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EX-31.2 - EX-31.2 - ANWORTH MORTGAGE ASSET CORPanh-ex312_76.htm
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EX-32.2 - EX-32.2 - ANWORTH MORTGAGE ASSET CORPanh-ex322_74.htm
EX-32.1 - EX-32.1 - ANWORTH MORTGAGE ASSET CORPanh-ex321_73.htm

 

  

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2016

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-13709

 

ANWORTH MORTGAGE ASSET CORPORATION

(Exact name of registrant as specified in its charter)

 

 

MARYLAND

52-2059785

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer
Identification No.)

 

1299 Ocean Avenue, Second Floor,
Santa Monica, California

90401

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (310) 255-4493

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

Large Accelerated Filer

¨

Accelerated Filer

x

 

 

 

 

Non-Accelerated Filer

¨  (Do not check if a smaller reporting company)

Smaller Reporting Company

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

At May 4, 2016, the registrant had 96,612,137 shares of common stock issued and 96,455,610 shares outstanding.

 

 

 

 


ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

FORM 10-Q

INDEX

 

 

 

 

Page

Part I.

 

FINANCIAL INFORMATION

1

 

Item 1.

Consolidated Financial Statements

1

 

 

Consolidated Balance Sheets as March 31, 2016 (unaudited) and December 31, 2015

1

 

 

Consolidated Statements of Operations for the three months ended March 31, 2016 and 2015 (unaudited)

2

 

 

Consolidated Statements of Comprehensive Income (Loss) for the three months ended March 31, 2016 and 2015 (unaudited)

3

 

 

Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2016 (unaudited)

4

 

 

Consolidated Statements of Cash Flows for the three months ended March 31, 2016 and 2015 (unaudited)

5

 

 

Notes to Unaudited Consolidated Financial Statements

6

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

31

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

47

 

Item 4.

Controls and Procedures

51

Part II.

 

OTHER INFORMATION

52

 

Item 1.

Legal Proceedings

52

 

Item 1A.

Risk Factors

52

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

52

 

Item 3.

Defaults Upon Senior Securities

52

 

Item 4.

Mine Safety Disclosures

52

 

Item 5.

Other Information

52

 

Item 6.

Exhibits

53

 

 

Signatures

56

 

 

 


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

Part I. FINANCIAL INFORMATION

 

Item 1.

Consolidated Financial Statements

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

 

 

 

March 31,

 

 

December 31,

 

 

 

2016

 

 

2015

 

 

 

 

 

 

 

(audited)

 

ASSETS

 

 

 

 

 

 

 

 

Agency MBS:

 

 

 

 

 

 

 

 

Agency MBS pledged to counterparties at fair value

 

$

4,186,554

 

 

$

4,694,731

 

Agency MBS at fair value

 

 

147,420

 

 

 

173,344

 

Paydowns receivable

 

 

21,816

 

 

 

24,707

 

 

 

$

4,355,790

 

 

$

4,892,782

 

Non-Agency MBS at fair value (including $579,277 and $596,831 pledged to counterparties at

     March 31, 2016 and December 31, 2015, respectively)

 

 

662,054

 

 

 

682,061

 

Residential mortgage loans held-for-investment(1)

 

 

911,514

 

 

 

969,172

 

Residential real estate

 

 

14,337

 

 

 

14,363

 

Cash and cash equivalents

 

 

12,547

 

 

 

5,754

 

Restricted cash

 

 

30,029

 

 

 

39,230

 

Interest and dividends receivable

 

 

19,089

 

 

 

17,525

 

Derivative instruments at fair value

 

 

6,970

 

 

 

12,470

 

Prepaid expenses and other

 

 

3,248

 

 

 

2,983

 

Total Assets:

 

$

6,015,578

 

 

$

6,636,340

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

Accrued interest payable

 

$

13,002

 

 

$

13,443

 

Repurchase agreements

 

 

4,360,991

 

 

 

4,915,528

 

Asset-backed securities issued by securitization trusts(1)

 

 

857,965

 

 

 

915,486

 

Junior subordinated notes

 

 

37,380

 

 

 

37,380

 

Derivative instruments at fair value

 

 

58,186

 

 

 

34,547

 

Dividends payable on Series A Preferred Stock

 

 

1,035

 

 

 

1,035

 

Dividends payable on Series B Preferred Stock

 

 

394

 

 

 

394

 

Dividends payable on Series C Preferred Stock

 

 

207

 

 

 

207

 

Dividends payable on common stock

 

 

14,539

 

 

 

14,861

 

Accrued expenses and other

 

 

6,415

 

 

 

1,308

 

Total Liabilities:

 

$

5,350,114

 

 

$

5,934,189

 

Series B Cumulative Convertible Preferred Stock: par value $0.01 per share; liquidating

    preference $25.00 per share ($25,241 and $25,241, respectively); 1,010 and 1,010

    shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively

 

$

23,924

 

 

$

23,924

 

Stockholders' Equity:

 

 

 

 

 

 

 

 

          Series A Cumulative Preferred Stock: par value $0.01 per share; liquidating

              preference $25.00 per share ($47,984 and $47,984, respectively); 1,919 and 1,919

              shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively

 

$

46,537

 

 

$

46,537

 

          Series C Cumulative Preferred Stock: par value $0.01 per share; liquidating

              preference $25.00 per share ($10,848 and $10,848, respectively); 434 and 434 shares

               issued and outstanding at March 31, 2016 and December 31, 2015, respectively

 

 

10,039

 

 

 

10,039

 

          Common Stock: par value $0.01 per share; authorized 200,000 shares, 96,939 shares

               issued and 96,836 shares outstanding at March 31, 2016 and 99,078 shares issued

               and 98,944 shares outstanding at December 31, 2015, respectively

 

 

969

 

 

 

991

 

Additional paid-in capital

 

 

971,937

 

 

 

981,034

 

Accumulated other comprehensive income consisting of unrealized gains and losses

 

 

9,811

 

 

 

949

 

Accumulated deficit

 

 

(397,753

)

 

 

(361,323

)

Total Stockholders' Equity:

 

$

641,540

 

 

$

678,227

 

Total Liabilities and Stockholders' Equity:

 

$

6,015,578

 

 

$

6,636,340

 

 

 

(1)

The consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations and liabilities of the VIEs for which creditors do not have recourse to the Company. At March 31, 2016 and December 31, 2015, total assets of the consolidated VIEs were $915 million and $972 million, respectively, and total liabilities were $861 million and $918 million, respectively. Please refer to Note 4, “Variable Interest Entities,” for further discussion.  

