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EX-32.2 - EXHIBIT 32.2 - Cherry Hill Mortgage Investment Corpex32_2.htm
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EX-31.2 - EXHIBIT 31.2 - Cherry Hill Mortgage Investment Corpex31_2.htm
EX-31.1 - EXHIBIT 31.1 - Cherry Hill Mortgage Investment Corpex31_1.htm
EX-10.1 - EXHIBIT 10.1 - Cherry Hill Mortgage Investment Corpex10_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, 2017

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.          
 
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, 2017, there were 12,700,348 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
   
3
     
PART I.
5
     
Item 1.
5
     
  5
     
  6
     
  7
     
  8
     
  9
     
  10
     
Item 2.
41
     
Item 3.
61
     
Item 4.
65
   
PART II.
66
   
Item 1.
66
   
Item 1A.
67
     
Item 2.
67
     
Item 3.
67
     
Item 4.
67
     
Item 5.
67
     
Item 6.
68
 
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 acquire mortgage servicing rights (“MSRs”  or “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, the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the Government National Mortgage Association 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 “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q and “Part I, Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016;

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
 (in thousands — except share data)

   
(unaudited)
       
   
March 31, 2017
   
December 31, 2016
 
Assets
           
RMBS, available-for-sale
 
$
1,139,056
   
$
671,904
 
Investments in Servicing Related Assets at fair value
   
76,698
     
61,263
 
Cash and cash equivalents
   
75,115
     
15,824
 
Restricted cash
   
7,085
     
22,469
 
Derivative assets
   
9,540
     
9,121
 
Receivables and other assets
   
10,285
     
12,297
 
Total Assets
 
$
1,317,779
   
$
792,878
 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Repurchase agreements
 
$
773,317
   
$
594,615
 
Derivative liabilities
   
640
     
694
 
Notes payable
   
16,000
     
22,886
 
Dividends payable
   
3,687
     
4,816
 
Due to affiliates
   
2,337
     
1,894
 
Payables for unsettled trades
   
257,792
     
6,202
 
Accrued expenses and other liabilities
   
6,466
     
5,762
 
Total Liabilities
 
$
1,060,239
   
$
636,869
 
Stockholders’ Equity
               
Preferred stock, $0.01 par value, 100,000,000 shares authorized, none issued and outstanding as of March 31, 2017 and December, 31, 2016
 
$
-
   
$
-
 
Common stock, $0.01 par value, 500,000,000 shares authorized and 12,700,348 shares issued and outstanding as of March 31, 2017 and 500,000,000 shares authorized and 7,525,348 shares issued and outstanding as of December, 31, 2016
   
127
     
75
 
Additional paid-in capital
   
229,320
     
148,457
 
Retained earnings (deficit)
   
30,584
     
12,093
 
Accumulated other comprehensive income (loss)
   
(4,721
)
   
(6,393
)
Total Cherry Hill Mortgage Investment Corporation Stockholders’ Equity
 
$
255,310
   
$
154,232
 
Non-controlling interests in Operating Partnership
   
2,230
     
1,777
 
Total Stockholders’ Equity
 
$
257,540
   
$
156,009
 
Total Liabilities and Stockholders’ Equity
 
$
1,317,779
   
$
792,878
 
 
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,
 
   
2017
   
2016
 
Income
           
Interest income
 
$
6,078
   
$
5,188
 
Interest expense
   
2,431
     
1,657
 
Net interest income
   
3,647
     
3,531
 
Servicing fee income
   
4,574
     
1,495
 
Servicing costs
   
1,227
     
402
 
Net servicing income (loss)
   
3,347
     
1,093
 
Other income (loss)
               
Realized gain (loss) on RMBS, net
   
(256
)
   
320
 
Realized gain (loss) on investments in Excess MSRs, net
   
6,678
 
   
-
 
Realized gain (loss) on derivatives, net
   
(1,017
)
   
(1,461
)
Unrealized gain (loss) on derivatives, net
   
1,082
     
(5,198
)
Unrealized gain (loss) on investments in Excess MSRs
   
-
     
(2,307
)
Unrealized gain (loss) on investments in MSRs
   
12,312
     
(2,232
)
Total Income
   
25,793
     
(6,254
)
Expenses
               
General and administrative expense
   
975
     
808
 
Management fee to affiliate
   
892
     
690
 
Total Expenses
   
1,867
     
1,498
 
Income (Loss) Before Income Taxes
   
23,926
     
(7,752
)
Provision for corporate business taxes
   
1,339
     
(590
)
Net Income (Loss)
   
22,587
     
(7,162
)
Net (income) loss allocated to noncontrolling interests in Operating Partnership
   
(409
)
   
99
 
Net Income (Loss) Applicable to Common Stockholders
 
$
22,178
   
$
(7,063
)
Net income (Loss) Per Share of Common Stock
               
Basic
 
$
2.91
   
$
(0.94
)
Diluted
 
$
2.90
   
$
(0.94
)
Weighted Average Number of Shares of Common Stock Outstanding
               
Basic
   
7,634,038
     
7,509,543
 
Diluted
   
7,640,348
     
7,519,038
 

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,
 
   
2017
   
2016
 
Net income (loss)
 
$
22,587
   
$
(7,162
)
Other comprehensive income (loss):
               
Net unrealized gain (loss) on RMBS
   
1,416
     
7,652
 
Reclassification of net realized (gain) loss on RMBS in earnings
   
256
     
(320
)
Other comprehensive income (loss)
   
1,672
     
7,332
 
Comprehensive income (loss)
 
$
24,259
   
$
170
 
Comprehensive income (loss) attributable to noncontrolling interests in Operating Partnership
   
440
     
2
 
Comprehensive income (loss) attributable to common stockholders
 
$
23,819
   
$
168
 

See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
 (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, 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
 
                                                         
Balance, December 31, 2016
   
7,525,348
   
$
75
   
$
148,457
   
$
(6,393
)
 
$
12,093
   
$
1,777
   
$
156,009
 
Issuance of common stock
   
5,175,000
     
52
     
80,863
     
-
     
-
     
-
     
80,915
 
Net Income (Loss)
   
-
     
-
     
-
     
-
     
22,178
     
409
     
22,587
 
Other Comprehensive Income
   
-
     
-
     
-
     
1,672
     
-
     
-
     
1,672
 
LTIP-OP Unit awards
   
-
     
-
     
-
     
-
     
-
     
135
     
135
 
Distribution paid on LTIP-OP Units
   
-
     
-
     
-
     
-
     
-
     
(91
)
   
