - assets
 
$

 
$

 
$
957,000

 
$
9,543

Swaptions - assets
 
1,100,000

 
1,633

 
1,250,000

 
1,555

Swaptions - (liabilities)
 
200,000

 
(3,924
)
 

 

Swaps - (liabilities)
 
1,687,000

 
(21,671
)
 
730,000

 
(8,949
)
Long TBA Contracts - assets
 

 

 
100,000

 
544

Short TBA Contracts - (liabilities)
 
125,000

 
(820
)
 

 

Total derivative instruments, net
 
$
3,112,000

 
$
(24,782
)
 
$
3,037,000

 
$
2,693

The following tables present our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the periods presented: (See “Non-GAAP Financial Measures,” below.)
Table 10
 
Repurchase Borrowings on Agency RMBS
 
Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1)
 
Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2)
 
Total
Three Months Ended September 30, 2015
 
 
 
 
 
 
 
 
Effective interest expense
 
$
6,649

 
$
5,347

 
$
1,086

 
$
13,082

Effective cost of funds
 
1.47
%
 
1.86
%
 
3.70
%
 
1.70
%
Effective net interest income
 
$
8,174

 
$
17,012

 
$
2,746

 
$
27,932

Effective net interest rate spread
 
1.50
%
 
4.29
%
 
5.37
%
 
2.83
%
Three Months Ended September 30, 2014
 
 
 
 
 
 
 
 
Effective interest expense
 
$
6,617

 
$
5,541

 
$
678

 
$
12,836

Effective cost of funds
 
1.37
%
 
2.01
%
 
4.04
%
 
1.65
%
Effective net interest income
 
$
9,946

 
$
14,567

 
$
1,193

 
$
25,706

Effective net interest rate spread
 
1.72
%
 
3.88
%
 
3.52
%
 
2.62
%
(1) 
Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the quarter ended September 30, 2015. Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended September 30, 2014.
(2) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.
Realized and Unrealized Gains/(Losses) on Investments and Securitized Debt
During the three months ended September 30, 2015, as we identified attractive investment opportunities in residential credit investment securities, we sold certain Agency RMBS and non-Agency RMBS, reinvesting such net sale proceeds in Agency Risk Sharing Securities, SBC-MBS and SBA-IO, we also continued to reinvest in Agency and non-Agency RMBS. During the three months ended September 30, 2015 and 2014, we sold Agency RMBS of $194,699 and $129,870, respectively, realizing net gains/(losses) of $(727) and $2,050, respectively, and sold non-Agency RMBS of $100,384 and $2,253, respectively, realizing net gains of $4,058 and $531, respectively. As we find attractive investment opportunities in non-Agency RMBS, whole loans and mortgage related assets, we may continue to sell Agency and/or certain non-Agency RMBS to provide funds to make such purchases. With respect to non-Agency RMBS, we continue to emphasize investments in seasoned securities, backed by subprime and other credit sensitive mortgage loans, targeting securities at or near the top of the capital structure.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, mortgage loan pools, other investment securities and securitized debt and, as a result, record changes in the estimated fair value of such instruments in


59



earnings. As described above in “Recent Market Conditions and our Strategy,” we experienced declines in the value of our non-Agency RMBS and hedging instruments that resulted in unrealized losses during the three months ending September 30, 2015.
The following table presents amounts related to realized gains and losses, OTTI recognized and changes in estimated fair value of our assets and liabilities carried at fair value for the three months ended September 30, 2015 and September 30, 2014:
Table 11
 
Three Months Ended September 30,
 
 
2015
 
2014
Realized gain/(loss) on sale of Agency RMBS, net
 
$
(727
)
 
$
2,050

Realized gain on sale of non-Agency RMBS, net
 
4,058

 
531

Unrealized gain/(loss) on Agency RMBS, net
 
15,233

 
(8,752
)
Unrealized (loss) on non-Agency RMBS, net
 
(15,072
)
 
(4,402
)
Realized (loss) on derivatives, net (1)
 
(9,263
)
 
(11,633
)
Unrealized gain/(loss) on derivatives, net
 
(31,882
)
 
12,434

Unrealized (loss) on other investment securities
 
(3,014
)
 
(101
)
Unrealized (loss) on securitized mortgage loans, net
 
(576
)
 
(650
)
Unrealized gain on securitized debt
 
172

 
67

Other-than-temporary impairments recognized
 
(7,088
)
 
(3,817
)
Total
 
$
(48,159
)
 
$
(14,273
)
(1) 
Realized losses on derivatives include net interest payments/accruals on Swaps, net losses on the termination and expiration of Swaptions and net losses on the settlement of TBA Contracts.
Expenses
General and Administrative Expenses: We reimburse our Manager for our allocable share of the compensation of our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance, and miscellaneous other operating costs. Costs for our third-party investment accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $3,705 and $2,925 for the three months ended September 30, 2015 and 2014, respectively. The increase in our expenses during the three months ended September 30, 2015 compared to the three months ended September 30, 2014 primarily reflects our expanded use of analytical tools associated with our credit investments and incremental expenses associated with our Seller Financing Program, servicing costs associated with our securitized mortgage loan portfolios and accounting support functions. To the extent that we continue to expand our portfolio to include a broader spectrum of investments, we expect to incur costs for associated legal work, due diligence, contract finance, credit analysis and asset surveillance.
Management Fee Expense: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of adjusted stockholders’ equity as defined in the Management Agreement, per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel, who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fees of $2,667 and $2,800 for the three months ended September 30, 2015 and 2014, respectively.
The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 13(a) to the consolidated financial statements included under Item 1 of this quarterly report Form 10-Q.
Nine Months Ended September 30, 2015 compared to the Nine Months Ended September 30, 2014
For the nine months ended September 30, 2015, we had a net loss of $(10,401), or $(0.65) per basic share and diluted share, compared to net income of $82,761, or $2.25 per basic and diluted share, for the nine months ended September 30, 2014. Our results of operations for the nine months ended September 30, 2015 were significantly impacted by declines in the value of


60



our investment portfolio and derivatives. (See “Recent Market Conditions and Our Strategy during the Quarter Ended September 30, 2015,” above.)
Net Interest Income
Our net interest income was $97,654 for the nine months ended September 30, 2015 compared to $92,377 for the comparative period in 2014. For the nine months ended September 30, 2015 and September 30, 2014, we earned interest income of $121,927 and $114,863, respectively, and incurred interest expense of $24,273 and $22,486, respectively, which was primarily related to our borrowings under repurchase agreements. Our higher earnings and borrowing expense reflects the increase in our investments and associated borrowings for the current nine month period compared to the nine months ended September 30, 2014. (See Tables 12 and 13 below.) Borrowings collateralized by Agency RMBS have lower funding rates than borrowings collateralized by our other investment securities. At September 30, 2015, we had securitized debt with a contractual balance of $21,351 with a fixed stated interest rate of 4.00%.
For the nine months ended September 30, 2015, we had average debt-to-equity of 4.06 times, compared to 3.75 times for the nine months ended September 30, 2014. This increase in leverage reflects the use of additional leverage on our Agency and non-Agency RMBS. Our interest rate spread and net interest margin were 3.28% and 3.49% for the nine months ended September 30, 2015, respectively, compared to 3.31% and 3.43%, respectively, for the nine months ended September 30, 2014.
The impact of our Swaps is not reflected in our net interest rate spread and net interest margin. However, when making investment decisions, we consider our effective cost of borrowings, which includes the net interest component of our Swaps. (See Tables 12, 21 and 22 below.)
Our yield on Agency RMBS for the nine months ended September 30, 2015 decreased to 2.96% compared to 3.05% for nine months ended September 30, 2014. This decrease primarily reflects our migration to Agency RMBS backed by ARMs and lower coupon fixed rate bonds since the second quarter of 2014. Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income recognized in future periods on such investments.
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the nine months ended September 30, 2015 and 2014:
Table 12
 
 
 
 
Nine Months Ended September 30, 2015
 
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,126,641

 
$
1,451,581

 
$
153,216

 
$
3,731,438

Total interest income
 
$
47,173

 
$
64,949

 
$
9,805

 
$
121,927

Yield on average assets
 
2.96
%
 
5.97
%
 
8.88
%
 
4.29
%
Average balance of associated repurchase agreements
 
$
1,941,319

 
$
1,139,657

 
$
92,585

 
$
3,173,561

Average balance of securitized debt
 
$

 
$

 
$
28,213

 
$
28,213

Total interest expense
 
$
5,668

 
$
15,951

 
$
2,654

 
$
24,273

Average cost of funds (3) (4)
 
0.39
%
 
1.87
%
 
2.93
%
 
1.01
%
Net interest income
 
$
41,505

 
$
48,998

 
$
7,151

 
$
97,654

Net interest rate spread
 
2.57
%
 
4.10
%
 
5.95
%
 
3.28
%
Total interest expense including net interest cost of Swaps
 
$
20,024

 
$
15,951

 
$
3,055

 
$
39,030

Effective cost of funds
 
1.38
%
 
1.87
%
 
3.37
%
 
1.63
%
Net interest income including net interest cost of Swaps
 
$
27,149

 
$
48,998

 
$
6,750

 
$
82,897

Effective net interest rate spread (5)
 
1.58
%
 
4.10
%
 
5.51
%
 
2.66
%
(Tables and notes continued on next page.)


