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Form 10-Q Apollo Residential Mortg For: Jun 30

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August 9, 2016 3:55 PM EDT
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________
        
FORM 10-Q
_________________________________________
  (Mark One)
þ
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2016
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 001-35246
____________________________________________________ 
Apollo Residential Mortgage, Inc.
(Exact name of Registrant as specified in its charter)
____________________________________________________
Maryland
 
45-0679215
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
Apollo Residential Mortgage, Inc.
c/o Apollo Global Management, LLC
9 West 57th Street, 43rd Floor
New York, New York 10019
(Address of Registrant’s principal executive offices)
(212) 515–3200
(Registrant’s telephone number, including area code)
  ____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer
 
o
 
Accelerated filer
 
þ
 
 
 
 
Non-accelerated filer
 
o (Do not check if a smaller reporting company)
 
Smaller reporting company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934).    Yes  o    No  þ
As of August 8, 2016, there were 31,895,226 shares, par value $0.01, of the registrant’s common stock issued and outstanding.



TABLE OF CONTENTS





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


 
 
June 30, 2016
 
December 31, 2015
 
 
(Unaudited)
 
 
Assets:
 
 
 
 
Cash and cash equivalents
 
$
104,168

 
$
120,144

Restricted cash
 
24,263

 
83,693

Residential mortgage-backed securities, at fair value ($2,368,893 and $2,981,085 pledged as collateral, respectively)
 
2,478,448

 
3,061,582

Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value
 
160,206

 
167,624

Other investment securities, at fair value ($155,904 and $163,263 pledged as collateral, respectively)
 
160,396

 
166,190

Other investments
 
45,724

 
45,233

Investment related receivable
 
6,071

 
2,692

Interest receivable
 
8,065

 
9,849

Derivative instruments, at fair value
 
—

 
4,347

Other assets
 
1,337

 
1,616

Total Assets
 
$
2,988,678

 
$
3,662,970

 
 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
Liabilities:
 
 
 
 
Borrowings under repurchase agreements (net of deferred financing costs of $3 and $55, respectively)
 
$
2,269,850

 
$
2,898,292

Non-recourse securitized debt, at fair value
 
13,407

 
18,951

Obligation to return cash held as collateral
 
—

 
280

Accrued interest payable
 
2,359

 
9,138

Derivative instruments, at fair value
 
8,542

 
13,813

Payable to related party
 
4,243

 
6,373

Dividends and dividend equivalents payable
 
18,923

 
19,170

Investment related payable
 
1,256

 
—

Accounts payable, accrued expenses and other liabilities
 
5,297

 
2,090

Total Liabilities
 
2,323,877

 
$
2,968,107

 
 
 
 
 
Commitments and Contingencies (Note 13)
 

 

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

 
$
69

Common stock, $0.01 par value, 450,000,000 shares authorized, 31,894,717 and 31,853,025 shares issued and outstanding, respectively
 
319

 
319

Additional paid-in capital
 
789,767

 
789,465

Accumulated deficit
 
(125,354
)
 
(94,990
)
Total Stockholders’ Equity
 
664,801

 
694,863

Total Liabilities and Stockholders’ Equity
 
$
2,988,678

 
$
3,662,970


See notes to unaudited consolidated financial statements.

3
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Operations (Unaudited)
(in thousands—except per share data)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Interest Income:
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
 
$
25,303

 
$
35,818

 
$
53,880

 
$
71,432

Securitized mortgage loans
 
3,231

 
3,623

 
6,496

 
5,790

Other
 
3,083

 
2,177

 
6,102

 
3,691

Total Interest Income
 
31,617


41,618


66,478

 
80,913

Interest Expense:
 
 
 
 
 
 
 
 
Repurchase agreements
 
(8,046
)
 
(7,901
)
 
(16,477
)
 
(15,366
)
Securitized debt
 
(197
)
 
(333
)
 
(447
)
 
(699
)
Total Interest Expense
 
(8,243
)
 
(8,234
)
 
(16,924
)
 
(16,065
)
 
 
 
 
 
 
 
 
 
Net Interest Income
 
23,374

 
33,384

 
49,554

 
64,848

 
 
 
 
 
 
 
 
 
Other Income/(Loss), net:
 
 
 
 
 
 
 
 
Realized gain/(loss) on sale of residential mortgage-backed securities, net
 
273

 
(4,530
)
 
595

 
4,008

Other-than-temporary impairments recognized
 
(5,012
)
 
(197
)
 
(5,707
)
 
(2,772
)
Gain/(loss) on derivative instruments, net (includes $11,508, $23,553, $8,876 and $7,835 of unrealized gains, respectively)
 
(7,870
)
 
12,463

 
(36,344
)
 
(14,058
)
Realized gain/(loss) on sale of other investment securities, net
 
—

 
102

 
(26
)
 
102

Unrealized gain/(loss) on residential mortgage-backed securities, net
 
7,599

 
(41,266
)
 
11,280

 
(26,486
)
Unrealized gain on securitized debt
 
20

 
1,001

 
22

 
1,014

Unrealized gain/(loss) on securitized mortgage loans
 
5,751

 
(1,896
)
 
1,992

 
466

Unrealized gain/(loss) on other investment securities
 
3,726

 
(2,540
)
 
3,418

 
(2,569
)
Other, net
 
(85
)
 
(3
)
 
(68
)
 
9

Other Income/(Loss), net
 
4,402

 
(36,866
)
 
(24,838
)
 
(40,286
)
 
 
 
 
 
 
 
 
 
Operating Expenses:
 
 
 
 
 
 
 
 
General and administrative (includes ($194), ($304), ($302) and ($797) of stock based compensation, respectively)
 
(3,664
)
 
(3,655
)
 
(7,238
)
 
(7,505
)
Merger related costs
 
(1,321
)
 
—

 
(4,936
)
 
—

Management fee - related party
 
(2,493
)
 
(2,895
)
 
(5,278
)
 
(5,682
)
Total Operating Expenses
 
(7,478
)
 
(6,550
)
 
(17,452
)

(13,187
)
 
 
 
 
 
 
 
 
 
Net Income/(Loss)
 
$
20,298

 
$
(10,032
)

$
7,264


$
11,375

Preferred Stock Dividends Declared
 
(3,450
)
 
(3,450
)
 
(6,900
)
 
(6,900
)
Net Income/(Loss) Allocable to Common Stock and Participating Securities*
 
$
16,848

 
$
(13,482
)
 
$
364

 
$
4,475

 
 
 
 
 
 
 
 
 
Earnings/(Loss) per Common Share - Basic and Diluted
 
$
0.52

 
$
(0.43
)
 
$
—

 
$
0.13

 
 
 
 
 
 
 
 
 
Dividends Declared per Share of Common Stock
 
$
0.48

 
$
0.48

 
$
0.96

 
$
0.96

* Losses are not allocated to participating securities.

See notes to unaudited consolidated financial statements.

4
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
(in thousands—except share data)


 
 
Preferred Stock
 
Common Stock
 
Additional
Paid- In
Capital
 
(Accumulated Deficit)
 
Total
 
 
Shares
 
Par
 
Shares
 
Par
 
Balance at December 31, 2015
 
6,900,000

 
$
69

 
31,853,025

 
$
319

 
$
789,465

 
$
(94,990
)
 
$
694,863

Settlement of vested restricted stock units in common stock
 
—

 
—

 
41,692

 
*

 
—

 
—

 
—

Capital increase related to equity compensation
 
—

 
—

 


 
—

 
302

 
—

 
302

Net income
 
—

 
—

 
—

 
—

 
—

 
7,264

 
7,264

Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
—

 
(6,900
)
 
(6,900
)
Dividends declared on common stock, restricted stock and restricted stock units
 
—

 
—

 
—

 
—

 
—

 
(30,728
)
 
(30,728
)
Balance at June 30, 2016
 
6,900,000

 
$
69

 
31,894,717

 
$
319

 
$
789,767

 
$
(125,354
)
 
$
664,801

*Rounds to less than 1.

See notes to unaudited consolidated financial statements.

5
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

 
 
Six Months Ended June 30,
 
 
2016
 
2015
Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
7,264

 
$
11,375

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Premium amortization/(discount accretion), net
 
(12,718
)
 
(16,916
)
Amortization of deferred financing costs
 
309

 
250

Equity based compensation expense
 
302

 
797

Unrealized (gain)/loss on mortgage-backed securities, net
 
(11,280
)
 
26,486

Unrealized gain on securitized mortgage loans
 
(1,992
)
 
(466
)
Unrealized (gain)/loss on other investment securities
 
(3,418
)
 
2,569

Unrealized gain on derivative instruments, net
 
(8,876
)
 
(7,835
)
Unrealized (gain) on securitized debt
 
(22
)
 
(1,014
)
Other-than-temporary impairments recognized
 
5,707

 
2,772

Realized (gain) on sales of mortgage-backed securities
 
(3,999
)
 
(13,763
)
Realized loss on sales of mortgage-backed securities
 
3,404

 
9,755

Realized loss on derivative instruments
 
46,476

 
12,009

Realized loss on real estate owned, net
 
310

 
1,128

Realized (gain)/loss on sale of other investment securities, net
 
26

 
(102
)
Depreciation on real estate underlying bond for title contracts
 
461

 
179

Changes in operating assets and liabilities:
 

 
 
Increase/(decrease) in accrued interest receivable, less purchased interest
 
1,784

 
195

Decrease in other assets
 
513

 
456

Decrease in accrued interest payable
 
(6,779
)
 
(4,475
)
Increase/(decrease) in accounts payable and accrued expenses
 
3,087

 
(226
)
Decrease in payable to related party
 
(2,128
)
 
(440
)
Increase in other liabilities
 
120

 
76

Net cash provided by operating activities
 
18,551

 
22,810

Cash Flows from Investing Activities:
 
 
 
 
Purchases of mortgage-backed securities
 
(251,630
)
 
(1,353,785
)
Proceeds from sales of mortgage-backed securities
 
647,044

 
1,581,047

Purchases of mortgage loans, simultaneously securitized
 
—

 
(67,357
)
Purchases of other investment securities
 
—

 
(142,383
)
Proceeds from sales of other investment securities
 
2,900

 
17,679

Purchases of other investments
 
(7,863
)
 
(11,223
)
Proceeds from other investments
 
6,900

 
8,563

Proceeds from sales of real estate owned
 
255

 
—

Decrease in restricted cash related to investing activities
 
12,317

 
805

Increase in cash collateral held related to investing activities
 
(280
)
 
8,820

Principal payments received on mortgage-backed securities
 
201,290

 
209,146

Principal payments received on securitized mortgage loans
 
8,823

 
5,512

Principal payments received on other investment securities
 
7,763

 
7,565

Payments made for termination of derivative instruments
 
(37,268
)
 
(1,977
)
Purchase of interest rate swaptions
 
—

 
(8,385
)
Other, net
 
—

 
14

Net cash provided by investing activities
 
590,251

 
254,041

(Continued on next page.)

See notes to unaudited consolidated financial statements.

6
Apollo Residential Mortgage, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)

(Continued.)
 
 
Six Months Ended June 30,
 
 
2016
 
2015
Cash Flows from Financing Activities:
 
 
 
 
Proceeds from repurchase agreement borrowings
 
10,630,914

 
7,943,331

Repayments of repurchase agreement borrowings
 
(11,259,408
)
 
(8,167,979
)
Decrease in restricted cash related to financing activities
 
47,113

 
(8,915
)
Principal payments on securitized debt
 
(5,522
)
 
(7,269
)
Dividends paid on preferred stock
 
(6,900
)
 
(6,900
)
Dividends paid on common stock and dividend equivalent rights
 
(30,975
)
 
(30,186
)
Deferred financing costs/offering costs expensed/(incurred) net
 
—

 
(26
)
Net cash used by financing activities
 
(624,778
)
 
(277,944
)
Net decrease in cash
 
(15,976
)
 
(1,093
)
Cash and cash equivalents at beginning of period
 
120,144

 
114,443

Cash and cash equivalents at end of period
 
$
104,168

 
$
113,350

Supplemental Disclosure of Operating Cash Flow Information:
 
 
 
 
Interest Paid
 
$
20,970

 
$
19,936

Supplemental Disclosure of Non-cash Financing/Investing Activities:
 
 
 
 
Dividends and dividend equivalent rights declared, not yet paid
 
$
18,923

 
$
19,192

Residential mortgage-backed securities purchased not settled, net
 
$
—

 
$
3,322

Due from broker
 
$
6,071

 
$
4,559

Due to broker
 
$
1,256

 
$
—



See notes to unaudited consolidated financial statements.

7
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Unless the context requires otherwise, references to “we,” “us,” “our,” “AMTG” or “Company” refer to Apollo Residential Mortgage, Inc., as consolidated with its subsidiaries including variable interest entities in which we are the primary beneficiary. The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” refers to a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the United States (or, U.S.) Government, such as Ginnie Mae or the U.S. Small Business Administration or, in the aggregate “Agencies”; “Agency Inverse Floater” refers to securities that have a floating interest rate with coupons that reset periodically based on an index and which coupon varies inversely with changes in a referenced index, which index is typically the one month LIBOR; “Agency IO” and “Agency Inverse IO” refers to Agency interest-only and Agency inverse interest-only securities, respectively, which receive some or all of the interest payments, but no principal payments, made on a related series of Agency RMBS, based on a notional principal balance; “Agency-RMBS” refer to RMBS issued or guaranteed by an Agency; “Alt-A” refers to residential mortgage loans made to borrowers whose qualifying mortgage characteristics do not conform to Agency underwriting guidelines and generally allow homeowners to qualify for a mortgage loan with reduced or alternate forms of documentation; “ARMs” refer to adjustable rate mortgages; “BFT Contracts” refer to agreements in which a seller finances the sale of property, the buyer agrees to pay the purchase price of the property in monthly installments and legal title to the property is transferred when the terms of the contract are fulfilled; “CMOs” refer to collateralized mortgage obligation bonds; “December 2014 Pool” refers to the loan pool we purchased in December 2014; “Fannie Mae” refers to the Agency formerly known as Federal National Mortgage Association; “February 2013 Pool” refers to the loan pool we purchased in February 2013; “February 2013 Securitization” refers to the securitization that we transacted in February 2013 simultaneously with the purchase of the February 2013 Pool; “Freddie Mac” refers to the Federal Home Loan Mortgage Corporation; “Hybrids” refer to mortgage loans that have fixed interest rates for a period of time and, thereafter, generally adjust annually based on an increment over a specified interest rate index; “IO” refers to securities that have no principal balance and bear interest based on a notional balance; “LIBOR” refers to the London Interbank Offered Rate; “Long TBA Contracts” refer to TBA Contracts for which we would be required to buy certain Agency RMBS on a forward basis; “March 2015 Pool” refers to the loan pool we purchased in March 2015; “March 2015 Securitization” refers to the securitization that we transacted in March 2015, combining the December 2014 Pool with the March 2015 Pool, for which we retained the security issued in the securitization; “Merger” refers to the proposed merger transaction as discussed in Note 18 to the consolidated financial statements; “Merger Agreement” refers to the definitive merger agreement we entered into on February 26, 2016, as amended as of June 30, 2016, in connection with the Merger as discussed in Note 18 to the consolidated financial statements; “non-Agency RMBS” refer to RMBS that are not issued or guaranteed by an Agency; “Option ARMs” refer to mortgages that provide the mortgagee payment options, which may initially include a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment or a 30-year fully amortizing payment; “REO” refers to real estate owned as a result of foreclosure on mortgage loans; “Risk Sharing Securities” refer to securities issued by Fannie Mae and/or Freddie Mac which are structured to be subject to the performance of referenced pools of residential mortgage loans and represent unsecured general obligations of the issuing Agency; “RMBS” refer to residential mortgage-backed securities; “SBA” refers to the U.S. Small Business Administration; “SBA-IO” refers to IO securities issued by the SBA; “SBC-MBS” refer to small balance commercial-mortgage-backed securities; “Seller Financing Program” refers to our initiative whereby we provide advances through a warehouse line to a third party to finance the acquisition and improvement of single family homes and, once the homes are improved, they are marketed for sale, with the seller providing financing to the buyer in the form of a mortgage loan or a BFT Contract; “Short TBA Contracts” refer to TBA Contracts for which we would be required to sell certain Agency RMBS on a forward basis; “Subprime” refers to mortgage loans that have been originated using underwriting standards that are less restrictive than those used to originate prime mortgage loans; “Swaps” refer to interest rate swap contracts where we agree to pay a fixed rate of interest and receive a variable rate of interest based on the notional amount of the interest rate swap contract; “Swaptions” refer to option contracts that allow the option holder to enter into a Swap with a specified fixed rate at the expiration of the option period; “Swaption Purchase Contracts” refer to Swaptions that we purchase which provide that at expiration of the option period, we may either (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the Swap notional amount, or (ii) we would receive a cash payment equal to the fair value, (if any) of the underlying Swap, which termination option is prescribed in the contract confirmation; “Swaption Sale Contracts” refer to Swaptions that we sell which provide that at expiration of the option period, the counterparty to such contract may either (i) enter into a Swap under which we would pay a fixed interest rate and receive a variable interest rate on the Swap notional amount or (ii) we would make a payment equal to the fair value (if any) of the underlying Swap, which termination option is prescribed in the contract confirmation; “TBA Contracts” refer to to-be-announced contracts to purchase or sell certain Agency RMBS on a forward basis and “VIE” refers to a variable interest entity.