 

See accompanying notes to unaudited consolidated financial statements.

 

1


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

March 31,

 

 

 

2016

 

 

2015

 

Interest and other income:

 

 

 

 

 

 

 

 

Interest-Agency MBS

 

$

20,765

 

 

$

30,588

 

Interest-Non-Agency MBS

 

 

9,281

 

 

 

3,647

 

Interest-residential mortgage loans

 

 

9,313

 

 

 

-

 

Income-rental properties

 

 

410

 

 

 

370

 

Other interest income

 

 

12

 

 

 

10

 

 

 

 

39,781

 

 

 

34,615

 

Interest Expense:

 

 

 

 

 

 

 

 

Interest expense on repurchase agreements

 

 

9,398

 

 

 

6,689

 

Interest expense on asset-backed securities

 

 

8,599

 

 

 

-

 

Interest expense on junior subordinated notes

 

 

346

 

 

 

315

 

 

 

 

18,343

 

 

 

7,004

 

Net operating income

 

 

21,438

 

 

 

27,611

 

Provision for loan losses

 

 

-

 

 

 

-

 

Net operating income after provision for loan losses

 

 

21,438

 

 

 

27,611

 

Operating Expenses:

 

 

 

 

 

 

 

 

Management fee to related party

 

 

(2,044

)

 

 

(2,336

)

General and administrative expenses

 

 

(1,568

)

 

 

(1,279

)

Total operating expenses

 

 

(3,612

)

 

 

(3,615

)

Other (Loss):

 

 

 

 

 

 

 

 

(Loss) on sales of Agency MBS

 

 

(3,239

)

 

 

-

 

(Loss) on sales of Non-Agency MBS

 

 

-

 

 

 

(3

)

(Loss) on interest rate swaps, net

 

 

(50,219

)

 

 

(46,488

)

Gain on derivatives-TBA Agency MBS, net

 

 

15,354

 

 

 

8,525

 

Gain (loss) on derivatives-Eurodollar Futures Contracts

 

 

22

 

 

 

(2,338

)

Recovery on Non-Agency MBS

 

 

1

 

 

 

1

 

Total other (loss)

 

 

(38,081

)

 

 

(40,303

)

Net (loss)

 

$

(20,255

)

 

$

(16,307

)

Dividend on Series A Cumulative Preferred Stock

 

 

(1,035

)

 

 

(1,035

)

Dividend on Series B Cumulative Convertible Preferred Stock

 

 

(394

)

 

 

(394

)

Dividend on Series C Cumulative Redeemable Preferred Stock

 

 

(207

)

 

 

(111

)

Net (loss) to common stockholders

 

$

(21,891

)

 

$

(17,847

)

Basic (loss) per common share

 

$

(0.22

)

 

$

(0.17

)

Diluted (loss) per common share

 

$

(0.22

)

 

$

(0.17

)

Basic weighted average number of shares outstanding

 

 

97,704

 

 

 

107,228

 

Diluted weighted average number of shares outstanding

 

 

97,704

 

 

 

107,228

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

2


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

(unaudited)

 

 

 

Three Months Ended

March 31,

 

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

Net (loss)

 

$

(20,255

)

 

$

(16,307

)

Available-for-sale Agency MBS, fair value adjustment

 

 

24,385

 

 

 

23,803

 

Reclassification adjustment for loss on sales of Agency MBS included in

     net (loss)

 

 

3,239

 

 

 

-

 

Available-for-sale Non-Agency MBS, fair value adjustment

 

 

(22,333

)

 

 

2,157

 

Reclassification adjustment for loss on sales of Non-Agency MBS

     included in net (loss)

 

 

-

 

 

 

3

 

Unrealized gains on derivatives

 

 

3,369

 

 

 

6,108

 

Reclassification adjustment for interest expense on swap agreements

     included in net (loss)

 

 

202

 

 

 

524

 

Other comprehensive income

 

 

8,862

 

 

 

32,595

 

Comprehensive (loss) income

 

$

(11,393

)

 

$

16,288

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

 

3


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except per share amounts)

(unaudited)

 

 

 

Series A

Preferred Stock Shares Outstanding

 

 

Series C

Preferred Stock Shares Outstanding

 

 

Common Stock Shares Outstanding

 

 

Series A

Preferred Stock

Par Value

 

 

Series C

Preferred Stock

Par Value

 

 

Common Stock Par Value

 

 

Additional

Paid-In

Capital

 

 

Accum. Other

Comp.

Income Gain

Agency MBS

 

 

Accum. Other

Comp.