61



(Tables and notes continued.)
Table 13
 
 
 
 
Nine Months Ended September 30, 2014
Collateral
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,191,119

 
$
1,257,144

 
$
102,420

 
$
3,550,683

Total interest income
 
$
50,077

 
$
58,742

 
$
6,044

 
$
114,863

Yield on average assets
 
3.05
%
 
6.23
%
 
7.87
%
 
4.31
%
Average balance of associated repurchase agreements
 
$
1,900,722

 
$
999,697

 
$
28,599

 
$
2,929,018

Average balance of securitized debt
 
$

 
$

 
$
39,136

 
$
39,136

Total interest expense
 
$
5,204

 
$
15,588

 
$
1,694

 
$
22,486

Average cost of funds (3) (4) (5)
 
0.36
%
 
2.06
%
 
3.30
%
 
1.00
%
Net interest income
 
$
44,873

 
$
43,154

 
$
4,350

 
$
92,377

Net interest rate spread
 
2.69
%
 
4.17
%
 
4.57
%
 
3.31
%
Total interest expense including net interest cost of Swaps
 
$
19,789

 
$
15,588

 
$
2,107

 
$
37,484

Effective cost of funds
 
1.37
%
 
2.06
%
 
4.10
%
 
1.67
%
Net interest income including net interest cost of Swaps
 
$
30,288

 
$
43,154

 
$
3,937

 
$
77,379

Effective net interest rate spread (5)
 
1.68
%
 
4.17
%
 
3.77
%
 
2.64
%
(1) 
Other credit investments were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the quarter ended September 30, 2015. Other credit investments were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended September 30, 2014.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(4) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, such costs are included in “Gain/(loss) on derivative instruments, net” in our consolidated statements of operations.
(5) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction as well as the associated net interest component of Swaps. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
(6) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.




62



Swaps and Swaptions
While we view that our net Swaps and Swaption positions will serve as an economic hedge against increases in future market interest rates associated with our repurchase agreement borrowings, we have not elected hedge accounting under GAAP. Alternatively, we present the “effective cost of funds” to reflect our interest expense adjusted to include the interest component for our Swaps that would be reported had we elected and qualified for hedge accounting for such instruments. We believe that the presentation of our effective cost of funds, which is a non-GAAP financial measure, is useful for investors as it presents our borrowing costs as viewed by us. (See “Non-GAAP Financial Measures,” below and Note 11 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
The following table presents our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the nine months ended September 30, 2015 and September 30, 2014. (See Tables 21 and 22 below.)
Table 14
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
 
Repurchase Borrowings on Agency RMBS
 
Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1)
 
Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (6)
 
Total
Effective interest expense
 
$
20,024

 
$
15,951

 
$
3,055

 
$
39,030

Effective cost of funds
 
1.38
%
 
1.87
%
 
3.37
%
 
1.63
%
Effective net interest income
 
$
27,149

 
$
48,998

 
$
6,750

 
$
82,897

Effective net interest rate spread
 
1.58
%
 
4.10
%
 
5.51
%
 
2.66
%
Nine Months Ended September 30, 2014
 
 
 
 
 
 
 
 
Effective interest expense
 
$
19,789

 
$
15,588

 
$
2,107

 
$
37,484

Effective cost of funds
 
1.37
%
 
2.06
%
 
4.10
%
 
1.67
%
Effective net interest income
 
$
30,288

 
$
43,154

 
$
3,937

 
$
77,379

Effective net interest rate spread
 
1.68
%
 
4.17
%
 
3.77
%
 
2.64
%
(1) 
Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, SBA-IO and other investments for the quarter ended September 30, 2015. Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS, mortgage loans and other investments for the quarter ended September 30, 2014.
(2) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.
Realized and Unrealized Gains/(Losses)
During the nine months ended September 30, 2015 and 2014, we sold Agency RMBS of $1,581,754 and $744,437, respectively, realizing net gains/(losses) of $(542) and $(19,266), respectively, and sold non-Agency RMBS of $273,316 and $13,562, respectively, realizing net gains of $7,882 and $11,500, respectively. From time to time we sell certain securities to balance our portfolio in light of current and anticipated market conditions. In addition, as we find attractive investment opportunities in non-Agency RMBS and whole loans and mortgage-related assets, we may sell additional Agency RMBS to fund such purchases. With respect to non-Agency RMBS, we continue to emphasize investment in securities backed by subprime and other credit sensitive mortgage loans, targeting securities at or near the top of the capital structure.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, other investment securities and securitized debt and given that we do not apply hedge accounting, our derivatives are carried at fair value. As a result, we record the change in estimated fair value of each of these instruments in earnings.


63



The following table presents amounts related to realized gains and losses, OTTI recognized and changes in estimated fair value of our RMBS, securitized mortgage loans, securitized debt, other investment securities and derivative instruments, all of which are included in our consolidated statements of operations, for the nine months ended September 30, 2015 and September 30, 2014:
Table 15
 
Nine Months Ended
 
 
September 30, 2015
 
September 30, 2014
Realized (loss) on sale of Agency RMBS, net
 
$
(542
)
 
$
(19,266
)
Realized gain on sale of non-Agency RMBS, net
 
7,882

 
2,965

Realized gain on sale on other investment securities, net
 
102

 

Unrealized gain/(loss) on Agency RMBS, net
 
(503
)
 
82,959

Unrealized gain/(loss) on non-Agency RMBS, net
 
(25,822
)
 
11,240

Realized (loss) on derivatives, net (1)
 
(31,156
)
 
(42,771
)
Unrealized (loss) on derivatives, net (2)
 
(24,047
)
 
(20,751
)
Unrealized gain/(loss) on other investment securities
 
(5,583
)
 
75

Unrealized gain/(loss) on securitized mortgage loans, net
 
(110
)
 
2,440

Unrealized gain/(loss) on securitized debt
 
1,186

 
(287
)
Other-than-temporary impairments recognized
 
(9,860
)
 
(8,933
)
Total
 
$
(88,453
)
 
$
7,671

(1) 
For the nine months ended September 30, 2015 and September 30, 2014 amounts include net interest payments (made)/received, including accrued amounts, of $(14,758) and ($14,998), respectively, associated with our Swaps, $(11,895) and $(20,617), respectively, of realized losses on terminations and expirations of Swaptions and $(4,503) and $(7,156), respectively, of (losses) on settlement of Short TBA Contracts, respectively.
(2) 
For the nine months ended September 30, 2015 and September 30, 2014, we recognized net unrealized gains/(losses) of $(22,265) and ($18,113), respectively, related to the change in fair value of our Swaps, $(417) and ($1,888), respectively, related to the change in fair value of our Swaptions and $(1,365) and ($750), respectively, related to the change in fair value of our Short TBA Contracts, respectively.
Expenses
General and Administrative Expenses: We are responsible for our operating expenses, which include the cost of data and analytical systems, outsourced accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. We reimburse our Manager, or its affiliates, for our allocable share of the compensation of our Chief Financial Officer based on the percentage of her time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. Costs we incur for our third-party accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $11,210 and $8,941 for the nine months ended September 30, 2015 and September 30, 2014, respectively. The increase in our general and administrative expenses was primarily driven by costs incurred in connection with the pool of mortgage loans we purchased in March 2015. While these costs are expensed when incurred under GAAP, we consider such costs in assessing the total return on our investment. The remaining increases in our expenses primarily reflect our expanded use of analytical tools associated with our credit investments and incremental expenses associated with our Seller Financing Program, servicing costs associated with our securitized mortgage loan portfolios and accounting support functions. To the extent that we continue to expand our portfolio to include a broader spectrum of investments, we expect to incur costs for associated legal work, due diligence, contract finance, credit analysis and asset surveillance.
Management Fee: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement), per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fee expenses of $8,349 and $8,360 for the nine months ended September 30, 2015 and September 30, 2014, respectively.
The management fees, expense reimbursements and the relationship with our Manager are discussed further in Note 13(a) to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.