8
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 1– Organization
We were incorporated as a Maryland corporation on March 15, 2011 and commenced operations on July 27, 2011. We are externally managed and advised by ARM Manager, LLC (or, Manager), an indirect subsidiary of Apollo Global Management, LLC (together with its subsidiaries,“Apollo”).
We operate and have elected to qualify as a real estate investment trust (or, REIT) under the Internal Revenue Code of 1986, as amended (or, Internal Revenue Code), commencing with the taxable year ended December 31, 2011. We also operate our business in a manner that allows us not to register as an “Investment Company” as defined under the Investment Company Act of 1940 (or, 1940 Act).
We invest on a levered basis in residential mortgage and mortgage-related assets in the U.S. At June 30, 2016, our portfolio was comprised of: (i) Agency RMBS, (which include pass-through securities whose underlying collateral primarily includes 30 year fixed-rate mortgages) and Agency IO, (ii) non-Agency RMBS; (iii) securitized mortgage loans; (iv) other mortgage-related securities; (v) mortgage loans; and (vi) other real estate related investments associated with our Seller Financing Program.
Note 2 – Summary of Significant Accounting Policies
(a)
Basis of Presentation and Consolidation
The interim unaudited consolidated financial statements include our accounts and those of our consolidated subsidiaries and VIEs in which we are the primary beneficiary. All intercompany amounts have been eliminated in consolidation. We currently operate as one business segment.
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. (or, GAAP) requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
In the opinion of management, all adjustments have been made (which include only normal recurring adjustments) necessary to present fairly our financial position, results of operations and cash flows. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q. These consolidated financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the Securities and Exchange Commission (or, the SEC) on March 4, 2016. Our results of operations for the quarterly period ended June 30, 2016 are not necessarily indicative of the results to be expected for the full year or any other future period.
(b)
Cash and Cash Equivalents
We consider all highly liquid short term investments with original maturities of 90 days or less when purchased to be cash equivalents. Cash and cash equivalents are exposed to concentrations of credit risk. We deposit our cash with what we believe to be high credit quality institutions. From time to time, our cash may include amounts pledged to us by our counterparties as collateral for our derivative instruments. At June 30, 2016 and December 31, 2015, our cash and cash equivalents were primarily comprised of cash on deposit with our prime broker (which is domiciled in the U.S.); substantially all of which was in excess of applicable insurance limits and, we had $40,051 and $40,012 invested in a money market fund at June 30, 2016 and December 31, 2015, respectively. Included in cash and cash equivalents was cash pledged by our counterparties to us of $280 at December 31, 2015; we had no cash pledged to us by counterparties at June 30, 2016.
(c)
Obligation to Return Cash Held as Collateral
From time to time, we may hold cash pledged as collateral to us by certain of our derivative counterparties as a result of margin calls made by us. Cash pledged to us is unrestricted in use and, accordingly, is included as a component of cash on our consolidated balance sheets. In addition, a corresponding liability is reported as an obligation to return cash held as collateral.
(d)
Restricted Cash
Restricted cash represents cash held by our counterparties as collateral against our repurchase agreement borrowings, Swaps or other derivative instruments. Restricted cash is not available for general corporate purposes, but may be applied


9
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


against amounts due to counterparties under our repurchase agreement borrowings and Swaps, or returned to us when our collateral requirements are exceeded or at the maturity or termination of the derivative instrument or repurchase agreement.
(e) Investment Securities and Securitized Mortgage Loans
Our investment securities, which are comprised of RMBS and other investment securities, are designated as available for sale. Our RMBS portfolio may be comprised of mortgage pass-through certificates, CMOs, including Agency IO and Agency Inverse IO representing interests in or obligations backed by pools of mortgage loans. Our securitized mortgage loans, which are designated as held for investment, are presented on our balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” These mortgage loans are comprised of pools of performing, re-performing and non-performing mortgage loans that we purchased at a discount to principal balance.
At June 30, 2016, our other investment securities were comprised of investments in Risk Sharing Securities issued by Freddie Mac and Fannie Mae and SBC-MBS. Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property.  In some instances, certain of the mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principals of the related business and/or borrowing entity. Our investments in Risk Sharing Securities and SBC-MBS are included in “Other investment securities, at fair value” on our consolidated balance sheet. Interest income on our Risk Sharing Securities is included in “Interest Income - Other” and changes in the estimated fair value of such securities is included in “Unrealized gain/(loss) on other investment securities” on our consolidated statements of operations.
Balance Sheet Presentation
Purchases and sales of our investment securities are recorded on the trade date. Our RMBS and other investment securities pledged as collateral against borrowings under repurchase agreements are included in “Residential mortgage-backed securities, at fair value” and “Other investment securities, at fair value” on our consolidated balance sheet, respectively, with the fair value of securities pledged disclosed parenthetically. Amounts receivable/payable associated with sales/purchases of securities at the balance sheet date are reflected on our consolidated balance sheet as “Investment related receivable” and “Investment related payable,” respectively.
For purposes of determining the applicable accounting policy with respect to our investment securities, we review credit ratings available from each of the three major credit rating agencies (i.e. Moody’s Investors Services, Inc., Standard & Poor’s Ratings Services and Fitch, Inc.) for each investment security at the time of purchase and apply the lowest rating.
The aggregate fair value of the mortgage loans associated with our securitization transactions are presented on our consolidated balance sheet as “Securitized mortgage loans transferred to consolidated variable interest entities, at fair value.” (See Notes 5 and 14.)
Impairments
Investment Securities: We have elected the fair value option of accounting for our investment securities and, as such, all changes in the market value of our investment securities are recorded through earnings. When the fair value of an investment security is less than its amortized cost at the balance sheet date, the security is considered impaired. We assess our investment securities for impairment on at least a quarterly basis and designate such impairments as either “temporary” or “other-than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell an impaired security before its anticipated recovery, then we recognize an other-than-temporary impairment (or, OTTI) through earnings. If we do not expect to sell an other-than-temporarily impaired security, only the portion of the OTTI that is related to credit losses will be recognized as an OTTI, with the remainder recognized through earnings as a component of unrealized gains/(losses) on our statement of operations. When an OTTI is recognized, a new cost basis is established for the security, which new cost basis may not be adjusted for subsequent recoveries in fair value through earnings. However, if the performance of a security on which an OTTI was previously recognized improves, future yields may increase on such securities, resulting in a reversal of all or a portion of previously recognized OTTI over time. The determination as to whether an OTTI exists and, if so, the amount of such impairment recognized is subjective, as such determinations are based on information available at the time of assessment, as well as our Manager’s estimates of the future performance and cash flow projections for the individual security. (See Notes 4 and 6.)
Securitized Mortgage Loans: We have elected the fair value option of accounting for our securitized mortgage loans and, as such, all changes in the estimated fair value of our securitized mortgage loans are recorded through earnings, including a provision for loan losses, if any. Our securitized mortgage loans had evidence of deterioration of credit quality at the time of


10
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


acquisition. We analyze our securitized mortgage loan pool at least quarterly to assess the actual performance compared to the expected performance. If the revised cash flow estimates on our securitized mortgage loans provide a lower yield than the previous yield, we recognize a provision to loan losses (i.e., a reduction in the amortized cost of the securitized mortgage loans that is recorded in earnings) in an amount such that the yield will remain unchanged. If cash flow estimates on our securitized mortgage loans increase subsequent to recording a provision to loan losses, we will reverse previously recognized provision for loan losses before any increase to the yield is made. (See Note 5.)
(f) Designation and Fair Value Option Election
To date, we have elected the fair value option of accounting for all of our investment securities, at the time of purchase, and our securitized debt, when initially incurred. As a result of the fair value election on such assets/liabilities, we record the change in the estimated fair value of such assets and liabilities in earnings as unrealized gains/(losses). We generally intend to hold our investment securities to generate interest income; however, we have and may continue to sell certain of our investment securities as part of the overall management of our assets and liabilities and operating our business. Realized gains/(losses) on the sale of investment securities are recorded in earnings using the specific identification method.
Our securitized mortgage loans are considered held for investment purposes. Consistent with our investments in RMBS, we have elected the fair value option for our securitized mortgage loans and, as a result, we record changes in the estimated fair value of such assets in earnings as unrealized gains/(losses).
We believe that our election of the fair value option for our investment securities, securitized mortgage loans and securitized debt improves financial reporting, as such treatment is consistent with how we present the changes in the fair value of our Swaps, Swaptions and TBA Contracts, all of which are derivative instruments, through earnings.
(g)
Interest Income Recognition
Investment Securities
Interest income on investment securities is accrued based on the outstanding principal balance and the current coupon interest rate on each security. In addition, premiums and discounts associated with Agency RMBS, non-Agency RMBS and other investment securities rated AA and higher by a nationally recognized statistical rating organization at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. In order to determine the effective yield, we estimate prepayments for each security. For those securities, if prepayment levels differ, or are expected to differ in the future from our previous assessment, we adjust the amount of premium amortization recognized in the period that such change is made, applying the retrospective method, resulting in a cumulative catch-up reflecting such change. To the extent that prepayment activity varies significantly from our previous prepayment estimates, we may experience volatility in our interest income. For Agency pass-through RMBS that we acquired subsequent to June 30, 2013, we do not estimate prepayments to determine premium amortization or discount accretion on such securities. Instead, the amount of premium amortization/discount accretion on Agency pass-through RMBS acquired subsequent to June 30, 2013 is based upon actual prepayment experience, which may vary significantly over time. All Agency RMBS we held at June 30, 2016 were acquired subsequent to June 30, 2013.
For Agency IO, Agency Inverse IO and Agency Inverse Floaters, income is accrued based on the amortized cost and the effective yield. Cash received on Agency IO and Agency Inverse IO is first applied to accrued interest and then to reduce the amortized cost. At each reporting date, the effective yield is adjusted prospectively based on the current cash flow projections, which reflect prepayment estimates and the contractual terms of the security.
Interest income on non-Agency RMBS and other investment securities rated below AA or not rated by a nationally recognized statistical rating organization is recognized based on the effective yield method of accounting. The effective yield on these securities is based on the projected cash flows from each security, which are estimated based on our observation of current information and events and include assumptions related to the future path of interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models and our judgment about interest rates, prepayment speeds, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such securities. Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal and the payment priority structure of the security; therefore, actual maturities are generally shorter than the stated contractual maturities of the underlying mortgages. Based on the projected cash flows for our non-Agency RMBS, we generally expect that a portion of the purchase discount on such securities will not be recognized as interest income and is instead viewed as a credit discount. The credit discount mitigates our


11
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


risk of loss on our non-Agency securities. The amount considered to be credit discount may change over time, based on the actual performance of the underlying mortgage collateral, actual and projected cash flows from such collateral, economic conditions and other factors. If the performance of a non-Agency RMBS with a credit discount is more favorable than forecasted, we may accrete more discount into interest income than expected at the time of purchase or when performance was last assessed. Conversely, if the performance of a non-Agency RMBS with a credit discount is less favorable than forecasted, the amount of discount accreted into income may be less than expected at the time of purchase or when performance was last assessed and/or impairment and write-downs of such securities to a new lower cost basis could result.
Securitized Mortgage Loans
Application of the interest method of accounting for our pools of securitized mortgage loans requires the use of estimates to calculate a projected yield. We calculate the yield based on the projected cash flows for each pool of mortgage loans. To the extent the actual performance of a loan pool is better than last expected, the yield is adjusted upward prospectively to reflect the revised estimate of cash flows over the remaining life of such mortgage pool. However, if the revised cash flow estimates on a loan pool provides a lower yield than the original or the last calculated yield, we recognize an OTTI (i.e., a reduction in the amortized cost of the loan pool that is recorded in earnings) such that the yield will remain unchanged. Decreasing yields arising solely from a change in the contractual interest rate on variable rate loans are not treated as an OTTI. If future cash collections are materially different in amount or timing than projected cash collections, earnings could be affected, either positively or negatively.
On at least a quarterly basis, our Manager reviews and, if appropriate, makes adjustments to cash flow projections based on input and analysis received from external sources, internal models and our Manager’s judgment about interest rates, prepayment speeds, home prices, the timing and amount of credit losses and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on such loans and/or the recognition of an OTTI.
Warehouse Line Receivable, BFT Contracts and Mortgage Loans Purchased Under Seller Financing Program
We accrue interest income on our warehouse line receivable, which is included as a component of our “Interest income-other” and “Other investments,” on our consolidated financial statements, based on the contractual terms governing the warehouse line receivable agreement. We assess the collectability of the warehouse receivable and associated income on at least a quarterly basis. We record interest on a cash basis for our BFT Contracts and mortgage loans purchased under the Seller Financing Program.
(h)
Investment Consolidation and Transfers of Financial Assets
We evaluate the underlying entity that issues securities we acquire or to which we make a loan to determine the appropriate accounting methods.
In VIEs, an entity is subject to consolidation if the equity investors either do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity’s activities or are not exposed to the entity’s losses or entitled to its residual returns. VIEs that meet certain scope characteristics are required to be consolidated by their primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. This determination can sometimes involve complex and subjective analysis. We are required on an ongoing basis to assess whether we are the primary beneficiary of a VIE.
In determining the accounting treatment to be applied to securitization transactions, we evaluate whether the entity used to facilitate the transactions was a VIE and, if so, whether it should be consolidated. Based on our evaluations, we have concluded since inception of our securitizations that each of the securitizations is a VIE and that the VIEs should be consolidated. If we determine in the future that consolidation is not required for a securitization, we would have to assess whether the transfer of the underlying assets qualify as a sale or should be accounted for as secured financings under GAAP.
We may periodically enter into transactions in which we sell assets. Upon a transfer of financial assets, we may sometimes retain or acquire senior or subordinated interests in the related assets. In connection with such transactions, a determination must be made as to whether we, as the transferor, have surrendered control over transferred financial assets. That determination must consider our continuing involvement in the transferred financial asset, including all arrangements or agreements made contemporaneously with, or in contemplation of, the transfer, even if they were not entered into at the time of the transfer. The financial components approach under applicable GAAP limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to


12
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. It defines the term “participating interest” to establish specific conditions for reporting a transfer of a portion of a financial asset as a sale.
From time to time, we have securitized mortgage loans. Depending upon the structure of the securitization transaction these transactions may be accounted for as either a “sale” and the loans will be removed from the consolidated balance sheet or, as a “financing” with the loans remaining on our consolidated balance sheet. Significant judgment may be exercised by us in determining whether a transaction should be recorded as a “sale” or a “financing.”
(i)
Deferred Financing Costs
Costs incurred in connection with securing our financings are capitalized and amortized using the effective interest rate method over the respective financing term with such amortization reflected on our consolidated statements of operations as a component of interest expense. Deferred financing costs may include legal, accounting and other related fees. In connection with the adoption of accounting to simplify the presentation of debt issuance costs, on January 1, 2016, we reclassified deferred financing costs associated with our borrowings under repurchase agreements for prior periods as a component of the associated borrowings on our consolidated balance sheet. Previously, these deferred charges were included on our consolidated balance sheet as a component of “Other assets.”
(j)    Earnings Per Share
Earnings per common share (or, EPS) is computed using the two-class method of accounting, which includes the weighted-average number of shares of common stock outstanding during the period and other securities that participate in dividends, such as our unvested restricted stock and restricted stock units (or, RSUs), to arrive at total common equivalent shares. In applying the two-class method, earnings are allocated to both shares of common stock and securities that participate in dividends based on their respective weighted-average shares outstanding for the period. During periods of net loss, losses are allocated only to the extent that the participating securities are required to absorb such losses. (See Note 17.)
(k)
Derivative Instruments
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments, currently comprised of Swaps, Swaptions and, from time to time, TBA Contracts as part of our interest rate risk management. We view our derivative instruments as economic hedges, which we believe mitigate interest rate risk associated with our borrowings under repurchase agreements and/or the fair value of our RMBS portfolio. We do not enter into derivative instruments for speculative purposes.
All derivatives are reported as either assets or liabilities on the balance sheet at estimated fair value. We have not elected hedge accounting for our derivative instruments and, as a result, changes in the fair value for our derivatives are recorded in earnings. The fair value adjustments, along with the related interest income or interest expense, are recognized in the consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”
To-Be-Announced Securities
TBA Contracts are forward contracts for the purchase or sale of Agency RMBS by a specified issuer and for a specified face amount, coupon and stated term, at a predetermined price on the date stated in the contract. The particular Agency RMBS as identified by a Committee on Uniform Securities Identification Procedures number (commonly known as a CUSIP) delivered into the contract upon the settlement date are not known at the time of the transaction. We recognize in earnings unrealized gains and losses associated with TBA Contracts that are not subject to the regular-way exception, which applies: (i) when there is no other way to purchase or sell that security; (ii) if delivery of that security and settlement will occur within the shortest period possible for that type of security and (iii) if it is probable at inception and throughout the term of the individual contract that physical delivery of the security will occur. Changes in the value of our TBA Contracts and realized gains or losses on settlement are recognized in our consolidated statements of operations in the line item “Gain/(loss) on derivative instruments, net.”
(l)
Repurchase Agreements
Investment securities financed under repurchase agreements are treated as collateralized borrowings, unless they meet sale treatment or are deemed to be linked transactions. Through June 30, 2016, none of our repurchase agreements had been accounted for as a linked transaction. As of June 30, 2016, all securities financed through a repurchase agreement remained on our consolidated balance sheet as an asset (with the fair value of the securities pledged as collateral disclosed parenthetically) and cash received from the lender is recorded on our consolidated balance sheet as a liability. However, securities associated


13
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


with our securitizations are eliminated in consolidation with VIEs. Interest paid and accrued in connection with our repurchase agreements is recorded as interest expense.
(m)
Stock-based Payments
We account for stock-based awards granted to our independent directors, to our Manager and to employees of our Manager and its affiliates using the fair value based methodology prescribed by GAAP. Expense related to restricted common stock issued to our independent directors is based on the fair value of our common stock on the grant date, and amortized into expense over the award vesting period on a straight-line basis. Expense related to RSUs issued to our Manager and to employees of our Manager and its affiliates are based on the estimated fair value of such award at the grant date and are remeasured quarterly for unvested awards. We measure the fair value of our RSUs using the price of our common stock and other measurement assumptions, including implied volatility and discount rates. We use the graded vesting attribution method of accounting to amortize expense related to RSUs granted to our Manager and its affiliates.
(n)
Income Taxes (Dollar amounts in this Note 2(n) are not presented in thousands.)
We elected to be taxed as a REIT for U.S. Federal income tax purposes, commencing with our taxable year ended December 31, 2011. Pursuant to the Internal Revenue Code, a REIT that distributes at least 90% of its net taxable income, excluding net capital gains, as a dividend to its stockholders each year and which meets certain other conditions, will not be taxed on the portion of its taxable income that is distributed to its stockholders. We expect to meet the conditions required to enable us to continue to operate as a REIT and to distribute all of our taxable income, including net capital gains for the periods presented and therefore we have not recorded any provisions for income taxes on our consolidated statements of operations through June 30, 2016.
As of December 31, 2015, we had estimated net capital loss carryforward amounts of $67.7 million which may be carried forward and applied against future net capital gains. Our capital loss carryforward amounts will reduce the amount of future capital gains, if any, that we would otherwise expect to distribute as capital gains, since capital gains would first be reduced by the capital loss carryforward. At December 31, 2015, we had estimated capital loss carryforward amounts of $47.3 million and $20.4 million which will expire in 2018 and 2019, respectively.
We have elected to treat a wholly owned subsidiary as a taxable REIT subsidiary (or, TRS). A TRS may participate in activities that would otherwise not be allowed to be carried on in a REIT. A TRS is subject to U.S. Federal, state and local income tax at regular corporate tax rates.
As of December 31, 2015 our TRS and its subsidiaries, which are not consolidated with the Company for income tax purposes, had an estimated net operating loss carryforward of $1.5 million. Given the limited operating history of our TRS and its subsidiaries, there can be no assurance that such entities will generate taxable income in the future. As a result, the deferred tax asset of approximately $0.6 million associated with our net operating loss carryforward has been offset by a valuation allowance, such that we had no net deferred tax asset or liability at December 31, 2015 and, had not recorded any tax benefits through June 30, 2016.
Under GAAP, a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Based upon review of our federal, state and local income tax returns and tax filing positions, we determined that no unrecognized tax benefits for uncertain tax positions were required to be recorded. In addition, we do not believe that we have any tax positions for which it is reasonably possible that we will be required to record significant amounts of unrecognized tax benefits within the next twelve months.
Our major tax jurisdictions are U.S. Federal, New York State and New York City. The statute of limitations is open for all jurisdictions for tax years beginning 2012.
(o) Variable Interest Entities
We consolidate a VIE when we have both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE.   We are required to reconsider our evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE. (See Note 2(h).)        
(p)
Recent Accounting Pronouncements
Accounting Standards Adopted