(91
)
Common dividends declared, $0.49 per share
   
-
     
-
     
-
     
-
     
(3,687
)
   
-
     
(3,687
)
Balance, March 31, 2017
   
12,700,348
   
$
127
   
$
229,320
   
$
(4,721
)
 
$
30,584
   
$
2,230
   
$
257,540
 

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,
 
   
2017
   
2016
 
Cash Flows From Operating Activities
           
Net income (loss)
 
$
22,587
   
$
(7,162
)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Realized (gain) loss on RMBS, net
   
256
     
(320
)
Realized gain (loss) on investments in Excess MSRs, net
   
(6,678
)    
-
 
Accretion of premium and other amortization
   
1,419
     
853
 
Change in fair value of investments in Servicing Related Assets
   
(12,312
)
   
4,539
 
Unrealized (gain) loss on derivatives, net
   
(1,082
)
   
5,198
 
Realized (gain) loss on derivatives, net
   
1,017
     
1,461
 
LTIP-OP Unit awards
   
135
     
147
 
Changes in:
               
Receivables and other assets
   
2,012
     
(1,474
)
Due to affiliate
   
443
     
51
 
Payables for unsettled trades
   
251,590
     
-
 
Accrued expenses and other liabilities
   
(425
)
   
(8
)
Net cash provided by (used in) operating activities
 
$
258,962
   
$
3,285
 
Cash Flows From Investing Activities
               
Purchase of RMBS
   
(491,869
)
   
(27,340
)
Principal paydown of RMBS
   
17,104
     
10,755
 
Proceeds from sale of RMBS
   
7,610
     
23,467
 
Principal paydown of Excess MSRs
   
-
     
4,912
 
Proceeds from sale of Excess MSRs
   
35,905
     
-
 
Acquisition of MSRs
   
(32,350
)
   
(4,252
)
Purchase of derivatives
   
(408
)
   
(1,458
)
Net cash provided by (used in) investing activities
 
$
(464,008
)
 
$
6,084
 
Cash Flows From Financing Activities
               
Changes in restricted cash
   
15,384
     
(2,964
)
Borrowings under repurchase agreements
   
784,497
     
436,447
 
Repayments of repurchase agreements
   
(605,795
)
   
(423,633
)
Proceeds from Federal Home Loan Bank advances
   
-
     
7,000
 
Repayments of Federal Home Loan Bank advances
   
-
     
(22,000
)
Proceeds from bank loans
   
2,000
     
-
 
Principal paydown of bank loans
   
(8,886
)
   
(476
)
Dividends paid
   
(3,687
)
   
(3,684
)
LTIP-OP Units distributions paid
   
(91
)
   
(51
)
Issuance of common stock, net of offering costs
   
80,915
     
38
 
Net cash provided by (used in) financing activities
 
$
264,337
   
$
(9,323
)
Net Increase (Decrease) in Cash and Cash Equivalents
 
$
59,291
   
$
46
 
Cash and Cash Equivalents, Beginning of Period
   
15,824
     
10,603
 
Cash and Cash Equivalents, End of Period
 
$
75,115
   
$
10,649
 
Supplemental Disclosure of Cash Flow Information
               
Cash paid during the period for interest expense
 
$
1,800
   
$
1,494
 
Dividends declared but not paid
 
$
3,687
   
$
3,684
 

See accompanying notes to consolidated financial statements.
 
Cherry Hill Mortgage Investment Corporation and Subsidiaries

Notes to Consolidated Financial Statements

March 31, 2017

(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. Under the Company’s charter, as of December 31, 2012, the Company was authorized to issue 1,000 shares of common stock. On June 6, 2013, the Company amended and restated its charter and increased its authorized capitalization. Accordingly, at December 31, 2013, the Company was authorized to issue up to 500,000,000 shares of common stock and 100,000,000 shares of preferred stock, each with a par value of $0.01 per share.

The accompanying interim consolidated financial statements include the accounts of the Company’s subsidiaries, Cherry Hill Operating Partnership LP (“Operating Partnership”), Cherry Hill QRS I, LLC, Cherry Hill QRS II, LLC, 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”).

On March 29, 2017, the Company issued and sold 5,175,000 shares of its common stock, par value $0.01 per share, raising approximately $81.1 million after underwriting discounts and commissions but before expenses of approximately $229,000. All of the net proceeds were used to invest in RMBS pending re-deployment of a substantial portion of those proceeds into the acquisition of MSRs.

The Company is party to a management agreement (the “Management Agreement”) with Cherry Hill Mortgage Management, LLC (the “Manager”), a Delaware limited liability company established by Mr. Stanley Middleman. The Manager is a party to a Services Agreement with Freedom Mortgage Corporation (“Freedom Mortgage”) which is owned and controlled by Mr. Middleman. The Manager is owned by a “blind trust” for the benefit of Mr. Middleman. For a further discussion of the Management Agreement, see Note 7.

The Company has elected to be taxed as a real estate investment trust (“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 interim 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 interim 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, including prepayment speeds on the Company’s RMBS and Servicing Related Assets. 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 on its REIT income (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 (loss), 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 Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (“ASC 820”). 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. Approximately $257.8 million in Agency RMBS purchased, but not yet settled, was payable at March 31, 2017. All RMBS sold in the three month period ended March 31, 2017 were settled prior to period-end. Approximately $6.2 million in Agency RMBS purchased, but not yet settled, was payable at December 31, 2016. All RMBS sold in the year ended December 31, 2016 were settled prior to year-end.

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 effective 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 $2.7 million and $2.0 million in interest income was receivable at March 31, 2017 and December 31, 2016, respectively, and has been classified within “Receivables and other assets” on the consolidated balance sheets. For further discussion on Receivables and other assets, see Note 13.

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. The Company did not record any OTTI charges during the three month period ended March 31, 2017. There were approximately $173,000 of OTTI during the year ended December 31, 2016 and  have been classified within “Realized gain (loss) on RMBS, net” on the consolidated statements of income.

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 interim 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 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. Changes to expected cash flows result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the retrospective method, the interest income recognized for a reporting period would be 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 consolidated statements of 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. The sale of investments in Excess MSRs are recognized upon settlement date. Approximately $2.0 million and $5.6 million in Excess MSR cash flow was receivable at March 31, 2017 and December 31, 2016, respectively, and has been classified within “Receivables and other assets” on the consolidated balance sheets.

In connection with the sale of its Excess MSRs, the Company elected a settlement date accounting policy to account for the gain on sale from that transaction. For a further discussion of the Company’s sale of its Excess MSRs, see Note 7.