Income (Loss)

Non-Agency MBS

 

 

Accum. Other Comp.Gain (Loss) Derivatives

 

 

Accum. (Deficit)

 

 

Total

 

Balance, December 31, 2015

 

 

1,919

 

 

 

434

 

 

 

98,944

 

 

$

46,537

 

 

$

10,039

 

 

$

991

 

 

$

981,034

 

 

$

23,143

 

 

 

2,363

 

 

$

(24,557

)

 

$

(361,323

)

 

$

678,227

 

Issuance of Series C Preferred Stock

 

 

 

 

 

 

-

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

-

 

Issuance of common stock

 

 

 

 

 

 

 

 

 

 

59

 

 

 

 

 

 

 

 

 

 

 

1

 

 

 

253

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

254

 

Redemption of common stock

 

 

 

 

 

 

 

 

 

 

(2,074

)

 

 

 

 

 

 

 

 

 

 

(23

)

 

 

(8,991

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,014

)

Other comprehensive income, fair     value adjustments and  reclassifications

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27,624

 

 

 

(22,333

)

 

 

3,571

 

 

 

 

 

 

 

8,862

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(20,255

)

 

 

(20,255

)

Shares repurchased pending retirement

 

 

 

 

 

 

 

 

 

 

(93

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(438

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(438

)

Amortization of restricted stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

79

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

79

 

Dividend declared - $0.539063 per Series A preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,035

)

 

 

(1,035

)

Dividend declared - $0.396025 per Series B preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(394

)

 

 

(394

)

Dividend declared - $0.4765625 per Series C preferred share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(207

)

 

 

(207

)

Dividend declared - $0.15 per common share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(14,539

)

 

 

(14,539

)

Balance, March 31, 2016

 

 

1,919

 

 

 

434

 

 

 

96,836

 

 

$

46,537

 

 

$

10,039

 

 

$

969

 

 

$

971,937

 

 

$

50,767

 

 

 

(19,970

)

 

$

(20,986

)

 

$

(397,753

)

 

$

641,540

 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

4


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

March 31,

 

 

 

2016

 

 

2015

 

Operating Activities:

 

 

 

 

 

 

 

 

Net (loss)

 

$

(20,255

)

 

$

(16,307

)

Adjustments to reconcile net (loss) to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Amortization of premium (Agency MBS)

 

 

7,429

 

 

 

11,784

 

Amortization/accretion of market yield adjustments (Non-Agency MBS)

 

 

922

 

 

 

(1,021

)

Accretion of discount (residential mortgage loans)

 

 

(114

)

 

 

-

 

Depreciation on rental properties

 

 

112

 

 

 

112

 

Loss on sales of Agency MBS

 

 

3,239

 

 

 

-

 

Loss on sales of Non-Agency MBS

 

 

-

 

 

 

3

 

Amortization of restricted stock

 

 

79

 

 

 

24

 

Recovery on Non-Agency MBS

 

 

(1

)

 

 

(1

)

Periodic net settlements on interest rate swaps, net of amortization

 

 

(6,558

)

 

 

(10,400

)

Loss on interest rate swaps, net

 

 

50,219

 

 

 

46,488

 

(Gain) on derivatives, net of derivative income - TBA Agency MBS

 

 

(15,354

)

 

 

(8,525

)

(Gain) loss on derivatives - Eurodollar Futures Contracts

 

 

(22

)

 

 

2,338

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

 

(Increase) decrease in interest receivable

 

 

(1,564

)

 

 

131

 

(Increase) in prepaid expenses and other

 

 

(1,910

)

 

 

(12,424

)

Decrease in restricted cash

 

 

9,222

 

 

 

-

 

Increase (decrease) in accrued interest payable

 

 

858

 

 

 

(6,334

)

Increase in accrued expenses

 

 

5,106

 

 

 

597

 

Net cash provided by operating activities

 

$

31,408

 

 

$

6,465

 

Investing Activities:

 

 

 

 

 

 

 

 

Available-for-sale Agency MBS:

 

 

 

 

 

 

 

 

Proceeds from sales

 

 

314,129

 

 

 

-

 

Principal payments

 

 

239,818

 

 

 

290,741

 

Available-for-sale Non-Agency MBS:

 

 

 

 

 

 

 

 

Proceeds from sales

 

 

-

 

 

 

4,120

 

Purchases

 

 

(19,834

)

 

 

(204,004

)

Principal payments

 

 

16,588

 

 

 

4,215

 

Residential mortgage loans held-for-investment:

 

 

 

 

 

 

 

 

Principal payments

 

 

252

 

 

 

-

 

Residential properties purchases

 

 

(86

)

 

 

(1,518

)

Net cash provided by investing activities

 

$

550,867

 

 

$

93,554

 

Financing Activities:

 

 

 

 

 

 

 

 

Borrowings from repurchase agreements

 

$

7,962,265

 

 

$

7,390,606

 

Repayments on repurchase agreements

 

 

(8,516,802

)

 

 

(7,477,309

)

Net settlements on TBA Agency MBS commitments

 

 

10,913

 

 

 

5,247

 

Settlements on terminated interest rate swaps

 

 

(6,162

)

 

 

-

 

Common stock repurchased, net of proceeds from common stock issued

 

 

(9,198

)

 

 

(21,130

)

Proceeds on Series C Preferred Stock issued

 

 

-

 

 

 

8,085

 

Series A Preferred stock dividends paid

 

 

(1,035

)

 

 

(1,035

)

Series B Preferred stock dividends paid

 

 

(394

)

 

 

(394

)

Series C Preferred stock dividends paid

 

 

(207

)

 

 

-

 

Common stock dividends paid

 

 

(14,862

)

 

 

(15,396

)

Net cash (used in) financing activities

 

$

(575,482

)

 

$

(111,326

)

Net increase (decrease) in cash and cash equivalents

 

$

6,793

 

 

$

(11,307

)

Cash and cash equivalents at beginning of period

 

 

5,754

 

 

 

14,989

 

Cash and cash equivalents at end of period

 

$

12,547

 

 

$

3,682

 

Supplemental Disclosure of Cash Flow Information:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

19,606

 

 

$

23,737

 

Common stock repurchased

 

$

9,439

 

 

$

24,634

 

Change in payable for MBS purchased

 

$

-

 

 

$

(22,179

)

See accompanying notes to unaudited consolidated financial statements.