64



Dividends
We have had 6,900,000 shares of Preferred Stock outstanding since September 20, 2012. No dividends may be paid on our common stock unless full cumulative dividends have been paid on our Preferred Stock, all of which have been paid to date. The following table presents cash dividends we have declared on our Preferred Stock from January 1, 2014 through September 30, 2015:
Table 16
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.50

June 17, 2015
 
June 30, 2015
 
July 31, 2015
 
$
0.50

March 19, 2015
 
March 31, 2015
 
April 30, 2015
 
$
0.50

December 18, 2014
 
December 31, 2014
 
January 30, 2015
 
$
0.50

September 17, 2014
 
September 30, 2014
 
October 31, 2014
 
$
0.50

June 19, 2014
 
June 30, 2014
 
July 31, 2014
 
$
0.50

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

As a REIT we are required to distribute at least 90% of our annual net taxable income. As of December 31, 2014, for tax purposes we had non-deductible net capital losses of approximately $84 million which may be carried forward and applied against future net capital gains, of which approximately $20 million may be carried forward five years and approximately $64 million may be carried forward four years. This capital loss carryforward will reduce the amount of future capital gains, if any, that we would otherwise expect to distribute, as capital gains would first be reduced by capital loss carryforward amounts. In addition, as of September 30, 2015, we had estimated net deferred tax gains from terminated Swaps of $17.1 million and estimated net deferred tax losses from terminated Swaptions of $25.1 million which will be amortized into future ordinary taxable income over the remaining terms of the underlying Swaps.
The following table presents cash dividends we declared on our common stock for the quarterly periods presented:
Table 17
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.48

June 17, 2015
 
June 30, 2015
 
July 31, 2015
 
$
0.48

March 19, 2015
 
March 31, 2015
 
April 30, 2015
 
$
0.48

December 18, 2014
 
December 31, 2014
 
January 30, 2015
 
$
0.45

September 17, 2014
 
September 30, 2014
 
October 31, 2014
 
$
0.44

June 19, 2014
 
June 30, 2014
 
July 31, 2014
 
$
0.42

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

Liquidity and Capital Resources
General
To maintain our qualification as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our net taxable income, excluding net capital gains. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations.
Our principal sources of cash generally consist of borrowings under repurchase agreements, payments of principal and interest received on the RMBS portfolios, cash generated from operating results and, depending on market conditions, proceeds from capital market transactions, which to date have reflected issuances of our common stock and preferred stock (collectively our capital stock). As part of managing our investment portfolio, we may also generate cash through sales of RMBS. Cash is needed to fund our ongoing obligations, make payments of principal and interest on repurchase agreement borrowings, purchase target assets, meet margin calls, make dividend distributions to stockholders and for other general business and operating purposes.
Our primary sources of cash for the nine months ended September 30, 2015 consisted of proceeds from repurchase facility borrowings, proceeds from sales of Agency and non-Agency RMBS and payments of principal and interest we received


65



on our investment portfolio. We expect that in the future, subject to market conditions, that we may issue additional shares of our common stock, other types of debt and/or equity securities and engage in additional securitization/resecuritization transactions.
Under our repurchase agreements, lenders retain the right to mark the collateral pledged to estimated fair value. A reduction in the value of the collateral pledged will require us to provide additional securities or cash as collateral. As part of our risk management process, our Manager closely monitors our liquidity position and subjects our balance sheet to scenario testing designed to assess our liquidity in the face of different economic and market developments.
We believe we have adequate financial resources to meet our obligations, including margin calls, as they come due, to actively hold and acquire our target assets, to fund dividends we declare on our capital stock and to pay our operating expenses. However, should the value of our pledged assets suddenly decrease, significant margin calls on repurchase agreement borrowings could result and our liquidity position could be materially and adversely affected. Further, should market liquidity tighten, our repurchase agreement counterparties could increase the percentage by which the collateral value is required to exceed the loan amount on new financings, reducing our ability to use leverage. Access to financing may also be negatively impacted by the ongoing volatility in the global financial markets, potentially adversely impacting our current or potential lenders’ ability to provide us with financing.
Stock Repurchase Plan
On November 6, 2013, our Board of Directors authorized the Repurchase Program to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program are canceled and, until reissued by us, are deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by our board of directors at any time and without prior notice. Through September 30, 2015, we repurchased 360,800 shares of common stock at an average cost per share of $13.86. At September 30, 2015, $45,000 of common stock remained authorized for future share repurchases under the Repurchase Program.
Investing Activity
During the nine months ended September 30, 2015, we (i) invested $1,399,299 in Agency pass-through RMBS at a weighted average purchase price of 106.4% of par value, $74,190 in Agency IOs, $15,789 in Agency Inverse IO, $205,086 in non-Agency RMBS with a weighted average purchase price of 91.9% of par value, $161,944 in other investment securities and $25,131 associated with our Seller Financing Program; (ii) received prepayments and scheduled amortization of $153,047 for Agency RMBS, $134,001 for non-Agency RMBS and $20,911 associated with our Seller Financing Program; and (iii) sold Agency RMBS of $1,521 realizing aggregate net gains of $849 and sold $273,316 of non-Agency RMBS realizing gains of $7,882.
We receive interest-only payments with respect to the notional amount of Agency IO, Agency Inverse IO, and SBA-IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of assets. Unlike Agency RMBS, the market prices of an IO generally have a positive correlation to changes in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an IO will decrease, which in turn is expected to increase the cash flow and the value of such securities; inverse results are expected with respect to decreases in market interest rates. In addition to viewing Agency IO as attractive investments, we also view such instruments as an economic hedge, in part, against the impact that an increase in market interest rates would have on our Agency RMBS. However, given that we had Agency IO with an aggregate notional balance of $565,199, the overall impact of Agency IO in off-setting the impact of increases in interest rates on the value of our Agency RMBS portfolio is limited. During the nine months ended September 30, 2015, we sold $56,125 of Agency IO and Agency Inverse IO securities, realizing an aggregate net gains of $263.
As of September 30, 2015, our non-Agency RMBS consisted primarily of RMBS backed by seasoned Subprime mortgages and, to a lesser extent, Alt-A and Option ARMs. The average cost basis of our non-Agency RMBS portfolio was 82.8% of par as of September 30, 2015 and December 31, 2014. (For additional information about our RMBS portfolios as of September 30, 2015, see Note 4 to the consolidated financial statements included under Item 1 of this quarterly report on Form 10-Q.)


66



Financing Activity
We use repurchase agreements to finance a substantial majority of our Agency RMBS, non-Agency RMBS and other investment securities with such securities pledged as collateral to secure such borrowings. At September 30, 2015, we had outstanding repurchase agreement borrowings with 18 counterparties totaling $3,011,025. We continue to have available capacity under our repurchase agreements; however, our repurchase agreements are generally uncommitted and renewable at the discretion of our lenders. As of September 30, 2015, we had master repurchase agreements with 24 counterparties and as a matter of routine business we may have discussions with other financial institutions in order to potentially increase repurchase agreement capacity.
The following table presents certain information about our borrowings for the periods presented:
Table 18
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase Agreements
 
Securitized Debt (1)
Quarter Ended
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
September 30, 2015
 
$
3,047,811

 
$
3,011,025

 
$
3,071,188

 
$
24,708

 
$
21,351

 
$
24,730

June 30, 2015
 
$
3,215,482

 
$
3,177,679

 
$
3,240,446

 
$
28,582

 
$
25,828

 
$
28,883

March 31, 2015
 
$
3,217,137

 
$
3,303,385

 
$
3,303,385

 
$
31,321

 
$
29,240

 
$
31,026

December 31, 2014
 
$
3,178,580

 
$
3,402,327

 
$
3,402,327

 
$
34,176

 
$
33,098

 
$
34,519

September 30, 2014
 
$
2,998,470

 
$
3,076,808

 
$
3,076,808

 
$
36,500

 
$
34,947

 
$
36,692

June 30, 2014
 
$
2,900,282

 
$
2,991,989

 
$
2,991,989

 
$
39,133

 
$
37,348

 
$
39,066

March 31, 2014
 
$
2,887,060

 
$
2,859,344

 
$
2,956,389

 
$
41,835

 
$
40,281

 
$
41,292

(1) 
The balances presented for securitized debt reflect the balance of such debt, which does not reflect the impact of changes in the fair value of such liability.