Investments in MSRs

Classification – MSRs include rights associated with servicing contracts acquired in connection with the Company’s acquisition of Aurora on May 29, 2015 and MSRs acquired through bulk purchases of such rights from third parties. At initial recognition, the fair value of MSRs is established using assumptions consistent with those used to establish the fair value of existing MSRs. The Company has elected the fair value option to record its investments in MSRs in order to provide users of the consolidated interim 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 expenses 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). For reporting purposes, conventional conforming loans are aggregated into one category.

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 $3.1 million and $1.4 million in reimbursable servicing advances were receivable at March 31, 2017 and December 31, 2016, respectively, and have been classified within “Receivables and other assets” on the consolidated balance sheets. Although advances on Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) MSRs made in accordance with the relevant guidelines are recoverable, the recoverability of similar advances made on Government National Mortgage Association (“Ginnie Mae”) MSRs may be limited under the rules and regulations of the U.S. Department of Housing and Urban Development, the Department of Veterans Affairs (the “VA”) and the Federal Housing Administration (“FHA”). Because the Ginnie Mae MSRs were only acquired in February 2017, and advances on the Fannie Mae and Freddie Mac MSRs are expected to be recoverable, the Company has determined that no reserves for unrecoverable advances are necessary at March 31, 2017 and December 31, 2016. For further discussion on Receivables and other assets, see Note 13.
 
Servicing fee income received and servicing expenses 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 consolidated statements of income 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.

As a result of the Company’s investments in MSRs, it is obligated from time to time to repurchase an underlying loan from the applicable agency for which it is being serviced due to an alleged breach of a representation or warranty. Loans acquired in this manner are recorded at the purchase price less any principal recoveries and are then offered for sale in the scratch and dent market. There were no loans purchased in the three month period ended March 31, 2017. In the year ended December 31, 2016, the Company purchased five loans, with an aggregate unpaid principal balance (“UPB”) of approximately $1.64 million at the time of purchase, as required by the applicable agency. Four of those loans were sold during the quarter ended March 31, 2017, and the Company did not recognize a loss on such sales.

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 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 to its derivative financial instruments.

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.
 
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 (i) as collateral against the Company’s derivatives (approximately $1.2 million and $1.1 million at  March 31, 2017 and December 31, 2016, respectively), (ii) as collateral  for borrowings under its repurchase agreements (approximately $5.9 million and $20.4 million at March 31, 2017 and December 31, 2016, respectively) and (iii) as collateral for  outstanding borrowings on a $25 million term loan secured by a pledge of the Company’s existing portfolio of Excess MSRs  (none at March 31, 2017 and approximately $1.1 million at December 31, 2016). For further information on the restricted cash as it relates to the term loan, see Note 12.

Due to Affiliates

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 elected to be taxed as a REIT under the Code commencing with its short taxable year ended December 31, 2013. The Company expects to continue to qualify to be treated as a REIT. 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”), CHMI 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 Investments, Net

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

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Realized gain (loss) on RMBS, net
           
Gain on RMBS
 
$
-
   
$
320
 
Loss on RMBS
   
(256
)
   
-
 
Net realized gain (loss) on RMBS
   
(256
)
   
320
 
Realized gain (loss) on derivatives, net
   
(1,017
)
   
(1,461
)
Unrealized gain (loss) on derivatives, net
   
1,082
     
(5,198
)
Realized gain (loss) on Excess MSRs, net
   
6,678
 
   
-
 
Unrealized gain (loss) on Excess MSRs, net
   
-
     
(2,307
)
Unrealized gain (loss) on MSRs, net
   
12,312
     
(2,232
)
Total
 
$
18,799
   
$
(10,878
)
 
Repurchase Agreements and Interest Expense

The Company finances its investments in RMBS with short-term borrowings under 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 and are generally uncommitted. 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.

Dividends Payable

Because the Company is organized and operated 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 and special 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 805, Business Combinations (“ASC 805”). 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 statements of income (loss) from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. The Company applied this guidance to the Aurora acquisition that occurred in 2015.

Recent Accounting Pronouncements
 
Revenue Recognition – In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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. Under the new revenue recognition guidance, entities are required to identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when the entity satisfies a performance obligation. In April 2015, the FASB voted for a one-year deferral of the effective date, resulting in this new guidance being effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017. Subsequent to the initial issuance, the FASB has continued to issue updates to this guidance to provide additional clarification and implementation instructions to issuers regarding (i) principal versus agent considerations, (ii) identifying performance obligations, (iii) licensing, and (iv) narrow-scope improvements and practical expedients relating to assessing collectability, presentation of sales taxes, non-cash consideration, and completed contracts and contract modifications at transition. The Company has reviewed the scope of the guidance and monitored the determinations of the FASB Transition Resource Group and concluded that a number of the Company's most significant revenue streams are not within the scope of the standard because the standard does not apply to revenue on contracts accounted for under the transfers and servicing of financial assets or financial instruments standards. Therefore, revenue recognition for these contracts will remain unchanged. Further, the FASB has issued, and may issue in the future, interpretive guidance that may cause the Company’s evaluation to change. However, the Company continues to evaluate certain select revenue streams for the effect that this guidance will have on its consolidated financial statements. The Company is also still assessing the standard’s new disclosure requirements. The Company has not yet selected a transition method.
 
Business Combinations − In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which amends ASC 805, Business Combinations. ASU 2015-16 provides updated guidance regarding simplifying the accounting for recognizing adjustments to provisional amounts identified during the measurement period in a business combination. To simplify the accounting for these adjustments, the amendments in this update eliminate the requirement to retrospectively account for the adjustments and to recognize them in the period that they are identified. This guidance was effective for the Company beginning January 1, 2016. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements.
 
In January 2017, the FASB issued ASU 2017-01, Business Combinations, an accounting standards update that amends the guidance on business combinations. The update clarifies the definition of a business and provides a framework that gives entities a basis for making reasonable judgments about whether a transaction should be accounted for as an acquisition of assets or a business. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company will apply this guidance to its assessment of applicable transactions, such as acquisitions and disposals of assets or businesses, consummated after the adoption date.
 
Leases −In February 2016, the FASB issued ASU 2016-02, Leases, an accounting standards update that requires the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset to not recognize lease assets and lease liabilities. In transition, lessees are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach, which includes a number of optional practical expedients that entities may elect to apply. This guidance is effective for fiscal years beginning after December 15, 2018, with early application permitted. While the Company is currently evaluating the effect that this guidance will have on its consolidated financial statements, it will result in the recognition of certain operating leases as right-of-use assets and lease liabilities on the consolidated balance sheets. The Company currently has no commitments under noncancelable operating leases.
 