14
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


In June 2015, the Financial Accounting Standard’s Board (or, FASB) issued guidance providing for technical corrections and improvements to existing accounting standards. The amendments in this update represent changes to clarify, correct unintended application of guidance, or make minor improvements to existing accounting standards that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. Transition guidance varies based on the amendments in this guidance. The amendments that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015.  The adoption of this accounting guidance during the three months ended March 31, 2016 did not have a material impact on our consolidated financial statements.
In April 2015, the FASB issued guidance on the presentation of debt issuance costs. This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This guidance became effective for fiscal years and interim periods beginning after December 15, 2015, and requires retrospective application. As of June 30, 2016 and December 31, 2015, we had $3 and $55 of net deferred financing costs. Under the new guidance these net deferred financing costs have been reclassified such that they reduce the carrying value of the associated borrowings on our consolidated balance sheets for the periods presented. In August 2015, the FASB expanded its April 2015 guidance associated with the presentation of debt issue costs, to address costs related to line-of-credit arrangements. In this update, the FASB noted that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowing on the line-of-credit arrangement. The adoption of this accounting guidance during the three months ended March 31, 2016 did not have a material impact on our consolidated financial statements.
Accounting Standards Issued but Not Yet Adopted
In May 2014, the FASB issued guidance to establish a comprehensive and converged standard on revenue recognition to enable financial statement users to better understand and consistently analyze an entity’s revenue across industries, transactions, and geographies. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The new guidance also specifies the accounting for certain costs to obtain or fulfill a contract with a customer. The new guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. Qualitative and quantitative information is required to be disclosed about: (1) contracts with customers, (2) significant judgments and changes in judgments, and (3) assets recognized from costs to obtain or fulfill a contract. The new guidance will apply to all entities. The guidance is effective for interim and annual reporting periods in fiscal years beginning after December 15, 2017. We are currently assessing the impact that this accounting guidance will have on our consolidated financial statements when adopted.
In August 2014, the FASB issued guidance regarding management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related financial statement note disclosures. The new guidance requires that management evaluate each annual and interim reporting period whether conditions exist that give rise to substantial doubt about the entity’s ability to continue as a going concern within one year from the financial statement issuance date, and if so, provide related disclosures. Disclosures are only required if conditions give rise to substantial doubt, whether or not the substantial doubt is alleviated by management’s plans. No disclosures are required specific to going concern uncertainties if an assessment of the conditions does not give rise to substantial doubt. Substantial doubt exists when conditions and events, considered in the aggregate, indicate that it is probable that a company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. If substantial doubt is alleviated as a result of the consideration of management’s plans, a company should disclose information that enables users of financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the financial statement notes): (1) principal conditions that initially give rise to substantial doubt, (2) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (3) management’s plans that alleviated substantial doubt. If substantial doubt is not alleviated after considering management’s plans, disclosures should enable investors to understand the underlying conditions, and include the following: (1) a statement indicating that there is substantial doubt about the company’s ability to continue as a going concern within one year after the issuance date, (2) the principal conditions that give rise to substantial doubt, (3) management’s evaluation of the significance of those conditions in relation to the company’s ability to meet its obligations, and (4) management’s plans that are intended to mitigate the adverse conditions. The new guidance applies to all companies. The guidance is effective for interim and annual reporting periods in fiscal years beginning


15
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


after December 15, 2016, with early adoption permitted. Based on our current financial condition, we do not expect this guidance will have a material impact on our consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities,” (“ASU 2016-01”), which significantly revises an entity’s accounting related to the classification and measurement of investments in equity securities and requires the presentation of certain fair value changes for financial liabilities measured at fair value. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. We are currently evaluating the potential impact that this accounting guidance will have on our consolidated financial statements when adopted.
In June 2016, the FASB issued ASU No.2016-13, “Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments” (“ASU No.2016-13”). The ASU replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of information such as relevant information about past events including historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount, for the purpose of informing credit loss estimates. The ASU requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The ASU also requires that credit losses on available-for-sale debt securities be presented as an allowance for credit losses rather than as a write-down, and limits the amount of the allowance for credit losses on available-for-sale to the amount by which fair value is below amortized cost. The ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and will be applied using a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. Early application is permitted as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently evaluating the potential impact that this accounting guidance will have on our consolidated financial statements when adopted.
(q)    Reclassifications
Certain prior period amounts have been reclassified to conform to the current presentation.
Note 3 – Fair Value of Financial Instruments
(a) General
We disclose the estimated fair value of our financial instruments according to a fair value hierarchy (Levels I, II, and III, as defined below). We are required to provide enhanced disclosures regarding instruments in the Level III category, including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities. GAAP provides a framework for measuring estimated fair value and for providing financial statement disclosure requirements for fair value measurements. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level I - Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level II - Fair values are determined using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing a security. These inputs may include quoted prices for similar securities, interest rates, prepayment speeds, credit risk and others.
Level III - Fair values are determined using significant unobservable inputs. In situations where quoted prices or observable inputs are unavailable (for example, when there is little or no market activity for an investment at the end of the period), unobservable inputs may be used.
The level in the fair value hierarchy, within which a fair measurement falls in its entirety, is based on the lowest level input that is significant to the fair value measurement. When available, we use quoted market prices to determine the estimated fair value of an asset or liability.
Fair value under GAAP represents an exit price in the normal course of business, not a forced liquidation price. If we were forced to sell assets in a short period to meet liquidity needs, the prices received for such assets could be substantially less than their recorded fair values. Furthermore, the analysis of whether it is more likely than not that we will be required to sell securities in an unrealized loss position prior to an expected recovery in value (if any), the amount of such expected required sales, and the projected identification of which securities would be sold are also subject to significant judgment, particularly in times of market illiquidity.


16
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


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


17
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(d) Fair Value Hierarchy
The following tables present our financial instruments carried at estimated fair value as of June 30, 2016 and December 31, 2015 based upon our consolidated balance sheet by the valuation hierarchy:
 
 
Estimated Fair Value at June 30, 2016
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$
—

 
$
1,397,947

 
$
1,080,501

 
$
2,478,448

Securitized mortgage loans (transferred to consolidated variable interest entities)
 
—

 
—

 
160,206

 
160,206

Other investment securities
 
—

 
100,716

 
59,680

 
160,396

Total
 
$
—

 
$
1,498,663

 
$
1,300,387

 
$
2,799,050

Liabilities:
 
 
 
 
 
 
 
 
Swaps/Swaptions
 
$
—

 
$
1,274

 
$
—

 
$
1,274

Non-recourse securitized debt
 
—

 
—

 
13,407

 
13,407

Short TBA Contracts
 
—

 
7,268

 
—

 
7,268

Total
 
$
—

 
$
8,542

 
$
13,407

 
$
21,949

 
 
Estimated Fair Value at December 31, 2015
 
 
Level I
 
Level II
 
Level III
 
Total
Assets:
 
 
 
 
 
 
 
 
RMBS
 
$
—

 
$
1,864,356

 
$
1,197,226

 
$
3,061,582

Securitized mortgage loans (transferred to consolidated variable interest entities)
 
—

 
—

 
167,624

 
167,624

Other investment securities
 
—

 
98,656

 
67,534

 
166,190

Swaps/Swaptions
 
—

 
4,347

 
—

 
4,347

Total
 
$
—

 
$
1,967,359

 
$
1,432,384

 
$
3,399,743

Liabilities:
 
 
 
 
 
 
 
 
Swaps
 
$
—

 
$
13,618

 
$
—

 
$
13,618

Non-recourse securitized debt
 
—

 
—

 
18,951

 
18,951

Long TBA Contracts
 
—

 
195

 
—

 
195

Total
 
$
—

 
$
13,813

 
$
18,951

 
$
32,764

(e) Level III Fair Value Measurement Disclosures
Our non-Agency RMBS, other investment securities, securitized mortgage loans and securitized debt are measured at fair value and are considered to be Level III measurements of fair value.
The following table presents a summary of changes in the fair value of our non-Agency RMBS for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Beginning balance
 
$
1,126,720

 
$
1,374,966

 
$
1,197,226

 
$
1,468,109

Purchases
 
—

 
96,312

 
50,656

 
183,838

Sales
 
—

 
(29,056
)
 
(66,077
)
 
(172,931
)
Principal repayments
 
(56,000
)
 
(66,129
)
 
(112,621
)
 
(119,384
)
Total net gains/(losses) included in net income:
 
 
 
 
 
 
 
 
         Realized gains/(losses), net
 
—

 
(254
)
 
1,134

 
3,823

         Unrealized gains/(losses), net
 
1,327

 
(11,634
)
 
(8,590
)
 
(10,750
)
OTTI recognized
 
(1,395
)
 
(88
)
 
(1,850
)
 
(1,879
)
Discount accretion
 
9,849

 
14,148

 
20,623

 
27,439

Ending balance
 
$
1,080,501

 
$
1,378,265

 
$
1,080,501

 
$
1,378,265

 


18
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table presents a summary of the changes in the fair value of our securitized mortgage loan pools associated with our securitizations for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Beginning balance
 
$
159,301

 
$
183,328

 
$
167,624

 
$
104,438

Mortgage loans securitized
 
—

 
—

 
—

 
81,093

Principal repayments
 
(4,447
)
 
(1,816
)
 
(8,823
)
 
(5,512
)
Discount accretion and other adjustments
 
236

 
(126
)
 
471

 
(756
)
Unrealized gain/(loss) during the period, net
 
5,751

 
(1,866
)
 
1,992

 
702

Loans transferred to REO
 
(635
)
 
(616
)
 
(1,058
)
 
(1,061
)
Ending balance
 
$
160,206


$
178,904

 
$
160,206

 
$
178,904


The following table presents a summary of the changes in fair value of our Level III other investment securities for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Beginning balance
 
$
60,887

 
$
39,916

 
$
67,534

 
$
23,833

Purchases
 
—

 
22,086

 
—

 
39,601

Sales
 
—

 
—

 
(2,900
)
 
—

Principal repayments
 
(3,087
)
 
(3,046
)
 
(6,412
)
 
(4,552
)
Total net gains/(losses) included in net income:
 
 
 
 
 
 
 
 
         Realized (losses), net
 
—

 
—

 
(26
)
 
—

         Unrealized gains/(losses), net
 
1,328

 
(591
)
 
416

 
(808
)
OTTI recognized
 
—

 
—

 
(116
)
 
—

Discount accretion
 
552

 
525

 
1,184

 
816

Ending balance
 
$
59,680

 
$
58,890

 
$
59,680

 
$
58,890


The following table presents a summary of the changes in fair value of our securitized debt for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Beginning balance
 
$
16,531

 
$
30,306

 
$
18,951

 
$
34,176

Principal paid
 
(3,104
)
 
(3,412
)
 
(5,522
)
 
(7,270
)
Unrealized losses, net
 
(20
)
 
(1,001
)
 
(22
)
 
(1,013
)
Ending balance
 
$
13,407

 
$
25,893

 
$
13,407

 
$
25,893



19
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(f) Financial Instruments Not Carried at Fair Value
The following table presents the carrying value and estimated fair value of our financial instruments that are not carried at fair value on our consolidated balance sheet, at June 30, 2016 and December 31, 2015: 
 
 
June 30, 2016
 
December 31, 2015
 
 
Carrying Value
 
Estimated  Fair
Value
 
Carrying Value
 
Estimated  Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
Investment related receivable (1)
 
$
6,071

 
$
6,071

 
$
2,692

 
$
2,692

Warehouse line receivable (2) (3)
 
$
3,919

 
$
3,919

 
$
10,239

 
$
10,239

Mortgage loans  and real estate subject to BFT Contracts under Seller Financing Program (3)
 
$
41,805

 
$
41,805

 
$
34,994

 
$
34,994

Financial liabilities:
 
 
 
 
 
 
 
 
Repurchase agreements
 
$
2,269,850

 
$
2,269,821

 
$
2,898,347

 
$
2,898,347

Investment related payable (1)
 
$
1,256

 
$
1,256

 
$
—

 
$
—

(1) 
Carrying value approximates fair value due to the short-term nature of the item.
(2) 
Carrying value approximates fair value as such investment has a variable interest rate and there has been no material change in the credit-worthiness of the borrower.
(3) 
Carrying value approximates fair value based on the assessment that there has been no material change in value or impairment of the associated real estate.
To determine the estimated fair value of our borrowings under repurchase agreements, contractual cash flows from such borrowings are discounted at estimated market interest rates, which rates may be based upon actual transactions executed by us or indicative rates quoted by brokers. The estimated fair values are not necessarily indicative of the amount we would realize on disposition of the financial instruments. Our borrowings under repurchase agreements had a weighted average remaining term to maturity of 38 and 51 days at June 30, 2016 and December 31, 2015, respectively. Adjustments to valuations may be made as deemed appropriate to capture market information at the valuation date. Inputs used to arrive at the fair value of our repurchase agreement borrowings are generally observable and therefore the fair value of our repurchase agreement borrowings are classified as Level II valuations in the fair value hierarchy.



20
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 4 – Residential Mortgage-Backed Securities
(a) RMBS
The following tables present certain information about our RMBS portfolio at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
 
Principal
Balance
 
Premium/
(Discount)and OTTI, Net (1)
 
Amortized
Cost (2) 
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Weighted Average Coupon
Agency pass-through RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
232,315

 
$
16,439

 
$
248,754

 
$
243,929

 
$
—

 
$
(4,825
)
 
2.64
%
3.5% coupon
 
505,139

 
23,735

 
528,874

 
537,330

 
8,456

 
—

 
3.50
%
4.0% coupon
 
531,924

 
33,759

 
565,683

 
575,218

 
9,552

 
(17
)
 
4.00
%
 
 
1,269,378

 
73,933

 
1,343,311

 
1,356,477

 
18,008

 
(4,842
)
 
3.55
%
Agency IO (2) 
 
—

 
—

 
49,763

 
41,470

 
—

 
(8,293
)
 
2.31
%
Total Agency securities
 
1,269,378

 
73,933

 
1,393,074

 
1,397,947

 
18,008

 
(13,135
)
 
4.49
%
Non-Agency RMBS
 
1,268,284

 
(209,621
)
 
1,058,663

 
1,080,501

 
43,122

 
(21,284
)
 
1.68
%
Total RMBS
 
$
2,537,662

 
$
(135,688
)
 
$
2,451,737

 
$
2,478,448

 
$
61,130

 
$
(34,419
)
 
3.09
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
Principal
Balance
 
Premium/
(Discount)and OTTI, Net (1)
 
Amortized
Cost (2) 
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
 
Weighted Average Coupon
Agency pass-through RMBS - 30-Year Mortgages:
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
272,533

 
$
19,247

 
$
291,780

 
$
289,057

 
$
—

 
$
(2,723
)
 
2.51
%
3.5% coupon
 
511,184

 
24,295

 
535,479

 
527,657

 
—

 
(7,822
)
 
3.50
%
4.0% coupon
 
925,929

 
61,523

 
987,452

 
983,536

 
1,307

 
(5,223
)
 
4.00
%
 
 
1,709,646

 
105,065

 
1,814,711

 
1,800,250

 
1,307

 
(15,768
)
 
3.61
%
Agency IO (2)
 
—

 
—

 
57,778

 
57,354

 
1,175

 
(1,599
)
 
2.33
%
Agency Inverse IO (2)
 
—

 
—

 
6,864

 
6,752

 
—

 
(112
)
 
6.62
%
Total Agency securities
 
1,709,646

 
105,065

 
1,879,353

 
1,864,356

 
2,482

 
(17,479
)
 
4.53
%
Non-Agency RMBS
 
1,395,873

 
(229,075
)
 
1,166,798

 
1,197,226

 
47,857

 
(17,429
)
 
1.67
%
Total RMBS
 
$
3,105,519

 
$
(124,010
)
 
$
3,046,151

 
$
3,061,582

 
$
50,339

 
$
(34,908
)
 
3.24
%
(1) 
A portion of the purchase discount on non-Agency RMBS is not expected to be recognized as interest income, and is instead viewed as a credit discount. See Notes 4(e) and 4(h).
(2) 
At June 30, 2016 and December 31, 2015, our Agency IO had a notional balance of $515,081 and $564,931, respectively, and our Agency Inverse IO had a notional balance of $38,529 as December 31, 2015.


21
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(b) Agency Pass-through RMBS
The following tables present certain information about our Agency pass-through RMBS by issuer at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
Fannie Mae:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
218,650

 
$
15,508

 
$
234,158

 
$
229,551

 
$
—

 
$
(4,607
)
3.5% Coupon
 
91,388

 
3,907

 
95,295

 
97,111

 
1,816

 
—

4.0% Coupon
 
279,477

 
17,960

 
297,437

 
302,013

 
4,593

 
(17
)
 
 
589,515

 
37,375

 
626,890

 
628,675

 
6,409

 
(4,624
)
Freddie Mac:
 
 
 


 
 
 
 
 
 
 
 
ARMs
 
13,665

 
931

 
14,596

 
14,378

 
—

 
(218
)
3.5% Coupon
 
413,751

 
19,828

 
433,579

 
440,219

 
6,640

 
—

4.0% Coupon
 
252,447

 
15,799

 
268,246

 
273,205

 
4,959

 
—

 
 
679,863

 
36,558

 
716,421

 
727,802

 
11,599

 
(218
)
Total Agency pass-through RMBS
 
$
1,269,378

 
$
73,933

 
$
1,343,311

 
$
1,356,477

 
$
18,008

 
$
(4,842
)
 
 
December 31, 2015
 
 
Principal
Balance
 
Unamortized Premium/
(Discount), Net
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
Fannie Mae:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
$
256,983

 
$
18,188

 
$
275,171

 
$
272,631

 
$
—

 
$
(2,540
)
3.5% Coupon
 
90,310

 
4,123

 
94,433

 
93,429

 
—

 
(1,004
)
4.0% Coupon
 
343,887

 
22,519

 
366,406

 
365,238

 
373

 
(1,541
)
 
 
691,180

 
44,830

 
736,010

 
731,298

 
373

 
(5,085
)
Freddie Mac:
 
 
 
 
 
 
 
 
 
 
 
 
ARMs
 
15,550

 
1,059

 
16,609

 
16,426

 
—

 
(183
)
3.5% Coupon
 
420,874

 
20,172

 
441,046

 
434,228

 
—

 
(6,818
)
4.0% Coupon
 
582,042

 
39,004

 
621,046

 
618,298

 
934

 
(3,682
)
 
 
1,018,466

 
60,235

 
1,078,701

 
1,068,952

 
934

 
(10,683
)
Total Agency pass-through RMBS
 
$
1,709,646

 
$
105,065

 
$
1,814,711

 
$
1,800,250

 
$
1,307

 
$
(15,768
)


22
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(c) Non-Agency RMBS
The following tables present certain information about our non-Agency RMBS by type of underlying mortgage loan collateral type at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
Underlying Loan Characteristics:
 
Principal
Balance
 
Unamortized Premium/
(Discount) and OTTI, Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
Subprime
 
$
812,460

 
$
(106,424
)
 
$
706,036

 
$
726,212

 
$
29,845

 
$
(9,669
)
Alt-A
 
178,810

 
(43,995
)
 
134,815

 
141,602

 
9,304

 
(2,517
)
Option ARMs
 
277,014

 
(59,202
)
 
217,812

 
212,687

 
3,973

 
(9,098
)
Total Non-Agency RMBS
 
$
1,268,284

 
$
(209,621
)
 
$
1,058,663

 
$
1,080,501

 
$
43,122

 
$
(21,284
)
 
 
December 31, 2015
Underlying Loan Characteristics:
 
Principal
Balance
 
Unamortized Premium/
(Discount) and OTTI, Net 
 
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
(Losses)
Subprime
 
$
939,161

 
$
(124,776
)
 
$
814,385

 
$
838,128

 
$
33,503

 
$
(9,760
)
Alt-A
 
184,932

 
(45,194
)
 