67



The following table presents information+ about our borrowings by type of collateral pledged, and the fair value of collateral pledged as of the dates presented and the weighted average interest rate, the cost of funds and effective cost of funds for the quarterly periods then ended:
Table 19
 
 
 
 
 
 
 
 
Quarterly Period Ended:
 
Principal Balance  of Borrowing
 
Fair Value of Collateral Pledged (1)
 
Weighted Average Cost of Funds
 
Effective Cost of Funds (2)
September 30, 2015
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,809,868

 
$
1,900,594

 
0.42
%
 
1.47
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
1,109,399

 
1,434,741

 
1.86

 
1.86

Securitized mortgage loans and mortgage loan repurchase borrowings (3)
 
91,758

 
125,948

 
2.61

 
3.18

Total repurchase borrowings
 
3,011,025

 
3,461,283

 
1.04

 
1.68

Securitized debt  (4)
 
21,351

 
93,751

 
4.97

 
4.97

Total
 
$
3,032,376


$
3,555,034

 
1.07
%
 
1.70
%
June 30, 2015
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,868,994

 
$
1,955,767

 
0.38
%
 
1.35
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
1,215,083

 
1,577,653

 
1.82

 
1.82

Securitized mortgage loans and mortgage loan repurchase borrowings (3)
 
93,602

 
128,933

 
2.76

 
3.33

Total repurchase borrowings
 
3,177,679

 
3,662,353

 
0.97

 
1.57

Securitized debt  (4)
 
25,828

 
98,223

 
4.60

 
4.60

Total
 
$
3,203,507

 
$
3,760,576

 
1.00
%
 
1.60
%
March 31, 2015
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
2,074,306

 
$
2,192,291

 
0.37
%
 
1.30
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
1,134,211

 
1,492,830

 
1.88

 
1.88

Securitized mortgage loans and mortgage loan repurchase borrowings (3)
 
94,868

 
130,672

 
2.15

 
3.08

Total repurchase borrowings
 
3,303,385

 
3,815,793

 
0.93

 
1.52

Securitized debt (4)
 
29,240

 
101,261

 
4.69

 
4.69

Total
 
$
3,332,625

 
$
3,917,054

 
0.96
%
 
1.58
%
September 30, 2014
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,934,669

 
$
2,022,839

 
0.34
%
 
1.37
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
1,112,962

 
1,486,250

 
2.01

 
2.01

Securitized mortgage loans repurchase borrowings (3)
 
29,177

 
48,036

 
1.88

 
3.76

Total repurchase borrowings
 
3,076,808

 
3,557,125

 
0.95

 
1.62

Securitized debt (4)
 
34,947

 
106,947

 
4.27

 
4.27

Total
 
$
3,111,755

 
$
3,664,072

 
0.99
%
 
1.65
%
June 30, 2014
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,905,783

 
$
2,029,915

 
0.36
%
 
1.41
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
1,057,637

 
1,390,446

 
2.07

 
2.07

Securitized mortgage loans repurchase borrowings (3)
 
28,569

 
48,638

 
1.88

 
3.80

Total repurchase borrowings
 
2,991,989

 
3,468,999

 
0.97

 
1.66

Securitized debt (4)
 
37,348

 
109,712

 
4.36

 
4.36

Total
 
$
3,029,337

 
$
3,578,711

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

 
$
1,962,536

 
0.39
%
 
1.34
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
970,044

 
1,303,098

 
2.10

 
2.10

Securitized mortgage loans repurchase borrowings (3)
 
28,234

 
47,614

 
2.06

 
4.00

Total repurchase borrowings
 
2,859,344

 
3,313,248

 
0.95

 
1.61

Securitized debt (4)
 
40,281

 
110,307

 
4.23

 
4.23

Total
 
$
2,899,625

 
$
3,423,555

 
0.99
%
 
1.65
%
(1) 
Includes cash collateral pledged for Agency RMBS, non-Agency RMBS and other investment securities. (See Note 9 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
(Notes to table continued on next page.)


68



(Notes to table continued.)
(2) 
The effective cost of funds for the quarterly periods are calculated on an annualized basis and adjusts interest expense to include the net interest component for Swaps. (See “Non-GAAP Financial Measures,” below.)
(3) 
Repurchase agreements collateralized by securitized mortgage loans represent borrowings associated with non-Agency RMBS retained in connection with our securitizations. Non-Agency RMBS associated with our securitizations are eliminated in consolidation with the VIE associated with such securitizations, and we consolidate the mortgage loans held by the securitization trust. (See Notes 5 and 14 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
(4) 
Fair value of collateral pledged reflects the fair value of the securitized mortgage loans held by the applicable securitization trust.
With respect to our repurchase agreement borrowings, the “haircut” represents the percentage by which the collateral value is contractually required to exceed the loan amount. At September 30, 2015, haircuts ranged from 3.0% to 5.0% for our repurchase borrowings secured by Agency RMBS and 10.0% to 45.0% for repurchase borrowings secured by non-Agency RMBS and other investment securities. Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call. Margin calls are satisfied when we pledge additional collateral in the form of securities and/or cash to the lender. We have met all margin calls to date.
Certain repurchase agreements and other transactional agreements subject us to financial covenants. An event of default or termination event would give certain of our counterparties the option to terminate all existing repurchase transactions with us and require amounts due to the counterparties by us to be payable immediately. We were in compliance with all of our financial covenants through September 30, 2015. At September 30, 2015, RMBS pledged as collateral to lenders as security for repurchase agreements totaled $3,146,670 (including securities that are eliminated in consolidation with VIEs) and RMBS held as a component of clearing margin totaled $4,215. Cash collateral held by counterparties is reported on our balance sheet as “Restricted cash” and, at September 30, 2015, was comprised of $33,557 provided in connection with repurchase borrowings and $36,105 provided in connection with derivative contracts.
Cash Flows and Liquidity for the Nine Months Ended September 30, 2015
Our cash and cash equivalents decreased by $12,591 during the nine months ended September 30, 2015, reflecting $443,150 used by financing activities, $34,807 provided by operating activities and $395,752 provided by investing activities. We held cash and cash equivalents of $101,852 at September 30, 2015. (See “Consolidated Statements of Cash Flows,” included under Item 1 with our consolidated Financial Statements in this Quarterly Report on Form 10-Q.)
Contractual Obligations and Commitments
The following table summarizes the effect on our liquidity and cash flows of our contractual obligations for principal and interest as of September 30, 2015:
Table 20
 
 
 
 
 
 
 
 
 
 
 
 
Less than  1
year
 
1 to 3
years
 
3 to 5
years
 
More than
5 years
 
Total
Borrowings under repurchase agreements
 
$
2,792,802

 
$
218,223

 
$

 
$

 
$
3,011,025

Interest on repurchase agreements borrowings (1) 
 
9,252

 
5,359

 

 

 
14,611

Total
 
$
2,802,054

 
$
223,582

 
$

 
$

 
$
3,025,636

(1) 
Interest expense is calculated based on the interest rate in effect at September 30, 2015 and includes all interest expense incurred and expected to be incurred in the future through the contractual maturity of the associated repurchase agreement.
The table above does not include amounts due under the Management Agreement as such obligations, discussed below, do not have fixed and determinable payments, or our anticipated dividend on our Preferred Stock. (See Notes 13(a) and 16(b) to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q for a discussion with respect to our Management Agreement and Preferred Stock.) At September 30, 2015, we had securitized debt with a balance of $21,351 (and a fair value of $21,243) with a contractual interest rate of 4.00%. Our securitized debt is not included in the table above, as such debt is non-recourse to us and is only paid to the extent of the performance of the mortgage loans in the February 2013 Securitization trust, which collateralize such debt.
Management Agreement
Pursuant to the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement) per annum. Our management fee is used, in part, to pay compensation to officers and personnel of the Manager who may also be our officers,


69



but receive no cash compensation directly from us. We reimburse our Manager and/or its affiliates for the allocable share of the compensation of (1) our Chief Financial Officer/Treasurer/Secretary based on the percentage of her time spent on our affairs and (2) other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs based on the percentage of time devoted by such personnel to our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, board of director fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. To the extent that our Manager or its affiliates pay for services provided on our behalf, we are required to reimburse our Manager and/or its affiliates for such items. Expense reimbursements to our Manager and/or its affiliates are made in cash generally on a monthly basis in arrears. Our reimbursement obligation is not subject to any dollar limitation.
Our Management Agreement currently runs through July 27, 2016, with automatic one year renewals thereafter provided that the independent directors of our board do not provide notice of termination. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. Following a meeting of our independent directors in January 2015, which included a discussion of the Manager’s performance and the level of the management fees, we determined not to seek termination of the Management Agreement.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment to provide additional funding to any such entities.
Dividends on Our Capital Stock
We have outstanding 6,900,000 shares of Preferred Stock, which entitles holders to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. The dividends on Preferred Stock are cumulative and payable quarterly in arrears. Except under certain limited circumstances, the Preferred Stock is generally not convertible into or exchangeable for any other property or any other of our securities at the election of the holders. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. No dividends may be paid on our common stock unless full cumulative dividends have been paid on the Preferred Stock, all of which have been paid to date.
We intend to make regular quarterly dividend distributions to holders of our common stock. U.S. Federal income tax law
generally requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains and
without regard to the deduction for dividends paid, and that it pay tax at regular corporate rates to the extent that it annually
distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our common stockholders in an amount at least equal to our net taxable income, if and to the extent authorized by our board of directors. Before we pay any dividend, whether for U.S. Federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debts payable. If our cash available for distribution is less than our net
taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the
required distribution in the form of a taxable stock distribution or distribution of debt securities. (See “Variances between
GAAP Income and Taxable Income,” above.)
Non-GAAP Financial Measures
We have included in this Form 10-Q disclosures about our “operating earnings,” “operating earnings per common share” and “effective cost of funds” which disclosures constitute non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. We believe that the non-GAAP financial measures presented, when considered together with GAAP financial measures, provide information that is useful to investors in understanding our operating results. An analysis of any non-GAAP financial measures should be made in conjunction with results presented in accordance with GAAP.