Credit Losses − In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses, an accounting standards update that changes the impairment model for most financial assets and certain other instruments. Allowances for credit losses on Available-for-Sale debt securities will be recognized, rather than direct reductions in the amortized cost of the investments. The new model also requires the estimation of lifetime expected credit losses and corresponding recognition of allowance for losses on trade and other receivables, held-to-maturity debt securities, loans, and other instruments held at amortized cost. This guidance requires certain recurring disclosures and is effective for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2019, with early adoption permitted for annual periods, and interim periods within those annual periods, beginning on or after December 15, 2018. The Company is evaluating the adoption of this ASU.
 
Statement of Cash Flows − In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, an accounting standards update that amends the guidance on the classification of certain cash receipts and cash payments presented within the statement of cash flows to reduce the existing diversity in practice. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements.
 
Income Taxes − In October 2016, the FASB issued ASU 2016-16, Income Taxes, an accounting standards update that amends the guidance on the classification of income taxes related to the intra-entity transfer of assets other than inventory. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the effect that this guidance will have on its consolidated financial statements. However, the significance of adoption is dependent on the nature of the transactions and corresponding tax laws in effect at the time of adoption.
 
Restricted Cash − In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, an accounting standards update that amends the guidance on restricted cash within the statement of cash flows. The update amends the classification of restricted cash and cash equivalents to be included within cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts. This guidance is effective for annual reporting periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The adoption will impact the presentation of the cash flows, but will not otherwise have a material impact on the consolidated results of operations or financial condition.
 
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 paid to the Company’s directors and management fees paid to the Manager 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, 2017
                       
Interest income
 
$
523
   
$
5,555
   
$
-
   
$
6,078
 
Interest expense
   
114
     
2,317
     
-
     
2,431
 
Net interest income
   
409
     
3,238
     
-
     
3,647
 
Servicing fee income
   
4,574
     
-
     
-
     
4,574
 
Servicing costs
   
1,227
     
-
     
-
     
1,227
 
Net servicing income
   
3,347
     
-
     
-
     
3,347
 
Other income
   
18,990
     
(191
)
   
-
     
18,799
 
Other operating expenses
   
-
     
-
     
1,867
     
1,867
 
Provision for corporate business taxes
   
1,339
     
-
     
-
     
1,339
 
Net income (loss)
 
$
21,407
   
$
3,047
   
$
(1,867
)
 
$
22,587
 
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)
 
$
(1,752
)
 
$
(3,912
)
 
$
(1,498
)
 
$
(7,162
)
 
Balance Sheet                        
March 31, 2017
                       
Investments
 
$
76,698
   
$
1,139,056
   
$
-
   
$
1,215,754
 
Other assets
   
6,446
     
22,517
     
73,062
     
102,025
 
Total assets
   
83,144
     
1,161,573
     
73,062
     
1,317,779
 
Debt
   
16,000
     
773,317
     
-
     
789,317
 
Other liabilities
   
3,506
     
259,460
     
7,956
     
270,922
 
Total liabilities
   
19,506
     
1,032,777
     
7,956
     
1,060,239
 
GAAP book value
 
$
63,638
   
$
128,796
   
$
65,106
   
$
257,540
 

December 31, 2016
                       
Investments
 
$
61,263
   
$
671,904
   
$
-
   
$
733,167
 
Other assets
   
8,826
     
32,495
     
18,390
     
59,711
 
Total assets
   
70,089
     
704,399
     
18,390
     
792,878
 
Debt
   
22,886
     
594,615
     
-
     
617,501
 
Other liabilities
   
2,481
     
9,490
     
7,397
     
19,368
 
Total liabilities
   
25,367
     
604,105
     
7,397
     
636,869
 
GAAP book value
 
$
44,722
   
$
100,294
   
$
10,993
   
$
156,009
 

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 (dollars in thousands):

Summary of RMBS Assets

As of March 31, 2017

   
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
 
$
772,819
   
$
732,675
   
$
1,766
   
$
(6,174
)
 
$
728,267
     
101
 
(B)
   
3.78
%
   
3.56
%
   
25
 
Freddie Mac
   
389,576
     
371,377
     
1,063
     
(2,789
)
   
369,651
     
45
 
(B)
   
3.77
%
   
3.52
%
   
26
 
CMOs
   
50,375
     
39,725
     
1,497
     
(84
)
   
41,138
     
12
 
Unrated
   
4.47
%
   
5.10
%
   
12
 
Total/Weighted Average
 
$
1,212,770
   
$
1,143,777
   
$
4,326
   
$
(9,047
)
 
$
1,139,056
     
158
       
3.80
%
   
3.62
%
   
25
 

As of December 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
 
$
493,645
   
$
454,012
   
$
1,517
   
$
(6,592
)
 
$
448,937
     
68
 
(B)
   
3.74
%
   
3.52
%
   
24
 
Freddie Mac
   
222,469
     
200,207
     
587
     
(2,691
)
   
198,103
     
27
 
(B)
   
3.62
%
   
3.44
%
   
26
 
CMOs
   
34,596
     
24,086
     
857
     
(79
)
   
24,864
     
9
 
Unrated
   
4.78
%
   
4.24
%
   
12
 
Total/Weighted Average
 
$
750,710
   
$
678,305
   
$
2,961
   
$
(9,362
)
 
$
671,904
     
104
       
3.74
%
   
3.53
%
   
24
 


(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, other than collateralized mortgage obligations, which are unrated.
(C)
The weighted average yield is based on the most recent annualized monthly interest income, divided by the book value of settled securities. 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, 2017

   
Original
         
Gross Unrealized
         
Number
 
Weighted Average
 
Years to Maturity
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
5-10 Years
 
$
16,069
   
$
16,892
   
$
214
   
$
(323
)
 
$
16,783
   
 
3
 
(B)
   
4.18
%
   
3.90
%
   
8
 
Over 10 Years
   
1,196,701
     
1,126,885
     
4,112
     
(8,724
)
   
1,122,273
     
155
 
(B)
   
3.79
%
   
3.61
%
   
25
 
Total/Weighted Average
 
$
1,212,770
   
$
1,143,777
   
$
4,326
   
$
(9,047
)
 
$
1,139,056
     
158
       
3.80
%
   
3.62
%
   
25
 

As of December 31, 2016

   
Original
         
Gross Unrealized
         
Number
 
Weighted Average
 
Years to Maturity
 
Face
Value
   
Book
Value
   
Gains
   
Losses
   
Carrying
Value(A)
   
of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
5-10 Years
 
$
16,069
   
$
17,110
   
$
185
   
$
(454
)
 
$
16,841
     
3
 
(B)
   
4.18
%
   
3.94
%
   
8
 
Over 10 Years
   
734,641
     
661,195
     
2,776
     
(8,908
)
   
655,063
     
101
 
(B)
   
3.73
%
   
3.52
%
   
24
 
Total/Weighted Average
 
$
750,710
   
$
678,305
   
$
2,961
   
$
(9,362
)
 
$
671,904
     
104
       
3.74
%
   
3.53
%
   
24
 


(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, other than collateralized mortgage obligations, which are unrated.
(C)
The weighted average yield is based on the most recent annualized monthly interest income, divided by the book value of settled securities. Prior period amounts have been reclassified to conform to current period presentation.
(D)
The weighted average stated maturity.