139,738

 
147,709

 
10,330

 
(2,359
)
Option ARMs
 
271,780

 
(59,105
)
 
212,675

 
211,389

 
4,024

 
(5,310
)
Total Non-Agency RMBS
 
$
1,395,873

 
$
(229,075
)
 
$
1,166,798

 
$
1,197,226

 
$
47,857

 
$
(17,429
)
(d) Unrealized Loss Positions on RMBS
The following table presents information about our RMBS that were in an unrealized loss position at June 30, 2016:
 
 
Unrealized Loss Position for Less than
12 Months
 
Unrealized Loss Position for 12
Months or More
 
 
Fair Value
 
Unrealized
(Losses)
 
Number
of
Securities
 
Fair Value
 
Unrealized
(Losses)
 
Number
of
Securities
Agency RMBS
 
$
50,738

 
$
(664
)
 
6
 
$
205,904

 
$
(4,178
)
 
7
Agency IO
 
29,237

 
(4,854
)
 
10
 
12,233

 
(3,439
)
 
6
Total Agency Securities
 
79,975

 
(5,518
)
 
16
 
218,137

 
(7,617
)
 
13
Non-Agency RMBS
 
266,565

 
(10,094
)
 
58
 
271,339

 
(11,190
)
 
72
Total
 
$
346,540

 
$
(15,612
)
 
74
 
$
489,476

 
$
(18,807
)
 
85


23
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(e) Interest Income on RMBS
The following tables present components of interest income on our Agency RMBS and non-Agency RMBS for the periods presented:
 
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
Agency RMBS
 
$
15,502

 
$
(5,439
)
 
$
10,063

 
$
32,457

 
$
(10,172
)
 
$
22,285

Non-Agency RMBS
 
5,391

 
9,849

 
15,240

 
10,972

 
20,623

 
31,595

Total
 
$
20,893

 
$
4,410

 
$
25,303

 
$
43,429

 
$
10,451

 
$
53,880

 
 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
Agency RMBS
 
$
21,500

 
$
(5,670
)
 
$
15,830

 
$
44,039

 
$
(11,688
)
 
$
32,351

Non-Agency RMBS
 
5,840

 
14,148

 
19,988

 
11,642

 
27,439

 
39,081

Total
 
$
27,340

 
$
8,478

 
$
35,818

 
$
55,681

 
$
15,751

 
$
71,432

(f) Realized and Unrealized Gains and Losses and OTTI on RMBS
The following tables present components of net realized gains/(losses), changes in net unrealized gains/(losses) and OTTI recognized on our RMBS for the periods presented:
 
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
RMBS Type
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairments
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
(Other-Than-Temporary-Impairments)
Agency fixed rate
 
$
486

 
$
9,688

 
$
—

 
$
(140
)
 
$
29,729

 
$
—

Agency adjustable rate
 
(213
)
 
(669
)
 
—

 
(263
)
 
(2,101
)
 
—

Agency Inverse
 
—

 
—

 
—

 
—

 
—

 
—

Agency IO
 
—

 
(2,745
)
 
(3,402
)
 
—

 
(7,869
)
 
(3,527
)
Agency Inverse IO
 
—

 
—

 
—

 
(136
)
 
112

 
—

Non-Agency RMBS
 
—

 
1,325

 
(1,396
)
 
1,134

 
(8,591
)
 
(1,850
)
Total
 
$
273

 
$
7,599

 
$
(4,798
)
 
$
595

 
$
11,280

 
$
(5,377
)
 
 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
RMBS Type
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
Other-Than-Temporary-Impairment
 
Net Realized
Gains/(Losses)
 
Net Unrealized
Gains/(Losses)
 
(Other-Than-Temporary-Impairment)
Agency fixed rate
 
$
(4,351
)
 
$
(30,137
)
 
$
—

 
$
(57
)
 
$
(16,560
)
 
$
—

Agency Inverse
 
—

 
(613
)
 
—

 
43

 
(758
)
 
—

Agency IO
 
(15
)
 
1,458

 
—

 
(127
)
 
1,839

 
(173
)
Agency Inverse IO
 
74

 
199

 
—

 
311

 
568

 
(612
)
Agency adjustable rate
 
16

 
(539
)
 
—

 
15

 
(825
)
 
—

Non-Agency RMBS
 
(254
)
 
(11,634
)
 
(88
)
 
3,823

 
(10,750
)
 
(1,878
)
Total
 
$
(4,530
)
 
$
(41,266
)
 
$
(88
)
 
$
4,008

 
$
(26,486
)
 
$
(2,663
)


24
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(g) Contractual Maturities of RMBS
The following table presents the maturities of our RMBS, based on the contractual maturities of the underlying mortgages at June 30, 2016 and December 31, 2015:
Contractual Maturities of RMBS (1)
 
June 30, 2016
 
December 31, 2015
10 years or less
 
$
65,932

 
$
112,087

> 10 years and < or equal to 20 years
 
674,939

 
667,595

> 20 years and < or equal to 30 years
 
1,626,790

 
2,155,087

> 30 years
 
110,787

 
126,813

Total
 
$
2,478,448

 
$
3,061,582

(1) 
Actual maturities of the securities are affected by the contractual lives of the associated mortgage collateral, periodic payments of principal, prepayments of principal, and the payment priority structure of the security; therefore actual maturities are generally shorter than the stated contractual maturities of the underlying or referenced mortgages.
(h) Non-Agency RMBS Discounts and OTTI
The following tables present the changes in the components of our purchase discount on non-Agency RMBS between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented:
 
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
 
 
Discount
Designated as
Credit Reserve
and OTTI (1)
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI (1)
 
Accretable Discount
Balance at beginning of period
 
$
(81,354
)
 
$
(137,828
)
 
$
(81,217
)
 
$
(147,989
)
Accretion of discount
 
—

 
9,828

 
—

 
20,574

Realized credit losses
 
949

 
—

 
1,682

 
—

Purchases
 
—

 
—

 
(2,726
)
 
(6,305
)
Sales and other
 
2

 
(2
)
 
343

 
7,687

OTTI recognized in earnings
 
(1,365
)
 
—

 
(1,819
)
 
—

Transfers/release of credit reserve
 
2,081

 
(2,081
)
 
4,050

 
(4,050
)
Balance at end of period
 
$
(79,687
)
 
$
(130,083
)
 
$
(79,687
)
 
$
(130,083
)
(1) 
At June 30, 2016, our non-Agency RMBS had gross discounts of $209,770, which included credit discounts of $64,290 and OTTI of $15,397.
The following table presents a roll-forward of the credit loss component of OTTI on our Agency IO and Inverse IO securities for the periods presented:
 
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
OTTI at beginning of period
 
$
1,048

 
$
1,008

Additions to OTTI
 
3,403

 
3,527

Sale of securities with OTTI
 
—

 
(84
)
OTTI at end of period
 
$
4,451

 
$
4,451

Note 5 – Securitized Mortgage Loans
In connection with our securitization transactions, we consolidate the associated securitization trusts. As such, we report on our consolidated balance sheet the residential mortgage loans held by the securitization trusts. (See Note 14.)


25
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table presents a summary of the changes in the carrying value of our securitized mortgage loans for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Beginning balance
 
$
159,301

 
$
183,328

 
$
167,624

 
$
104,438

Securitization of March 2015 Pool
 
—

 
—

 
—

 
81,093

Principal repayments
 
(4,447
)
 
(1,816
)
 
(8,823
)
 
(5,512
)
Discount accretion and other adjustments
 
236

 
(126
)
 
471

 
(756
)
Unrealized gain/(loss) during the period, net
 
5,751

 
(1,866
)
 
1,992

 
702

Loans transferred to REO
 
(635
)
 
(616
)
 
(1,058
)
 
(1,061
)
Ending balance
 
$
160,206

 
$
178,904

 
$
160,206

 
$
178,904


The following table presents certain information about mortgage loans underlying our securitized mortgage loans at June 30, 2016:
Securitized Mortgage Loans
 
June 30, 2016
Performing (1)
 
$
65,194

Re-performing (1)
 
106,828

Non-performing (1)
 
28,118

Purchase discount
 
(46,121
)
Allowance for loan losses (OTTI)
 
(2,699
)
Fair value adjustment
 
8,886

Total
 
$
160,206

(1) 
We consider loans that are no more than 60 days delinquent as “performing,” loans that have had their initial terms modified and are no more than 60 days delinquent as “re-performing” and loans that are more than 60 days past due as “non-performing.”
At June 30, 2016, $5,737 of our securitized mortgage loans were in the process of foreclosure and we held five properties with an estimated fair value of $713 as REO. The following table presents the five largest state concentrations, in the aggregate, for our securitized mortgage loans based on principal balance at June 30, 2016:
Property Location
 
Principal Balance
 
Total Concentration
Florida
 
$
35,635

 
17.8
%
California
 
35,355

 
17.7

Maryland
 
16,287

 
8.1

Texas
 
12,370

 
6.2

New Jersey
 
10,898

 
5.4

Other states and the District of Columbia
 
89,594

 
44.8

Total
 
$
200,139

 
100.0
%



26
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 6 – Other Investment Securities and Other Investments
(a) Other Investment Securities
The following table presents certain information about our other investment securities portfolio at June 30, 2016 and December 31, 2015:
 
 
Par or Reference Balance
 
Unamortized Premium/
(Discount) and OTTI, Net
 
Amortized Cost (1)
 
Estimated Fair Value
 
Gross Unrealized Gain
 
Gross Unrealized Losses
 
Weighted Average Coupon
 
 
June 30, 2016
Risk Sharing Securities - Freddie Mac
 
$
47,174

 
$
(220
)
 
$
46,954

 
$
46,900

 
$
124

 
$
(178
)
 
3.97
%
Risk Sharing Securities - Fannie Mae
 
55,287

 
(1,240
)
 
54,047

 
$
53,816

 
308

 
(539
)
 
4.02

SBC-MBS
 
69,863

 
(7,750
)
 
62,113

 
$
59,680

 
92

 
(2,525
)
 
0.97

Total
 
$
172,324

 
$
(9,210
)
 
$
163,114

 
$
160,396

 
$
524

 
$
(3,242
)
 
2.77
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2015
Risk Sharing Securities - Freddie Mac
 
$
48,526

 
$
(212
)
 
$
48,314

 
$
47,232

 
$
189

 
$
(1,271
)
 
3.92
%
Risk Sharing Securities - Fannie Mae
 
55,287

 
(1,659
)
 
53,628

 
51,424

 
—

 
(2,204
)
 
3.99

SBC-MBS
 
76,276

 
(8,811
)
 
67,465

 
64,607

 
10

 
(2,868
)
 
2.40

SBA-IO (2)
 
—

 
—

 
2,918

 
2,927

 
9

 
—

 
0.95

Total
 
$
180,089

 
$
(10,682
)
 
$
172,325

 
$
166,190

 
$
208

 
$
(6,343
)
 
2.63
%
(1) 
Amortized cost is reduced by unrealized losses that are classified as OTTI, which was $1,853 and $1,523 at June 30, 2016 and December 31, 2015, respectively.
(2) 
SBA-IO have no principal balance and bear interest based on a notional balance. At December 31, 2015 our SBA-IO had a notional balance of $27,546; we held no investments in SBA-IO at June 30, 2016.
(b) Income on Other Investment Securities
The following tables present components of interest income on our other investment securities for the periods presented:
 
 
Three Months Ended June 30, 2016
 
Six Months Ended June 30, 2016
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Weighted Average Yield
Risk Sharing Securities - Freddie Mac
 
$
476

 
$
83

 
$
559

 
4.70
%
 
$
959

 
$
204

 
$
1,163

 
4.85
%
Risk Sharing Securities - Fannie Mae
 
561

 
218

 
779

 
5.73

 
1,120

 
419

 
1,539

 
5.72

SBC-MBS
 
167

 
552

 
719

 
4.52

 
347

 
1,177

 
1,524

 
4.68

SBA-IO
 
—

 
—

 
—

 
—

 
42

 
8

 
50

 
6.99

Total
 
$
1,204

 
$
853

 
$
2,057

 
4.98
%
 
$
2,468

 
$
1,808

 
$
4,276

 
5.04
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2015
 
Six Months Ended June 30, 2015
 
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, net
 
Interest
Income
 
Weighted Average Yield
 
Coupon
Interest
 
(Premium
Amortization)/
Discount
Accretion, Net
 
Interest
Income
 
Weighted Average Yield
Risk Sharing Securities - Freddie Mac
 
$
376

 
$
118

 
$
494

 
3.36
%
 
$
537

 
$
140

 
$
677

 
3.45
%
Risk Sharing Securities - Fannie Mae
 
239

 
78

 
317

 
4.61

 
287

 
89

 
376

 
3.54

SBC-MBS
 
93

 
490

 
583

 
5.09

 
161

 
781

 
942

 
5.05

Total
 
$
708

 
$
686

 
$
1,394

 
4.37
%
 
$
985

 
$
1,010

 
$
1,995

 
4.22
%


27
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(c) Other Investment Securities – Discounts and OTTI
The following table presents the changes in the components of our purchase discount on other investment securities between purchase discount designated as credit reserve and OTTI versus accretable purchase discount for the periods presented.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2016
 
 
Discount
Designated as
Credit Reserve
and OTTI
 
Accretable Discount
 
Discount
Designated as
Credit Reserve
and OTTI
 
Accretable Discount
Balance at beginning of period
 
$
(1,113
)
 
$
(9,092
)
 
$
(672
)
 
$
(10,332
)
Accretion of discount
 
—

 
856

 
—

 
1,771

Purchases
 
—

 
—

 
—

 
—

OTTI recognized
 
(182
)
 
—

 
(298
)
 
—

Transfers/release of credit reserve
 
814

 
(814
)
 
489

 
(489
)
Balance at end of period
 
$
(481
)
 
$
(9,050
)
 
$
(481
)
 
$
(9,050
)
Our SBC-MBS generally include mortgage loans collateralized by a mix of residential multi-family (i.e., properties with five or more units), mixed use residential/commercial, small retail, office building, warehouse and other types of property. In some instances, certain mortgage loans underlying the SBC-MBS that we own may also be additionally secured by a personal guarantee from the primary principal(s) of the related business and/or borrowing entity. As part of underwriting small balance commercial loans, real estate appraisals of the underlying real estate are generally obtained at origination of the mortgage assets underlying the SBC-MBS.
(d) Other Investment Securities Unrealized Losses
The following table presents information about our Other Investment Securities that were in an unrealized loss position at June 30, 2016:
 
 
Unrealized Loss Position for Less than
12 Months
 
Unrealized Loss Position for 12
Months or More
 
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair Value
 
Unrealized
Losses
 
Number
of
Securities
Risk Sharing Securities - Freddie Mac
 
$
12,576

 
$
(113
)
 
2

 
$
7,019

 
$
(65
)
 
4

Risk Sharing Securities - Fannie Mae
 
7,887

 
(25
)
 
2

 
21,936

 
(514
)
 
1

SBC-MBS
 
9,670

 
(157
)
 
3

 
44,722

 
(2,368
)
 
4

Total Other Investment Securities
 
$
30,133

 
$
(295
)
 
7

 
$
73,677

 
$
(2,947
)
 
9

(e) Other Investments
Our other investments are comprised of our warehouse line, real estate subject to BFT Contracts, and mortgage loans, all of which are associated with our Seller Financing Program.
BFT Contracts are agreements to finance the purchase of real property in which the seller provides the buyer with financing to purchase the property for an agreed-upon purchase price, and the buyer repays the loan in installments over the ensuing 20 to 30 years, depending on the term of the financing agreement. Pursuant to a BFT Contract, unlike a mortgage loan, the seller retains the legal title to the property, granting the buyer complete use of the property and requiring the buyer to maintain the property and bear the cost of property taxes. Pursuant to a BFT Contract, the seller generally conveys legal title of the property to the buyer when the full purchase price set forth in the contract has been paid, including all interest incurred through the date of final payment. All BFT Contracts purchased by us through June 30, 2016 are designated as “real estate subject to BFT Contracts” which properties, excluding land, are depreciated until such time that the criteria for sale have been met. With respect to payments we receive under BFT Contracts, we record the principal component of the buyer’s monthly payment as a deposit liability and record the interest payments we receive as interest income. In connection with our Seller Financing Program we had $292 and $230 of deposit liabilities included as a component of other liabilities on our consolidated balance sheet at June 30, 2016 and December 31, 2015, respectively.
Our warehouse line receivable is secured by a pledge of substantially all the assets of the third-party borrower that owns the homes, BFT Contracts and mortgage loans during the time they are pledged on the warehouse line.


28
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table presents components of the carrying value of our other investments at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
Warehouse line receivable
 
$
3,919

 
$
10,239

Real estate subject to BFT Contracts, net of accumulated depreciation (1)
 
31,045

 
26,525

Mortgage loans purchased through Seller Financing Program
 
10,760

 
8,469

Total
 
$
45,724

 
$
45,233

(1) 
At June 30, 2016, BFT Contracts had an aggregate principal balance of $31,986 with a weighted average contractual interest rate of 8.17% and BFT Contracts at December 31, 2015 had an aggregate principal balance of $27,140 with a weighted average stated interest rate of 8.20%. Amount is presented net of $941 and $545 of accumulated depreciation at June 30, 2016 and December 31, 2015, respectively.
(f) Income on Other Investments
The following table presents components of income on our other investments for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 31,
 
 
2016
 
2015
 
2016
 
2015
Warehouse line interest
 
$
76

 
$
303

 
$
190

 
$
680

Real estate subject to BFT Contracts
 
946

 
367

 
1,439

 
644

Mortgage loans purchased through Seller Financing Program
 
4

 
114

 
197

 
189

Total
 
$
1,026

 
$
784

 
$
1,826

 
$
1,513

Note 7 – Receivables
(a) Interest Receivable
The following table presents our interest receivable by investment category at June 30, 2016 and December 31, 2015:
Investment Category
 
June 30, 2016
 
December 31, 2015
Agency RMBS - Fannie Mae (1)
 
$
2,333

 
$
2,697

Agency RMBS - Freddie Mac (1)
 
2,601

 
3,834

Agency RMBS - Ginnie Mae (1)
 
86

 
110

Non-Agency RMBS
 
1,146

 
1,076

Securitized mortgage loans
 
947

 
936

Other investment securities
 
341

 
262

Other investments
 
611

 
934

Total
 
$
8,065

 
$
9,849

(1) 
Includes interest income receivable on pass-through, IO, Inverse IO and Inverse Floater securities issued by an Agency, as applicable.
(b) Investment Related Receivables
Investment related receivables at June 30, 2016 and December 31, 2015 were comprised of principal payments on our investment securities that are due from brokers.
Note 8 – Borrowings Under Repurchase Agreements
As of June 30, 2016, we had master repurchase agreements with 24 counterparties and had outstanding borrowings of $2,269,853 with 16 counterparties.
Our repurchase agreements bear interest at a contractually agreed-upon rate and typically have initial terms up to one to three months, but in some cases may have initial terms that are shorter or longer, up to 24 months.