70



Operating earnings and operating earnings per common share presented exclude, as applicable: (i) certain realized and unrealized gains and losses recognized through earnings; (ii) non-cash equity compensation; (iii) one-time events pursuant to changes in GAAP; and (iv) certain other non-cash charges. Operating Earnings is a non-GAAP financial measure that is used by us to assess our business results.
While we have not elected hedge accounting under GAAP for our Swaps, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates. To present for investors how we view our Swaps, we provide the “effective cost of funds” which is comprised of GAAP interest expense plus the interest expense component for our Swaps. The interest expense component of our Swaps reflects the net interest payments made or accrued on our Swaps. We believe that the presentation of the effective cost of funds is useful for investors, as it presents borrowing costs as viewed by us.
We believe that the non-GAAP measures we present provide investors and other readers of this Quarterly Report on Form 10-Q with useful measures to assess the performance of our ongoing business and useful supplemental information to both management and investors in evaluating our financial results. The primary limitation associated with operating earnings as a measure of our financial performance over any period is that it excludes, except for the net interest component of Swaps, the effects of net realized and unrealized gains/(losses) from investments and derivative instruments. Our presentation of operating earnings may not be comparable to similarly-titled measures of other companies, who may use different definitions or calculations for such term. As a result, operating earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP.
A reconciliation of the GAAP items discussed above to their non-GAAP measures presented in this Quarterly Report on Form 10-Q are as follows:
Table 21
 
Three Months Ended
 
 
September 30, 2015
 
September 30, 2014
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
8,208

 
1.07
%
 
$
7,708

 
0.99
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest component of Swaps
 
4,874

 
0.63

 
5,128

 
0.66

Effective cost of funds
 
$
13,082

 
1.70
%
 
$
12,836

 
1.65
%
Average balance of borrowings
 
$
3,047,811

 
 
 
$
3,034,970

 
 
 
 
 
Nine Months Ended
 
 
September 30, 2015
 
September 30, 2014
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
24,273

 
1.01
%
 
$
22,486

 
1.00
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest paid for Swaps
 
14,757

 
0.62

 
14,998

 
0.67

Effective interest expense/effective cost of funds
 
$
39,030

 
1.63
%
 
$
37,484

 
1.67
%
Average balance of borrowings
 
$
3,173,561

 
 
 
$
2,968,154

 
 


71



Table 22
 
Three Months Ended
 
 
September 30, 2015
 
September 30, 2014
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
41,014

 
4.53
%
 
$
38,542

 
4.27
%
Less: effective interest expense/effective cost of funds (1)
 
13,082

 
1.70

 
12,836

 
1.65

Effective net interest income
 
$
27,932

 
2.83
%
 
$
25,706

 
2.62
%
Average balance of interest-earning assets
 
$
3,617,800

 
 
 
$
3,612,155

 
 
 
 
 
Nine Months Ended
 
 
September 30, 2015
 
September 30, 2014
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
121,927

 
4.29
%
 
$
114,863

 
4.31
%
Less: effective interest expense/effective cost of funds (1)
 
39,030

 
1.63

 
37,484

 
1.67

Effective net interest income
 
$
82,897

 
2.66
%
 
$
77,379

 
2.64
%
Average balance of interest-earning assets
 
$
3,731,438

 
 
 
$
3,550,683

 
 
(1) 
As reconciled above in Table 21.
The following table presents the reconciliation from net income/(loss) allocable to common stockholders to operating earnings:
Table 23
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014 (1)
 
2015
 
2014
Net income/(loss) allocable to common stockholders
 
$
(25,384
)
 
$
7,344

 
$
(21,215
)
 
$
71,960

Adjustments to arrive at operating earnings:
 
 
 
 
 
 
 
 
Realized (gain)/loss on sale of RMBS, net
 
(3,331
)
 
(2,581
)
 
(7,340
)
 
16,301

Realized (gain) on sale of other investment securities, net
 

 

 
(102
)
 

Unrealized (gain)/loss on RMBS, net
 
(161
)
 
13,154

 
26,325

 
(94,199
)
OTTI recognized
 
7,088

 
3,817

 
9,860

 
8,933

Unrealized (gain)/loss on derivative instruments, net
 
31,882

 
(12,434
)
 
24,047

 
20,751

Unrealized (gain)/loss on securitized mortgage loans, net
 
576

 
650

 
110

 
(2,440
)
Unrealized (gain)/loss on securitized debt
 
(172
)
 
(67
)
 
(1,186
)
 
287

Unrealized (gain)/loss on other investment securities
 
3,014

 
101

 
5,583

 
(75
)
Non-cash stock-based compensation expense
 
171

 
144

 
967

 
1,011

Realized loss on Swap and Swaption terminations, net
 
1,863

 
6,505

 
11,895

 
20,617

Realized loss on TBA Contracts
 
2,526

 

 
4,503

 
7,156

Other
 

 
(11
)
 

 
52

Tax amortization of (loss) on Swaption terminations and expirations, net
 
(721
)
 
(250
)
 
(1,779
)
 
(342
)
Total adjustments to arrive at operating earnings
 
42,735

 
9,028

 
72,883

 
(21,948
)
Operating earnings
 
$
17,351

 
$
16,372

 
$
51,668

 
$
50,012

Basic and diluted operating earnings per share of common stock
 
$
0.54

 
$
0.51

 
$
1.61

 
$
1.56

Weighted average common shares outstanding- basic (2)
 
31,947

 
32,035

 
32,013

 
32,024

(1) 
Prior presentation is conformed to the current presentation.
(2) 
Amounts in thousands.


72



ITEM 3.
Quantitative and Qualitative Disclosures about Market Risk.
(Dollar amounts in thousands – except per share data.)
We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from our assets through ownership of our capital stock. While we do not seek to avoid risk completely, we believe that risk can be quantified from historical experience and seek to actively manage risk, to earn sufficient returns to justify taking such risks and to maintain capital levels consistent with the risks we undertake.
Credit Risk
We are subject to varying degrees of credit risk in connection with our assets. Although we do not expect to encounter credit risk in our Agency RMBS, we do expect to encounter credit risk related to our non-Agency RMBS, other investment securities, securitized mortgage loans, mortgage loans and other investments. The credit support built into non-Agency RMBS and SBC-MBS transaction structures is designed to mitigate credit losses. In addition, to date, we have purchased the substantial majority of our non-Agency RMBS at a discount to par value, which is expected to further mitigate our risk of loss in the event that less than 100% of the par value of such securities is received. However, credit losses greater than those anticipated or in excess of the recorded purchase discount could occur, which could materially adversely impact our operating results. The credit risk associated with our warehouse line receivable is mitigated by a pledge of substantially all the equity of the third-party borrower/guarantor, which borrower has legal title to the homes, BFT Contracts and mortgage loans that we finance on a warehouse line. With respect to our securitized mortgage loans, we retain the risk of potential credit losses. Our Manager seeks to reduce downside risk related to unanticipated credit events through the use of active asset surveillance to evaluate collateral pool performance and overseeing the servicer.
Investment decisions are made following a bottom-up credit analysis and specific risk assumptions. As part of the risk management process our Manager uses detailed proprietary models to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure frequency, cost and timing.


