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EX-32.2 - EXHIBIT 32.2 - Cherry Hill Mortgage Investment Corpex32_2.htm
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EX-31.1 - EXHIBIT 31.1 - Cherry Hill Mortgage Investment Corpex31_1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)
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 001-36099
 

 
CHERRY HILL MORTGAGE INVESTMENT CORPORATION
(Exact name of registrant as specified in its charter)
 


N/A
(Former name, former address and former fiscal year, if changed since last report)

Maryland
 
46-1315605
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
     
301 Harper Drive, Suite 110
Moorestown, New Jersey
 
08057
(Address of Principal Executive Offices)
 
(Zip Code)

(877) 870 – 7005
(Registrant’s Telephone Number, Including Area Code)
 


Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No 
 
Indicate by check mark whether the registrant is a large accelerated filed, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer
Accelerated filer
       
Non-accelerated filer
  (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  

As of May 9, 2016, there were 7,519,038 outstanding shares of common stock, $0.01 par value per share, of Cherry Hill Mortgage Investment Corporation.
 


CHERRY HILL MORTGAGE INVESTMENT CORPORATION
TABLE OF CONTENTS

   
Page
   
2
     
PART I.
4
     
Item 1.
4
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8
     
 
9
     
Item 2.
38
     
Item 3.
54
     
Item 4.
58
     
PART II.
59
     
Item 1.
59
     
Item 1A.
59
     
Item 2.
60
     
Item 3.
60
     
Item 4.
60
     
Item 5.
60
     
Item 6.
60
 
FORWARD-LOOKING INFORMATION

Cherry Hill Mortgage Investment Corporation (together with its consolidated subsidiaries, the “Company”, “we”, “our” or “us”) makes forward-looking statements in this Quarterly Report on Form 10-Q within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such Sections. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Company’s control. These forward-looking statements include information about possible or assumed future results of the Company’s business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “could,” “would,” “may,” “potential” or the negative of these terms or other comparable terminology, the Company intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking:

  the Company’s investment objectives and business strategy;

the Company’s ability to raise capital through the sale of its equity and debt securities;

the Company’s ability to obtain future financing arrangements and refinance existing financing arrangements as they mature;

the Company’s expected leverage;

the Company’s expected investments;

the Company’s ability to execute its prime mortgage loan strategy and its ability to finance this asset class;

the Company’s ability to acquire Servicing Related Assets;

estimates or statements relating to, and the Company’s ability to make, future distributions;

the Company’s ability to compete in the marketplace;

market, industry and economic trends;

recent market developments and actions taken and to be taken by the U.S. Government, the U.S. Treasury and the Board of Governors of the Federal Reserve System, Fannie Mae, Freddie Mac, Ginnie Mae and the U.S. Securities and Exchange Commission (“SEC”);

mortgage loan modification programs and future legislative actions;

the Company’s ability to maintain its qualification as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”);

the Company’s ability to maintain its exclusion from registration as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”);

projected capital and operating expenditures;

availability of investment opportunities in mortgage-related, real estate-related and other securities;

availability of qualified personnel;

prepayment rates; and

projected default rates.

The Company’s beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to it or are within its control. If any such change occurs, the Company’s business, financial condition, liquidity and results of operations may vary materially from those expressed in, or implied by, the Company’s forward-looking statements. These risks, along with, among others, the following factors, could cause actual results to vary from the Company’s forward-looking statements:
 
the factors discussed under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q and “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015;
 
general volatility of the capital markets;
 
changes in the Company’s investment objectives and business strategy;

availability, terms and deployment of capital;

availability of suitable investment opportunities;

the Company’s dependence on its external manager, Cherry Hill Mortgage Management, LLC (“the Manager”), and the Company’s ability to find a suitable replacement if the Company or the Manager were to terminate the management agreement the Company has entered into with the Manager;

changes in the Company’s assets, interest rates or the general economy;

increased rates of default and/or decreased recovery rates on the Company’s investments;

changes in interest rates, interest rate spreads, the yield curve, prepayment rates or recapture rates;

limitations on the Company’s business due to compliance with requirements for maintaining its qualification as a REIT under the Code and its exclusion from registration as an investment company under the Investment Company Act; and

the degree and nature of the Company’s competition, including competition for its targeted assets.

Although the Company believes that the expectations reflected in the forward-looking statements are reasonable, it cannot guarantee future results, levels of activity, performance or achievements. These forward-looking statements apply only as of the date of this Quarterly Report on Form 10-Q. The Company is not obligated, and does not intend, to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
 
PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Balance Sheets
March 31, 2016 (Unaudited) and December 31, 2015
(in thousands — except share data)
 
   
March 31, 2016
   
December 31, 2015
 
Assets
           
RMBS, available-for-sale
 
$
508,159
   
$
508,242
 
Investments in Servicing Related Assets at fair value
   
92,604
     
97,803
 
Cash and cash equivalents
   
10,649
     
10,603
 
Restricted cash
   
12,906
     
9,942
 
Derivative assets
   
73
     
422
 
Receivables and other assets
   
10,801
     
9,328
 
Total Assets
 
$
635,192
   
$
636,340
 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Repurchase agreements
 
$
398,374
   
$
385,560
 
Federal Home Loan Bank advances
   
47,250
     
62,250
 
Derivative liabilities
   
9,447
     
4,595
 
Notes payable
   
23,836
     
24,313
 
Dividends payable
   
3,684
     
3,684
 
Due to affiliates
   
1,049
     
998
 
Accrued expenses and other liabilities
   
2,595
     
2,603
 
Total Liabilities
 
$
486,235
   
$
484,003
 
Stockholders’ Equity
               
Preferred stock, $0.01 par value, 100,000,000 shares authorized, none issued and outstanding as of March 31, 2016 and December 31, 2015
 
$
-
   
$
-
 
Common stock, $0.01 par value, 500,000,000 shares authorized, 7,519,038 shares issued and outstanding as of March 31, 2016 and December 31, 2015
   
75
     
75
 
Additional paid-in capital
   
148,370
     
148,332
 
Retained earnings (deficit)
   
(7,614
)
   
3,133
 
Accumulated other comprehensive income (loss)
   
7,135
     
(197
)
Total CHMI Stockholders’ Equity
 
$
147,966
   
$
151,343
 
Non-controlling interests in operating partnership
   
991
     
994
 
Total Stockholders’ Equity
 
$
148,957
   
$
152,337
 
Total Liabilities and Stockholders’ Equity
 
$
635,192
   
$
636,340
 

See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Statements of Income (Loss)
(Unaudited)
(in thousands — except per share data)
 
   
Three Months Ended March 31,
 
   
2016
   
2015
 
Income
           
Interest income
 
$
5,188
   
$
5,827
 
Interest expense
   
1,657
     
1,235
 
Net interest income
   
3,531
     
4,592
 
Servicing fee income
   
1,495
     
-
 
Servicing costs
   
402
     
-
 
Net servicing income (loss)
   
1,093
     
-
 
Other income (loss)
               
Realized gain (loss) on RMBS, net
   
320
     
307
 
Realized gain (loss) on derivatives, net
   
(1,461
)
   
(1,242
)
Unrealized gain (loss) on derivatives, net
   
(5,198
)
   
(2,542
)
Unrealized gain (loss) on investments in Excess MSRs
   
(2,307
)
   
(2,117
)
Unrealized gain (loss) on investments in MSRs
   
(2,232
)
   
-
 
Total Income (Loss)
   
(6,254
)
   
(1,002
)
Expenses
               
General and administrative expense
   
808
     
742
 
Management fee to affiliate
   
690
     
690
 
Total Expenses
   
1,498
     
1,432
 
Income (Loss) Before Income Taxes
   
(7,752
)
   
(2,434
)
Provision for corporate business taxes
   
(590
)
   
-
 
Net Income (Loss)
   
(7,162
)
   
(2,434
)
Net (Income) loss allocated to noncontrolling interests
   
99
     
22
 
Net Income (Loss) Applicable to Common Stockholders
 
$
(7,063
)
 
$
(2,412
)
Net income (Loss) Per Share of Common Stock
               
Basic
 
$
(0.94
)
 
$
(0.32
)
Diluted
 
$
(0.94
)
 
$
(0.32
)
Weighted Average Number of Shares of Common Stock Outstanding
               
Basic
   
7,509,543
     
7,509,543
 
Diluted
   
7,519,038
     
7,509,543
 


See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)
(in thousands)

   
Three Months Ended March 31,
 
   
2016
   
2015
 
Net income (loss)
 
$
(7,162
)
 
$
(2,434
)
Other comprehensive income (loss):
               
Net unrealized gain (loss) on RMBS
   
7,652
     
2,791
 
Reclassification of net realized (gain) loss on RMBS in earnings
   
(320
)
   
(307
)
Other comprehensive income (loss)
   
7,332
     
2,484
 
Comprehensive income (loss)
 
$
170
   
$
50
 
Comprehensive income (loss) attributable to noncontrolling interests
   
2
     
0
(A)
Comprehensive income (loss) attributable to common stockholders
 
$
168
   
$
50
 
 

(A) de minimis ($458.00 rounds to $0.00).