 

5


 

ANWORTH MORTGAGE ASSET CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

As used in this Quarterly Report on Form 10-Q, “Company,” “we,” “us,” “our,” and “Anworth” refer to Anworth Mortgage Asset Corporation.

NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Our Company

We were incorporated in Maryland on October 20, 1997 and commenced operations on March 17, 1998. Our principal business is to invest in, finance and manage a leveraged portfolio of residential mortgage-backed securities, or MBS, and residential mortgage loans which presently include the following types of investments:

 

·

Agency mortgage-backed securities, or Agency MBS, which include residential mortgage pass-through certificates and collateralized mortgage obligations, or CMOs, which are securities representing interests in pools of mortgage loans secured by residential property in which the principal and interest payments are guaranteed by a government-sponsored enterprise, or GSE, such as the Federal National Mortgage Association, or Fannie Mae, or the Federal Home Loan Mortgage Corporation, or Freddie Mac.

 

·

Non-agency mortgage-backed securities, or Non-Agency MBS, which are securities issued by companies that are not guaranteed by federally sponsored enterprises and that are secured primarily by first-lien residential mortgage loans.

 

·

Residential mortgage loans through consolidated securitization trusts. We finance our residential mortgage loans through asset-backed securities, or ABS, issued by the consolidated securitization trusts. The ABS which are held by unaffiliated third parties are non-recourse financing. The difference in the amount of the loans and the amount of the ABS represents our retained net interest in the securitization trusts.

Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets.

We have elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code. As long as we retain our REIT status, we generally will not be subject to federal or state income taxes to the extent that we distribute our income to our stockholders, and we routinely distribute to our stockholders substantially all of the income generated from our operations. In order to qualify as a REIT, we must meet various ongoing requirements under the tax law, including requirements relating to the composition of our assets, the nature of our gross income, minimum distribution requirements, and requirements relating to the ownership of our stock.

Our Manager

We are externally managed and advised by Anworth Management, LLC, or our Manager. Our Manager is supervised and directed by our board of directors, or our Board. Our day-to-day operations are being conducted by our Manager through the authority delegated to it under the Management Agreement between us and our Manager (which we refer to as the “Management Agreement”) and pursuant to the policies established by our Board.

Our Manager will also perform such other services and activities relating to our assets and operations as may be appropriate. In exchange for services provided, our Manager receives a management fee paid monthly in arrears in an amount equal to one-twelfth of 1.20% of our Equity (as defined in the Management Agreement).

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles utilized in the United States of America, or GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Material estimates that are susceptible to change relate to the determination of the fair value of investments and derivatives, cash flow projections for and credit performance of Non-Agency MBS and residential mortgage loans held-for-investment, amortization of security and loan premiums, accretion of security and loan discounts, and accounting for derivative activities. Actual results could materially differ from these estimates. In the opinion of management, all material adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included.

6


 

Our consolidated financial statements include the accounts of all subsidiaries. Significant intercompany accounts and transactions have been eliminated. The interim financial information in the accompanying unaudited consolidated financial statements and the notes thereto should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. Our consolidated financial statements also include the consolidation of certain securitization trusts that meet the definition of a variable interest entity, or VIE, because the Company has been deemed to be the primary beneficiary of the securitization trusts. These securitization trusts hold pools of residential mortgage loans and issue series of ABS payable from the cash flows generated by the underlying pools of residential mortgage loans. These securitizations are non-recourse financing for the residential mortgage loans held-for-investment. Generally, a portion of the ABS issued by the securitization trusts are sold to unaffiliated third parties and the balance is purchased by the Company. The Company classifies the underlying residential mortgage loans owned by the securitization trusts as residential mortgage loans held-for-investment in its consolidated balance sheets. The ABS issued to third parties are recorded as liabilities on the Company’s consolidated balance sheets. The Company records interest income on the residential mortgage loans held-for-investment and interest expense on the ABS issued to third parties in the Company’s consolidated statements of operations. The Company records the initial underlying assets and liabilities of the consolidated securitization trusts at their fair value upon consolidation into the Company and, as such, no gain or loss is recorded upon consolidation. See Note 4, “Variable Interest Entities,” for additional information regarding the impact of consolidation of securitization trusts.

The consolidated securitization trusts are VIEs because the securitization trusts do not have equity that meets the definition of U.S. GAAP equity at risk. In determining if a securitization trust should be consolidated, the Company evaluates (in accordance with the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 810-10) whether it has both (i) the power to direct the activities of the securitization trust that most significantly impact its economic performance and (ii) the right to receive benefits from the securitization trust or the obligation to absorb losses of the securitization trust that could be significant. The Company determined that it is the primary beneficiary of certain securitization trusts because it has certain delinquency and default oversight rights on residential mortgage loans. In addition, the Company owns the most subordinated class of ABS issued by the securitization trusts and has the obligation to absorb losses and right to receive benefits from the securitization trusts that could potentially be significant to the securitization trusts. The Company assesses modifications, if any, to VIEs on an ongoing basis to determine if a significant reconsideration event has occurred that would change the Company’s initial consolidation assessment.

The following is a summary of our significant accounting policies:

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and highly liquid investments with original maturities of three months or less. The carrying amount of cash equivalents approximates their fair value. Restricted cash includes cash pledged as collateral to counterparties on various derivative transactions and reverse repurchase agreements.