73



The following table presents information about our non-Agency RMBS and the mortgages underlying such securities at September 30, 2015. Information presented with respect to weighted average original loan-to-value, weighted average credit score reported by Fair Isaac Corporation (or, FICO) and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 24
 
 
 
Year of Securitization (1)
 
 
 
 
2015
 
2014
 
2007
 
2006
 
2005
 
2004
 
2003 & 
Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of Securities
 
7

 
6

 
13

 
37

 
66

 
62

 
36

 
227

Carrying Value/Estimated Fair Value
 
$
50,205

 
$
87,792

 
$
85,600

 
$
238,998

 
$
371,247

 
$
298,085

 
$
108,261

 
$
1,240,188

Amortized Cost
 
$
50,445

 
$
88,045

 
$
74,981

 
$
220,900

 
$
361,780

 
$
290,596

 
$
104,668

 
$
1,191,415

Current Par Value
 
$
50,688

 
$
88,058

 
$
114,536

 
$
298,078

 
$
444,199

 
$
326,006

 
$
117,367

 
$
1,438,932

Carrying Value to Current Par
 
99.05
%
 
99.70
%
 
74.74
%
 
80.18
%
 
83.58
%
 
91.44
%
 
92.24
%
 
86.19
%
Amortized Cost to Current Par
 
99.52
%
 
99.99
%
 
65.46
%
 
74.11
%
 
81.45
%
 
89.14
%
 
89.18
%
 
82.80
%
Net Weighted Average Coupon
 
3.34
%
 
3.84
%
 
1.51
%
 
0.83
%
 
1.04
%
 
1.54
%
 
2.03
%
 
1.48
%
Collateral Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted Average Loan Age (in months)
 
110

 
106

 
104

 
113

 
125

 
136

 
156

 
125

Weighted Average Original Loan-to-Value
 
99.61
%
 
82.38
%
 
78.47
%
 
78.87
%
 
79.88
%
 
80.49
%
 
81.54
%
 
80.85
%
Weighted Average Original FICO
 
614

 
564

 
667

 
665

 
660

 
626

 
604

 
640

Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
60+ Days Delinquent
 
36.14
%
 
78.08
%
 
26.50
%
 
25.37
%
 
25.78
%
 
22.62
%
 
24.92
%
 
29.04
%
Average Credit Enhancement (2)
 
31.70
%
 
49.87
%
 
13.05
%
 
22.01
%
 
31.57
%
 
28.15
%
 
24.70
%
 
28.33
%
3 Month CRR (3)
 
3.37
%
 
2.67
%
 
4.82
%
 
4.50
%
 
6.84
%
 
7.09
%
 
6.28
%
 
5.88
%
(1) 
Certain of our non-Agency RMBS have been resecuritized; however, the vintage and information presented is based on the initial year of securitization and the data available at that time.
(2) 
Credit enhancement is expressed as a percentage of all outstanding mortgage loan collateral. Our RMBS may incur losses if credit enhancement is reduced to zero.
(3) 
Amounts presented reflect the weighted average monthly performance for the three months ended September 30, 2015.


74



The following table presents certain characteristics about mortgage loans underlying the February 2013 Securitization at September 30, 2015. All of the mortgage liens underlying the February 2013 Securitization are first liens on residential properties. Information presented with respect to weighted average original loan-to-value, weighted average FICO score, and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 25
 
Year of Origination
 
 
 
 
2008
 
2007
 
2006
 
2005
 
2004 & Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
Number of loans
 
57

 
577

 
13

 
6

 
2

 
655

Current unpaid principal balance
 
$
11,391

 
$
113,408

 
$
2,550

 
$
1,143

 
$
144

 
$
128,636

Loan Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average loan age (in months)
 
90

 
99

 
105

 
122

 
134

 
98

Weighted average original loan-to-value
 
74.08
%
 
80.14
%
 
82.60
%
 
80.69
%
 
100.00
%
 
79.68
%
Weighted average original FICO score
 
603

 
629

 
624

 
609

 
669

 
627

Net weighted average coupon rate
 
6.79
%

5.93
%

5.21
%

5.39
%

6.38
%

5.98
%
Performance:
 
 
 
 
 
 
 
 
 
 
 
 
Current
 
68.89
%
 
71.41
%
 
72.66
%
 
100.00
%
 
%
 
71.39
%
30 day delinquent
 
6.23
%
 
8.64
%
 
%
 
%
 
%
 
8.17
%
60 days delinquent
 
4.23
%
 
2.63
%
 
%
 
%
 
%
 
2.69
%
90+ days delinquent
 
11.73
%
 
9.43
%
 
10.25
%
 
%
 
42.63
%
 
9.60
%
Bankruptcy/foreclosure
 
8.92
%
 
7.89
%
 
17.09
%
 
%
 
57.37
%
 
8.15
%
The following table presents certain characteristics about mortgage loans underlying the March 2015 Securitization at September 30, 2015. All of the mortgage liens underlying the March 2015 Securitization are first liens on residential properties. Information presented with respect to weighted average original loan-to-value, weighted average FICO score, and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 26
 
Year of Origination
 
 
 
 
2009
 
2008
 
2007
 
2006
 
2005
 
2004 & Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of loans
 
3

 
9

 
111

 
146

 
96

 
295

 
660

Current unpaid principal balance
 
$
470

 
$
3,053

 
$
21,144

 
$
25,350

 
$
14,124

 
$
23,284

 
$
87,425

Loan Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average loan age (in months)
 
74

 
89

 
99

 
108

 
121

 
154

 
119

Weighted average original loan-to-value
 
72.77
%
 
70.86
%
 
80.34
%
 
81.01
%
 
76.46
%
 
83.56
%
 
80.39
%
Weighted average original FICO score
 
518

 
721

 
638

 
620

 
653

 
605

 
627

Net weighted average coupon rate
 
7.28
%
 
5.02
%
 
5.47
%
 
5.97
%
 
5.22
%
 
6.53
%
 
5.85
%
Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
 
%
 
79.56
%
 
80.72
%
 
79.50
%
 
85.47
%
 
77.08
%
 
79.70
%
30 day delinquent
 
%
 
12.07
%
 
9.41
%
 
11.41
%
 
10.03
%
 
12.98
%
 
11.08
%
60 days delinquent
 
40.70
%
 
%
 
2.62
%
 
2.77
%
 
%
 
5.54
%
 
3.13
%
90+ days delinquent
 
35.70
%
 
8.37
%
 
5.31
%
 
6.24
%
 
3.08
%
 
0.86
%
 
4.30
%
Bankruptcy/foreclosure
 
23.60
%
 
%
 
1.94
%
 
0.08
%
 
1.42
%
 
3.54
%
 
1.79
%
At September 30, 2015, our other investment securities included investments in Agency Risk Sharing Securities and SBC-MBS. The performance of our SBC-MBS is based upon the performance of the underlying loans collateralizing the SBC-MBS securitization and the performance of our Agency Risk Sharing securities is based upon the performance of the referenced securities.


75



The table below presents certain information about the credit characteristics of the underlying referenced mortgage pools or, underlying assets as applicable, associated with the securities presented at September 30, 2015:
Table 27
 
Risk Sharing Securities-Freddie Mac
 
Risk Sharing Securities- Fannie Mae
 
SBC-MBS
Portfolio Characteristics:
 
 
 
 
 
 
Carrying value/estimated fair value
 
$
48,206

 
$
51,532

 
$
59,985

Amortized cost
 
$
49,546

 
$
53,572

 
$
61,950

Current par value
 
$
49,242

 
$
55,287

 
$
70,032

Net weighted average coupon
 
3.72
%
 
3.77
%
 
0.75
%
Collateral Attributes:
 

 

 

Weighted average loan age (in months)
 
28

 
24

 
108

Weighted average original loan-to-value
 
71.48
%
 
71.84
%
 
59.44
%
Weighted average original FICO score
 
762

 
757

 
674

Performance:
 

 

 

60+ days delinquent
 
0.05
%
 
0.05
%
 
19.24
%
Average credit enhancement
 
1.03
%
 
0.40
%
 
23.68
%
The following table presents the fair value of our non-Agency RMBS at September 30, 2015, by original purchase price as a percentage of our par value by year of acquisition:
Table 28
 
Year of Acquisition
 
 
 
 
Acquisition Price (1)
 
2015
 
2014
 
2013
 
2012
 
2011
 
Total
 
Percent of Total
>100%
 
$
5,224

 
$
1,972

 
$
1,708

 
$

 
$

 
$
8,904

 
0.7
%
100% to 95%
 
59,125

 
119,905

 
17,815

 

 

 
196,845

 
15.9

<95% to 85%
 
65,893

 
94,062

 
181,500

 
27,846

 
2,945

 
372,246

 
30.0

<85% to 75%
 
8,958

 
75,962

 
159,226

 
59,935

 
8,371

 
312,452

 
25.2

<75% to 65%
 
4,394

 
22,740

 
64,201

 
80,784

 
14,595

 
186,714

 
15.1

<65%
 
6,762

 
7,799

 
7,798

 
119,231

 
21,437

 
163,027

 
13.1

Total
 
$
150,356

 
$
322,440

 
$
432,248

 
$
287,796

 
$
47,348

 
$
1,240,188

 
100.0
%
(1) 
Prices are expressed as a percentage of par value.
The mortgages underlying our non-Agency RMBS are located in various states across the U.S. The following table presents the five largest concentrations by state for the mortgages collateralizing our non-Agency RMBS at September 30, 2015 based on fair value:
Table 29
 
 
Property Location
 
Percent (1)
California
 
26.8
%
New York
 
11.1

Florida
 
8.6

New Jersey
 
5.2

Texas
 
4.9

Other (2) 
 
43.4

Total
 
100.0
%
(1) 
Percentages are weighted to reflect our proportional share for each of the securities we own.
(2) 
Includes mortgages on properties located in each of the remaining 45 states and the District of Columbia, with no state concentration exceeding 3.2% of the total.