At March 31, 2017 and December 31, 2016, the Company pledged Agency RMBS investments with a carrying value of approximately $812.3 million and $608.6 million, respectively, as collateral for repurchase agreements. At March 31, 2017 and December 31, 2016, 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. 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. Significant judgment is required in this analysis. 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.
 
The Company did not record any OTTI during the three month period ended March 31, 2017. There was approximately $173,000 of OTTI during the year ended December 31, 2016.

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, 2017

   
Original
         
Gross
           
Weighted Average
 
Duration in Loss
Position
 
Face
Value
   
Book
Value
   
Unrealized
Losses
   
Carrying
Value(A)
   
Number of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
Less than Twelve Months
 
$
371,708
   
$
364,658
   
$
(6,387
)
 
$
358,271
     
49
 
(B)
   
3.78
%
   
3.54
%
   
27
 
Twelve or More Months
   
264,515
     
227,513
     
(2,660
)
   
224,853
     
37
 
(B)
   
3.60
%
   
3.49
%
   
23
 
Total/Weighted Average
 
$
636,223
   
$
592,171
   
$
(9,047
)
 
$
583,124
     
86
       
3.71
%
   
3.52
%
   
26
 

As of December 31, 2016

   
Original
         
Gross
           
Weighted Average
 
Duration in Loss
Position
 
Face
Value
   
Book
Value
   
Unrealized
Losses
   
Carrying
Value(A)
   
Number of
Securities
 
Rating
 
Coupon
   
Yield(C)
   
Maturity
(Years)(D)
 
Less than Twelve Months
 
$
494,847
   
$
476,129
   
$
(9,362
)
 
$
466,767
     
68
 
(B)
   
3.65
%
   
3.40
%
   
25
 
Total/Weighted Average
 
$
494,847
   
$
476,129
   
$
(9,362
)
 
$
466,767
     
68
       
3.65
%
   
3.40
%
   
25
 
 

(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, other than collateralized mortgage obligations, which are unrated.
(C)
The weighted average yield is based on the most recent annualized monthly interest income, divided by the book value of settled securities. Prior period amounts have been reclassified to conform to current period presentation.
(D)
The weighted average stated maturity. Except for the security for which the Company has recognized OTTI, 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 (“Excess MSR Agreement 1”) with 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 UPB of approximately $10.0 billion (“Excess MSR Pool 1”). Freedom Mortgage was 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 Excess MSR Pool 1. Pursuant to Excess MSR Agreement 1, Freedom Mortgage performed all servicing functions and advancing functions related to Excess 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,” was initially equal to a weighted average of 20 bps.

Pursuant to Excess MSR Agreement 1, the Company acquired the right to receive 85% of the excess mortgage servicing amount on Excess MSR Pool 1 and, subject to certain limitations and pursuant to a recapture agreement (the “Excess MSR Pool 1—Recapture Agreement”), 85% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represented refinancings of loans in Excess MSR Pool l (which loans then become part of Excess MSR Pool 1) for approximately $60.6 million. Freedom Mortgage co-invested, pari passu with the Company, in 15% of the Excess MSRs. Freedom Mortgage, as servicer, also retained the ancillary income and the servicing obligations and liabilities.
 
In October 2013, the Company entered into an agreement (“Excess 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 aggregate principal balance of approximately $10.7 billion (“Excess MSR Pool 2”). Freedom Mortgage was 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 Excess MSR Pool 2. Pursuant to Excess MSR Agreement 2, Freedom Mortgage performed all servicing functions and advancing functions related to Excess 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” was initially equal to a weighted average of 34 bps.

Pursuant to Excess MSR Agreement 2, the Company acquired the right to receive 50% of the excess mortgage servicing amount on Excess MSR Pool 2 and, subject to certain limitations and pursuant to a recapture agreement (the “Excess MSR Pool 2—Recapture Agreement”), 50% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represented refinancings of loans in Excess MSR Pool 2 (which loans then become part of Excess MSR Pool 2) for approximately $38.4 million. Freedom Mortgage co-invested, pari passu with the Company, in 50% of the Excess MSRs. Freedom Mortgage, as servicer, also retained the ancillary income and the servicing obligations and liabilities.

In October 2013, the Company also entered into a flow and bulk Excess MSR purchase agreement related to future purchases of Excess MSRs from Freedom Mortgage (the “Flow and Bulk Excess MSR Purchase Agreement”). 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 included recapture provisions that were 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 included recapture provisions that were 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 included recapture provisions that were 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 “Excess MSR Pool 2014,” and the recapture provisions, which are identical, are collectively referred to as the “Excess MSR Pool 2014—Recapture Agreement.”

On November 15, 2016, the Company agreed to sell all of its Excess MSRs back to Freedom Mortgage. Excess MSR Pool 1 and Excess MSR Pool 2014 were sold on November 15, 2016, and Excess MSR Pool 2 was sold on February 1, 2017. Each of the Excess MSR purchase agreements was terminated at the time the related pool(s) of Excess MSRs were sold. See Note 7.
 
MSRs

On May 29, 2015, in conjunction with the acquisition of Aurora, the Company acquired MSRs on conventional mortgage loans with an aggregate UPB of approximately $718.4 million.

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 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 was included in servicing costs on the consolidated statements of income (loss).

Aurora subsequently acquired from third parties three portfolios of MSRs on loans owned or securitized by Fannie Mae or Freddie Mac with an aggregate UPB of approximately $3.1 billion as of their respective closing dates.

In June 2016, Aurora entered into a joint marketing recapture agreement with Freedom Mortgage. Pursuant to this agreement, Freedom Mortgage will attempt to refinance certain mortgage loans underlying Aurora’s MSR portfolio as directed by Aurora. See Note 7.