See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
For the three month periods ended March 31, 2016 and 2015
(Unaudited)
(in thousands — except share data)
 
   
Common
Stock
Shares
   
Common
Stock
Amount
   
Additional
Paid-in
Capital
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Retained
Earnings
 (Deficit)
   
Non-
Controlling
Interest in
Operating
Partnership
   
Total
Stockholders’
 Equity
 
Balance, December 31, 2014
   
7,509,543
   
$
75
   
$
148,258
   
$
6,641
   
$
4,799
   
$
545
   
$
160,318
 
Issuance of common stock
   
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Net Income (Loss)
   
-
     
-
     
-
     
-
     
(2,412
)
   
(22
)
   
(2,434
)
Other Comprehensive Income
   
-
     
-
     
-
     
2,484
     
-
     
-
     
2,484
 
LTIP-OP Unit awards
   
-
     
-
     
-
     
-
     
-
     
102
     
102
 
Distribution paid on LTIP-OP Units, $0.51 per share
   
-
     
-
     
-
     
-
     
-
     
(35
)
   
(35
)
Common dividends declared
   
-
     
-
     
-
     
-
     
(3,830
)
   
-
     
(3,830
)
Balance, March 31, 2015
   
7,509,543
   
$
75
   
$
148,258
   
$
9,125
   
$
(1,443
)
 
$
590
   
$
156,605
 
                                                         
Balance, December 31, 2015
   
7,519,038
   
$
75
   
$
148,332
   
$
(197
)
 
$
3,133
   
$
994
   
$
152,337
 
Issuance of common stock
   
-
     
-
     
38
     
-
     
-
     
-
     
38
 
Net Income (Loss)
   
-
     
-
     
-
     
-
     
(7,063
)
   
(99
)
   
(7,162
)
Other Comprehensive Income
   
-
     
-
     
-
     
7,332
     
-
     
-
     
7,332
 
LTIP-OP Unit awards
   
-
     
-
     
-
     
-
     
-
     
147
     
147
 
Distribution paid on LTIP-OP Units
   
-
     
-
     
-
     
-
     
-
     
(51
)
   
(51
)
Common dividends declared, $0.49 per share
   
-
     
-
     
-
     
-
     
(3,684
)
   
-
     
(3,684
)
Balance, March 31, 2016
   
7,519,038
   
$
75
   
$
148,370
   
$
7,135
   
$
(7,614
)
 
$
991
   
$
148,957
 
 
See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)
 
   
Three Months Ended March 31,
 
   
2016
   
2015
 
Cash Flows From Operating Activities
           
Net income (loss)
 
$
(7,162
)
 
$
(2,434
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Realized (gain) loss on RMBS, net
   
(320
)
   
(307
)
Accretion of premium and other amortization
   
853
     
677
 
Change in fair value of investments in Servicing Related Assets
   
4,539
     
2,117
 
Unrealized (gain) loss on derivatives, net
   
5,198
     
2,542
 
Realized (gain) loss on derivatives, net
   
1,461
     
1,242
 
LTIP-OP Unit awards
   
147
     
102
 
Changes in:
               
Receivables from unsettled trades
   
-
     
309
 
Receivables and other assets
   
(1,474
)
   
21
 
Due to affiliate
   
51
     
(20
)
Accrued expenses and other liabilities
   
(8
)
   
(195
)
Net cash provided by (used in) operating activities
 
$
3,285
   
$
4,054
 
Cash Flows From Investing Activities
               
Purchase of RMBS
   
(27,340
)
   
(72,544
)
Principal paydown of RMBS
   
10,755
     
8,906
 
Proceeds from sale of RMBS
   
23,467
     
52,142
 
Acquisition of Excess MSRs
   
-
     
-
 
Principal paydown of Excess MSRs
   
4,912
     
4,644
 
Acquisition of MSRs
   
(4,252
)
   
-
 
Purchase of derivatives
   
(1,458
)
   
(528
)
Net cash provided by (used in) investing activities
 
$
6,084
   
$
(7,380
)
Cash Flows From Financing Activities
               
Changes in restricted cash
   
(2,964
)
   
(3,326
)
Borrowings under repurchase agreements
   
436,447
     
356,317
 
Repayments of repurchase agreements
   
(423,633
)
   
(344,575
)
Proceeds from Federal Home Loan Bank advances
   
7,000
     
-
 
Repayments of Federal Home Loan Bank advances
   
(22,000
)
   
-
 
Principal paydown of bank loans
   
(476
)
   
-
 
Dividends paid
   
(3,684
)
   
(3,830
)
LTIP-OP Units distributions paid
   
(51
)
   
(35
)
Issuance of common stock, net of offering costs
   
38
     
-
 
Net cash provided by (used in) financing activities
 
$
(9,323
)
 
$
4,551
 
Net Increase (Decrease) in Cash and Cash Equivalents
 
$
46
   
$
1,225
 
Cash and Cash Equivalents, Beginning of Period
   
10,603
     
12,447
 
Cash and Cash Equivalents, End of Period
 
$
10,649
   
$
13,672
 
Supplemental Disclosure of Cash Flow Information
               
Cash paid during the period for interest expense
 
$
1,494
   
$
517
 
Dividends declared but not paid
 
$
3,684
   
$
3,830
 
 
See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries

Notes to Consolidated Financial Statements

March 31, 2016

(Unaudited)
Note 1 — Organization and Operations

Cherry Hill Mortgage Investment Corporation (together with its consolidated subsidiaries, the “Company”) was organized in the state of Maryland on October 31, 2012 to invest in residential mortgage assets in the United States.

The accompanying interim consolidated financial statements include the accounts of the Company’s subsidiaries, Cherry Hill Operating Partnership LP, Cherry Hill QRS I, LLC, Cherry Hill QRS II, Cherry Hill QRS III, LLC, CHMI Insurance Company, LLC (“CHMI Insurance”), CHMI Solutions, Inc. (“CHMI Solutions”) and Aurora Financial Group, Inc. (“Aurora”).

On October 9, 2013, the Company completed an initial public offering (the “IPO”) and a concurrent private placement of its common stock. The Company did not conduct any activity prior to the IPO and the concurrent private placement. Substantially all of the net proceeds from the IPO and the concurrent private placement were used to invest in excess mortgage servicing rights on residential mortgage loans (“Excess MSRs”) and residential mortgage-backed securities (“RMBS” or “securities”), the payment of principal and interest on which is guaranteed by a U.S. government agency or a U.S. government sponsored enterprise (“Agency RMBS”).

The Company is party to a management agreement (the “Management Agreement”) with Cherry Hill Mortgage Management, LLC (the “Manager”), a Delaware limited liability company and an affiliate of Freedom Mortgage Corporation (“Freedom Mortgage”). The Manager and Freedom Mortgage are controlled by Mr. Middleman. For a further discussion of the Management Agreement, see Note 7.

The Company has elected to be taxed as a REIT, as defined under the Internal Revenue Code of 1986, as amended (the “Code”), commencing with its short taxable year ended December 31, 2013. As long as the Company continues to comply with a number of requirements under federal tax law and maintains its qualification as a REIT, the Company generally will not be subject to U.S. federal income taxes to the extent that the Company distributes its taxable income to its stockholders on an annual basis and does not engage in prohibited transactions. However, certain activities that the Company may perform may cause it to earn income that will not be qualifying income for REIT purposes.

Note 2 — Basis of Presentation and Significant Accounting Policies

Basis of Accounting

The accompanying interim consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X. The interim consolidated financial statements include the accounts of the Company and its consolidated subsidiaries. All significant intercompany transactions and balances have been eliminated. The Company consolidates those entities in which it has an investment of 50% or more and has control over significant operating, financial and investing decisions of the entity. The interim consolidated financial statements reflect all necessary and recurring adjustments for fair presentation of the results for the interim periods presented herein.

Emerging Growth Company Status

On April 5, 2012, the Jumpstart Our Business Startups Act (the “JOBS Act”) was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. Because the Company qualifies as an “emerging growth company,” it may, under Section 7(a)(2)(B) of the Securities Act of 1933, delay adoption of new or revised accounting standards applicable to public companies until such standards would otherwise apply to private companies. The Company has elected to take advantage of this extended transition period until the first to occur of the date that it (i) is no longer an “emerging growth company” or (ii) affirmatively and irrevocably opts out of this extended transition period. As a result, the consolidated financial statements may not be comparable to those of other public companies that comply with such new or revised accounting standards. Until the date that the Company is no longer an “emerging growth company” or affirmatively and irrevocably opts out of the extended transition period, upon issuance of a new or revised accounting standard that applies to the consolidated financial statements and that has a different effective date for public and private companies, the Company will disclose the date on which adoption is required for non-emerging growth companies and the date on which it will adopt the recently issued accounting standard.
 
Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make a number of significant estimates and assumptions. These include estimates of fair value of Excess MSRs and MSRs (collectively, “Servicing Related Assets”), RMBS, derivatives and credit losses including the period of time during which the Company anticipates an increase in the fair values of securities sufficient to recover unrealized losses on those securities, and other estimates that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim consolidated financial statements and the reported amounts of certain revenues and expenses during the reporting period. It is likely that changes in these estimates (e.g., valuation changes due to supply and demand, credit performance, prepayments, interest rates, or other reasons) will occur in the near term. The Company’s estimates are inherently subjective in nature. Actual results could differ from the Company’s estimates and differences may be material.