76



The following table presents certain information about the mortgage loans underlying our non-Agency RMBS at September 30, 2015:
Table 30
 
 
 
 
Underlying Mortgage Loan Collateral Type
 
Market Value
 
Percent of Total
Subprime
 
$
884,211

 
71.3
%
Alt-A
 
156,128

 
12.6

Option ARMs
 
199,849

 
16.1

Total
 
$
1,240,188

 
100.0
%
The following table presents the five largest state concentrations, in the aggregate, for mortgage loans included in our securitizations based on principal balance at September 30, 2015:
Table 31
 
 
 
 
Property Location
 
Principal Balance
 
Total Concentration
Florida
 
$
39,417

 
18.2
%
California
 
37,835

 
17.5

Maryland
 
17,931

 
8.3

Texas
 
13,824

 
6.4

New York
 
12,200

 
5.6

Other states and the District of Columbia
 
94,854

 
44.0

Total
 
$
216,061

 
100.0
%
Interest Rate Risk
Interest rates are sensitive to many factors, including fiscal and monetary policies, domestic and international economic and political considerations, as well as other factors, all of which are beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset specific funding arrangements.
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments to mitigate the impact of increases in interest rates. Increases in interest rates may impact the cost of our repurchase borrowings and reduce the value of our Agency RMBS. Our hedges are not designed to protect against market value fluctuations in our assets caused by changes in the spread between our investments and other benchmark rates such as Swaps and Treasury bonds. Therefore, the risk of adverse spread changes is inherent to our business. Our asset composition and general market conditions may cause the amount of interest rate protection provided by our derivatives to vary considerably over time. We also may utilize a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS, Inverse IO and Inverse Floater securities and Long TBA Contracts to decrease; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts, if any, Swaps and Swaption contracts to increase. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.


77



Interest Rate Cap Risk
Certain of our RMBS and securitized mortgage loans are subject to interest rate caps, which could cause such assets to acquire characteristics similar to fixed-rate securities if interest rates were to rise above the cap levels. Interim interest rate caps limit the amount that interest rates on a particular instrument can adjust periodically. Lifetime interest rate caps limit the amount interest rates can adjust upward from inception through maturity of a particular instrument. Investments that are subject to caps could result in us receiving income on such investments that is less than the interest expense we may incur on borrowings to finance such investments. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under “Interest Rate Risk.”
Interest Rate Effects on Estimated Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease differently from our derivative instruments.
The impact of changing interest rates on estimated fair value can change significantly when interest rates change materially. Accordingly, changes in actual interest rates may have a material adverse effect on us. Therefore, the volatility in the estimated fair value of our assets could increase significantly in the event that interest rates change materially. In addition, other factors impact the estimated fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions.
Our RMBS are carried at their estimated fair value with unrealized gains and losses included in earnings. The estimated fair value of these securities fluctuates primarily due to changes in interest rates, and with respect to our non-Agency RMBS, credit changes, and other factors. Generally, in a rising interest rate environment, the estimated fair value of our RMBS portfolio, on a net basis, would generally be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would generally be expected to increase.
Our securitized mortgage loans are carried at their estimated fair value with unrealized gains and losses included in earnings. Such assets, which are credit sensitive, are comprised of both ARMs and fixed rate mortgage loans. As a result, changes in the fair value of our securitized mortgage loans are expected to be impacted by delinquencies, changes in housing prices, jobless rates and other factors to a greater extent than by changes in interest rates.
Nearly all of our Agency pass-through RMBS, which comprise the substantial majority of our Agency portfolio, are fixed- rate securities. In general, as market interest rates increase the market prices for fixed-rate securities generally decrease; conversely, as market interest rates decrease the market prices for fixed-rate securities generally increase. We monitor the duration of our Agency RMBS and derivatives, using empirical data as well as third-party models and may adjust our portfolio to maintain duration at a level that we believe is prudent in the current or anticipated interest rate environment. In a rising interest rate environment, the weighted average life of our Agency RMBS could extend significantly beyond the terms of our Swaps or other hedging instruments. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed beyond the term of the hedging instrument while the income earned on the remaining Agency RMBS would remain fixed for a period of time. This situation may also cause the market value of our Agency RMBS to decline with insufficient or no offsetting gain from the related hedging transactions. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses. Variations in models and methodologies in measuring duration may produce differing results for the same securities or portfolio.
Our non-Agency RMBS and securitized mortgage loans, are backed by Hybrid, ARMs and fixed rate mortgage loans. These loans may be performing, re-performing or non-performing and, as such, are more significantly impacted by the performance of the underlying collateral (i.e., credit) than by changes in interest rates.
Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call, which we satisfy by pledging additional collateral in the form of securities and/or cash to the lender. In general, decreases in the fair value of our RMBS and MBS will reduce the amount we are able to borrow.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including derivative instruments and net interest income at September 30, 2015, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilizes our Manager’s assumptions, models and estimates, which are based on our Manager’s judgment and experience. For example, given the low level of interest rates at September 30, 2015, we have


78



assumed a floor on repurchase agreement borrowing rates of 25 basis points and we have assumed a floor of six basis points with respect to the variable rate that we receive on our Swaps.
Table 32
 
 
 
 
Basis Point Change in Interest Rates
 
Percentage Change in Projected
Portfolio Value
 
Percentage Change in Projected 
Net Interest Income and Periodic Interest Settlements for Swaps
+100
 
0.78%
 
8.96%
+50
 
1.37%
 
5.07%
(50)
 
(0.61)%
 
(13.12)%
(100)
 
(2.03)%
 
(22.65)%
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at September 30, 2015. The analysis presented utilizes assumptions and estimates based on our Manager’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.
Prepayment Risk
The value of our assets may be affected by prepayment rates on residential mortgage loans. If we acquire residential mortgage loans and mortgage related securities, we anticipate that the residential mortgage loans or the underlying residential mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated.
Counterparty Risk
We finance the acquisition of a significant portion of our investments with repurchase agreements. The aggregate of our repurchase agreement financings are reflected as a liability in our consolidated balance sheet. In connection with these financing arrangements, we pledge our securities as collateral to secure the borrowing. The amount of collateral pledged will typically exceed the amount of the borrowing, as lenders apply a haircut to the collateral value, whereby the haircut reflects the percentage by which the collateral value is discounted to determine the loan amount. As a result, we are exposed to the counterparty if, during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral. (For additional information about our assets pledged as collateral as of September 30, 2015, see Note 9 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)

We enter into Swaps, Swaptions, and TBA Contracts to manage our interest rate risk and are required to pledge cash or securities as collateral as part of a margin arrangement in connection with such contracts. The amount of margin that we are required to post will vary by counterparty and generally reflects collateral posted with respect to Swaps and TBA Contracts that are in an unrealized loss position to us and a percentage of the aggregate notional amount of Swaps and Swaptions per counterparty. In the event that a counterparty to one of these contracts were to default on its obligation, we would be exposed to a loss when the amount of cash or securities pledged by us exceeds the unrealized loss on such contracts and to the extent that we are not able to recover our excess collateral. In addition, if a counterparty to a Swap cannot perform under the terms of the Swap, we may not receive payments due under that agreement, and thus, may lose any unrealized gain associated with the Swap or, be unable to collect the cash value, if any, at expiration. Therefore, upon a default by a Swap counterparty, the Swap would no longer mitigate the impact of changes in interest rates as intended. If a counterparty to a Swaption contract we purchased cannot perform under the terms of a Swaption, we would lose our ability to exercise our option to enter into a Swap and could lose the amount by which the Swaption is in-the-money.