Mortgage-Backed Securities (MBS)

Agency MBS are securities that are obligations (including principal and interest) guaranteed by the U.S. government, such as Ginnie Mae, or guaranteed by federally sponsored enterprises, such as Fannie Mae or Freddie Mac. Our investment-grade Agency MBS portfolio is invested primarily in fixed-rate and adjustable-rate mortgage-backed pass-through certificates and hybrid adjustable-rate MBS. Hybrid adjustable-rate MBS have an initial interest rate that is fixed for a certain period, usually one to ten years, and then adjusts annually for the remainder of the term of the asset. We structure our investment portfolio to be diversified with a variety of prepayment characteristics, investing in mortgage assets with prepayment penalties, investing in certain mortgage security structures that have prepayment protections and purchasing mortgage assets at a premium and at a discount. A portion of our portfolio consists of Non-Agency MBS. Our principal business objective is to generate net income for distribution to our stockholders primarily based upon the spread between the interest income on our mortgage assets and our borrowing costs to finance our acquisition of those assets.

We classify our MBS as either trading investments, available-for-sale investments or held-to-maturity investments. Our management determines the appropriate classification of the securities at the time they are acquired and evaluates the appropriateness of such classifications at each balance sheet date. We currently classify all of our MBS as available-for-sale. All assets that are classified as available-for-sale are carried at fair value and unrealized gains or losses are generally included in “Other comprehensive income (loss)” as a component of stockholders’ equity. Losses that are credit-related on securities classified as available-for-sale, which are determined by management to be other-than-temporary in nature, are reclassified from “Other comprehensive income” to income (loss).

The most significant source of our revenue is derived from our investments in MBS. Interest income on Agency MBS is accrued based on the actual coupon rate and the outstanding principal amount of the underlying mortgages. Premiums and discounts are amortized or accreted into interest income over the estimated lives of the securities using the effective interest yield method, adjusted for the effects of actual and estimated prepayments based on ASC 320-10. Our policy for estimating prepayment speeds for

7


 

calculating the effective yield is to evaluate historical performance, street consensus prepayment speeds and current market conditions. If our estimate of prepayments is materially incorrect, as compared to the aforementioned references, we may be required to make an adjustment to the amortization or accretion of premiums and discounts that would have an impact on future income, which could be material and adverse.

A majority of our Non-Agency MBS are accounted for under ASC 310-30, “Loans and Debt Securities Acquired with Credit Deterioration.” A debt security accounted for under ASC 310-30 is initially recorded at its purchase price (fair value). The amount of expected cash flows that exceed the initial investment represents the market yield adjustment (accretable yield), which is recognized as interest income on a level yield basis over the life of the security. The excess of total contractual cash flows over the cash flows expected at its origination is considered to be the non-accretable difference. We must periodically reassess the expected cash flows of loans accounted for under ASC 310-30 along with the cash flows received. A significant increase in expected cash flows must be accounted for as an increase in the rate of accretion over the remaining life of the security. Conversely, if expected cash flows decrease, an other-than-temporary impairment must be recognized as a charge to earnings. Adjustments to the fair value of Non-Agency MBS, accounted for as available-for-sale securities, are recorded in “Accumulated other comprehensive income,” or AOCI. The determination as to whether impairment and accretable yield exists is based on cash flow projections related to the securities. As a result, the timing and amount of impairment and accretable yield constitutes a material estimate that is susceptible to significant change.

Interest income on the Non-Agency MBS that were purchased at a discount to par value and were rated below AA at the time of purchase is recognized based on the security’s effective interest rate. The effective interest rate 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 interest rates, prepayment rates, 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 rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the available-for-sale securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, and prepayments of principal. Therefore actual maturities of available-for-sale securities are generally shorter than stated contractual maturities. Stated contractual maturities are generally greater than ten years. There can be no assurance that our assumptions used to estimate future cash flows or the current period’s yield for each asset would not change in the near term, and the change could be material.

Based on the projected cash flows from our Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as a non-accretable difference and, therefore, not accreted into interest income. The amount designated as a non-accretable difference may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions, and other factors. If the performance of a security with a non-accretable difference is more favorable than forecasted, a portion of the amount designated as a non-accretable difference may be accreted into interest income prospectively. Conversely, if the performance of a security with a non-accretable difference is less favorable than forecasted, an impairment charge and write-down of such security to a new cost basis results.

Securities transactions are recorded on the date the securities are purchased or sold. Realized gains or losses from securities transactions are determined based on the specific identified cost of the securities.

The following table shows the gross unrealized losses and fair value of those individual securities in our MBS portfolio that have been in a continuous unrealized loss position at March 31, 2016 and December 31, 2015, aggregated by investment category and length of time (dollar amounts in thousands):

March 31, 2016

 

 

 

Less Than 12 Months

 

 

12 Months or More

 

 

Total

 

Description

of

Securities

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

Agency MBS

 

 

80

 

 

$

261,738

 

 

$

(1,126

)

 

 

288

 

 

$

1,077,307

 

 

$

(9,349

)

 

 

368

 

 

$

1,339,045

 

 

$

(10,475

)

Non-Agency MBS

 

 

89

 

 

$

567,315

 

 

$

(24,092

)

 

 

-

 

 

$

-

 

 

$

-

 

 

 

89

 

 

$

567,315

 

 

$

(24,092

)

 

December 31, 2015

 

 

Less Than 12 Months

 

 

12 Months or More

 

 

Total

 

Description

of

Securities

 

Number

of

Securities

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

 

Number

of

Securities

 

 

Fair

Value

 

 

Unrealized

Losses

 

Agency MBS

 

107

 

$

731,112

 

 

$

(5,177

)

 

 

332

 

 

$

1,637,714

 

 

$

(33,085

)

 

 

439

 

 

$

2,368,826

 

 

$

(38,262

)

Non-Agency MBS

 

53

 

$

323,198

 

 

$

(5,530

)

 

 

-

 

 

$

-

 

 

$

-

 

 