Risks and Uncertainties

In the normal course of business, the Company encounters primarily two significant types of economic risk: credit and market. Credit risk is the risk of default on the Company’s investments in RMBS, Servicing Related Assets and derivatives that results from a borrower’s or derivative counterparty’s inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of investments in RMBS, Servicing Related Assets and derivatives due to changes in interest rates, spreads or other market factors. The Company is subject to the risks involved with real estate and real estate-related debt instruments. These include, among others, the risks normally associated with changes in the general economic climate, changes in the mortgage market, changes in tax laws, interest rate levels, and the availability of financing.

The Company also is subject to significant tax risks. If the Company were to fail to qualify as a REIT in any taxable year, the Company would be subject to U.S. federal income tax (including any applicable alternative minimum tax), which could be material. Unless entitled to relief under certain statutory provisions, the Company would also be disqualified from treatment as a REIT for the four taxable years following the year during which qualification is lost.

Investments in RMBS

Classification – The Company classifies its investments in RMBS as securities available for sale. Although the Company generally intends to hold most of its securities until maturity, it may, from time to time, sell any of its securities as part of its overall management of its portfolio. Securities available for sale are carried at fair value with the net unrealized gains or losses reported as a separate component of accumulated other comprehensive income, to the extent impairment losses, if any, are considered temporary. Unrealized losses on securities are charged to earnings if they reflect a decline in value that is other-than-temporary, as described below.

Fair value is determined under the guidance of ASC 820, Fair Value Measurements and Disclosures. The Company determines fair value of its RMBS investments based upon prices obtained from third-party pricing providers. The third-party pricing providers use pricing models that generally incorporate such factors as coupons, primary and secondary mortgage rates, rate reset period, issuer, prepayment speeds, credit enhancements and expected life of the security. In determining the fair value of RMBS, management’s judgment is used to arrive at fair value that considers prices obtained from third-party pricing providers and other applicable market data. The Company’s application of ASC 820 guidance is discussed in further detail in Note 9.

Investment securities transactions are recorded on the trade date. At disposition, the net realized gain or loss is determined on the basis of the cost of the specific investment and is included in earnings. All RMBS sold in the three month periods ended March 31, 2016 and in the year ended December 31, 2015, were settled prior to their respective period ends.

Revenue Recognition Interest income from coupon payments is accrued based on the outstanding principal amount of the RMBS and their contractual terms. Premiums and discounts associated with the purchase of the RMBS are accreted into interest income over the projected lives of the securities using the interest method. The Company’s policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, consensus on prepayment speeds, and current market conditions. Adjustments are made for actual prepayment activity. Approximately $1.5 million and $1.5 million in interest income was receivable at March 31, 2016 and December 31, 2015, respectively, and has been classified within “Receivables and other assets” on the consolidated balance sheets.
 
Impairment The Company evaluates its RMBS, on a quarterly basis, to assess whether a decline in the fair value below the amortized cost basis is an other-than-temporary impairment (“OTTI”). The presence of OTTI is based upon a fair value decline below a security’s amortized cost basis and a corresponding adverse change in expected cash flows due to credit related factors as well as non-credit factors, such as changes in interest rates and market spreads. Impairment is considered other-than-temporary if an entity (i) intends to sell the security, (ii) will more likely than not be required to sell the security before it recovers in value, or (iii) does not expect to recover the security’s amortized cost basis, even if the entity does not intend to sell the security. Under these scenarios, the impairment is other-than-temporary and the full amount of impairment should be recognized currently in earnings and the cost basis of the security is adjusted. However, if an entity does not intend to sell the impaired security and it is more likely than not that it will not be required to sell before recovery, the OTTI should be separated into (i) the estimated amount relating to credit loss, or the credit component, and (ii) the amount relating to all other factors, or the non-credit component. Only the estimated credit loss amount is recognized currently in earnings, with the remainder of the loss recognized in other comprehensive income. The difference between the new amortized cost basis and the cash flows expected to be collected is accreted into interest income in accordance with the effective interest method.

Investments in Excess MSRs

Classification – The Company has elected the fair value option to record its investments in Excess MSRs in order to provide users of the consolidated financial statements with better information regarding the effects of prepayment risk and other market factors on the Excess MSRs. Under this election, the Company records a valuation adjustment on its investments in Excess MSRs on a quarterly basis to recognize the changes in fair value in net income as described below. In determining the valuation of Excess MSRs, management uses internally developed models that are primarily based on observable market-based inputs but which also include unobservable market data inputs (see Note 9).

Revenue Recognition – Excess MSRs are aggregated into pools as applicable. Each pool of Excess MSRs is accounted for in the aggregate. Interest income for each pool of Excess MSRs is accreted into interest income on an effective yield or “interest” method, based upon the expected excess mortgage servicing amount over the expected life of the underlying mortgages. A change to expected cash flows results in a cumulative retrospective adjustment, which is recorded in the period in which the change in occurs. Under the retrospective method, the interest income recognized for a reporting period is measured as the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial investment. The difference between the fair value of Excess MSRs and their amortized cost basis is recorded on the income statement as “Unrealized gain (loss) on investments in Excess MSRs.” Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the Excess MSRs and, therefore, may differ from their effective yields. Approximately $2.1 million and $2.2 million in Excess MSR cashflow was receivable at March 31, 2016 and December 31, 2015, respectively, and has been classified within “Receivables and other assets” on the consolidated balance sheets.

Investments in MSRs

Classification – The Company has elected the fair value option to record its investments in MSRs in order to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors on the MSRs. Under this election, the Company records a valuation adjustment on its investments in MSRs on a quarterly basis to recognize the changes in fair value in net income as described below. The Company’s MSRs represent the right to service mortgage loans. As an owner and manager of MSRs, the Company may be obligated to fund advances of principal and interest payments due to third-party owners of the loans, but not yet received from the individual borrowers. These advances are reported as servicing advances within the “Receivables and other assets” line item on the consolidated balance sheets. MSRs are reported at fair value on the consolidated balance sheets. Although transactions in MSRs are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds, delinquency levels, costs to service and discount rates). Changes in the fair value of MSRs as well as servicing fee income and servicing costs are reported on the consolidated statements of income. In determining the valuation of MSRs, management uses internally developed models that are primarily based on observable market-based inputs but which also include unobservable market data inputs (see Note 9).
 
Revenue Recognition – Mortgage servicing fee income represents revenue earned for servicing mortgage loans. The servicing fees are based on a contractual percentage of the outstanding principal balance and recognized as revenue as the related mortgage payments are collected. Corresponding costs to service are charged to expense as incurred. Approximately $612,000 in reimbursable servicing advances was receivable at March 31, 2016, and has been classified within “Receivables and other assets” on the consolidated balance sheets. For further discussion on Receivables and other assets, see Note 14.
 
Servicing fee income received and servicing costs incurred are reported on the consolidated statements of comprehensive income. The difference between the fair value of MSRs and their amortized cost basis is recorded on the income statement as “Unrealized gain (loss) on investments in MSRs.” Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the MSRs and, therefore, may differ from their effective yields.

Derivatives and Hedging Activities

Derivative transactions include swaps, swaptions, Treasury futures and “to-be-announced” securities (“TBAs”). Swaps and swaptions are entered into by the Company solely for interest rate risk management purposes. TBAs and treasury futures are used for duration risk and basis risk management purposes. The decision of whether or not a given transaction/position (or portion thereof) is economically hedged is made on a case-by-case basis, based on the risks involved and other factors as determined by senior management, including restrictions imposed by the Code on REITs. In determining whether to economically hedge a risk, the Company may consider whether other assets, liabilities, firm commitments and anticipated transactions already offset or reduce the risk. All transactions undertaken as economic hedges are entered into with a view towards minimizing the potential for economic losses that could be incurred by the Company. Generally, derivatives entered into are not intended to qualify as hedges under GAAP, unless specifically stated otherwise.

The Company’s derivative financial instruments contain credit risk to the extent that its bank counterparties may be unable to meet the terms of the agreements. The Company reduces such risk by limiting its counterparties to major financial institutions. In addition, the potential risk of loss with any one party resulting from this type of credit risk is monitored. Finally, the Company’s interest rate swaps are required to be cleared on an exchange, which further mitigates, but does not eliminate, credit risk. Management does not expect any material losses as a result of default by other parties.

Classification – All derivatives are recognized as either assets or liabilities on the consolidated balance sheets and measured at fair value. Due to the nature of these instruments, they may be in a receivable/asset position or a payable/liability position at the end of an accounting period. Derivative amounts payable to, and receivable from, the same party under a contract may be offset as long as the following conditions are met: (i) each of the two parties owes the other determinable amounts; (ii) the reporting party has the right to offset the amount owed with the amount owed by the other party; (iii) the reporting party intends to offset; and (iv) the right to offset is enforceable by law. The Company reports the fair value of derivative instruments gross of cash paid or received pursuant to credit support agreements, and fair value may be reflected on a net counterparty basis when the Company believes a legal right of offset exists under an enforceable master netting agreement. For further discussion on offsetting assets and liabilities, see Note 8.