29
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table presents certain characteristics of our repurchase agreements for the periods presented:
 
 
June 30, 2016
 
December 31, 2015
 
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
 
Repurchase Agreement Borrowings
 
Weighted Average Borrowing Rate
 
Weighted Average Remaining Maturity (days)
Securities Financed:
 
 
 
 
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,253,520

 
0.67
%
 
19
 
$
1,719,479

 
0.49
%
 
15
Non-Agency RMBS (1)
 
901,219

 
2.12

 
59
 
1,052,231

 
1.94

 
101
Other investment securities
 
115,114

 
2.14

 
81
 
126,637

 
1.91

 
116
Total
 
$
2,269,853

 
1.32
%
 
38
 
$
2,898,347

 
1.08
%
 
51
(1) 
Includes $82,814 and $90,281 of repurchase borrowings collateralized by non-Agency RMBS of $118,443 and $125,125 at June 30, 2016 and December 31, 2015, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with securitization transactions. Amounts presented do not reflect associated deferred financing costs.
The following table presents repricing information about our borrowings under repurchase agreements at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
Time Until Interest Rate Reset:
 
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
Within 30 days
 
$
1,942,822

 
1.29
%
 
$
2,422,224

 
1.00
%
Over 30 days to 60 days
 
319,918

 
1.49

 
403,226

 
1.38

Over 60 days to 90 days
 
—

 
—

 
32,552

 
2.05

Over 90 days to 120 days
 
—

 
—

 
38,956

 
1.89

Over 120 days to 360 days
 
7,113

 
2.45

 
1,389

 
2.00

Total
 
$
2,269,853

 
1.32
%
 
$
2,898,347

 
1.08
%
     
The following table presents the contractual maturity of our repurchase agreements at June 30, 2016 and December 31, 2015:
 
June 30, 2016
 
December 31, 2015
Time Until Contractual Maturity:
Balance
 
Weighted Average Interest Rate
 
Balance
 
Weighted Average Interest Rate
Within 30 days
$
1,624,594

 
1.08
%
 
$
2,165,418

 
0.88
%
Over 30 days to 60 days
319,918

 
1.49

 
288,487

 
0.88

Over 60 days to 90 days
50,201

 
2.95

 
90,220

 
2.61

Over 90 days to 120 days
—

 
—

 
38,956

 
1.89

Over 120 days to 360 days
275,140

 
2.21

 
315,266

 
2.06

Total
$
2,269,853

 
1.32
%
 
$
2,898,347

 
1.08
%



30
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 9 – Collateral Positions
(a) Collateral Pledged and Collateral Held
The following table presents the fair value of our collateral positions, reflecting assets pledged and collateral we held, with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
 
 
Assets Pledged as Collateral
 
Collateral Held
 
Assets Pledged as Collateral
 
Collateral Held
Derivatives:
 
 
 
 
 
 
 
 
Restricted cash/cash (1)
 
$
9,605

 
$
—

 
$
21,921

 
$
280

Repurchase agreement borrowings:
 
 
 
 
 
 
 
 
Agency RMBS
 
1,312,753

 
—

 
1,769,351

 
—

Non-Agency RMBS (2)
 
1,171,200

 
—

 
1,333,337

 
—

Other investment securities
 
155,904

 
—

 
163,263

 
—

Mortgage loans
 
—

 
 
 
—

 
 
Restricted cash
 
14,658

 
—

 
61,772

 
—

 
 
2,654,515

 
—

 
3,327,723

 
—

Clearing margin:
 
 
 
 
 
 
 
 
Agency RMBS
 
3,383

 
—

 
3,522

 
—

Total
 
$
2,667,503

 
$
—

 
$
3,353,166

 
$
280

(1) 
Cash pledged as collateral is reported as “Restricted cash” on our consolidated balance sheet. Cash held by us as collateral is unrestricted in use and therefore is included with “Cash and cash equivalents” with a corresponding liability, “Obligation to return cash held as collateral” on our consolidated balance sheet.
(2) 
Includes non-Agency RMBS of $118,443 and $125,125 at June 30, 2016 and December 31, 2015, respectively, that were eliminated from our balance sheet in consolidation with the VIEs associated with our securitizations. Our securitized mortgage loans collateralize the securities we have pledged as collateral.
(b) Collateral Pledged Components
The following tables present our collateral positions, reflecting assets pledged with respect to our borrowings under repurchase agreements, derivatives and clearing margin account at June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
 
Assets Pledged at
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,312,753

 
$
1,306,153

 
$
3,664

 
$
1,316,417

 Non-Agency RMBS (1)
 
1,171,200

 
1,156,816

 
1,718

 
1,172,918

Other investment securities
 
155,904

 
158,542

 
338

 
156,242

Cash
 
14,658

 
—

 
—

 
14,658

 
 
2,654,515

 
2,621,511

 
5,720

 
2,660,235

Cash pledged for derivatives contracts
 
9,605

 
—

 
—

 
9,605

Agency RMBS pledged for clearing margin
 
3,383

 
3,280

 
10

 
3,393

Total
 
$
2,667,503

 
$
2,624,791

 
$
5,730

 
$
2,673,233



31
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


 
 
December 31, 2015
 
 
Assets Pledged-
Fair Value
 
Amortized
Cost
 
Accrued
Interest
 
Fair Value of Assets Pledged and Accrued Interest
Assets pledged for borrowings under repurchase agreements:
 
 
 
 
 
 
 
 
Agency RMBS
 
$
1,769,351

 
$
1,784,557

 
$
5,081

 
$
1,774,432

Non-Agency RMBS (2)
 
1,333,337

 
1,301,167

 
1,479

 
1,334,816

Other investment securities
 
163,263

 
169,409

 
251

 
163,514

Cash
 
61,772

 
—

 
—

 
61,772

 
 
3,327,723

 
3,255,133

 
6,811

 
3,334,534

Cash pledged for derivative contracts
 
21,921

 
—

 
—

 
21,921

Agency RMBS pledged for clearing margin
 
3,522

 
3,657

 
12

 
3,534

Total
 
$
3,353,166

 
$
3,258,790

 
$
6,823

 
$
3,359,989

 
(1) 
Includes a non-Agency RMBS with a fair value of $118,443, an amortized cost of $122,357 and the associated interest receivable of $579, all of which were eliminated in consolidation with VIEs at June 30, 2016.
(2) 
Includes non-Agency RMBS with a fair value of $125,125, an amortized cost of $123,552 and the associated interest receivable of $599, all of which were eliminated in consolidation with VIEs at December 31, 2015.
We consolidate the securitization trusts associated with our securitizations, each of which is a VIE, that were created to facilitate our securitization transactions. As part of the February 2013 Securitization, the most senior security created was sold to a third-party investor and as such, when we consolidate this securitization trust, this senior security is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value.” Our securitized mortgage loans are restricted in that they can only be used to fulfill the obligations of their associated securitization trust. (See Note 14.)
A reduction in the value of pledged assets may result in the repurchase agreement counterparty initiating a margin call. If a margin call is made, we are required to provide additional collateral or repay a portion of the borrowing. Certain repurchase agreements, Swaps and other financial instruments are subject to financial covenants, which if breached could cause an event of default or early termination event to occur under such agreements. If an event of default or trigger of an early termination event occurs pursuant to one of these agreements, the counterparty to such agreement may have the option to terminate all of its outstanding agreements with us and, if applicable, any close-out amount due to the counterparty upon termination of such agreements would be immediately payable by us. Through June 30, 2016, we remained in compliance with all of our financial covenants. (See Notes 9 and 10.)
Note 10 – Offsetting Assets and Liabilities
All balances associated with the repurchase agreements and derivatives transactions are presented on a gross basis in our consolidated balance sheets. Certain of our repurchase agreements and derivative transactions are governed by underlying agreements that generally provide for a right of set-off in the event of default or in the event of a bankruptcy of either party to the transaction. We do not generally take delivery of or deliver securities pursuant to our TBA Contracts; rather we settle the associated receivable/payable with our trading counterparty on a net basis. Transactions with the same counterparty for the same TBA Contract that results in a reduction or elimination of the position are treated as extinguished.


32
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and can potentially be offset on our consolidated balance sheet at June 30, 2016 and December 31, 2015:
Offsetting of Financial Assets and Derivative Assets
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Assets
 
Gross Amounts
Offset in  the
Consolidated
Balance Sheet
 
Net Amounts
 of Assets  Presented
in the
Consolidated
Balance Sheet
 
Financial
Instruments (1)
 
Cash
Collateral
Received
 
Net
Amount
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Long TBA Contracts, at fair value
 
—

 
—

 
—

 
—

 
 
 
—

Total
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
4,347

 
$
—

 
$
4,347

 
$
(3,577
)
 
$
(280
)
 
$
490

Long TBA Contracts, at fair value
 
—

 
—

 
—

 
—

 
—

 
—

Total
 
$
4,347

 
$
—

 
$
4,347

 
$
(3,577
)
 
$
(280
)
 
$
490

Offsetting of Financial Liabilities and Derivative Liabilities
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Consolidated Balance Sheet
 
 
 
 
Gross
Amounts of
Recognized
Liabilities
 
Gross Amounts
Offset in the
Consolidated
Balance Sheet
 
Net Amounts of
Liabilities
Presented in the
Consolidated
Balance Sheet
 
Financial
Instruments (2) (3)
 
Cash
Collateral
Pledged  (2) (4)
 
Net
Amount
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
1,274

 
$
—

 
$
1,274

 
$
—

 
$
(1,660
)
 
$
(386
)
Short TBA Contracts, at fair value
 
7,268

 
—

 
7,268

 
—

 
(7,945
)
 
(677
)
Repurchase agreements (5)
 
2,269,853

 
—

 
2,269,853

 
(2,269,853
)
 
(14,658
)
 
(14,658
)
Total
 
$
2,278,395

 
$
—

 
$
2,278,395

 
$
(2,269,853
)
 
$
(24,263
)
 
$
(15,721
)
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
Swaps and Swaptions, at fair value
 
$
13,618

 
$
—

 
$
13,618

 
$
(3,577
)
 
$
(10,041
)
 
$
—

Long TBA Contracts, at fair value
 
195

 
—

 
195

 
—

 
74

 
269

Repurchase agreements (5)
 
2,898,347

 
—

 
2,898,347

 
(2,898,347
)
 
—

 
—

Total
 
$
2,912,160

 
$
—

 
$
2,912,160

 
$
(2,901,924
)
 
$
(9,967
)
 
$
269

(1) 
Amounts represent derivative instruments in an asset position which could potentially be offset against interest rate derivatives in a liability position at June 30, 2016 and December 31, 2015, subject to a netting arrangement.
(2) 
Amounts represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements, and interest rate derivatives.
(3) 
The fair value of securities pledged against our borrowings under repurchase agreements was $2,639,857 and $2,877,663 at June 30, 2016 and December 31, 2015, respectively. The amounts pledged include $118,443 and $125,125 of RMBS that are not included in our consolidated balance sheet at June 30, 2016 and December 31, 2015, respectively, as such securities were eliminated in consolidation with VIEs.
(4) 
Total cash pledged against our derivative instruments was $9,605 and $21,921 at June 30, 2016 and December 31, 2015, respectively. Total cash collateral pledged against our borrowings under repurchase agreements was $14,658 and $61,772 at June 30, 2016 and December 31, 2015, respectively.
(5) 
Amount does not include deferred financing costs.



33
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 11 – Derivative Instruments
We enter into derivative contracts, which through June 30, 2016 have from time to time been comprised of Swaps, Swaptions, and TBA Contracts. We use derivative instruments to manage interest rate risk and, as such, view them as economic hedges. We have not elected hedge accounting under GAAP for any of our derivative instruments and, as a result, the fair value adjustments on such instruments are recorded in earnings. The fair value adjustments for our derivatives, along with the related interest income, interest expense and gains/(losses) on termination of such instruments, are reported as “Realized and unrealized gain/(loss) on derivative instruments, net” on our consolidated statements of operations.
(a) Derivative Instruments Summary
Information with respect to our derivative instruments as presented on our consolidated balance sheets at June 30, 2016 and December 31, 2015 was as follows:
 
 
June 30, 2016
 
December 31, 2015
 
 
Notional
Amount
 
Estimated
Fair Value
 
Notional
Amount
 
Estimated
Fair Value
Swaps - assets
 
$
—

 
$
—

 
$
693,000

 
$
3,103

Swaptions - assets
 
—

 
—

 
875,000

 
1,244

Swaps - (liabilities)
 
42,000

 
(1,274
)
 
994,000

 
(10,237
)
Swaptions - (liabilities)
 
—

 
—

 
300,000

 
(3,381
)
Long TBA Contracts - assets
 
—

 
—

 
100,000

 
(195
)
Short TBA Contracts - (liabilities)
 
868,000

 
(7,268
)
 
—

 
—

Total
 
$
910,000

 
$
(8,542
)
 
$
2,962,000

 
$
(9,466
)
(b) Swaps
The variable amount of interest that we receive from our Swap counterparties is typically based on three-month LIBOR. The following table summarizes the average fixed-pay rate and average maturity for our Swaps as of June 30, 2016 and December 31, 2015:
 
 
June 30, 2016
 
December 31, 2015
Term to Maturity
 
Notional
Amount
 
Weighted Average
Fixed-Pay
Rate
 
Weighted Average
Maturity
(Years)
 
Notional
Amount
 
Weighted Average
Fixed-Pay
Rate
 
Weighted Average
Maturity
(Years)
Less than one year
 
$
—

 
—
%
 
—

 
110,000

 
1.38
%
 
0.8
More than one year up to and including three years
 
14,000

 
1.04

 
1.7

 
999,000

 
1.02

 
1.6
More than three years up to and including five years
 
14,000

 
1.51

 
3.7

 
64,000

 
2.28

 
4.5
More than five years
 
14,000

 
2.05

 
6.7

 
514,000

 
2.11

 
7.2
Total
 
$
42,000

 
1.53
%
 
4.0

 
$
1,687,000

 
1.43
%
 
3.4
(c) Swaptions
We terminated all Swaptions during the three months ended June 30, 2016 and, as a result, had no remaining Swaptions at June 30, 2016.


34
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(d) Gains/(Losses) on Derivatives
The following table summarizes the amounts recognized on our consolidated statements of operations related to our derivative instruments for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
Character of Gain/(Loss) on Derivative Instruments
 
2016
 
2015
 
2016
 
2015
Net interest payments/accruals on Swaps (1)
 
$
(807
)
 
$
(4,920
)
 
$
(3,361
)
 
$
(9,884
)
Losses on the termination of Swaps, net (1)
 
(5,871
)
 
—

 
(24,797
)
 
—

Losses on terminations and expirations of Swaptions, net (1)
 
(12,100
)
 
(6,170
)
 
(18,126
)
 
(10,032
)
Gain/(losses) on settlement of TBA Contracts, net (1)
 
(600
)
 
—

 
1,064

 
(1,977
)
Change in fair value of Swaps (2)
 
6,493

 
14,769

 
5,859

 
(707
)
Change in fair value of Swaptions, net (2)
 
12,661

 
8,879

 
10,090

 
9,181

Change in fair value of TBA Contracts (2)
 
(7,646
)
 
(95
)
 
(7,073
)
 
(639
)
Total
 
$
(7,870
)
 
$
12,463

 
$
(36,344
)
 
$
(14,058
)
Note: Each of the items presented is included as a component of “Realized and unrealized gain/(loss) on derivative instruments, net” on our consolidated statements of operations for the periods presented.
(1) 
Amounts are realized.
(2) 
Amounts are unrealized and reflect the net change in fair value.


35
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(e) Derivative Activity
The following table provides information with respect to our use of derivative instruments during the periods presented:
 
 
Three Months Ended June 30, 2016
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
—

 
$
100,000

 
$
1,287,000

 
$
425,000

 
$
300,000

Notional amount of contracts entered
 
(1,118,000
)
 
—

 
—

 
—

 
—

Notional amount of contracts terminated
 
250,000

 
(100,000
)
 
(1,245,000
)
 
(425,000
)
 
(300,000
)
Ending Notional Balance
 
$
(868,000
)
 
$
—

 
$
42,000

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2015
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
—

 
$
—

 
$
1,687,000

 
$
1,425,000

 
$
—

Notional amount of contracts entered
 
(200,000
)
 
—

 
—

 
200,000

 
—

Notional amount of contracts terminated
 
—

 
—

 
—

 
(560,000
)
 
—

Ending Notional Balance
 
$
(200,000
)
 
$
—

 
$
1,687,000

 
$
1,065,000

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
—

 
$
100,000

 
$
1,687,000

 
$
875,000

 
$
300,000

Notional amount of contracts entered
 
(1,118,000
)
 
—

 
—

 
—

 
—

Notional amount of contracts terminated
 
250,000

 
(100,000
)
 
(1,645,000
)
 
(875,000
)
 
(300,000
)
Ending Notional Balance
 
$
(868,000
)
 
$
—

 
$
42,000

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2015
 
 
Short TBA Contracts
 
Long TBA Contracts
 
Swaps
 
Swaption Purchase Contracts
 
Swaption Sale Contracts
Beginning Notional Balance
 
$
—

 
$
100,000

 
$
1,687,000

 
$
1,250,000

 
$
—

Notional amount of contracts entered
 
(200,000
)
 
500,000

 
—

 
650,000

 
—

Notional amount of contracts terminated
 
—

 
(600,000
)
 
—

 
(835,000
)
 
—

Ending Notional Balance
 
$
(200,000
)
 
$
—

 
$
1,687,000

 
$
1,065,000

 
$
—

(f) Financial Covenants
Our agreements with certain of our derivative counterparties contain financial covenants; through June 30, 2016 we were in compliance with the terms of all such covenants. We have minimum collateral posting thresholds with certain of our derivative counterparties, for which we typically pledge cash. (See Notes 9, 10 and 11.) If we breach any of these financial covenants, we could be required to settle our obligations under our derivative contracts at their termination value. At June 30, 2016, the estimated termination value of our derivative contracts was $8,580, which reflects the estimated fair value of such derivatives, plus net accrued interest payable.



36
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 12 – Interest Payable
The following table presents the components of our interest payable at June 30, 2016 and December 31, 2015: 
 
 
June 30, 2016
 
December 31, 2015
Repurchase borrowings collateralized by Agency RMBS
 
$
656

 
$
1,687

Repurchase borrowings collateralized by non-Agency RMBS (1)
 
1,460

 
4,268

Repurchase borrowings collateralized by other investment securities
 
161

 
350

Securitized debt
 
45

 
63

Swaps
 
37

 
2,770

Total
 
$
2,359

 
$
9,138

(1) 
Includes $136 and $125 of interest payable on repurchase borrowings collateralized by non-Agency RMBS issued by consolidated VIEs at June 30, 2016 and December 31, 2015, respectively, which securities were eliminated from our balance sheet in consolidation.
Note 13 – Commitments and Contingencies
(a) Management Agreement – Related Party Transactions
In connection with our initial public offering in July 2011, we entered into a management agreement with our Manager (or, Management Agreement), which describes the services to be provided for us by our Manager and compensation for such services. Our Manager is responsible for managing our day-to-day operations, subject to the direction and oversight of our board of directors (or, the Board).
Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.5% per annum of adjusted stockholders’ equity (as defined in the Management Agreement), calculated and payable quarterly in arrears.
The term of our Management Agreement currently runs through July 27, 2017. Absent certain action by the independent directors of the Board, as described below, the Management Agreement will automatically renew on each anniversary for a one year term. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors, based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us; or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. (See Note 13(a), 13(c) and 18 below.)
We incurred management fees of $2,493 and $2,895 for the three months ended June 30, 2016 and 2015. In addition to the management fee, we are responsible for reimbursing our Manager for certain expenses paid by our Manager on behalf of us and for certain services provided by our Manager to us. Expenses incurred by our Manager and reimbursed by us are typically included in our general and administrative expense on the consolidated statement of operations, or may be reflected on the consolidated balance sheet and associated consolidated statement of changes in stockholders’ equity, based on the nature of the item. Included in “Payable to related party” on our consolidated balance sheet at June 30, 2016 and December 31, 2015, was $2,493 and $5,388, respectively, for management fees payable to our Manager, with the remainder of such payable reflecting reimbursements due to Apollo for our general and administrative expenses paid or incurred by them on our behalf.
(b) Representations and Warranties in Connection with Securitization
In connection with our February 2013 Securitization, we have the obligation under certain circumstances to repurchase assets from the VIE upon breach of certain representations and warranties. In February 2014, the substantial majority of these obligations expired, with only the representations and warranties surviving such obligations, which may expose us to losses, being that the loans transferred to the VIE are qualified mortgages under Section 860G(a)(3) of the Internal Revenue Code. Through June 30, 2016, no repurchase claims had been made against us, and we do not believe that the amount of any future potential liability with respect to such item (the maximum of which would be the current unpaid principal balance of any such loan plus accrued interest, unreimbursed advances and any expenses) is material to us. Through June 30, 2016, we had no reserve established for repurchases of loans and were not aware of any repurchase claims that would require the establishment of such a reserve. (See Note 14.)