53

 

 

$

323,198

 

 

$

(5,530

)

 

 

8


 

We do not consider those Agency MBS that have been in a continuous loss position for 12 months or more to be other-than-temporarily impaired. The unrealized losses on our investments in Agency MBS were caused by fluctuations in interest rates. We purchased the Agency MBS primarily at a premium relative to their face value and the contractual cash flows of those investments are guaranteed by the U.S. government or government-sponsored agencies. Since September 2008, the government-sponsored agencies have been in the conservatorship of the U.S. government. At March 31, 2016, we did not expect to sell the Agency MBS at a price less than the amortized cost basis of our investments. Because the decline in market value of the Agency MBS is attributable to changes in interest rates and not the credit quality of the Agency MBS in our portfolio, and because we did not have the intent to sell these investments nor is it more likely than not that we will be required to sell these investments before recovery of their amortized cost basis, which may be at maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2016.

 

There are no Non-Agency MBS that have been in a continuous loss position for 12 months or more to be other-than-temporarily impaired. The unrealized losses on our investments in Non-Agency MBS were caused by fluctuations in interest rates. We purchased the Non-Agency MBS primarily at a discount relative to their face value. At March 31, 2016, we did not expect to sell the Non-Agency MBS at a price less than the amortized cost basis of our investments. Because the decline in market value of the Non-Agency MBS is attributable to changes in interest rates and not the credit quality of the Non-Agency MBS in our portfolio, and because we did not have the intent to sell these investments nor is it more likely than not that we will be required to sell these investments before recovery of their amortized cost basis, which may be at maturity, we do not consider these investments to be other-than-temporarily impaired at March 31, 2016.

Residential Mortgage Loans Held-for-Investment

Residential mortgage loans held-for-investment are residential mortgage loans held by consolidated securitization trusts. Residential mortgage loans held-for-investment are carried at unpaid principal balances net of any premiums or discounts and allowance for loan losses. We expect that we will be required to continue to consolidate the securitization trusts that hold the residential mortgage loans.

We establish an allowance for residential loan losses based on our estimate of credit losses. These estimates for the allowance for loan losses require consideration of various observable inputs including, but not limited to, historical loss experience, delinquency status, borrower credit scores, geographic concentrations and loan-to-value ratios, and are adjusted for current economic conditions as deemed necessary by our management. Many of these factors are subjective and cannot be reduced to a mathematical formula. In addition, since we have not incurred any direct losses on our portfolio, we review national historical credit performance information from external sources to assist in our analysis. Changes in our estimates can significantly impact the allowance for loan losses and provision expense. The allowance reflects management’s best estimate of the credit losses inherent in the loan portfolio at the balance sheet date. It is also possible that we will experience credit losses that are different from our current estimates or that the time of those losses may differ from our estimates.

We recognize interest income from residential mortgage loans on an accrual basis. Any related premium or discount is amortized into interest income using the effective interest method over the weighted average life of these loans. Coupon interest is recognized as revenue when earned and deemed collectable or until a loan becomes more than 90 days past due, at which point the loan is placed on non-accrual status. Interest previously accrued for loans that have been placed on non-accrual status is reversed against interest income in the period the loan is placed in non-accrual status. Residential loans delinquent more than 90 days or in foreclosure are characterized as delinquent. Cash principal and interest that are advanced from servicers after a loan becomes greater than 90 days past due are recorded as a liability due to the servicer. When a delinquent loan previously placed on non-accrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternatively, non-accrual loans may be placed back on accrual status if restructured and after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.

Residential Properties

Residential properties are stated at cost and consist of land, buildings and improvements, including other costs incurred during their acquisition, possession and renovation. Residential properties purchased that are not subject to an existing lease are treated as asset acquisitions and, as such, are recorded at their purchase price, including acquisition and renovation costs, all of which are allocated to land and building based upon their relative fair values at the date of acquisition. Residential properties acquired either subject to an existing lease or as part of a portfolio level transaction are treated as a business combination under ASC 805, Business Combinations, and, as such, are recorded at fair value, allocated to land, building and the existing lease, if applicable, based upon their relative fair values at the date of acquisition, with acquisition fees and other costs expensed as incurred.

Building depreciation is computed on a straight-line basis over the estimated useful lives of the assets. We will generally use a 27.5 year estimated life with no salvage value. We will incur costs to prepare our acquired properties to be leased. These costs will be capitalized and allocated to building costs. Costs related to the restoration, renovation, or improvement of our properties that improve

9


 

and extend their useful lives are capitalized and depreciated over their estimated useful lives. Expenditures for ordinary repairs and maintenance are expensed as incurred. Costs incurred by us to lease the properties will be capitalized and amortized over the life of the lease. Escrow deposits include refundable and non-refundable cash and earnest money on deposit with independent third parties for property purchases.

Repurchase Agreements

We finance the acquisition of MBS primarily through the use of repurchase agreements. Under these repurchase agreements, we sell securities to a lender and agree to repurchase the same securities in the future for a price that is higher than the original sales price. The difference between the sale price that we receive and the repurchase price that we pay represents interest paid to the lender. Although structured as a sale and repurchase obligation, a repurchase agreement operates as a financing under which we pledge our securities and accrued interest as collateral to secure a loan which is equal in value to a specified percentage of the estimated fair value of the pledged collateral. We retain beneficial ownership of the pledged collateral. Upon the maturity of a repurchase agreement, we are required to repay the loan and concurrently receive back our pledged collateral from the lender or, with the consent of the lender, we may renew such agreement at the then-prevailing financing rate. These repurchase agreements may require us to pledge additional assets to the lender in the event the estimated fair value of the existing pledged collateral declines.