Revenue Recognition – With respect to derivatives that have not been designated as hedges, any net payments under, or fluctuations in the fair value of, such derivatives have been recognized currently in “Realized and unrealized gains (losses) on derivatives, net” in the consolidated statements of income. These derivatives may, to some extent, be economically effective as hedges.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid short-term investments with maturities of 90 days or less when purchased to be cash equivalents. Substantially all amounts on deposit with major financial institutions exceed insured limits. Restricted cash represents the Company’s cash held by counterparties as collateral against the Company’s derivatives (approximately $9.7 million and $4.6 million at March 31, 2016 and December 31, 2015, respectively), borrowings under its repurchase agreements (approximately $2.1 million and $4.2 million at March 31, 2016 and December 31, 2015, respectively) as well as cash held that relates to the $23.8 million and $ 24.3 million of borrowings on a term loan (“Term Loan”) (approximately $1.1 million at March 31, 2016 and December 31, 2015, respectively). For further information on the restricted cash as it relates to the Term Loan, see Note 13.
 
Due to Affiliate

This represents amounts due to the Manager pursuant to the Management Agreement. For further information on the Management Agreement, see Note 7.

Income Taxes

The Company has elected to be taxed as a REIT under the Code commencing with its short taxable year ended December 31, 2013. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes at least 90% of its REIT taxable income to stockholders and does not engage in prohibited transactions. The Company’s taxable REIT subsidiaries (“TRSs”), Solutions and Aurora, are subject to U.S. federal income taxes on their taxable income.
 
The Company accounts for income taxes in accordance with ASC 740, Income Taxes. ASC 740 requires the recording of deferred income taxes that reflect the net tax effect of temporary differences between the carrying amounts of the Company’s assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, including operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period that includes the enactment date. The Company assesses its tax positions for all open tax years and determines if it has any material unrecognized liabilities in accordance with ASC 740. The Company records these liabilities to the extent it deems them more-likely-than-not to be incurred. The Company records interest and penalties related to income taxes within the provision for income taxes in the consolidated statements of income (loss). The Company has not incurred any interest or penalties.

Realized Gain (Loss) on RMBS and Derivatives, Net

The following table presents gains and losses on sales of RMBS and derivatives for the periods indicated (dollars in thousands):

   
Three Months Ended March 31,
 
   
2016
   
2015
 
Realized gain (loss) on RMBS, net
           
Gain on RMBS
 
$
320
   
$
307
 
Loss on RMBS
   
-
     
-
 
Net realized gain (loss) on RMBS
   
320
     
307
 
Realized gain (loss) on derivatives, net
   
(1,461
)
   
(1,242
)
Unrealized gain (loss) on derivatives, net
   
(5,198
)
   
(2,542
)
Total
 
$
(6,339
)
 
$
(3,477
)
 
The gain and loss on RMBS presented above represent the amounts reclassified from other comprehensive income (loss) in earnings.

Repurchase Agreements and Interest Expense

The Company finances its investments in RMBS with short-term borrowings under uncommitted master repurchase agreements. The repurchase agreements are generally short-term debt, which expire within one year. Borrowings under repurchase agreements generally bear interest rates of a specified margin over one-month LIBOR. The repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, as specified in the respective agreements. Interest is recorded at the contractual amount on an accrual basis.

Federal Home Loan Bank of Indianapolis Advances

Advances from the Federal Home Loan Bank of Indianapolis (“FHLBI”) are secured by the pledge of Agency RMBS, have varying amortization structures and maturities and bear interest at rates set by FHLBI based on market conditions and a number of criteria, including the size of the transaction and the FHLBI’s cost of funds. Advances are treated as collateralized financing transactions and are carried at their contractual amounts. Interest is recorded at the contractual amount on an accrual basis.

Dividends Payable

Because the Company is organized and operated so as to qualify as a REIT under the Code, it is required by law to distribute annually at least 90% of its REIT taxable income, which it does in the form of quarterly dividend payments. The Company accrues the dividend payable on the accounting date, which causes an offsetting reduction in retained earnings.

Comprehensive Income

Comprehensive income is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. For the Company’s purposes, comprehensive income represents net income, as presented in the consolidated statements of income, adjusted for unrealized gains or losses on RMBS, which are designated as available for sale.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations. Under the acquisition method the acquiring entity in a business combination recognizes 100 percent of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceeds the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statement of income (loss) from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. We applied this guidance to the Aurora acquisition.
 
Recent Accounting Pronouncements

Business Combinations – In September 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which amends ASC 805, Business Combinations. ASU 2015-16 requires that an acquirer recognize adjustments to previously identified provisional amounts in the reporting period in which the adjustment amounts are determined. ASU 2015-16 requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. Adoption of ASU 2015-16 did not have a material impact on the consolidated statement of income (loss) or earnings per share.

Revenue Recognition – In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in ASC 606, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. The core principle of ASU 2014-09 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. ASU 2014-09 is effective for fiscal years and interim periods beginning after December 15, 2017. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance in ASU 2014-09. Management is currently evaluating the impact ASU 2014-09 may have on its consolidated financial statements.

Transfers and Servicing – In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, which amends ASC 860, Transfers and Servicing. ASU 2014-11, which affects all entities that enter into repurchase-to-maturity transactions or repurchase financings, requires two accounting changes. First, ASU 2014-11 changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, ASU 2014-11 requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. ASU 2014-11 also requires disclosures for certain transactions comprising (1) a transfer of a financial asset accounted for as a sale and (2) an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. For those transactions outstanding at the reporting date, the transferor is required to disclose additional information by type of transaction. ASU 2014-11 also requires certain disclosures for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The accounting changes in ASU 2014-11 are effective for public business entities for the first interim or annual period beginning after December 15, 2014. For public business entities, the disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015, with early adoption prohibited. Adoption of ASU 2014-11 did not have a material impact on the consolidated balance sheet, statement of income (loss), or earnings per share.
 
Stock Compensation – In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved After the Requisite Service Period, which amends ASC 718, Compensation – Stock Compensation. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. Adoption of ASU 2014-12 did not have a material impact on the consolidated balance sheet, statement of income (loss), or earnings per share.

Going Concern  In August 2014, the FASB issued ASU 2014-15, Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which amends ASC Subtopic 205-40, Presentation of Financial Statements – Going Concern. ASU 2014-15 provides guidance in GAAP about management’s responsibility to evaluate whether there are conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued and to provide related footnote disclosures of the relevant facts and circumstances. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, with early adoption permitted. Management does not expect the adoption of ASU 2014-15 to have an impact on its consolidated financial statements.

Changes in Presentation

Certain prior period amounts have been reclassified to conform to current period presentation.
 
Note 3 — Segment Reporting

The Company conducts its business through the following segments: (i) investments in RMBS; (ii) investments in Servicing Related Assets; and (iii) “All Other” which consists primarily of general and administrative expenses, including fees to the directors and management fees pursuant to the Management Agreement (See Note 7). For segment reporting purposes, the Company does not allocate interest income on short-term investments or general and administrative expenses.

Summary financial data on the Company’s segments is given below, together with a reconciliation to the same data for the Company as a whole (dollars in thousands):

   
Servicing
Related Assets
   
RMBS
   
All Other
   
Total
 
Three Months Ended March 31, 2016
                       
Interest income
 
$
1,444
   
$
3,744
   
$
-
   
$
5,188
 
Interest expense
   
340
     
1,317
     
-
     
1,657
 
Net interest income
   
1,104
     
2,427
     
-
     
3,531
 
Servicing fee income
   
1,495
     
-
     
-
     
1,495
 
Servicing costs
   
402
     
-
     
-
     
402
 
Net servicing income
   
1,093
     
-
     
-
     
1,093
 
Other income
   
(4,539
)
   
(6,339
)
   
-
     
(10,878
)
Other operating expenses
   
-
     
-
     
1,498
     
1,498
 
Provision for corporate business taxes
   
-
     
-
     
(590
)
   
(590
)
Net income (loss)
 
$
(2,342
)
 
$
(3,912
)
 
$
(908
)
 
$
(7,162
)
Three Months Ended March 31, 2015
                               
Interest income
 
$
2,575
   
$
3,252
   
$
-
   
$
5,827
 
Interest expense
   
-
     
1,235
     
-
     
1,235
 
Net interest income
   
2,575
     
2,017
     
-
     
4,592
 
Servicing fee income
   
-
     
-
     
-
     
-
 
Servicing costs
   
-
     
-
     
-
     
-
 
Net servicing income
   
-
     
-
     
-
     
-
 
Other income
   
(2,117
)
   
(3,477
)
   
-
     
(5,594
)
Other operating expenses
   
-
     
-
     
1,432
     
1,432
 
Provision for corporate business taxes
   
-
     
-
     
-
     
-
 
Net income (loss)
 
$
458
   
$
(1,460
)
 
$
(1,432
)
 
$
(2,434
)
                                 