See Note 7 for a description of the Company’s acquisition of MSRs from Freedom Mortgage in connection with the sale by the Company of its Excess MSRs.
 
The following is a summary of the Company’s Servicing Related Assets (dollars in thousands):

Servicing Related Assets Summary

As of March 31, 2017

   
Unpaid
Principal
Balance
   
Cost Basis
   
Carrying
Value(A)
   
Weighted
Average
Coupon
   
Weighted
Average
Maturity
(Years)(B)
   
Changes in
Fair Value
Recorded in
Other Income
(Loss)(C)
 
MSRs
                                   
Conventional
 
$
3,170,673
   
$
31,871
(D)  
$
31,088
     
3.81
%
   
23.5
     
(783
)
Government
   
4,421,039
     
32,515
(D)    
45,610
     
3.36
%
   
28.5
     
13,095
 
Total
 
$
7,591,712
   
$
64,386
   
$
76,698
     
3.55
%
   
26.4
   
$
12,312
 

As of December 31, 2016

   
Unpaid
Principal
Balance
   
Cost Basis
   
Carrying
Value(A)
   
Weighted
Average
Coupon
   
Weighted
Average
Maturity
(Years)(B)
   
Changes in
Fair Value
Recorded in
Other Income
(Loss)(C)
 
Excess MSR Pool 2
   
6,053,142
     
19,754
(E)    
28,526
     
2.96
%
   
26.3
     
(493
)
Excess MSR Pool 2 - Recapture Agreement
   
-
     
1,187
(E)    
866
             
-
     
742
 
Conventional MSRs
   
3,262,181
     
35,156
(D)    
31,871
     
3.81
%
   
23.7
     
(3,285
)
Total
 
$
9,315,323
   
$
56,097
   
$
61,263
     
3.26
%
   
25.4
   
$
(3,036
)


(A)
Carrying value represents the fair value of the pools or recapture agreements, as applicable (see Note 9).
(B)
The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.
(C)
The portion of the change in fair value of the recapture agreement relating to loans recaptured as of March 31, 2017 and December 31, 2016 is reflected in the respective pool.
(D)
MSR cost basis consists of the carrying value of the prior period, adjusted for any purchases, sales and principal paydowns.
(E)
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.
 
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, 2017

   
Percentage of Total Outstanding
Unpaid Principal Balance
 
California
   
12.4
%
New Jersey
   
8.2
%
Texas
   
5.6
%
Utah
   
5.5
%
Florida
   
5.1
%
All other
   
63.2
%
Total
   
100.0
%

As of December 31, 2016

   
Percentage of Total Outstanding
Unpaid Principal Balance
 
Texas
   
10.0
%
California
   
8.9
%
Florida
   
6.7
%
Virginia
   
5.9
%
North Carolina
   
5.8
%
Georgia
   
5.8
%
New Jersey
   
5.6
%
Washington
   
5.5
%
Colorado
   
5.2
%
All other
   
40.6
%
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 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 Operating Partnership.
 
The following tables present certain information about the 2013 Plan as of the dates indicated:
 
Equity Incentive Plan Information

                           
Number of Securities
Remaining Available For
       
   
LTIP-OP Units
   
Shares of Common Stock
   
Future Issuance Under
   
Issuance
 
   
Issued
   
Forefitted
   
Issued
   
Forefitted
   
Equity Compensation Plans
   
Price
 
March 31, 2016
   
(103,850
)
   
-
     
(19,038
)
   
-
     
1,377,112
       
Number of securities issued or to be issued upon exercise
   
(36,500
)
   
916
     
(9,465
)
   
-
     
(45,049
)
 
$
15.80
 
June 30, 2016
   
(140,350
)
   
916
     
(28,503
)
   
-
     
1,332,063
         
Number of securities issued or to be issued upon exercise
   
-
     
-
     
-
     
3,155
     
3,155
         
September 30, 2016
   
(140,350
)
   
916
     
(28,503
)
   
3,155
     
1,335,218
         
Number of securities issued or to be issued upon exercise
   
-
     
-
     
-
     
-
     
-
         
December 31, 2016
   
(140,350
)
   
916
     
(28,503
)
   
3,155
     
1,335,218
         
Number of securities issued or to be issued upon exercise
   
-
     
-
     
-
     
-
     
-
         
March 31, 2017
   
(140,350
)
   
916
     
(28,503
)
   
3,155
     
1,335,218
         

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 Operating Partnership’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 rights. Each LTIP-OP Unit awarded is deemed equivalent to an award of one share of the Company’s common stock 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 cash, or at the Company’s option, the Company may purchase the OP Units for common stock, 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 Unit 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
 
June 15, 2016
   
14
   
$
15.85
     
36,500
   
$
579
 
September 9, 2015
   
12
   
$
15.80
     
35,000
   
$
553
 
June 10, 2014
   
10
   
$
19.33
     
31,350
   
$
606
 

LTIP-OP Units vest ratably over the first three annual anniversaries of the grant date. The fair value of each LTIP-OP Unit was determined based on the closing price of the Company’s common stock on the applicable grant date in all other cases.

As of March 31, 2017, 69,901 LTIP-OP Units have vested. The Company recognized approximately $135,000 and $147,000 in share-based compensation expense in the three month periods ended March 31, 2017 and 2016, respectively. There was approximately $705,500 of total unrecognized share-based compensation expense as of March 31, 2017, related to the 69,901 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 $10,000 (based on the closing price on the grant date) of common stock (530 shares each for a total of 1,590 shares), which were fully vested on the date of grant, and $50,000 (based on the closing price on the date of grant) of restricted shares of common stock (2,651 shares each for a total of 7,953 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. The restricted shares 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 $50,000 (based on the closing price on the date of grant) of restricted shares of common stock (3,165 each for a total of 9,495 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. The shares are no longer subject to forfeiture and are vested.

On June 15, 2016, pursuant to the 2013 Plan, the Company granted each of the independent directors $50,000 (based on the closing price on the date of grant) of restricted shares of common stock (3,155 shares each for a total of 9,465 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 vesting period. The 3,155 shares granted to Mr. Kislak were forfeited when he resigned as a director of the Company on September 19, 2016. The forfeited shares have been returned to the shares available for future issuance under the 2013 Plan.

As of March 31, 2017, 1,335,218 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 interim financial statements relate to LTIP-OP Units in the Operating Partnership held by parties other than the Company.