Asset-Backed Securities Issued by Securitization Trusts

Asset-backed securities issued by the securitization trusts are recorded at principal balances net of unamortized premiums or discounts. This long-term debt is collateralized only by the assets held in the trusts and is otherwise non-recourse to the Company.

Derivative Financial Instruments

Risk Management

We primarily use short-term (less than or equal to 12 months) repurchase agreements to finance the purchase of MBS. These obligations expose us to variability in interest payments due to changes in interest rates. We continuously monitor changes in interest rate exposures and evaluate various opportunities to mitigate this risk. Our objective is to limit the impact of interest rate changes on earnings and cash flows. The principal instruments we use to achieve this are interest rate swaps and Eurodollar Futures Contracts. Interest rate swaps effectively convert a percentage of our repurchase agreements to fixed-rate obligations over a period of up to ten years. Under interest rate swaps, we agree to pay an amount equal to a specified fixed rate of interest times a notional principal amount and to receive in return an amount equal to a specified variable-rate of interest times a notional amount, generally based on the London Interbank Offered Rate, or LIBOR. The notional amounts are not exchanged. We do not issue or hold the interest rate swaps and the Eurodollar Futures Contracts for speculative purposes. See Note 14 for more information on the Eurodollar Futures Contracts.

We also enter into To-Be-Announced, or TBA, Agency MBS as either a means of investing in and financing Agency MBS or as a means of disposing of or reducing our exposure to agency securities. Pursuant to TBA contracts, we agree to purchase or sell, for future delivery, Agency MBS with certain principal and interest terms and certain types of collateral, but the particular Agency MBS to be delivered are not identified until shortly before the TBA settlement date. We also may choose, prior to settlement, to move the settlement of these MBS out to a later date by entering into an offsetting short or long position (referred to as a “pair off”), net settling the paired off positions for cash, and simultaneously purchasing a similar TBA contract for a later settlement date. This transaction is commonly referred to as a “dollar roll.” The Agency MBS purchased or sold for a forward settlement date are typically priced at a discount to agency securities for settlement in the current month. This difference (or discount) is referred to as the “price drop.” The price drop represents compensation to us for foregoing net interest margin (interest income less repurchase agreement financing cost). TBA Agency MBS are accounted for as derivative instruments since they do not meet the exemption allowed for a “regular way” security trade under ASC 815, as either the TBA contracts do not settle in the shortest period of time possible or we cannot assess that it is probable at inception that we will take physical delivery of the security or that we will not settle on a net basis.

Accounting for Derivatives and Hedging Activities

We account for derivative instruments in accordance with ASC 815, which requires recognition of all derivatives as either assets or liabilities and measurement of those instruments at fair value, which is typically based on values obtained from large financial institutions who are market makers for these types of instruments. The accounting for changes in the fair value of derivative instruments depends on whether the instruments are designated and qualify as hedges in accordance with ASC 815. Changes in fair value related to derivatives not designated as hedges are recorded in our consolidated statements of operations as “Gain (loss) on derivatives” and specifically identified as either relating to interest rate swaps, Eurodollar Futures Contracts or TBA Agency MBS. For a derivative to qualify for hedge accounting, we must anticipate that the hedge will be highly “effective” as defined by ASC 815-10. A hedge of the variability of cash flows that are to be received or paid in connection with a recognized asset or liability is known as a ”cash flow” hedge. Changes in the fair value of a derivative that is highly effective and that is designated as a cash flow hedge, to

10


 

the extent the hedge is effective, are recorded in AOCI and reclassified to income when the forecasted transaction affects income (e.g. when periodic settlement interest payments are due on repurchase agreements).  Hedge ineffectiveness, if any, is recorded in current period income.

When we discontinue hedge accounting, the gain or loss on the derivative remains in AOCI and is reclassified into income when the forecasted transaction affects income. In all situations where hedge accounting is discontinued and the derivative remains outstanding, we carry the derivative at its fair value on our balance sheet, recognizing changes in fair value in current period income. All of our swaps had historically been accounted for as cash flow hedges under ASC 815. After August 22, 2014, none of our swaps were designated for hedge accounting. As a result of discontinuing hedge accounting for our swaps, changes in the fair value of these swaps are recorded in “Gain (loss) on interest rate swaps, net” in our consolidated statements of operations rather than in AOCI.  Also, net interest paid or received on these swaps which was previously recognized in interest expense, is instead recognized in “Gain (loss) on interest rate swaps, net.” These swaps continue to be reported as assets or liabilities on our consolidated balance sheets at their fair value.

As long as the forecasted transactions that were being hedged (i.e. rollovers of our repurchase agreement borrowings) are still expected to occur, the balance in AOCI from the activity in these swaps through the dates of de-designation will remain in AOCI and be recognized in our consolidated statements of operations as “interest expense” over the remaining term of these swaps.

For purposes of the consolidated statements of cash flows, cash flows hedges were classified with the cash flows from the hedged item. Cash flows from derivatives that are not hedges are classified according to the underlying nature or purpose of the derivative transaction.

For more details on the amounts and other qualitative information on all our derivative transactions, see Note 14. For more information on the fair value of our derivative instruments, see Note 8.

Credit Risk

At March 31, 2016, we have attempted to limit our exposure to credit losses on our Agency MBS by purchasing securities primarily through Freddie Mac and Fannie Mae. The payment of principal and interest on the Freddie Mac and Fannie Mae MBS are guaranteed by those respective enterprises. In September 2008, both Freddie Mac and Fannie Mae were placed in the conservatorship of the U.S. government. While it is the intent that the conservatorship will help stabilize Freddie Mac’s and Fannie Mae’s overall financial position, there can be no assurance that it will succeed or that, if necessary, Freddie Mac and Fannie Mae will be able to satisfy its guarantees of Agency MBS. There have also been concerns as to what the U.S. government will do regarding winding down the operations of Freddie Mac and Fannie Mae. There have also been concerns over the past few years regarding the credit standing of Freddie Mac, Fannie Mae, and U.S. sovereign debt. We do not know what effect any future ratings of Freddie Mac, Fannie Mae and U.S. sovereign debt may ultimately have on the U.S. economy, the value of our securities, or the ability of Freddie Mac and Fannie Mae to satisfy its guarantees of Agency MBS, if necessary.