Balance Sheet
                               
March 31, 2016                                
Investments
 
$
92,604
   
$
508,159
   
$
-
   
$
600,763
 
Other assets
   
3,665
     
17,718
     
13,046
     
34,429
 
Total assets
   
96,269
     
525,877
     
13,046
     
635,192
 
Debt
   
23,836
     
445,624
     
-
     
469,460
 
Other liabilities
   
2,007
     
9,734
     
5,034
     
16,775
 
Total liabilities
   
25,843
     
455,358
     
5,034
     
486,235
 
GAAP book value
 
$
70,426
   
$
70,519
   
$
8,012
   
$
148,957
 
December 31, 2015
                               
Investments
 
$
97,803
   
$
508,242
   
$
-
   
$
606,045
 
Other assets
   
3,562
     
13,984
     
12,749
     
30,295
 
Total assets
   
101,365
     
522,226
     
12,749
     
636,340
 
Debt
   
24,313
     
447,810
     
-
     
472,123
 
Other liabilities
   
1,883
     
4,903
     
5,094
     
11,880
 
Total liabilities
   
26,196
     
452,713
     
5,094
     
484,003
 
GAAP book value
 
$
75,169
   
$
69,513
   
$
7,655
   
$
152,337
 
 
Note 4 — Investments in RMBS

All of the Company’s RMBS are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income except for securities that are OTTI. There were no OTTI securities as of March 31, 2016 and December 31, 2015 (dollars in thousands):

Summary of RMBS Assets

As of March 31, 2016
 
  Original        
Gross Unrealized
       
Number
 
Weighted Average
 
Asset Type
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
RMBS
                                   
 
                 
Fannie Mae
 
$
342,288
   
$
315,200
   
$
4,888
   
$
(64
)
 
$
320,024
     
46
 
(B)
   
3.77
%
   
3.59
%
   
23
 
Freddie Mac
   
190,523
     
178,119
     
2,620
     
-
     
180,739
     
23
 
(B)
   
3.62
%
   
3.35
%
   
25
 
CMOs
   
17,896
     
7,706
     
6
     
(316
)
   
7,396
     
5
 
Unrated
   
4.35
%
   
6.96
%
   
10
 
Total/Weighted Average
 
$
550,707
   
$
501,025
   
$
7,514
   
$
(380
)
 
$
508,159
     
74
 
 
   
3.72
%
   
3.56
%
   
24
 
 

As of December 31, 2015
 
  Original        
Gross Unrealized
       
Number
 
Weighted Average
 
Asset Type
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
of
 Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
RMBS
                                   
 
                 
Fannie Mae
 
$
329,767
   
$
308,367
   
$
1,961
   
$
(1,556
)
 
$
308,772
     
44
 
(B)
   
3.77
%
   
3.59
%
   
24
 
Freddie Mac
   
208,154
     
193,567
     
821
     
(977
)
   
193,411
     
24
 
(B)
   
3.61
%
   
3.48
%
   
24
 
CMOs
   
16,646
     
6,493
     
-
     
(434
)
   
6,059
     
4
 
Unrated
   
4.55
%
   
7.39
%
   
10
 
Total/Weighted Average
 
$
554,567
   
$
508,427
   
$
2,782
   
$
(2,967
)
 
$
508,242
     
72
 
 
   
3.72
%
   
3.60
%
   
23
 
 

(A) See Note 9 regarding the estimation of fair value, which approximates carrying value for all securities.
(B) The Company used an implied AAA rating for the Fannie Mae and Freddie Mac securities.
(C) The weighted average yield is based on the most recent annualized monthly interest income, divided by the Book Value. Prior period amounts have been reclassified to conform to current period presentation.
(D) The weighted average stated maturity.
 
Summary of RMBS Assets by Maturity

As of March 31, 2016

  Original        
Gross Unrealized
       
Number
 
Weighted Average
 
Asset Type
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
Less than 1 Year
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
     
-
 
 
   
-
     
-
     
-
 
1-5 Years
   
-
     
-
     
-
     
-
     
-
     
-
       
-
     
-
     
-
 
5-10 Years
   
5,500
     
5,553
     
-
     
(159
)
   
5,394
     
3
 
(B)
   
4.77
%
   
4.57
%
   
9
 
Over 10 Years
   
545,207
     
495,472
     
7,514
     
(221
)
   
502,765
     
71
 
(B)
   
3.71
%
   
3.55
%
   
24
 
Total/Weighted Average
 
$
550,707
   
$
501,025
   
$
7,514
   
$
(380
)
 
$
508,159
     
74
 
 
   
3.72
%
   
3.56
%
   
24
 
 
As of December 31, 2015
 
  Original        
Gross Unrealized
       
Number
 
Weighted Average
 
Asset Type
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
 of
 Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
Less than 1 Year
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
     
-
 
 
   
-
     
-
     
-
 
1-5 Years
   
-
     
-
     
-
     
-
     
-
     
-
       
-
     
-
     
-
 
5-10 Years
   
5,500
     
5,553
     
-
     
(216
)
   
5,337
     
3
 
(B)
   
4.76
%
   
4.96
%
   
9
 
Over 10 Years
   
549,067
     
502,874
     
2,782
     
(2,751
)
   
502,905
     
69
 
(B)
   
3.71
%
   
3.59
%
   
24
 
Total/Weighted Average
 
$
554,567
   
$
508,427
   
$
2,782
   
$
(2,967
)
 
$
508,242
     
72
 
 
   
3.72
%
   
3.60
%
   
23
 
 

(A) See Note 9 regarding the estimation of fair value, which approximates carrying value for all securities.
(B) The Company used an implied AAA rating for the Fannie Mae and Freddie Mac securities.
(C) The weighted average yield is based on the most recent annualized monthly interest income, divided by the Book Value. Prior period amounts have been reclassified to conform to current period presentation.
(D) The weighted average stated maturity.
 
At March 31, 2016 and December 31, 2015, the Company pledged Agency RMBS investments with a carrying value of approximately $416.1 million and $399.8 million, respectively, as collateral for repurchase agreements. At March 31, 2016, and December 31, 2015, the Company pledged Agency RMBS investments with a carrying value of approximately $51.8 million and $83.2 million, respectively, as collateral for FHLBI advances. At March 31, 2016 and December 31, 2015, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the three month periods ended March 31, 2016 and 2015, the Company did not record any OTTI charges. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, management determined that unrealized losses as of the balance sheet date on the Company’s securities were primarily the result of changes in market factors, rather than issuer-specific credit impairment. The Company performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. Such market factors include changes in market interest rates and credit spreads, or certain macroeconomic events, which did not directly impact the Company’s ability to collect amounts contractually due. Management continually evaluates the credit status of each of the Company’s securities and the collateral supporting those securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security (if applicable), the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. In connection with the above, the Company weighs the fact that all of its investments in Agency RMBS are guaranteed by U.S. government agencies or U.S. government sponsored entities.
 
These factors include underlying loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. The result of this evaluation is considered when determining management’s estimate of cash flows and in relation to the amount of the unrealized loss and the period elapsed since it was incurred. Significant judgment is required in this analysis. The following tables summarize the Company’s securities in an unrealized loss position as of the dates indicated (dollars in thousands):
 
RMBS Unrealized Loss Positions

As of March 31, 2016

  Original        Gross        Number    
Weighted Average
 
Asset Type
Face
Value
  Book
Value
 
Unrealized
Losses
 
Carrying
Value(A)
 
 
of
Securities
   
Rating
 
Coupon
   
Yield(C)
 
Maturity
(Years)(D)
 
Less than Twelve Months
 
$
33,101
   
$
34,495
   
$
(187
)
 
$
34,308
     
7
   
 (B)
   
3.94
%
   
3.72
%
   
20
 
Twelve or More Months
   
28,577
     
17,577
     
(193
)
   
17,384
     
4
   
 (B)
   
3.15
%
   
4.15
%
   
15
 
Total/Weighted Average
 
$
61,678
   
$
52,072
   
$
(380
)
 
$
51,692
     
11
   
 
   
3.68
%
   
3.86
%
   
19
 
 
As of December 31, 2015
 
  Original     Gross     Number    
Weighted Average
 
Asset Type
Face
Value
   
Book
Value
  Unrealized
Losses
   
Carrying
Value(A)
 
of
Securities
   
Rating
 
Coupon
   
Yield(C)
 
Maturity
(Years)(D)
 
Less than Twelve Months
 
$
271,585
   
$
274,996
   
$
(2,749
)
 
$
272,247
     
39
   
 (B)
   
3.65
%
   
3.48
%
   
24
 
Twelve or More Months
   
11,146
     
940
     
(218
)
   
722
     
1
   
 (B)
   
3.00
%
   
25.37
%
   
17
 
Total/Weighted Average
 
$
282,731
   
$
275,936
   
$
(2,967
)
 
$
272,969
     
40
   
 
   
3.65
%
   
3.55
%
   
24
 
 

(A) See Note 9 regarding the estimation of fair value, which is equal to carrying value for all securities.
(B) The Company used an implied AAA rating for the Fannie Mae and Freddie Mac securities, other than CMOs, which are unrated.
(C) The weighted average yield is based on the most recent annualized monthly interest income, divided by the Book Value. Prior period amounts have been reclassified to conform to current period presentation.
(D) The weighted average stated maturity. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases which may be maturity.