37
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


(c) Merger Agreement
Contingent Fees
See Note 18 for information with respect to certain contingent fees associated with the Merger Agreement.
Pending Litigation
After the announcement of the execution of the Merger Agreement, two putative class action lawsuits challenging the proposed First Merger (as defined in the Merger Agreement), captioned Aivasian v. Apollo Residential Mortgage, Inc., et al., No. 24-C-16-001532 and Wiener v. Apollo Residential Mortgage, Inc., et al., No. 24-C-16-001837, were filed in the Circuit Court for Baltimore City (or, the Court). A putative class and derivative lawsuit was later filed in the Court captioned Crago v. Apollo Residential Mortgage, Inc., No. 24-C-16-002610. Following a hearing on May 6, 2016, the Court entered orders among other things, consolidating the three actions under the caption In Re Apollo Residential Mortgage, Inc. Shareholder Litigation, Case No.: 24-C-16-002610. The plaintiffs have designated the Crago complaint as the operative complaint. The operative complaint includes both direct and derivative claims, names as defendants the Company, the Board, Apollo Commercial Real Estate Finance, Inc. (or, ARI), Arrow Merger Sub, Inc. (or, Merger Sub), Apollo and Athene Holdings LTD. (or, Athene) and alleges, among other things, that the members of the Board breached their fiduciary duties to the Company’s stockholders and that the other corporate defendants aided and abetted such fiduciary breaches. The operative complaint further alleges, among other things, that the proposed First Merger involves inadequate consideration, was the result of an inadequate and conflicted sales process, and includes unreasonable deal protection devices that purportedly preclude competing offers. It also alleges that the transactions with Athene are unfair and that the registration statement on Form S-4 filed with the SEC on April 6, 2016 contains materially misleading disclosures and omits certain material information. The operative complaint seeks, among other things, certification of the proposed class, declaratory relief, preliminary and permanent injunctive relief, including enjoining or rescinding the First Merger, unspecified damages, and an award of other unspecified attorneys’ and other fees and costs. On May 6, 2016, counsel for the plaintiffs filed with the Court a stipulation seeking the appointment of interim co-lead counsel, which stipulation was approved by the Court on June 9, 2016. The defendants believe that the claims asserted in the complaints are without merit and intend to vigorously defend the lawsuits.
Note 14 – Use of Special Purpose Entities and Variable Interest Entities
Special purpose entities (or, SPEs) are entities designed to fulfill a specific limited need of the entity that organizes it. SPEs are often used to facilitate transactions that involve securitizing financial assets. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing the underlying securitized financial assets on more favorable terms than available on such assets on an unsecuritized basis. Securitization involves transferring assets to an SPE to convert all or a portion of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of debt or equity instruments. Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall structure of the transaction, may benefit from various forms of credit enhancement, such as over-collateralization in the form of excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement.
(a) Securitization Transactions
Through June 30, 2016, we had completed two securitization transactions. We consolidate the trusts, as VIEs, that were created to facilitate the transactions and to which the underlying assets in connection with the securitizations were transferred. (See Note 2(o) for a discussion of the accounting policies applied to the consolidation of VIEs and transfers of financial assets in connection with securitization transactions.)
As of June 30, 2016 and December 31, 2015, the aggregate fair value of securitized mortgage loans underlying our securitizations was $160,206 and $167,624, respectively, and are included in “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value,” on our consolidated balance sheet.
The mortgage loans in our securitizations are comprised of performing, re-performing and non-performing mortgage loans with characteristics similar to the mortgage loans underlying our non-Agency RMBS.


38
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table summarizes the key details of our securitization transactions as of June 30, 2016:
 
 
March 2015 Securitization
 
February 2013 Securitization
 
Total
Name of securitization trust consolidated as a VIE
 
AMST 2015-1
 
AMST 2013-1
 
 
Principal value of mortgage loans sold into the securitization trust
 
$
90,802

 
$
155,001

 
$
245,803

Current principal value of mortgage loans in securitization trust
 
$
80,938

 
$
119,201

 
$
200,139

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

 
$
50,375

 
$
50,375

Outstanding balance of senior security at June 30, 2016 (1)
 
$
72,598

 
$
13,382

 
$
85,980

Year of final contractual maturity of senior debt
 
2058

 
2047

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

 
$
104,426

 
$
186,713

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

 
$
50,375

 
$
50,375

Gross securitization expenses incurred
 
$
174

 
$
829

 
$
1,003

Stated interest rate for senior security issued
 
5.75
%
 
4.00
%
 
 
(1) 
With respect to the March 2015 Securitization, amount reflects 100% of the single security issued, which we retained. The stated rate is presented for informational purposes only, as such certificate is eliminated in consolidation with the associated trust.
(2) 
With respect to our February 2013 Securitization, the certificates we received are subordinate to and provide credit support for the sequential senior security sold to a third-party investor. While the RMBS that we retained in connection with February 2013 Securitization do not appear on our balance sheet, as they are eliminated in consolidation with the VIE/securitization trust, we legally own such securities and we, as legally permitted, pledge such securities as collateral against associated borrowings under repurchase agreements.
(b) Consolidation Assessment
On a quarterly basis, we complete an analysis to determine whether the VIEs associated with our securitizations should be consolidated by us. As part of this analysis, we consider our involvement in the creation of the VIE, including the design and purpose of the VIE and whether our involvement reflects a controlling financial interest that results in us being deemed the primary beneficiary of the VIE. In determining whether we would be considered the primary beneficiary, we consider: (i) whether we have both the power to direct the activities that most significantly impact the economic performance of the VIE; and (ii) whether we have a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. Based on our evaluation of these factors, including our involvement in the design of the VIE, we determined that we were required to consolidate the VIE created to facilitate the March 2015 Securitization and February 2013 Securitization for each reporting period from inception through June 30, 2016.
(c) Activities of Securitization Trusts
The securitization trusts receive principal and interest on the underlying mortgage loans and distribute those payments to the certificate holders. The assets and other instruments held by the securitization trusts are restricted in that they can only be used to fulfill the obligations of their respective securitization trust. The risks associated with our involvement with the VIEs are limited to the risks and rights as a certificate holder of the securities we retained.  
The activities of the securitization trusts are substantially set forth in the securitization transaction documents, primarily the mortgage loan trust agreements, the trust agreements, the indenture and the securitization servicing agreements (or collectively, the Securitization Agreements). Neither the trusts nor any other entity may sell or replace any assets of the trust except in connection with: (i) certain loan defects or breaches of certain representations and warranties which have a material adverse effect on the value of the related assets; (ii) loan defaults; (iii) certain trust events of default or (iv) an optional termination of the trust, each as specifically permitted under the Securitization Agreements.

(d) Securitized Debt
We consolidate the underlying trust associated with our February 2013 Securitization. As a result, the senior security that was sold to a third-party investor is presented on our consolidated balance sheet as “Non-recourse securitized debt, at fair value” and the residential mortgage loans held by the trust that collateralize the securities issued by the trust are included as a component of “Securitized mortgage loans (transferred to consolidated variable interest entities), at fair value” on our consolidated balance sheet. The third-party beneficial interest holders in the VIE have no recourse against us, except that we may have an obligation to repurchase assets from the VIE in the event that we breach certain representations and warranties in relation to the mortgage loans sold to the VIE. Other than the foregoing, we have no obligation to provide, nor have we provided, any other explicit or implicit support to this or any other VIE that we consolidate.


39
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Our securitized debt is carried at fair value, which is based on the fair value of the senior security held by third parties. The following table presents the estimated principal repayment schedule of the par value of the securitized debt at June 30, 2016, based on expected cash flows of the securitized residential mortgage loans, as adjusted for projected losses on such loans.
Estimated Maturity
 
June 30, 2016
One year or less
 
$
9,913

More than one year, up to and including three years
 
3,469

Total
 
$
13,382

Repayment of our securitized debt will be dependent upon the cash flows generated by the mortgage loans in the February 2013 Securitization trust that collateralize such debt. The actual cash flows from the securitized mortgage loans are comprised of coupon interest, scheduled principal payments, prepayments and liquidations of the underlying mortgage loans. The actual term of the securitized debt may differ significantly from our estimate given that actual interest collections, mortgage prepayments and/or losses on liquidation of mortgages may differ significantly from those expected. (See Note 5 for more information about the mortgage loans collateralizing our securitized debt.)
(e) VIEs - Impact on the Consolidated Financial Statements
The following table reflects the assets and liabilities recorded in our consolidated balance sheet related to our consolidated VIEs as of the dates presented:
 
 
June 30, 2016
 
December 31, 2015
Assets:
 
 
 
 
Securitized mortgage loans, at fair value
 
$
160,206

 
$
167,624

Interest receivable
 
$
947

 
$
936

Other assets
 
$
838

 
$
220

Liabilities:
 
 
 
 
Non-recourse securitized debt, at fair value
 
$
13,407

 
$
18,951

Accrued interest payable
 
$
45

 
$
63

The following table reflects the income and expense amounts recorded in our consolidated statements of operations related to our consolidated VIEs for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Interest income - securitized mortgage loans
 
$
3,231

 
$
3,623

 
$
6,496

 
$
5,790

Interest expense - securitized debt
 
$
(197
)
 
$
(333
)
 
$
(447
)
 
$
(699
)
Unrealized gain/(loss) on securitized mortgage loans, net
 
$
5,751

 
$
(1,896
)
 
$
1,992

 
$
466

Unrealized gain on securitized debt
 
$
20

 
$
1,001

 
$
22

 
$
1,014

Other, net
 
$
(97
)
 
$
—

 
$
(246
)
 
$
—

General and administrative expenses
 
$
(338
)
 
$
—

 
$
(404
)
 
$
—



40
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table reflects the amounts included on our consolidated statements of cash flows related to our consolidated VIEs for the periods presented:
 
 
Six Months Ended June 30,
 
 
2016
 
2015
Cash Flows from Operating Activities:
 
 
 
 
Net income
 
$
7,413

 
$
6,557

Reversal of discount accretion/(discount accretion), net
 
$
(471
)
 
$
214

Amortization of deferred financing costs
 
$
134

 
$
163

Unrealized gain on securitized mortgage loans, net
 
$
(1,992
)
 
$
(466
)
Unrealized (gain) on securitized debt
 
$
(22
)
 
$
(1,014
)
Realized loss on real estate owned, net
 
$
310

 
$
133

Changes in operating assets and liabilities:
 
 
 
 
(Increase) in accrued interest receivable, less purchased interest
 
$
(11
)
 
$
(287
)
(Decrease) in accrued interest payable
 
$
(18
)
 
$
(24
)
Cash Flows from Investing Activities:
 


 
 
(Purchase) of mortgage loans, simultaneously securitized
 
$
—

 
$
(67,357
)
Proceeds from sales of real estate owned
 
$
255

 
$
351

Principal payments received on securitized mortgage loans
 
$
8,823

 
$
5,512

Cash Flows from Financing Activities:
 
 
 
 
Principal (payments) on securitized debt
 
$
(5,522
)
 
$
(7,269
)
Note 15 – Equity Award Plan
On July 21, 2011, the Board approved the Apollo Residential Mortgage, Inc. 2011 Equity Incentive Plan (or, LTIP). The LTIP provides for grants of restricted common stock, RSUs and other equity-based awards up to an aggregate of 5% of the issued and outstanding shares of our common stock (on a fully diluted basis). The LTIP is administered by the compensation committee of the Board, which also must approve grants made under the LTIP. At June 30, 2016, 1,183,081 awards were available for grant under the LTIP.
The following table presents expenses related to our equity-based compensation awards for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Restricted Common Stock
 
$
71

 
$
105

 
$
130

 
$
211

RSUs
 
123

 
198

 
172

 
586

Total
 
$
194

 
$
303

 
$
302

 
$
797

At June 30, 2016, we had estimated unrecognized compensation expense of $1,898 and $498 related to RSUs and restricted common stock, respectively. The unrecognized compensation expense at June 30, 2016 is expected to be recognized over a weighted average period of twelve months, which does not include awards that have performance based vesting requirements. However, pursuant to the Merger Agreement, all outstanding unvested RSUs and restricted stock awards will vest upon consummation of the pending Merger. As of June 30, 2016, we had an expected average forfeiture rate of 0% with respect to restricted common stock and 5% with respect to RSUs.
Through June 30, 2016, we had not settled any RSUs in cash. However, the LTIP provides that we may allow RSU recipients to elect to settle their tax liabilities with a reduction of their share delivery from the originally granted and vested RSUs, which is referred to herein as “net share settlement.” Net share settlement results in us making a cash payment to an affiliate of our Manager related to this tax liability and a corresponding adjustment to additional paid-in-capital.


41
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The following table presents information about our equity awards for the periods presented:
 
 
Three Months Ended June 30,
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value (1)
 
Number of Awards (1)
 
Number of Awards (1)
 
Weighted Average Grant Date Fair Value(1)
 
Number of Awards (1)
RSUs outstanding at beginning of period
 
196,920

 
$
14.29

 
291,777

 
148,549

 
$
15.88

 
292,088

RSUs granted (2)
 
—

 
—

 
—

 
91,427

 
12.53

 
 
RSUs canceled upon delivery of common stock (3)
 
(1,000
)
 
22.22

 
(5,000
)
 
(44,056
)
 
16.16

 
(5,000
)
RSUs canceled or forfeited
 
(208
)
 
16.02

 
(2,289
)
 
(208
)
 
16.02

 
(2,600
)
RSUs outstanding at end of period
 
195,712

 
$
14.25

 
284,488

 
195,712

 
$
14.25

 
284,488

 
 
 
 
 
 
 
 
 
 
 
 
 
Vested RSUs at end of period
 
23,443

 
$
15.12

 
98,916

 
23,443

 
$
15.12

 
98,916

Unvested RSUs at end of period
 
172,269

 
$
14.13

 
185,572

 
172,269

 
$
14.13

 
185,572

 
 
 
 
 
 
 
 
 
 
 
 
 
Unvested restricted common stock awards outstanding at beginning of period
 
28,008

 
$
17.54

 
41,980

 
30,120

 
$
16.31

 
43,992

Restricted common stock granted
 
11,276

 
13.30

 
9,332

 
11,276

 
13.30

 
9,332

Restricted common stock vested
 
(2,108
)
 
17.80

 
(2,008
)
 
(4,220
)
 
17.79

 
(4,020
)
Unvested restricted common stock awards outstanding at end of period
 
37,176

 
$
15.23

 
49,304

 
37,176

 
$
15.23

 
49,304

(1) 
Amounts are not in thousands.
(2) 
On March 17, 2016, 91,427 RSUs were granted in connection with the Merger, which will fully vest only upon the achievement of certain conditions.
(3) 
Includes amounts deemed issued in connection with payment of grantee’s tax liability.
Note 16 – Stockholders’ Equity
(a) Common Stock Dividends
The following table presents cash dividends declared by the Board on our common stock from January 1, 2015 through June 30, 2016:
Declaration Date
 
Record Date
 
Payment Date
 
Dividend Per Share
June 17, 2016
 
June 30, 2016
 
July 29, 2016
 
$
0.48

March 17, 2016
 
March 31, 2016
 
April 29, 2016
 
$
0.48

December 17, 2015
 
December 31, 2015
 
January 29, 2015
 
$
0.48

September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.48

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

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

(b) Preferred Stock
At June 30, 2016 and December 31, 2015, we had outstanding 6,900,000 shares of 8.0% Series A Cumulative Redeemable Perpetual Preferred Stock (or, Preferred Stock) with a liquidation preference of $25.00 per share and a par value $0.01 per share. Holders of our Preferred Stock are entitled to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. These dividends are cumulative and payable quarterly in arrears. Generally, we may not redeem the Preferred Stock until September 20, 2017, except under certain limited circumstances intended to preserve our qualification as a REIT and upon the occurrence of a change in control as defined in the final prospectus supplement related to the Preferred Stock filed with the SEC on September 17, 2012. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. Based upon the characteristics of the Preferred Stock, such instruments are characterized as equity instruments.


42
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


The Preferred Stock generally has no voting rights. However, if dividends on the Preferred Stock are in arrears for six quarterly dividend periods, whether or not consecutive, the holders of the Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) will have the right to elect two additional directors to the Board until we pay (or declare and set aside for payment) all dividends that are then in arrears. In addition, the affirmative vote of at least two-thirds of the votes entitled to be cast by holders of outstanding shares of Preferred Stock (voting together as a single class with the holders of any other class or series of parity preferred stock upon which like voting rights have been conferred and are exercisable) is required for us to authorize, create or increase the number of any class or series of senior equity securities or to amend our charter (including the Articles Supplementary designating the Preferred Stock, or the Articles Supplementary) in a manner that materially and adversely affects the rights of the Preferred Stock.
(c) Direct Stock Purchase and Dividend Reinvestment Plan
On November 25, 2015, we filed a shelf registration statement on Form S-3 with the SEC under the Securities Act of 1933 (or, the Securities Act), for the purpose of registering additional common stock for sale through our Direct Stock Purchase and Dividend Reinvestment Plan (or, Stock Purchase Plan). This shelf registration statement, which was declared effective by the SEC on December 18, 2015, when combined with the unused portion of our previous Stock Purchase Plan shelf registration statement, registered an aggregate of 2,000,000 shares of common stock. At June 30, 2016, 2,000,000 shares of common stock remained available for issuance pursuant to the Stock Purchase Plan registration statement. Under the Stock Purchase Plan, stockholders who participate may purchase shares of our common stock directly from us. Stockholders may also automatically reinvest all or a portion of their dividends for additional shares of our stock. Through June 30, 2016, all shares issued pursuant to the Stock Purchase Plan were issued from shares purchased on the open market.
(d) Stock Repurchase Program
On November 6, 2013, the Board authorized a stock repurchase program (or, the Repurchase Program), to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program, if any, will be canceled and, until reissued by us, will be deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior notice. We repurchased 360,800 shares of common stock at an average cost per share of $13.86, all of which were purchased during the three months ended September 30, 2015. At June 30, 2016, $45,000 of common stock remained authorized for future share repurchase under the Repurchase Program.