Our adjustable-rate MBS are subject to periodic and lifetime interest rate caps. Periodic caps can limit the amount an interest rate can increase during any given period. Some adjustable-rate MBS subject to periodic payment caps may result in a portion of the interest being deferred and added to the principal outstanding.

We also invest in Non-Agency MBS, which are securities that are secured by pools of residential mortgages which are not issued by government-sponsored enterprises and are not guaranteed by any agency of the U.S. government or any federally chartered corporation. Such investments carry a risk that the borrower on the underlying mortgage may default on their obligation to make full and timely payments of principal and interest.

Other-than-temporary losses on our available-for-sale MBS, as measured by the amount of decline in estimated fair value attributable to credit losses that are considered to be other-than-temporary, are charged against income, resulting in an adjustment of the cost basis of such securities. Based on the criteria in ASC 320-10, the determination of whether a security is other-than-temporarily impaired, or OTTI, involves judgments and assumptions based on both subjective and objective factors. When a security is impaired, an OTTI is considered to have occurred if (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis or (iii) we do not expect to recover its amortized cost basis (i.e., there is a credit-related loss). The following are among, but not all of, the factors considered in determining whether and to what extent an OTTI exists and the portion that is related to credit loss: (i) the expected cash flow from the investment; (ii) whether there has been an other-than-temporary deterioration of the credit quality of the underlying mortgages; (iii) the credit protection available to the related mortgage pool for MBS; (iv) any other market information available, including analysts’ assessments and statements, public statements and filings made by the debtor or counterparty; (v) management’s internal analysis of the security, considering all known relevant information at the time of assessment; and (vi) the magnitude and duration of historical decline in market prices. Because management’s assessments are based on factual information as well as subjective information available at the time of

11


 

assessment, the determination as to whether an other-than-temporary decline exists and, if so, the amount considered impaired, is also subjective and therefore constitutes material estimates that are susceptible to significant change.

We also own residential mortgage loans held-for-investment. As the majority of these loans (the senior tranches of the securitization trusts) are collateral for the asset-backed securities issued by the trusts, our potential credit risk is on the subordinated tranches that we own, as these tranches would be the first ones to absorb any losses resulting from defaults by the borrowers on the underlying mortgage loans.

For all interest rate swaps entered into on or before September 9, 2013, we are exposed to credit losses in the event of non-performance by counterparties to interest rate swap agreements. In order to limit this risk, our practice was to only enter into swaps with large financial institution counterparties who were market makers for these types of instruments, limit our exposure on each swap to a single counterparty under our defined guidelines and either pay or receive collateral to or from each counterparty on a periodic basis to cover the net fair market position of the swaps held with that counterparty. For all swaps entered into on or after September 9, 2013, all swap participants are required by rules of the Commodities Futures Trading Commission, under authority granted to it pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, to clear swaps through a registered derivatives clearing organization, or “swap execution facility,” through standardized documents under which each swap counterparty transfers its position to another entity whereby a central clearinghouse effectively becomes the counterparty on each side of the swap. Both the swap execution facility and the central clearinghouse could require greater initial and periodic margin (collateral) requirements and additional transaction fees. It is the intent of the Dodd-Frank Act that the clearing of swaps in this manner is designed to avoid concentration of risk in any single entity by spreading and centralizing the risk in the clearinghouse and its members.

Income Taxes

We have elected to be taxed as a REIT and to comply with the provisions of the Code with respect thereto. Accordingly, we will not be subject to federal income tax to the extent that our distributions to our stockholders satisfy the REIT requirements and that certain asset, income and stock ownership tests are met.

We have no unrecognized tax benefits and do not anticipate any increase in unrecognized benefits during 2016 relative to any tax positions taken prior to January 1, 2016. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is our policy to record such accruals in our income taxes accounts; and no such accruals existed at March 31, 2016. We file REIT U.S. federal and California income tax returns. These returns are generally open to examination by the IRS and the California Franchise Tax Board for all years after 2011 and 2010, respectively.

Cumulative Convertible Preferred Stock

We classify our Series B Cumulative Convertible Preferred Stock, or Series B Preferred Stock, on our balance sheets using the guidance in ASC 480-10-S99. Our Series B Preferred Stock contains certain fundamental change provisions that allow the holder to redeem the preferred stock for cash only if certain events occur, such as a change in control. As redemption under these circumstances is not solely within our control, we have classified our Series B Preferred Stock as temporary equity.

We have analyzed whether the conversion features in our Series B Preferred Stock should be bifurcated under the guidance in ASC 815-10 and have determined that bifurcation is not necessary.

Stock-Based Expense

In accordance with ASC 718-10, any expense relating to share-based payment transactions is recognized in the unaudited consolidated financial statements.

Restricted stock is expensed over the vesting period (see Note 13).

Earnings Per Share

Basic earnings per share, or EPS, is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS assumes the conversion, exercise or issuance of all potential common stock equivalents (which includes stock options and convertible preferred stock) and the adding back of the Series B Preferred Stock dividends unless the effect is to reduce a loss or increase the income per share.

12


 

The computation of EPS for the three months ended March 31, 2016 and 2015 is as follows (amounts in thousands, except per share data):

 

 

 

Net (Loss)

to

Common

Stockholders

 

 

Average

Shares

 

 

Earnings

per

Share

 

For the three months ended March 31, 2016