Note 5 — Investments in Servicing Related Assets

Excess MSRs

In October 2013, the Company entered into an agreement (“MSR Agreement 1”) with Freedom Mortgage Corporation (“Freedom Mortgage”) to invest in Excess MSRs with Freedom Mortgage. Freedom Mortgage originated the mortgage servicing rights on the related pool of residential fixed rate Ginnie Mae-eligible FHA and VA mortgage loans with an aggregate unpaid principal balance (“UPB”) of approximately $10.0 billion (“MSR Pool 1”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of approximately 28 basis points (“bps”) on the performing UPB, as well as any ancillary income from MSR Pool 1. Pursuant to MSR Agreement 1, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 1 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 8 bps. The remainder, or “excess mortgage servicing amount,” is initially equal to a weighted average of 20 bps.

The Company acquired the right to receive 85% of the excess mortgage servicing amount on MSR Pool 1 and, subject to certain limitations and pursuant to a recapture agreement (the “MSR Pool 1—Recapture Agreement”), 85% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool l (which loans then become part of MSR Pool 1) for approximately $60.6 million. Freedom Mortgage has co-invested, pari passu with the Company, in 15% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 85%, of such termination payment.

The value, and absolute amount, of recapture activity tends to vary inversely with the direction of interest rates. When interest rates are falling, recapture rates tend to be higher due to increased opportunities for borrowers to refinance. As interest rates increase, however, there is likely to be less recapture activity.

In October 2013, the Company entered into an agreement (“MSR Agreement 2”) with Freedom Mortgage to invest with Freedom Mortgage in another pool of Excess MSRs. Freedom Mortgage acquired the mortgage servicing rights from a third-party seller on a pool of residential Ginnie Mae-eligible VA hybrid adjustable rate mortgage loans with an outstanding principal balance of approximately $10.7 billion (“MSR Pool 2”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of 44 bps on the performing UPB, as well as any ancillary income from MSR Pool 2. Pursuant to MSR Agreement 2, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 2 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 10 bps. Therefore, the remainder, or “excess mortgage servicing amount” is initially equal to a weighted average of 34 bps.
 
The Company acquired the right to receive 50% of the excess mortgage servicing amount on MSR Pool 2 and, subject to certain limitations and pursuant to a recapture agreement (the “MSR Pool 2—Recapture Agreement”), 50% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool 2 (which loans then become part of MSR Pool 2) for approximately $38.4 million. Freedom Mortgage has co-invested, pari passu with the Company, in 50% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 50%, of such termination payment.

Upon completion of the IPO and the concurrent private placement, the Company also entered into a flow and bulk Excess MSR purchase agreement related to future purchases of Excess MSRs from Freedom Mortgage. On February 28, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the first quarter of 2014 with an UPB of approximately $76.8 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $567,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On March 31, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by a third party originator with an aggregate UPB of approximately $159.8 million. Freedom Mortgage purchased the MSRs on these mortgage loans from a third party on January 31, 2014. The Company acquired an approximate 71% interest in the Excess MSRs for approximately $946,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On June 30, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the second quarter of 2014 with an aggregate UPB of approximately $98.1 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $661,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

The mortgage loans underlying the Excess MSRs purchased in 2014 are collectively referred to as “Pool 2014,” and the recapture provisions, which are identical, are collectively referred to as the “Pool 2014—Recapture Agreement.”

MSRs

On May 29, 2015, in conjunction with the acquisition of Aurora, we acquired MSRs on conventional mortgage loans with an aggregate UPB of approximately $718.4 million. We have not entered into a recapture agreement covering the MSRs as of March 31, 2016.

On June 10, 2015, the Company agreed to transfer the direct servicing of the MSR portfolio to Freedom Mortgage pursuant to a subservicing agreement with Freedom Mortgage. The transfer occurred in September 2015. Pending the transfer, the former servicing employees of Aurora, now employees of Freedom Mortgage, directly serviced the portfolio for Aurora. The servicing, which was provided at cost pursuant to the Management Agreement with the Manager and the Services Agreement between the Manager and Freedom Mortgage. The cost for such services during the third quarter of 2015 is included in servicing costs on the consolidated statements of income (loss).

On October 30, 2015, Aurora acquired a portfolio of MSRs on loans owned or securitized by Fannie Mae or Freddie Mac with an aggregate unpaid principal balance of approximately $1.4 billion.
 
On January 29, 2016, Aurora acquired a portfolio of MSRs on mortgage loans owned or securitized by Fannie Mae with an aggregate unpaid principal balance of approximately $463 million.
 
The following is a summary of the Company’s Servicing Related Assets (dollars in thousands):

Servicing Related Assets Summary

As of March 31, 2016

   
Unpaid
Principal
 Balance
   
Amortized
Cost Basis(A)
   
Carrying
Value(B)
   
Weighted
Average
Coupon
   
Weighted
Average
Maturity
(Years)(C)
   
Changes in
 Fair Value
Recorded in
Other Income
 (Loss)(D)
 
Pool 1
 
$
7,142,753
   
$
36,623
   
$
37,528
     
3.51
%
   
25.8
   
$
(2,449
)
Pool 1 - Recapture Agreement
   
-
     
2,025
     
1,566
                     
1,105
 
Pool 2
   
6,999,638
     
21,533
     
29,467
     
2.82
%
   
26.8
     
(1,288
)
Pool 2 - Recapture Agreement
   
-
     
1,632
     
945
                     
377
 
Pool 2014
   
254,898
     
1,548
     
1,317
     
3.65
%
   
27.2
     
(52
)
Pool 2014 - Recapture Agreement
   
-
     
-
     
-
                     
-
 
MSRs (E)
   
2,405,863
     
24,013
     
21,781
     
3.78
%    
22.6
     
(2,232
)
Total
 
$
16,803,152
   
$
87,374
   
$
92,604
     
3.26
%
   
25.8
   
$
(4,539
)
 
As of December 31, 2015

   
Unpaid
Principal
Balance
   
Amortized
Cost Basis(A)
   
Carrying
Value(B)
   
Weighted
Average
Coupon
   
Weighted
Average
 Maturity
 (Years)(C)
   
Changes in
Fair Value
Recorded in
Other Income
(Loss)(D)
 
Pool 1
 
$
7,416,465
   
$
39,483
   
$
42,837
     
3.51
%
   
26.0
   
$
(2,822
)
Pool 1 - Recapture Agreement
   
-
     
2,209
     
645
     
-
     
-
     
331
 
Pool 2
   
7,279,706
     
23,116
     
32,338
     
2.78
%
   
27.1
     
2,626
 
Pool 2 - Recapture Agreement
   
-
     
1,780
     
716
     
-
     
-
     
(324
)
Pool 2014
   
265,890
     
1,685
     
1,506
     
3.65
%
   
27.4
     
170
 
Pool 2014 - Recapture Agreement
   
-
     
-
     
-
     
-
     
-
     
-
 
MSRs (E)
   
2,016,351
     
20,884
     
19,761
     
3.76
%
   
22.7
     
(1,123
)
Total
 
$
16,978,412
   
$
89,157
   
$
97,803
     
3.23
%
   
26.1
   
$
(1,142
)
 

(A) The amortized cost basis of the recapture agreements is determined based on the relative fair values of the recapture agreements and related Excess MSRs at the time they were acquired.
(B) Carrying value represents the fair value of the pools or recapture agreements, as applicable (see Note 9).
(C) The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.
(D) The portion of the change in fair value of the recapture agreement relating to loans recaptured as of March 31, 2016 and December 31, 2015 is reflected in the respective pool.
(E)
MSR cost basis consists of the carrying value of the prior period, adjusted for any acquisitions made during the current period.
 
The tables below summarize the geographic distribution for the states representing 5% or greater of the underlying residential mortgage loans of the Servicing Related Assets:

Geographic Concentration of Servicing Related Assets

As of March 31, 2016
 
   
Percentage of Total Outstanding
Unpaid Principal Balance
 
California
  
 
12.0
Texas
  
 
9.2
Florida
  
 
6.5
Virginia
  
 
5.9
North Carolina
  
 
5.1
New Jersey
   
5.1
All other
 
 
56.2
Total
   
100.0
 
As of December 31, 2015
 
   
Percentage of Total Outstanding
Unpaid Principal Balance
 
California
  
 
12.3
Texas
  
 
9.4
Florida
  
 
6.5
Virginia
  
 
6.0
North Carolina
  
 
5.2
Washington
   
5.1
Georgia
 
 
5.0
All other
   
50.5
Total
 
 
100.0
 
Geographic concentrations of investments expose the Company to the risk of economic downturns within the relevant states. Any such downturn in a state where the Company holds significant investments could affect the underlying borrower’s ability to make the mortgage payment and, therefore, could have a meaningful, negative impact on the Company’s Servicing Related Assets.

Note 6 — Equity and Earnings per Share

Equity Incentive Plan

During 2013, the board of directors approved, and the Company’s sole stockholder at the time adopted, the Cherry Hill Mortgage Investment Corporation 2013 Equity Incentive Plan (“2013 Plan”). The 2013 Plan provides for the grant of options to purchase shares of the Company’s common stock, stock awards, stock appreciation rights, performance units, incentive awards and other equity-based awards, including long term incentive plan units (“LTIP-OP Units”) of the Company’s operating partnership, Cherry Hill Operating Partnership, LP (the “Operating Partnership”).
 