43
Apollo Residential Mortgage, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(Dollars in thousands—except per share data)
 


Note 17 – Earnings per Common Share
The following table presents basic and diluted net EPS of common stock using the two-class method for the periods presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Numerator:
 
 
 
 
 
 
 
 
Net Income/(Loss)
 
$
20,298

 
$
(10,032
)
 
$
7,264

 
$
11,375

Less:
 
 
 
 
 
 
 
 
Dividends declared on Preferred Stock
 
3,450

 
3,450

 
6,900

 
6,900

Dividends, dividend equivalents and undistributed earnings allocated to participating securities (1)
 
122

 
153

 
220

 
307

Net income/(loss) allocable to common stock – basic and diluted
 
$
16,726

 
$
(13,635
)
 
$
144

 
$
4,168

Denominator:
 
 
 
 
 
 
 
 
Weighted average common shares - basic
 
31,857

 
32,048

 
31,846

 
32,047

Weighted average common shares - diluted (1)
 
31,882

 
32,048

 
31,846

 
32,047

Earnings per common share - basic and diluted
 
$
0.52

 
$
(0.43
)
 
$
—

 
$
0.13

(1) 
For the six months ended June 30, 2016, all outstanding RSUs and unvested restricted stock were not included in the calculation of diluted earnings per common share, as their inclusion would have been anti-dilutive. These instruments may have dilutive impact on future EPS.
Note 18 – Merger Agreement
(a) Merger Agreement
On February 26, 2016, we entered into a Merger Agreement, under which we will be acquired by ARI for an aggregate purchase price equal to 89.25% of AMTG’s book value as determined in accordance with the Merger Agreement (or, Book Value) as of July 22, 2016 (or, the Pricing Date Book Value), plus the assumption of $172,500 of AMTG’s Preferred Stock. AMTG’s Pricing Date Book Value, and therefore the actual purchase price payable, was determined as of the July 22, 2016 pricing date and will be subject to adjustment in the event that the closing of the transactions contemplated by the Merger Agreement does not occur by September 5, 2016. The aggregate number of shares of ARI common stock issuable under the Merger Agreement is limited to 13,400,000 shares at a value of $16.75 per share, and the remainder of the consideration will be paid in cash. Based upon the Pricing Date Book Value of $15.52 per share, upon closing of the merger transaction, each outstanding share of AMTG common stock will be converted into the right to receive (i) $6.86 in cash, without interest and (ii) 0.417571 shares of ARI common stock, reflecting an aggregate purchase price value of $616,151, based upon the closing price of ARI common stock on the New York Stock Exchange (or, NYSE) on July 22, 2016, including the assumption of the $172,500 (liquidation preference) of our Preferred Stock; provided, however that the cash portion of the merger consideration may be subject to certain adjustments, as discussed above. In addition, each share of AMTG Preferred Stock will be converted into one share of preferred stock, par value $0.01 per share, of a newly-designated series of ARI preferred stock, which is expected to be designated as 8.00% Series C Cumulative Redeemable Perpetual Preferred Stock.
The Merger Agreement and related transactions were approved by all of the members of the Board (with the exception of Mark Biderman, who recused himself) upon the unanimous recommendation of a special committee of independent directors of our Board. Consummation of the merger transaction is subject to the satisfaction of customary closing conditions, including the registration and listing of the shares of ARI stock that will be issued in the merger transaction and the approval and adoption of the Merger Agreement by the holders of a majority of the shares of AMTG common stock entitled to vote on the transaction, including a majority of the votes entitled to be cast by persons unaffiliated with Apollo. ARI stockholder approval is not required in connection with the Merger. On July 27, 2016, we filed a definitive proxy statement/prospectus with the SEC and mailed such statement to our stockholders and ARI filed a definitive proxy statement/prospectus relating to the proposed transaction. The proxy statement/prospectus contains additional information regarding the proposed transaction, including risks associated with the proposed transaction.
(b) Letter Agreement with Manager
Concurrently with the execution of the Merger Agreement, we entered into a side letter agreement with our Manager (or, the Side Letter), pursuant to which the Manager agreed to perform such services and activities as may be necessary to enable us to consummate the Merger and other transactions contemplated by the Merger Agreement. In addition, our Manager acknowledged that, as a result of the transactions contemplated by the Merger Agreement, the Management Agreement will be assigned to ARI and such assignment will not give rise to a termination fee under the Management Agreement.


44


ITEM 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
(All currency figures are presented in thousands, except per share data or as otherwise noted.)
FORWARD-LOOKING INFORMATION
We make forward-looking statements in this Quarterly Report on Form 10-Q and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (or, the Exchange Act). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may,” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in our industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; our business and investment strategy; our operating results and potential asset performance; availability of opportunities to acquire Agency RMBS, non-Agency RMBS, residential mortgage loans and other residential mortgage assets or other real estate related assets; changes in the prepayment rates on the mortgage loans securing our RMBS; management’s assumptions regarding default rates on the mortgage loans securing our non-Agency RMBS and our SBC-MBS; our ability to borrow to finance our assets and the terms, including the cost, maturity and other terms, of any such borrowing; our estimates regarding taxable income, the actual amount of which is dependent on a number of factors, including, but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market discount on non-Agency RMBS, realized losses and changes in the composition of our Agency RMBS and non-Agency RMBS portfolios that may occur during the applicable tax period, including gain or loss on any RMBS disposals; expected leverage; general volatility of the securities markets in which we participate; our expected portfolio and scope of our target assets; our expected investment and underwriting process; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; rates of default or decreased recovery rates on our assets; the degree to which our hedging strategies may or may not protect us from interest rate volatility and the effects of hedging instruments on our assets; the impact of and changes in governmental regulations, tax law and rates, accounting, legal or regulatory issues or guidance and similar matters affecting our business; the timing and amount of distributions to stockholders, which are declared and paid at the discretion of the Board and will depend on, among other things, our taxable income, our financial results and overall financial condition and liquidity; continued maintenance of our qualification as a REIT for U.S. Federal income tax purposes and such other factors as the Board deems relevant; our continued maintenance of our exclusion from registration as an Investment Company under the1940 Act; availability of qualified personnel through our Manager; our present and potential future competition; risks associated with the ability and timing to consummate the proposed Merger with ARI and whether any terms may change; the risk that the anticipated benefits from the Merger and related transactions may not be realized or may take longer to realize than expected; and unexpected costs or unexpected liabilities, including those related to litigation, that may arise from the Merger and related transactions, whether or not consummated.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. See “Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2015. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of Part I of this Quarterly Report on Form 10-Q, as well as the information contained in our Annual Report on Form 10-K filed for the year ended December 31, 2015.



45


General
We were incorporated in Maryland on March 15, 2011 and commenced operations on July 27, 2011. We are structured as a holding company and conduct our business primarily through ARM Operating, LLC and our other operating subsidiaries. We have elected and operate to qualify as a REIT for U.S. Federal income tax purposes commencing with our taxable year ended December 31, 2011. We also operate our business in a manner that we believe will allow us to remain excluded from registration as an Investment Company under the 1940 Act. We are externally managed and advised by our Manager, an indirect subsidiary of Apollo Global Management, LLC.
At June 30, 2016, our portfolio was comprised of Agency RMBS (comprised of pass-through and IO securities), non-Agency RMBS, securitized mortgage loans, and other mortgage and mortgage related assets.
We use leverage as part of our business strategy in order to increase potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon our Manager’s assessment of a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties.
We use derivatives to hedge a portion of our interest rate risk and not for speculative purposes. As of June 30, 2016, our derivatives were comprised of Swaps and TBA Contracts.
Merger Agreement
On February 26, 2016, we entered into a Merger Agreement, under which we will be acquired by ARI for an aggregate purchase price equal to 89.25% of the Pricing Date Book Value, plus the assumption of $172,500 of AMTG’s Preferred Stock. AMTG’s Pricing Date Book Value, and therefore the actual purchase price payable, will be subject to adjustment in the event that the closing of the transactions contemplated by the Merger Agreement does not occur by September 5, 2016. The aggregate number of shares of ARI common stock issuable under the Merger Agreement is limited to 13,400,000 shares at a value of $16.75 per share, and the remainder of the consideration will be paid in cash. Based upon the Pricing Date Book Value of $15.52 per share, upon closing of the merger transaction, each outstanding share of AMTG common stock will be converted into the right to receive (i) $6.86 in cash, without interest and (ii) 0.417571 shares of ARI common stock, reflecting an aggregate purchase price value of $616,151, based upon the closing price of ARI common stock on the NYSE on July 22, 2016, including the assumption of the $172,500 (liquidation preference) of our Preferred Stock; provided, however that the cash portion of the merger consideration may be subject to certain adjustments, as discussed above. In addition, each share of AMTG Preferred Stock will be converted into one share of preferred stock, par value $0.01 per share, of a newly-designated series of ARI preferred stock, which is expected to be designated as 8.00% Series C Cumulative Redeemable Perpetual Preferred Stock.
The Merger Agreement and related transactions were approved by all of the members of the Board (with the exception of Mark Biderman, who recused himself) upon the unanimous recommendation of a special committee of independent directors of our Board. Consummation of the merger transaction is subject to the satisfaction of customary closing conditions, including the registration and listing of the shares of ARI stock that will be issued in the merger transaction and the approval and adoption of the Merger Agreement by the holders of a majority of the shares of AMTG common stock entitled to vote on the transaction, including a majority of the votes entitled to be cast by persons unaffiliated with Apollo. ARI stockholder approval is not required in connection with the Merger. On July 27, 2016, we filed a definitive proxy statement/prospectus with the SEC and mailed such statement to our stockholders and ARI filed a definitive proxy statement/prospectus relating to the proposed transaction. The proxy statement/prospectus contains additional information regarding the proposed transaction, including risks associated with the proposed transaction.
In connection with the Merger Agreement, we have certain restrictions on our investment activities. In addition, the Merger Agreement includes certain termination rights and provides that in such situations a fee of $12,000 could be payable by us to ARI if the transaction is terminated, and/or we could be required to reimburse ARI for its transaction expenses in an amount up to $6,000.
Concurrently with the execution of the Merger Agreement, we entered into a Side Letter with our Manager, pursuant to which the Manager agreed to perform such services and activities as may be necessary to enable us to consummate the Merger and other transactions contemplated by the Merger Agreement. In addition, our Manager acknowledged that, as a result of the transactions contemplated by the Merger Agreement, the Management Agreement will be assigned to ARI and such assignment will not give rise to a termination fee under the Management Agreement.


46


Factors Impacting Our Operating Results
Our results of operations are driven by, among other things, our net interest income, changes in the market value of our investments and derivative instruments and, from time to time, realized gains and losses on the sale of our investments and termination of our derivative instruments. The supply and demand for RMBS and other mortgage assets in the market place, the terms and availability of financing for such assets, general economic and real estate conditions, the impact of U.S Government actions that impact the real estate and mortgage sector, and the credit performance of our credit sensitive investments impact our overall performance. Our net interest income varies primarily as a result of changes in market interest rates and the slope of the yield curve (i.e., the differential between long-term and short-term interest rates) and constant prepayment rates (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on RMBS as a percentage of the principal balance, and includes the conditional repayment rate (or, CRR), which measures voluntary prepayments of mortgages collateralizing a particular RMBS and conditional default rates (or, CDR), which measures involuntary prepayments resulting from defaults of the underlying mortgage loans. CPRs vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. In addition, our borrowing costs and available credit are further affected by the collateral pledged and general conditions in the credit market.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS to decrease; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts and Swaps to increase. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.
Premiums arise when we purchase a security at a price in excess of the security’s par value and discounts arise when we purchase a security at a price below the security’s par value. Premiums on our RMBS are amortized against interest income over the life of the security, while discounts (excluding credit discounts, as discussed below) are accreted to income over the life of the security. The speeds at which premiums are amortized and discounts are accreted are significantly impacted by the CPR for each security. CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. CPRs on Agency RMBS and non-Agency RMBS may differ significantly.
We are exposed to credit risk with respect to our non-Agency RMBS, other investment securities, securitized mortgage loans, mortgage loans and other investments. Such credit risk is associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such investments. The credit risk on our non-Agency RMBS is generally mitigated by the credit support built into non-Agency RMBS structures and the purchase discounts on such securities, which provides a level of credit protection in the event that we receive less than 100% of the par value of these securities. The credit risk associated with our warehouse line receivable is mitigated by a pledge of substantially all the equity of the third-party borrower/guarantor, which borrower has legal title to the homes, BFT Contracts and mortgage loans that we finance on a warehouse line. To date we purchased substantially all of our non-Agency RMBS at a discount to par value; a portion of such discount may be viewed as a credit discount which is not expected to be amortized into interest income. The amount designated as credit discount on a security may change over time based on the security’s performance and its anticipated future performance. (See “Credit Risk”, included under Item 3 of Part I of this Quarterly Report on Form 10-Q.)
Our non-Agency RMBS investment process involves analysis focused primarily on quantifying and pricing credit risk. Interest income on our non-Agency RMBS is recorded at an effective yield, which reflects an estimate of expected cash flows for each security. In forecasting cash flows on our non-Agency RMBS, our Manager makes certain assumptions about the underlying mortgage loans which assumptions include, but are not limited to, future interest rates, voluntary prepayment rates, default rates, modifications and loss severities. As part of our non-Agency RMBS surveillance, we review, on at least a quarterly basis, each security’s performance. To the extent that actual performance and our current assessment of future performance differs from our prior assessment, such changes are reflected in the yield/income recognized on such securities prospectively. Credit losses greater than those anticipated, or in excess of purchase discount on a given security, could materially adversely impact our operating results.
We receive interest payments only with respect to the notional amount of Agency IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency pass-through RMBS,


47


the market prices of Agency IO generally have a positive correlation to increases in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO are expected to decrease, which in turn is expected to extend/increase the cash flow and the value of such securities; we expect the inverse to occur with respect to decreases in market interest rates. In addition to viewing Agency IO as investments, we also note that such instruments serve as a partial economic hedge against the impact that an increase in market interest rates would have on the value of our Agency RMBS in the marketplace. While Agency IO comprised a relatively small portion of our investments at June 30, 2016, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments; we had no investments in Agency Inverse IO at June 30, 2016.
Target Assets
We primarily invest in residential mortgage assets throughout the United States. At June 30, 2016, our portfolio was comprised of Agency RMBS (comprised of pass-through and IO securities), non-Agency RMBS, securitized mortgage loans, and other mortgage and mortgage related investments.
The following is a summary of our target assets at June 30, 2016:
Asset Classes
 
Principal Assets
 
 
Agency RMBS
 
Agency RMBS, primarily comprised of whole-pool pass-through securities, CMOs,
Agency IO and Agency principal-only securities.
 
 
Non-Agency RMBS and Real Estate
Related Asset-Backed Securities

 
Non-Agency RMBS, including highly rated, as well as non-investment grade and
unrated, tranches backed by Alt-A mortgage loans, Option ARMs, Subprime mortgage loans and prime mortgage loans, and other real estate related asset-backed securities.
 
 
Residential Mortgage Loans
 
Prime mortgage loans, jumbo mortgage loans, Alt-A mortgage loans, Option ARMs,
Subprime mortgage loans or other mortgage-like financing arrangements, including,
but not limited to, BFT Contracts. These investments may be performing, re-performing, sub-performing or non-performing.
 
 
Other Residential Mortgage-Related Assets
 
Non-Agency RMBS comprised of interest-only securities (or, non-Agency IO), principal-only securities (or, non-Agency PO), floating rate inverse interest-only securities (or, non-Agency Inverse IO), and floating rate securities, and other Agency and non-Agency RMBS derivative securities, as well as other financial assets, including, but not limited to, common stock, preferred stock and debt of other real estate-related entities, mortgage servicing rights, excess servicing spreads, advances on a warehouse line and mortgage loans to investors in residential properties and residential real estate. In addition, we may own real estate incidental to our financing arrangements associated with such properties.
We rely on our Manager’s expertise in identifying assets within our target asset classes and to efficiently finance those assets. We expect that our Manager will make decisions based on a variety of factors, including expected risk-adjusted returns on our assets, credit fundamentals, liquidity, availability of adequate financing, borrowing costs and macroeconomic conditions, as well as maintaining our qualification as a REIT and our exclusion from registration as an Investment Company under the 1940 Act.
Financing Strategy
We use leverage primarily for the purpose of financing our investment portfolio and increasing potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon a variety of factors, which include the availability of particular types of financing and our Manager’s assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We had an aggregate debt-to-equity multiple of 3.43 times at June 30, 2016, which multiple reflects the aggregate of our borrowings under repurchase agreements and securitized debt (based upon fair value) to our total stockholders’ equity.
We continue to have available capacity under our master repurchase agreements. However, such agreements are generally uncommitted and are renewable at the discretion of our lenders. We finance our Agency RMBS with repurchase


48


agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio in the range between approximately eight-to-one and ten-to-one and finance our non-Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity leverage ratio of approximately three-to-one. Our target and actual leverage may vary from time to time based on availability of financing and our assessment of market conditions. The terms of our repurchase agreements are typically one to six months at inception, but in some cases may have initial terms that are shorter or longer, up to 24 months. At June 30, 2016, we had master repurchase agreements with 24 counterparties. As a matter of routine business, we may have discussions with additional financial institutions with respect to expanding our repurchase agreement borrowing capacity. As of June 30, 2016, we had $2,269,853 of borrowings outstanding under our repurchase agreements with 16 counterparties collateralized by $1,312,753 of Agency RMBS and $1,171,200 of non-Agency RMBS (which included $118,443 of non-Agency RMBS that were eliminated from our balance sheet in consolidation with VIEs), and $155,904 of other investment securities. (See Notes 8, 9 and 10 to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)
Hedging Strategy
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we pursue various hedging strategies with the objective of reducing our exposure to increases in interest rates. The U.S. Federal income tax rules applicable to REITs may necessitate that we implement certain of these techniques through a TRS that will generally be subject to U.S. Federal and state income taxation. Our hedging activity may vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions.
Our Swaps and Swaptions are intended to mitigate the effects of increases in our borrowing costs associated with increases in interest rates on a portion of our future repurchase borrowings; in addition, these derivative instruments may also mitigate the impact of increases in interest rates on the value of our Agency RMBS portfolio.
At June 30, 2016, our Swaps had an aggregate notional balance of $42,000 with a weighted average fixed-pay rate of 1.53% and a weighted average term to maturity of 4.0 years. Our Swaps have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of our Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. (See Note 11 to the consolidated financial statements included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)
In addition to Swap and Swaptions, we also enter into TBA Contracts from time to time. Short TBA Contracts may serve as an economic hedge against decreases in the value of Agency RMBS held in our portfolio, in an amount equivalent to the Short TBA Contract notional balance, with the same characteristics as those stipulated in the TBA Contract, or may serve as an economic hedge of indebtedness incurred or to be incurred to acquire real estate assets.
We expect that any gains recognized in connection with the settlement of our derivative transactions that we identify for tax purposes to hedge indebtedness incurred or to be incurred to acquire real estate assets would not constitute gross income for purposes of the REIT 75% and 95% gross income tests. To date, we have identified our Swap and Swaptions as tax hedges and identified Short TBA Contracts entered into since May 2016 as tax hedges.
To date, we have not elected to apply hedge accounting pursuant to GAAP for our derivatives and, as a result, we record changes in the estimated fair value of such instruments, along with the associated net Swap interest in earnings, as a component of the net gain/(loss) on derivatives instruments in our consolidated statements of operations.
Certain Swap trades are required to be cleared through a clearinghouse, in accordance with the Commodities Futures Trading Commission (or, CFTC) Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties. The change in Swap margin collateral requirements generally increases the inherent cost of cleared Swaps, as higher amounts of cash are required to be pledged to meet the initial margin requirement on such transactions. (For additional information about our derivative instruments, see Note 11 to the consolidated financial statements included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)