79



During the past several years, certain repurchase agreement and derivative counterparties in the U.S. and Europe have experienced financial difficulty and have been either rescued by government assistance or otherwise benefited from accommodative monetary policy of their respective central banks. Certain Swap trades entered into since June 10, 2013 are required to be cleared through a clearinghouse, in accordance with the CFTC Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties.
The following table summarizes our exposure to our repurchase agreements and derivative counterparties at September 30, 2015:
Table 33
 
 
 
 
 
 
 
 
 
 
 
 
Number of
Counter-
parties
 
Repurchase
Agreement
Borrowings
 
Derivatives at
Fair Value
 
Exposure (1)
 
Exposure
as Percent
of Total
Assets
North America:
 
 
 
 
 
 
 
 
 
 
United States (2)
 
8

 
$
1,512,416

 
$
(18,434
)
 
$
221,760

 
5.8
%
Canada (3)
 
2

 
347,313

 

 
71,685

 
1.9

 
 
10

 
1,859,729

 
(18,434
)
 
293,445

 
7.7

Europe: (3)
 
 
 
 
 
 
 
 
 
 
Germany
 
1

 
13,262

 

 
2,419

 
0.1
%
Switzerland
 
3

 
216,119

 

 
76,535

 
2.0

United Kingdom
 
2

 
76,392

 
(2,610
)
 
26,894

 
0.7

Netherlands
 
1

 
235,090

 

 
14,190

 
0.4

France
 
1

 
227,043

 

 
26,141

 
0.7

 
 
8

 
767,906

 
(2,610
)
 
146,179

 
3.9

Asia: (3)
 
 
 
 
 
 
 
 
 
 
Japan
 
2

 
383,390

 
(3,738
)
 
23,552

 
0.6

Total
 
20

 
$
3,011,025

 
$
(24,782
)
 
$
463,176

 
12.2
%
 
(1) 
Represents the amount of cash and/or securities pledged as collateral to counterparties and associated accrued interest receivable less the aggregate of repurchase agreement borrowings, associated accrued interest payable and unrealized loss on Swaps for each counterparty net of collateral pledged to us, and the net fair value of our Swaptions.
(2) 
Includes $3,416 of exposure associated with a Swap that is cleared through a U.S. based clearing house.
(3) 
Includes foreign based counterparties as well as U.S. domiciled subsidiaries of such counterparties, as such transactions are generally entered into with a U.S. domiciled subsidiary of such counterparties.
We extend credit to our Seller Financing Program counterparty through a warehouse line, which is used by the counterparty to fund home purchases and improvements. Subsequent to purchasing and rehabilitating a home, our Seller Financing Program counterparty markets the home for sale, offering seller financing through either a BFT Contract or mortgage loan. Once the Seller Financing Program counterparty completes the transaction cycle, by entering into a BFT Contract or mortgage loan with a home buyer, we have the right of first refusal to purchase the corresponding BFT Contract or mortgage loan. The warehouse line is collateralized by a pledge of the ownership interest in the equity of our Seller Financing Program counterparty which holds title to the real estate properties funded with the warehouse line. At September 30, 2015, we had $12,424 outstanding under our warehouse line. If our Seller Financing Program counterparty becomes distressed, we may have difficulty in taking possession of the properties and completing improvements necessary to market the homes for sale.


80



We had outstanding balances under repurchase agreements with 18 counterparties at September 30, 2015. The following table presents information with respect to any counterparty for repurchase agreements for which we had greater than 5% of stockholders’ equity at risk in the aggregate at September 30, 2015:
Table 34
 
 
 
 
 
 
 
 
Counterparty
 
Counterparty Rating(1)
 
Amount of Risk(2)
 
Weighted Average Months to Maturity for Repurchase Agreements
 
Percent of Stockholders’ Equity
Credit Suisse Securities (USA) LLC
 
A/*/*
 
$
36,123

 
3

 
5.1
%
UBS(3)
 
A/A2/*
 
$
40,413

 
9

 
5.7
%
Royal Bank of Canada(4)
 
AA-/Aa3/AA
 
$
68,112

 
2

 
9.5
%
Wells Fargo(5)
 
AA-/Aa2/AA
 
$
85,250

 
11

 
11.9
%
(1) 
The counterparty rating presented is the long-term issuer credit rating as rated at September 30, 2015 by Standard & Poor’s Ratings Services, Moody’s Investor Services, Inc. and Fitch, Inc., respectively. An “*” indicates that no rating was given by the respective rating agency.  
(2) 
The amount at risk reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities.
(3) 
Includes amounts at risk with UBS AG, London Branch and UBS Securities, LLC. Counterparty rating is the rating for UBS AG, London Branch which represents $33,412 of total exposure. The remaining exposure is to UBS Securities, LLC which was rated A by Standard & Poor’s Ratings Services at September 30, 2015.
(4) 
Includes amounts at risk with Royal Bank of Canada and RBC (Barbados) Trading Bank Corporation. Counterparty rating is the rating for Royal Bank of Canada. which represents $30,424 of the total exposure. The remaining exposure is to RBC (Barbados) Trading Bank Corporation which was rated A2 by Moody’s Investor Services, Inc. at September 30, 2015.
(5) 
Includes amounts at risk with Wells Fargo Bank, N.A. and Wells Fargo Securities, LLC. Counterparty rating is the rating for Wells Fargo Bank, N.A. which represents $76,743 of the total exposure. The remaining exposure is to Wells Fargo Securities, LLC which was rated AA- by Standard & Poor’s Ratings Services as of September 30, 2015.
We maintain cash deposits with what we believe to be high credit quality financial institutions and invest in money market funds. Money market funds are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other U.S. Government agency. At September 30, 2015, we had cash and cash equivalents of $101,852, reflecting $40,009 invested in a money market fund and the remainder was primarily comprised of deposits with our prime broker domiciled in the U.S., substantially all of which was in excess of applicable insurance limits.
Funding Risk
We have financed a substantial majority of our securities and mortgage loans with repurchase agreement borrowings. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.
Liquidity Risk
The assets that comprise our asset portfolio are not traded on an exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than exchange-traded securities. Certain of our assets may from time to time become illiquid, making it difficult for us to sell such assets if the need or desire arises, or sell such assets at prices that are detrimental to us, including in response to changes in economic and other conditions.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation. Our financial statements are prepared in accordance with GAAP and dividends are based upon net ordinary income as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.


81



ITEM 4.
Controls and Procedures.
The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as of September 30, 2015, our disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder.
During the period ended September 30, 2015, there was no change in our internal control over financial reporting that has materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.


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PART II – OTHER INFORMATION
ITEM 1.
Legal Proceedings
From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of September 30, 2015, we were not involved in any legal proceedings that could have a material adverse impact on our financial condition or results of operations.

ITEM 1A.
Risk Factors
There were no material changes to the Risk Factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.
ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchase of Equity Securities
The following table sets forth our repurchases of common stock during each of the months in the quarter ended September 30, 2015:
(Dollars in thousands, except per share amounts.)
Period
 
Total Number of Shares of Common Stock Purchased (1)
 
Weighted Average Price Paid per Share (2) (3)
 
Total Number of Shares of Common Stock Purchased as Part of Publicly Announced Plans or Program
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans
July 1, 2015 through July 31, 2015
 
 
$

 
 
$
50,000

August 1, 2015 through August 31, 2015
 
202,655
 
13.86

 
202,655
 
47,191

September 1, 2015 through September 30, 2015
 
158,145
 
13.86

 
158,145
 
45,000

 
 
360,800
 
$
13.86

 
360,800
 
$
45,000

(1) 
On November 6, 2013, we announced that our board of directors approved a stock repurchase program to authorize us to repurchase up to an aggregate of $50,000 of our shares of common stock. This authorization does not have an expiration date and may be suspended or discontinued by our board of directors at any time without prior notice.
(2) 
Based on trade date.
(3) 
Includes brokerage commissions.


ITEM 3.
Defaults Upon Senior Securities
None.
ITEM 4.
Mine Safety Disclosures
Not Applicable.
ITEM 5.
Other Information
None.


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ITEM 6.
Exhibits
Exhibit No.
  
Description
 
 
3.1

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

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

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

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

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

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

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

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

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

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

 
Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K filed January 5, 2015.
 
 
 
10.7

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

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

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

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

  
XBRL Instance Document
 
 


84



101.SCH

  
XBRL Taxonomy Extension Schema Document
 
 
101.CAL

  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF

  
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB

  
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE

  
XBRL Taxonomy Extension Presentation Linkbase Document



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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
 
 
 
 
 
 
APOLLO RESIDENTIAL MORTGAGE, INC.
 
 
 
 
 
 
 
 
November 9, 2015
 
 
 
 
 
 
 
 
By:
 
/s/ Michael A. Commaroto
 
 
 
 
 Michael A. Commaroto
 
 
 
 
 President and Chief Executive Officer
 
 
 
 
 (Principal Executive Officer)
 
 
 
 
 
 
 
 
By:
 
/s/ Teresa D. Covello
 
 
 
 
 Teresa D. Covello
 
 
 
 
 Chief Financial Officer
 
 
 
 
 (Principal Financial Officer and Principal Accounting Officer)


86