The following tables present certain information about the Company’s 2013 Plan as of the dates indicated:

Equity Incentive Plan Information

As of March 31, 2016
 
   
Number of Securities Issued
or to be Issued Upon
Exercise
   
Number of Securities
Remaining Available For
Future Issuance Under
Equity Compensation Plans
 
Equity compensation Plans Approved By Shareholders
         
1,377,112
 
LTIP-OP Units
   
103,850
         
Shares of Common Stock
   
19,038
         
Equity Compensation Plans Not Approved By Shareholders
           
-
 

As of December 31, 2015
 
   
Number of Securities Issued
or to be Issued Upon
Exercise
   
Number of Securities
Remaining Available For
Future Issuance Under
Equity Compensation Plans
 
Equity compensation Plans Approved By Shareholders
         
1,377,112
 
LTIP-OP Units
   
103,850
         
Shares of Common Stock
   
19,038
         
Equity Compensation Plans Not Approved By Shareholders
           
-
 
 
LTIP-OP Units are a special class of partnership interest in the Operating Partnership. LTIP-OP Units may be issued to eligible participants for the performance of services to or for the benefit of the Operating Partnership. Initially, LTIP-OP Units do not have full parity with the Operating Partnership’s common units of limited partnership interest (“OP Units”) with respect to liquidating distributions; however, LTIP-OP Units receive, whether vested or not, the same per-unit distributions as OP Units and are allocated their pro-rata share of the Company’s net income or loss. Under the terms of the LTIP-OP Units, the Operating Partnership will revalue its assets upon the occurrence of certain specified events, and any increase in the Operating Partnership’s valuation from the time of grant of the LTIP-OP Units until such event will be allocated first to the holders of LTIP-OP Units to equalize the capital accounts of such holders with the capital accounts of the holders of OP Units. Upon equalization of the capital accounts of the holders of LTIP-OP Units with the other holders of OP Units, the LTIP-OP Units will achieve full parity with OP Units for all purposes, including with respect to liquidating distributions. If such parity is reached, vested LTIP-OP Units may be converted into an equal number of OP Units at any time and, thereafter, enjoy all the rights of OP Units, including redemption/exchange rights. Each LTIP-OP Unit awarded is deemed equivalent to an award of one share under the 2013 Plan and reduces the 2013 Plan’s share authorization for other awards on a one-for-one basis.
 
An LTIP-OP Unit and a share of common stock of the Company have substantially the same economic characteristics in as much as they effectively share equally in the net income or loss of the Operating Partnership. Holders of LTIP-OP Units that have reached parity with OP Units have the right to redeem their LTIP-OP Units, subject to certain restrictions. The redemption is required to be satisfied in shares of common stock, cash, or a combination thereof, at the Company’s option, calculated as follows: one share of the Company’s common stock, or cash equal to the fair value of a share of the Company’s common stock at the time of redemption, for each LTIP-OP Unit. When an LTIP-OP Units holder redeems an OP Unit (as described above), non-controlling interest in the Operating Partnership is reduced and the Company’s equity is increased.

The table below sets forth certain information regarding the LTIP-OP Units that have been granted by the board of directors (dollars in thousands, except per share data):

LTIP-OP Unit Grant Information
 
Grant Date
 
Number of Grantees
   
Stock Price on Grant Date
   
Number of Units Granted
   
Aggregate Fair Market Value
 
September 9, 2015
   
12
   
$
15.80
     
35,000
   
$
553
 
June 10, 2014
   
10
   
$
19.33
     
31,350
   
$
606
 
October 9, 2013
   
11
   
$
20.00
     
37,500
   
$
750
 
 
Except for 7,500 LTIP-OP Units that were granted to the Company’s independent directors at the time of the IPO, which vested immediately, LTIP-OP Units vest ratably over the first three year anniversaries of the grant date. The fair value of each LTIP-OP Unit was determined based on the initial offering price of the Company’s common stock in the case of the grant to the independent directors and based on the closing price of the Company’s common stock on the applicable grant date in all other cases.

As of March 31, 2016, 37,950 LTIP-OP Units have vested. The Company recognized approximately $147,000 and $102,000 in share-based compensation expense in the three month periods ended March 31, 2016 and 2015, respectively. There was approximately $781,000 of total unrecognized share-based compensation expense as of March 31, 2016, related to the 65,900 non-vested LTIP-OP Units. This unrecognized share-based compensation expense is expected to be recognized ratably over the remaining vesting period of up to three years. The aggregate expense related to the LTIP-OP Unit grants is presented as “General and administrative expense” in the Company’s consolidated income statement.

On January 27, 2014, the Company granted each of the independent directors pursuant to the 2013 Plan 530 shares of common stock (for a total of 1,590 shares), which were fully vested on the date of grant, and 2,651 restricted shares of common stock (for a total of 7,953 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. They are no longer subject to forfeiture and are vested.

On September 9, 2015, the Company granted each of the independent directors pursuant to the 2013 Plan 3,165 restricted shares of common stock (for a total of 9,495 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. This unrecognized share-based compensation expense is expected to be recognized ratably over the remaining vesting period of up to three years.

As of March 31, 2016, 1,377,112 shares of common stock remain available for future issuance under the 2013 Plan.

Non-Controlling Interests in Operating Partnership

Non-controlling interests in the Operating Partnership in the accompanying consolidated financial statements relate to LTIP-OP Units in the Operating Partnership held by parties other than the Company.

As of March 31, 2016, the non-controlling interest holders in the Operating Partnership owned 103,850 LTIP-OP Units, or approximately 1.4% of the Operating Partnership. Pursuant to ASC 810, Consolidation, changes in a parent’s ownership interest (and transactions with non-controlling interest unit holders in the Operating Partnership) while the parent retains its controlling interest in its subsidiary should be accounted for as equity transactions. The carrying amount of the non-controlling interest will be adjusted to reflect the change in its ownership interest in the subsidiary, with the offset to equity attributable to the Company.
 
Earnings per Share

The Company is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. In accordance with ASC 260, Earnings Per Share, if there is a loss from continuing operations, the common stock equivalents are deemed anti-dilutive and earnings (loss) per share is calculated excluding the potential common shares.
 
The following table presents basic earnings per share of common stock for the periods indicated (dollars in thousands, except per share data):

Earnings per Share Information

   
Three Months Ended March 31,
 
   
2016
   
2015
 
Numerator:
           
Net income attributable to common stockholders and participating securities
 
$
(7,162
)
 
$
(2,434
)
Net income allocable to common stockholders
 
$
(7,063
)
 
$
(2,412
)
Denominator:
               
Weighted average common shares outstanding
   
7,509,543
     
7,509,543
 
Weighted average diluted shares outstanding
   
7,519,038
     
7,509,543
 
Basic and Dilutive:
               
Basic earnings per share
 
$
(0.94
)
 
$
(0.32
)
Diluted earnings per share
 
$
(0.94
)
 
$
(0.32
)
 
There were no participating securities or equity instruments outstanding that were anti-dilutive for purposes of calculating earnings per share for the periods presented.

Note 7 — Transactions with Affiliates and Affiliated Entities

Manager

The Company has entered into a management agreement with the Manager, pursuant to which the Manager provides for the day-to-day management of the Company’s operations (the “Management Agreement”). The Management Agreement requires the Manager to manage the Company’s business affairs in conformity with the policies that are approved and monitored by the Company’s board of directors. The Management Agreement terminates on October 22, 2020, subject to automatic renewal for successive one-year terms and to certain termination rights. The Manager’s performance is reviewed prior to any renewal and may be terminated by the Company for cause without payment of a termination fee, or may be terminated without cause with payment of a termination fee, as defined in the Management Agreement, equal to three times the average annual management fee amount earned by the Manager during the two four-quarter periods ending as of the end of the most recently completed fiscal quarter prior to the effective date of the termination, upon either the affirmative vote of at least two-thirds of the members of the board of directors or the affirmative vote of the holders of at least a majority of the outstanding common stock. Pursuant to the Management Agreement, the Manager, under the supervision of the Company’s board of directors, formulates investment strategies, arranges for the acquisition of assets, arranges for financing, monitors the performance of the Company’s assets and provides certain advisory, administrative and managerial services in connection with the operations of the Company. For performing these services, the Company pays the Manager a quarterly management fee equal to the product of one quarter of the 1.5% Management Fee Annual Rate and the Stockholders’ Equity, adjusted as set forth in the Management Agreement, calculated and payable quarterly in arrears.
 
The Manager is a party to a services agreement (the “Services Agreement”) with Freedom Mortgage, pursuant to which Freedom Mortgage provides to the Manager the personnel, services and resources as needed by the Manager to enable the Manager to carry out its obligations and responsibilities under the Management Agreement. The Company is a named third-party beneficiary to the Services Agreement and, as a result, has, as a non-exclusive remedy, a direct right of action against Freedom Mortgage in the event of any breach by the Manager of any of its duties, obligations or agreements under the Management Agreement that arise out of or result from any breach by Freedom Mortgage of its obligations under the Services Agreement. The Services Agreement will terminate upon the termination of the Management Agreement. Pursuant to the Services Agreement, the Manager will make certain payments to Freedom Mortgage in connection with the services provided. All of the Company’s executive officers and the officers of the Manager are also officers or employees of Freedom Mortgage. As a result, the Management Agreement between the Company and the Manager was negotiated between related parties, and the terms, including fees payable, may not be as favorable to the Company as if it had been negotiated with an unaffiliated third party. Both the Manager and Freedom Mortgage are controlled by Mr. Stanley Middleman, who is also a shareholder of the Company.
 