As of March 31, 2017, the non-controlling interest holders in the Operating Partnership owned 139,434 LTIP-OP Units, or approximately 1.1% 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,
 
   
2017
   
2016
 
Numerator:
           
Net income attributable to common stockholders and participating securities
 
$
22,587
   
$
(7,162
)
Net income allocable to common stockholders
 
$
22,178
   
$
(7,063
)
Denominator:
               
Weighted average common shares outstanding
   
7,634,038
     
7,509,543
 
Weighted average diluted shares outstanding
   
7,640,348
     
7,519,038
 
Basic and Dilutive:
               
Basic earnings per share
 
$
2.91
   
$
(0.94
)
Diluted earnings per share
 
$
2.90
   
$
(0.94
)

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 the 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 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 the management fee which is payable in cash quarterly in arrears, in an amount equal to 1.5% per annum of the stockholders’ equity (as defined in the Management Agreement).

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. 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. At the time the Management Agreement was negotiated, both the Manager and Freedom Mortgage were controlled by Mr. Stanley Middleman, who is also a shareholder of the Company. Ownership of the Manager has been transferred to CHMM Blind Trust, a grantor trust for the benefit of Mr. Middleman.

The Management Agreement provides that the Company will reimburse the Manager for (i) 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 and (ii) the allocable portion of the compensation paid to specified officers dedicated to the Company. “Due to affiliates” consisted of the following for the periods indicated (dollars in thousands):
 
Management Fee to Affiliate

   
Three Months Ended March 31,
 
   
2017
   
2016
 
Management fees
 
$
701
   
$
560
 
Compensation reimbursement
   
191
     
130
 
Total
 
$
892
   
$
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.

Joint Marketing Recapture Agreement

In June 2016, Aurora entered into a joint marketing recapture agreement with Freedom Mortgage. Pursuant to this agreement, Freedom Mortgage will attempt to refinance certain mortgage loans underlying Aurora’s MSR portfolio as directed by Aurora. If a loan is refinanced, Aurora will pay Freedom Mortgage a fee for its origination services. Freedom Mortgage will be entitled to sell the loan for its own benefit and will transfer the related MSR to Aurora. The agreement has an initial term of one year, subject to automatic renewals of one year each and subject to termination by either party upon 60 days prior notice. All new loans must qualify for sale to Fannie Mae or Freddie Mac and meet other conditions set forth in the agreement. During the quarter ended March 31, 2017, MSRs on 40 loans with an aggregate UPB of approximately $10.2 million had been received from Freedom Mortgage which generated approximately $24,600 in fees due to Freedom Mortgage.

Sale of Excess MSRs
 
On November 15, 2016, the Company completed the sale of the Excess MSRs in Excess MSR Pool 1 and the Excess MSRs in Excess MSR Pool 2014 to Freedom Mortgage. At the closing, the Company received cash proceeds of approximately $38.0 million, repaid $12.0 million of outstanding borrowings drawn on the Company’s $25 million term loan facility with NexBank SSB (the “NexBank term loan”), with a portion of the cash proceeds and released the Company’s security interests arising under Excess MSR Agreement 1 and the Flow and Bulk Excess MSR Purchase Agreement. The Company invested the remaining cash proceeds in Agency RMBS and expects to redeploy those proceeds into future MSR acquisitions.  The Company completed the sale of the Excess MSRs in Excess MSR Pool 2 to Freedom Mortgage on February 1, 2017. In connection with the sale of those Excess MSRs, Freedom Mortgage transferred to Aurora Ginnie Mae MSRs with a weighted average servicing fee of approximately 30 basis points. The Ginnie Mae MSRs relate to a pool consisting primarily of newly originated Ginnie Mae conforming mortgage loans that had an aggregate UPB of approximately $4.5 billion as of January 31, 2017. At the closing of the sale of the Excess MSRs in Excess MSR Pool 2, the Company repaid the remaining outstanding borrowings drawn on the NexBank term loan with cash on hand.  In addition, the acknowledgment agreement that the Company and Freedom Mortgage entered into with Ginnie Mae at the time of the IPO was terminated.
 
In connection with the sale transactions, Freedom Mortgage agreed to make 12 monthly yield maintenance payments to the Company beginning in December 2016 aggregating $3.0 million.
 
See Note 5 for a discussion of the now terminated co-investments in Excess MSRs with Freedom Mortgage. See Note 10 for a discussion of the now terminated acknowledgment agreement among the Company, Freedom Mortgage and Ginnie Mae.

Other Transactions with 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 90 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. For the three month period ended March 31, 2017, there was no related income or expense earned or incurred. 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 which are included in “Interest income” and “Interest expense”, respectively, on the consolidated statements of income. There were no such assets, or related liabilities, as of March 31, 2017 and December 31, 2016.

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 qualifying 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, 2017
   
December 31, 2016
 
Notional amount of interest rate swaps
 
$
609,950
   
$
415,850
 
Notional amount of swaptions
   
80,000
     
70,000
 
Notional amount of TBAs, net
   
-
     
(6,000
)
Notional amount of Treasury futures
   
37,500
     
50,000
 
Notional amount of options on Treasury futures
   
15,000
     
20,000
 
Total notional amount
 
$
742,450
   
$
549,850
 
 
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, 2017
 
$
609,950
     
1.70
%
   
1.07
%
   
5.5
 
December 31, 2016
 
$
415,850
     
1.46
%
   
0.90
%
   
4.8
 

The following table presents information about the Company’s interest rate swaption agreements as of the dates indicated (dollars in thousands):

   
Notional
Amount
   
Weighted
Average Pay
Rate
   
Weighted
Average Receive
Rate(A)
   
Weighted
Average Years
to Maturity
 
March 31, 2017
 
$
80,000
     
2.76
%
   
LIBOR-BBA
   
10.9
 
December 31, 2016
 
$
70,000
     
2.74
%
   
LIBOR-BBA
   
10.9
 


(A)
Floats in accordance with LIBOR.