The Management Agreement provides that the Company will reimburse the Manager for various expenses incurred by the Manager or its officers, and agents on the Company’s behalf, including costs of software, legal, accounting, tax, administrative and other similar services rendered for the Company by providers retained by the Manager. “Due to affiliates” consisted of the following for the periods indicated (dollars in thousands):

Management Fee to Affiliate
 
 
Three Months Ended March 31,
 
 
2016
 
2015
 
Management fees
 
$
560
   
$
560
 
Expense reimbursement
   
130
     
130
 
Total
 
$
690
   
$
690
 
 
Subservicing Agreement

Freedom Mortgage is directly servicing the Company’s portfolio of Fannie Mae and Freddie Mac MSRs pursuant to a subservicing agreement entered into on June 10, 2015. The agreement has an initial term of three (3) years, expiring on September 1, 2018, and is subject to automatic renewal for additional three year terms unless either party chooses not to renew. The agreement may be terminated without cause by either party by giving notice as specified in the agreement.  Under that agreement, Freedom Mortgage agrees to service the applicable mortgage loans in accordance with applicable law and the requirements of the applicable agency. The Company pays fees for specified services.

Other Affiliated Entities

The Company, through one of its subsidiaries, has entered into an uncommitted master repurchase agreement with Freedom Mortgage pursuant to which the Company may, from time to time, purchase a newly issued Ginnie Mae RMBS, subject to Freedom Mortgage’s agreement to repurchase the security at a future date, generally no more than 120 days later. The Company simultaneously re-hypothecates the security to one of its counterparties with whom it has a repurchase agreement, for an identical term.  Each transaction is done at market rates. For the three- month period ended March 31, 2016, the Company earned approximately $2,000 in income and had a corresponding expense of less than $1,000.
 
See Note 5 for a discussion of the co-investments in Excess MSRs with Freedom Mortgage and the services provided by Freedom Mortgage during the period prior to transfer to Freedom Mortgage of the direct servicing obligations for the MSRs. See Note 10 for a discussion of the Acknowledgement Agreement among the Company, Freedom Mortgage and Ginnie Mae entered into in connection with the co-investments in Excess MSRs.

Note 8 — Derivative Instruments

Interest Rate Swap Agreements, Swaptions, TBAs and Treasury Futures

In order to help mitigate exposure to higher short-term interest rates in connection with its repurchase agreements, the Company enters into interest rate swap agreements. These agreements establish an economic fixed rate on related borrowings because the variable-rate payments received on the interest rate swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the interest rate swap agreements as the Company’s effective borrowing rate, subject to certain adjustments including changes in spreads between variable rates on the interest rate swap agreements and actual borrowing rates. A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. The Company’s interest rate swap agreements and swaptions have not been designated as hedging instruments for GAAP purposes.

In order to help mitigate duration risk and basis risk management, the Company utilizes treasury futures and forward-settling purchases and sales of RMBS where the underlying pools of mortgage loans are TBAs. Pursuant to these TBA transactions, the Company agrees to purchase or sell, for future delivery, RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular RMBS to be delivered is not identified until shortly before the TBA settlement date.
 
The following table summarizes the outstanding notional amounts of derivative instruments as of the dates indicated (dollars in thousands):
 
Non-hedge derivatives
 
March 31, 2016
   
December 31, 2015
 
Notional amount of interest rate swaps
 
$
286,750
   
$
300,300
 
Notional amount of swaptions
   
85,000
     
85,000
 
Notional amount of TBAs, net
   
-
     
-
 
Notional amount of Treasury Futures
   
3,000
     
-
 
Total notional amount
 
$
374,750
   
$
385,300
 
 
The following table presents information about the Company’s interest rate swap agreements as of the dates indicated (dollars in thousands):
 
   
Notional
Amount
   
Weighted
 Average Pay
Rate
   
Weighted
Average
Receive Rate
   
Weighted
Average Years
to Maturity
 
March 31, 2016
 
$
286,750
     
1.63
%
   
0.62
%
   
3.9
 
December 31, 2015
 
$
300,300
     
1.71
%
   
0.37
%
   
4.3
 
 
The following table presents information about derivatives realized gain (loss), which is included on the consolidated statement of income for the periods indicated (dollars in thousands):

Realized Gains (Losses) on Derivatives
 
        
Three Months Ended March 31,
 
Non-Hedge Derivatives
 
Income Statement Location
 
2016
   
2015
 
Interest rate swaps
 
Realized gain/(loss) on derivative assets
 
$
(1,350
)
 
$
(788
)
Swaptions
 
Realized gain/(loss) on derivative assets
   
-
     
-
 
TBAs
 
Realized gain/(loss) on derivative assets
   
(82
)
   
(109
)
Treasury futures
 
Realized gain/(loss) on derivative assets
   
(29
)
   
(345
)
Total
 
 
 
$
(1,461
)
 
$
(1,242
)
 
Offsetting Assets and Liabilities

The Company has netting arrangements in place with all of its derivative counterparties pursuant to standard documentation developed by the International Swap and Derivatives Association, or ISDA. Under GAAP, if the Company has a valid right of offset, it may offset the related asset and liability and report the net amount. The Company presents interest rate swaps, swaptions and treasury futures assets and liabilities on a gross basis in its consolidated balance sheets. The Company presents TBA assets and liabilities on a net basis in its consolidated balance sheets. The Company presents repurchase agreements subject to master netting arrangements on a gross basis. Additionally, the Company does not offset financial assets and liabilities with the associated cash collateral on the consolidated balance sheets.

The following tables present information about the Company’s assets and liabilities that are subject to master netting arrangements or similar agreements and can potentially be offset on the Company’s consolidated balance sheets as of the dates indicated (dollars in thousands):
 
Offsetting Assets and Liabilities

As of March 31, 2016
 
 
Gross
   
Gross
Amounts
   
Net Amounts
of Assets
 Presented in
   
Gross Amounts Not Offset in
the Consolidated Balance Sheet
     
 
 
Amounts of
Recognized
 Assets or
Liabilities
   
 Offset in the
Consolidated
Balance
Sheet
   
 the
Consolidated
Balance
Sheet
   
Financial
Instruments
   
Cash
 Collateral
 Received
 (Pledged)
   
Net Amount
 
Assets
                                   
Interest rate swaps
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Swaptions
   
39
     
-
     
39
     
(39
)
   
-
     
-
 
TBAs
   
4
     
-
     
4
     
(4
)
   
-
     
-
 
Treasury futures
   
30
     
-
     
30
     
(30
)
   
(257
)
       
Total Assets
 
$
73
   
$
-
   
$
73
   
$
(73
)
 
$
(257
)
 
$
-
 
                                                 
Liabilities
                                               
Repurchase agreements
 
$
398,374
   
$
-
   
$
398,374
   
$
(396,261
)
 
$
(2,113
)
 
$
-
 
Interest rate swaps
   
9,447
     
-
     
9,447
     
-
     
(9,447
)
   
-
 
Swaptions
   
-
     
-
     
-
     
-
     
-
     
-
 
TBAs
   
-
     
-
     
-
     
-
     
-
     
-
 
Treasury futures
   
-
     
-
     
-
     
-
     
-
     
-
 
Total Liabilities
 
$
407,821
   
$
-
   
$
407,821
   
$
(396,261
)
 
$
(11,560
)
 
$
-
 
 
As of December 31, 2015
 
 
Gross
   
Gross
 Amounts
   
Net Amounts
of Assets
Presented in
   
Gross Amounts Not Offset in
the Consolidated Balance Sheet
     
   
Amounts of
Recognized
Assets or
Liabilities
   
 Offset in the
 Consolidated
 Balance
Sheet
   
 the
Consolidated
Balance
Sheet
   
Financial
 Instruments
   
Cash
Collateral
Received
(Pledged)
   
Net Amount
 
Assets
                                   
Interest rate swaps
 
$
51
   
$
-
   
$
51
   
$
(51
)
 
$
-
   
$
-
 
Swaptions
   
371
     
-
     
371
     
(371
)
   
-
     
-
 
TBAs
   
-
     
-
     
-
     
-
     
-
     
-
 
Treasury futures
   
-
     
-
     
-
     
-
     
(84
)
       
Total Assets
 
$
422
   
$
-
   
$
422
   
$
(422
)
 
$
(84
)
 
$
-
 
                                                 
Liabilities
                                               
Repurchase agreements
 
$
385,560
   
$
-
   
$
385,560
   
$
(381,386
)
 
$
(4,174
)
 
$
-
 
Interest rate swaps
   
4,595
     
-
     
4,595
     
-
     
(4,595
)
   
-
 
Swaptions
   
-
     
-
     
-
     
-
     
-
     
-
 
TBAs
   
-
     
-
     
-
     
-
     
-
     
-
 
Treasury futures
   
-
     
-
     
-
     
-
     
-