The following table presents information about derivatives realized gain (loss), which is included on the consolidated statement of income (loss) for the periods indicated (dollars in thousands):

Realized Gains (Losses) on Derivatives

        
Three Months Ended March 31,
 
Non-Hedge Derivatives
 
Income Statement Location
 
2017
   
2016
 
Interest rate swaps
 
Realized gain (loss) on derivatives, net
 
$
(159
)
 
$
(1,350
)
Swaptions
 
Realized gain (loss) on derivatives, net
   
(69
)
   
-
 
TBAs
 
Realized gain (loss) on derivatives, net
   
(112
)
   
(82
)
Treasury futures
 
Realized gain (loss) on derivatives, net
   
(677
)
   
(29
)
Total
     
$
(1,017
)
 
$
(1,461
)

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 (“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 in this section even though they are not derivatives because they are subject to master netting arrangements. However, repurchase agreements are presented 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, 2017

   
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
 
$
8,240
   
$
-
   
$
8,240
   
$
(8,240
)
 
$
-
   
$
-
 
Swaptions
   
1,300
     
-
     
1,300
     
(1,300
)
   
-
     
-
 
Total Assets
 
$
9,540
   
$
-
   
$
9,540
   
$
(9,540
)
 
$
-
   
$
-
 
                                                 
Liabilities
                                               
Repurchase agreements
 
$
773,317
   
$
-
   
$
773,317
   
$
(767,450
)
 
$
(5,867
)
 
$
-
 
Interest rate swaps
   
413
     
-
     
413
     
-
     
(413
)
   
-
 
TBAs
   
83
     
-
     
83
     
(83
)
   
-
     
-
 
Treasury futures
   
144
     
-
     
144
     
661
     
(805
)
   
-
 
Total Liabilities
 
$
773,957
   
$
-
   
$
773,957
   
$
(766,872
)
 
$
(7,085
)
 
$
-
 

As of December 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
 
$
7,639
   
$
-
   
$
7,639
   
$
(7,639
)
 
$
-
   
$
-
 
Swaptions
   
1,482
     
-
     
1,482
     
(1,482
)
   
-
     
-
 
Total Assets
 
$
9,121
   
$
-
   
$
9,121
   
$
(9,121
)
 
$
-
   
$
-
 
                                                 
Liabilities
                                               
Repurchase agreements
 
$
594,615
   
$
-
   
$
594,615
   
$
(574,181
)
 
$
(20,434
)
 
$
-
 
Interest rate swaps
   
339
     
-
     
339
     
-
     
(339
)
   
-
 
TBAs
   
75
     
-
     
75
     
(75
)
   
-
     
-
 
Treasury futures
   
280
     
-
     
280
     
526
     
(806
)
   
-
 
Total Liabilities
 
$
595,309
   
$
-
   
$
595,309
   
$
(573,730
)
 
$
(21,579
)
 
$
-
 

Note 9 – Fair Value

Fair Value Measurements

ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority to data lacking transparency (i.e., unobservable inputs). Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity’s own credit standing, when measuring fair value of a liability.
 
ASC 820 establishes a three level hierarchy to be used when measuring and disclosing fair value. An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Following is a description of the three levels:

Level 1 inputs are quoted prices in active markets for identical assets or liabilities as of the measurement date under current market conditions. Additionally, the entity must have the ability to access the active market and the quoted prices cannot be adjusted by the entity.

Level 2 inputs include quoted prices in active markets for similar assets or liabilities; quoted prices in inactive markets for identical or similar assets or liabilities; or inputs that are observable or can be corroborated by observable market data by correlation or other means for substantially the full-term of the assets or liabilities.

Level 3 unobservable inputs are supported by little or no market activity. The unobservable inputs represent the assumptions that management believes market participants would use to price the assets and liabilities, including risk. Generally, Level 3 assets and liabilities are valued using pricing models, discounted cash flow methodologies, or similar techniques that require significant judgment or estimation.
 
Recurring Fair Value Measurements

The following is a description of the methods used to estimate the fair values of the Company’s assets and liabilities measured at fair value on a recurring basis, as well as the basis for classifying these assets and liabilities as Level 2 or 3 within the fair value hierarchy. The Company’s valuations consider assumptions that it believes a market participant would consider in valuing the assets and liabilities, the most significant of which are disclosed below. The Company reassesses and periodically adjusts the underlying inputs and assumptions used in the valuations for recent historical experience, as well as for current and expected relevant market conditions.

RMBS

The Company holds a portfolio of RMBS that are classified as available for sale and are carried at fair value in the consolidated balance sheets. The Company determines the fair value of its RMBS 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. As a result, the Company classified 100% of its RMBS as Level 2 fair value assets at March 31, 2017 and December 31, 2016.

Excess MSRs

The Company held a portfolio of Excess MSRs that are reported at fair value in the consolidated balance sheet at December 31, 2016. The Company uses a discounted cash flow model to estimate the fair value of these assets. Although Excess MSR transactions are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds, delinquency levels and discount rates). As a result, the Company classified 100% of its Excess MSRs as Level 3 fair value assets at December 31, 2016. The Company did not hold any Excess MSRs at March 31, 2017.

MSRs

The Company holds a portfolio of MSRs that are reported at fair value in the consolidated balance sheets. The Company uses a discounted cash flow model to estimate the fair value of these assets. Although MSR transactions are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds, delinquency levels, costs to service and discount rates). As a result, the Company classified 100% of its MSRs as Level 3 fair value assets at March 31, 2017 and December 31, 2016.
 
Derivative Instruments

The Company enters into a variety of derivative financial instruments as part of its economic hedging strategies. The Company executes interest rate swaps, swaptions, TBAs and treasury futures. The Company utilizes third-party pricing providers to value its financial derivative instruments. As a result, the Company classified 100% of the derivative instruments as Level 2 fair value assets and liabilities at March 31, 2017 and December 31, 2016.

Both the Company and the derivative counterparties under their netting arrangements are required to post cash collateral based upon the net underlying market value of the Company’s open positions with the counterparties. Posting of cash collateral typically occurs daily, subject to certain dollar thresholds. Due to the existence of netting arrangements, as well as frequent cash collateral posting at low posting thresholds, credit exposure to the Company and/or counterparties is considered materially mitigated. The Company’s interest rate swaps are required to be cleared on an exchange, which further mitigates, but does not eliminate, credit risk. Based on the Company’s assessment, there is no requirement for any additional adjustment to derivative valuations specifically for credit.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis as of the dates indicated (dollars in thousands).

Recurring Fair Value Measurements

As of March 31, 2017

   
Level 1
   
Level 2
   
Level 3
   
Carrying Value
 
Assets
                       
RMBS
                       
Fannie Mae
 
$
-
   
$
728,267
   
$
-
   
$
728,267
 
Freddie Mac
   
-
     
369,651
     
-
     
369,651
 
CMOs
   
-
     
41,138
     
-
     
41,138
 
RMBS total
   
-
     
1,139,056
     
-
     
1,139,056
 
Derivative assets
                               
Interest rate swaps
   
-
     
8,240
     
-
     
8,240
 
Interest rate swaptions
   
-
     
1,300
     
-