49


Variances between GAAP Income and Taxable Income
Our net income for financial reporting purposes differs from our taxable income. Certain of the differences between our GAAP net income and our taxable income arise from variations among the methods prescribed under GAAP and the Internal Revenue Code for recognizing certain items of income and/or expense. Certain of these variations give rise to “timing differences” between GAAP net income and taxable income while other variations cause “permanent differences” between GAAP net income and taxable net income. The differences are expected to reverse over time and may cause significant short-term variances between GAAP and taxable net income.
Timing differences between our GAAP and taxable net income arise as a result of temporary differences between when certain revenue or expense items are recognized in earnings. Such timing differences are expected to reverse over time and may cause significant short-term variances between GAAP and taxable net income. For the six months ended June 30, 2016, the primary differences between our GAAP and taxable income arose from the following: (1) unrealized gain/(losses) that are recognized for GAAP purposes are not recognized for tax purposes; (2) discount accretion on non-Agency RMBS was less for tax purposes than for GAAP; (3) gains and losses on the termination of Swaps and Swaptions were recognized in the period that the Swap or Swaption was terminated for GAAP purposes, while such gains/(losses) are recognized over the remaining term of the Swap or the term of the Swap underlying the Swaption for tax purposes; and (4) purchase premium amortization on Agency RMBS was higher for tax purposes than for GAAP. In addition, we hold certain securities that were issued with original issue discount (or, OID). We generally recognize OID in our current gross interest income over the term of the applicable securities as the OID accrues. The rate at which OID is recognized into taxable income is calculated using a constant yield to maturity, without a loss assumption provision. As a result, for tax purposes, REIT taxable income with respect to securities with OID may be recognized in excess of GAAP income or in advance of the corresponding cash flow from these assets. The differences discussed above with respect to our Agency and non-Agency RMBS may also impact the difference between net gains we recognized under GAAP compared to tax. In addition, certain permanent differences between our GAAP income and our taxable income arise when items are recognized for GAAP purposes which will never affect the calculation of taxable income.
Depending on the structure of securitization/resecuritization transactions, for tax purposes such transactions may be treated either as a sale or a financing of the underlying assets. Income recognized from securitization and resecuritization transactions will generally differ for tax and GAAP purposes.
Critical Accounting Policies and Use of Estimates
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q. A summary of our critical accounting policies is set forth in our Annual Report on Form 10-K for the year ended December 31, 2015 under “Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Use of Estimates.”
Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2016
General:
In the second quarter of 2016, long-term interest rates continued their decline which began late in the first quarter of 2016, while short-term borrowing rates moved slightly higher, as the market anticipated a rate increase by the Federal Open Market Committee (or, FOMC). However, despite the U.S. Federal reserve’s goal of normalizing short-term interest rates, economic data continued to show weakness, with slow growth in Europe and China and slow growth in U.S. payrolls. As a result, the FOMC did not increase the target federal funds rate during the second quarter 2016. During its July 2016 meeting, the FOMC again maintained the federal funds rate at a range of 0.25% to 0.50%, citing that global economics and financial developments influenced their decision.
Reflecting the weak economic data, during the second quarter of 2016, bond prices increased and yields, which move inversely with prices, declined. The 10-year U.S. Treasury yield, which began 2016 at 2.27%, hit a low of 1.66% in mid-February, closed at 1.77% on March 31, 2016, and ended at 1.47% on June 30, 2016, following market reaction to the British Referendum to exit the European Union.




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The table below presents quarterly information about rates for two and ten-year U.S. Treasuries, ten-year Swap rates and the spread between the two and ten year U.S. Treasury rate for the quarterly periods presented:
Table 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
High
 
Low
 
Average
 
Quarter End
 
High
 
Low
 
Average
 
Quarter End
Quarter Ended
 
Ten-Year U.S. Treasury Rate
 
Ten-Year Swap Rate
June 30, 2016
 
1.93
%
 
1.44
%
 
1.75
%
 
1.47
%
 
1.80
%
 
1.34
%
 
1.61
%
 
1.39
%
March 31, 2016
 
2.27
%
 
1.66
%
 
1.91
%
 
1.77
%
 
2.19
%
 
1.46
%
 
1.78
%
 
1.66
%
December 31, 2015
 
2.34
%
 
1.97
%
 
2.18
%
 
2.27
%
 
2.24
%
 
1.95
%
 
2.10
%
 
2.19
%
September 30, 2015
 
2.45
%
 
2.00
%
 
2.22
%
 
2.04
%
 
2.52
%
 
2.00
%
 
2.28
%
 
2.00
%
June 30, 2015
 
2.48
%
 
1.84
%
 
2.16
%
 
2.35
%
 
2.52
%
 
2.00
%
 
2.27
%
 
2.00
%
 
 
Two-Year U.S. Treasury Rate
 
Spread Between Two and Ten Year U.S. Treasury Rate
June 30, 2016
 
0.92
%
 
0.58
%
 
0.77
%
 
0.58
%
 
1.01
%
 
0.86
%
 
0.98
%
 
0.89
%
March 31, 2016
 
1.05
%
 
0.65
%
 
0.83
%
 
0.72
%
 
1.22
%
 
1.01
%
 
1.08
%
 
1.05
%
December 31, 2015
 
1.09
%
 
0.55
%
 
0.82
%
 
1.05
%
 
1.25
%
 
1.42
%
 
1.36
%
 
1.22
%
September 30, 2015
 
0.81
%
 
0.54
%
 
0.68
%
 
0.63
%
 
1.64
%
 
1.46
%
 
1.54
%
 
1.41
%
June 30, 2015
 
0.73
%
 
0.48
%
 
0.60
%
 
0.64
%
 
1.75
%
 
1.36
%
 
1.56
%
 
1.71
%
Our net income for the second quarter of 2016 was negatively impacted by realized and unrealized losses on our derivative instruments, net. During the second quarter of 2016, we repositioned our economic hedges, which is expected to provide greater stability to our net asset value. To effect this change, all Swaps and Swaptions associated with our Agency RMBS portfolio and related borrowings were terminated or allowed to expire, resulting in net realized losses of $17,971 of which $17,535 were included in unrealized losses at March 31, 2016. At June 30, 2016, our remaining Swaps, which had a notional balance of $42,000, were economically associated with our non-Agency RMBS and related borrowings. Our effective net interest rate spread increased to 2.82% for the second quarter of 2016, compared to 2.65% for the three months ended March 31, 2016, primarily driven by the reduction in our Swap and Swaption costs. (See Tables 21 and 22 below.)
Investment Strategy:
The following table presents the composition of our investment portfolio as a percentage of total investments as of June 30, 2016, March 31, 2016 and December 31, 2015:
Table 2
 
June 30, 2016
 
March 31, 2016
 
December 31, 2015
Rate Investments:
 
 
 
 
 
 
Agency pass-through RMBS, at fair value
 
47.7
%
 
50.6
%
 
52.3
%
Agency IO, at fair value
 
1.4

 
1.6

 
1.9

Total Agency RMBS, at fair value
 
49.1

 
52.2

 
54.2

Credit Investments:
 
 
 
 
 
 
Non-Agency RMBS, at fair value
 
38.0

 
36.1

 
34.8

Securitized mortgage loans, at fair value
 
5.6

 
5.1

 
4.9

Other investments, at fair value
 
1.6

 
1.5

 
1.3

Other investment securities, at fair value(1)
 
5.7

 
5.1

 
4.8

 
 
50.9

 
47.8

 
45.8

 
 
100.0
%
 
100.0
%
 
100.0
%
(1) 
Other investment securities at June 30, 2016 were comprised of investments in Agency Risk Sharing Securities and SBC-MBS.


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Agency RMBS Portfolio/Interest Rate Hedges:
During the second quarter of 2016, our Agency RMBS portfolio experienced a monthly fair value weighted average CPR of 10.6%, comprised of 10.4% CPR on Agency pass-through securities and 16.8% on Agency IO securities. During the second quarter of 2016, the maximum average monthly CPR for our Agency RMBS was experienced in May, with an overall CPR of 11.5% comprised of 11.3% on Agency pass-through securities and 16.7% on Agency IO securities in the aggregate.
The following table presents the composition and estimated fair value and net unrealized gain/(loss) position with respect to our Agency RMBS portfolio at June 30, 2016, March 31, 2016 and December 31, 2015:
Table 3
 
June 30, 2016
 
March 31, 2016
 
December 31, 2015
Agency RMBS Collateral Type
 
Estimated Fair Value
 
Unrealized Gain/(Loss), Net
 
Estimated Fair Value
 
Unrealized Gain/(Loss), Net
 
Estimated Fair Value
 
Unrealized Gain/(Loss), Net
30-Year Fixed:
 
 
 
 
 
 
 
 
 
 
 
 
3.5% coupon
 
$
537,330

 
$
8,456

 
$
623,281

 
$
1,984

 
$
527,657

 
$
(7,822
)
4.0% coupon
 
575,218

 
9,535

 
683,649

 
6,319

 
983,536

 
(3,916
)
 
 
1,112,548

 
17,991

 
1,306,930

 
8,303

 
1,511,193

 
(11,738
)
ARMs
 
243,929

 
(4,825
)
 
269,240

 
(4,155
)
 
289,057

 
(2,723
)
Agency IO
 
41,470

 
(8,293
)
 
49,975

 
(5,547
)
 
57,354

 
(424
)
Agency Inverse IO
 
—

 
—

 
—

 
—

 
6,752

 
(112
)
Total
 
$
1,397,947

 
$
4,873

 
$
1,626,145

 
$
(1,399
)
 
$
1,864,356

 
$
(14,997
)


52


During the second quarter of 2016, we replaced Swaptions and Swaps that served as economic hedges associated with our Agency portfolio and associated borrowings, with Short TBA Contracts. Among other things, we believe this change will reduce the net market value risk of our Agency RMBS as a result of changes in market interest rates and interest rate spread widening, which occurs when market spreads widen between the yield on RMBS relative to certain benchmark interest rates. The following table presents information with respect to our Swaps, Swaptions and TBA Contracts at June 30, 2016, March 31, 2016 and December 31, 2015:
Table 4
 
June 30, 2016
 
March 31, 2016
 
December 31, 2015
Swaps:
 
 
 
 
 
 
Notional amount
 
$
42,000

 
$
1,287,000

 
$
1,687,000

Estimated fair value
 
$
(1,274
)
 
$
(7,767
)
 
$
(7,134
)
Weighted average fixed pay rate
 
1.53
%
 
1.19
%
 
1.43
%
Weighted average months to maturity
 
48

 
23

 
41

 
 
 
 
 
 
 
Swaptions Purchase Contracts:
 
 
 
 
 
 
Notional amount
 
$
—

 
$
425,000

 
$
875,000

Estimated fair value
 
$
—

 
$
77

 
$
1,244

Weighted average term to expiration (months)
 
—

 
4

 
5

Weighted average underlying Swap term (months)
 
—

 
109

 
108

Weighted average underlying Swap fixed pay rate
 
—
%
 
3.05
%
 
2.92
%
 
 
 
 
 
 
 
Swaptions Sale Contracts:
 
 
 
 
 
 
Notional amount
 
$
—

 
$
300,000

 
$
300,000

Estimated fair value
 
$
—

 
$
(10,813
)
 
$
(3,381
)
Weighted average term to expiration (months)
 
—

 
5

 
8

Weighted average underlying Swap term (months)
 
—

 
105

 
105

Weighted average underlying Swap fixed pay rate
 
—
%
 
1.97
%
 
1.97
%
 
 
 
 
 
 
 
Long TBA Contracts:
 
 
 
 
 
 
Notional amount
 
$
—

 
$
100,000

 
$
100,000

Estimated fair value
 
$
—

 
$
378

 
$
(195
)
 
 
 
 
 
 
 
Short TBA Contracts:
 
 
 
 
 
 
Notional amount
 
$
868,000

 
$
—

 
$
—

Estimated fair value
 
$
(7,628
)
 
$
—

 
$
—

Credit Investments:
The net value of our non-Agency RMBS portfolio increased slightly at June 30, 2016 from March 31, 2016. The non-Agency market maintained stable credit enhancement and steady home price appreciation. We accreted $9,849 of purchase discounts on non-Agency RMBS into interest income during the three months ended June 30, 2016.


53


Our credit investments were comprised of the following at June 30, 2016, March 31, 2016 and December 31, 2015:
Table 5
 
June 30, 2016
 
March 31, 2016
 
December 31, 2015
Non-Agency RMBS (at fair value)
 
$
1,080,501

 
$
1,126,720

 
$
1,197,226

Securitized mortgage loans (at fair value)
 
160,206

 
159,301

 
167,624

Other investments
 
45,724

 
45,644

 
45,233

Other investment securities:
 
 
 
 
 
 
Risk Sharing Securities - Freddie Mac (at fair value)
 
46,900

 
46,649

 
47,232

Risk Sharing Securities - Fannie Mae (at fair value)
 
53,816

 
52,381

 
51,424

SBC-MBS (at fair value)
 
59,680

 
60,887

 
64,607

SBA-IO (at fair value)
 
—

 
—

 
2,927

Total
 
$
1,446,827

 
$
1,491,582

 
$
1,576,273

As of June 30, 2016, we had: (a) $3,919 of advances outstanding under a warehouse line; (b) $31,045 of legal title to real estate associated with BFT Contracts; and (c) $10,760 of mortgage loans, all of which were related to our Seller Financing Program. We provide warehouse advances to our Seller Financing Program counterparty to fund the acquisition of single-family homes primarily located in the southeastern U.S. We are not currently expanding our Seller Financing Program.
Borrowings:
During the second quarter of 2016, borrowings under repurchase agreements remained readily available from counterparties for repurchase agreements collateralized by Agency RMBS, non-Agency RMBS and residential whole loans. In light of the pending Merger, the term of certain borrowings at June 30, 2016 were shorter than previous terms. As excess cash becomes available, we may utilize such cash to repay certain of our repurchase borrowings at maturity.
Following an increase in market interest rates for repurchase borrowings collateralized by Agency RMBS in December 2015, such rates stabilized in the first quarter of 2016, and remained at similar levels for the three months ended June 30, 2016. With respect to repurchase borrowings collateralized by non-Agency RMBS and other investment securities, counterparties continued to offer financing on securities purchased from others at competitive levels. Spreads to LIBOR on non-Agency repurchase borrowings for the three months ended June 30, 2016 were relatively consistent with such borrowing spreads to LIBOR during the first quarter of 2016.
Results of Operations
Three Months Ended June 30, 2016 compared to the Three Months Ended June 30, 2015
For the three months ended June 30, 2016, we had net income of $20,298, or $0.52 per basic and diluted common share, compared to a net loss of $10,032, or ($0.43) per basic and diluted common share, for the three months ended June 30, 2015. Our results of operations for the three months ended June 30, 2016 were positively impacted by other income of $4,402 which was partially off-set by merger related costs of $1,321 and our net income for the three months ended June 30, 2015 were negatively impacted by other losses of $36,866, as discussed below.
Net Interest Income
Our net interest income is significantly impacted by the amount of leverage we use, our interest rate spread and our net interest margin. Interest rate spread measures the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities, while net interest margin reflects net interest income divided by average interest-earning assets. For the three months ended June 30, 2016 and June 30, 2015, we earned interest income of $31,617 and $41,618, respectively, and incurred interest expense of approximately $8,243 and $8,234, respectively, which was primarily related to our borrowings under repurchase agreements. The $10,010 decrease in our net interest income reflects lower investment balances, as we reduced our leverage, and the decrease in net interest rate spread and net interest margin for the three months ended June 30, 2016, compared to June 30, 2015. For the three months ended June 30, 2016, we had average debt-to-equity of 3.61 times, compared to 4.12 times for the three months ended June 30, 2015. We had an interest rate spread and net interest margin of 2.95% and 3.17% for the three months ended June 30, 2016, respectively, compared to 3.34% and 3.48%, respectively, for the three months ended June 30, 2015. The decrease in our interest rate spread and net interest margin reflects the increase in our funding costs and the slight reduction in the yield on our interest earning assets, compared to the three months ended June 30,


54


2015; the reduction in our net interest margin also reflects our lower leverage for the current quarter compared to the second quarter of 2015.
Actual prepayments may cause future premium amortization on our Agency RMBS and resulting yields to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income and resulting yields recognized on our non-Agency RMBS in future periods on such investments.
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the three months ended June 30, 2016 and 2015:
Table 6
 
Three Months Ended June 30, 2016
 
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average investment balance (2)
 
$
1,539,119

 
$
1,252,384

 
$
154,360

 
$
2,945,863

Total interest income
 
$
10,064

 
$
18,323

 
$
3,230

 
$
31,617

Weighted average CPR
 
10.57
%
 
6.39
%
 
6.36
%
 
8.60
%
Yield on average assets
 
2.62
%
 
5.85
%
 
8.37
%
 
4.29
%
Average balance of associated repurchase agreements
 
$
1,393,096

 
$
965,519

 
$
85,299

 
$
2,443,914

Average balance of securitized debt  (3)
 
$
—

 
$
—

 
$
15,010

 
$
15,010

Total interest expense
 
$
2,367

 
$
5,070

 
$
806

 
$
8,243

Average cost of funds (4) (5)
 
0.68
%
 
2.10
%
 
3.21
%
 
1.34
%
Net interest income
 
$
7,697

 
$
13,253

 
$
2,424

 
$
23,374

Net interest rate spread
 
1.94
%
 
3.75
%
 
5.16
%
 
2.95
%
Total interest expense including net interest cost of Swaps (6)
 
$
3,080

 
$
5,070

 
$
900

 
$
9,050

Effective cost of funds (6)
 
0.88
%
 
2.10
%
 
3.59
%
 
1.47
%
Net interest income including net interest cost of Swaps
 
$
6,984

 
$
13,253

 
$
2,330

 
$
22,567

Effective net interest rate spread (6)
 
1.74
%
 
3.75
%
 
4.78
%
 
2.82
%
 
 
Three Months Ended June 30, 2015
 
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
2,145,667

 
$
1,479,534

 
$
172,627

 
$
3,797,828

Total interest income
 
$
15,830

 
$
22,165

 
$
3,623

 
$
41,618

Weighted average CPR
 
8.6
%
 
4.8
%
 
5.1
%
 
6.2
%
Yield on average assets
 
2.92
%
 
5.93
%
 
8.31
%
 
4.34
%
Average balance of associated repurchase agreements
 
$
1,957,927

 
$
1,163,225

 
$
94,330

 
$
3,215,482

Average balance of securitized debt  (3)
 
$
—

 
$
—

 
$
28,582

 
$
28,582

Total interest expense
 
$
1,881

 
$
5,361

 
$
992

 
$
8,234

Average cost of funds (4) (5)
 
0.38
%
 
1.82
%
 
3.19
%
 
1.00
%
Net interest income
 
$
13,949

 
$
16,804

 
$
2,631

 
$
33,384

Net interest rate spread
 
2.54
%
 
4.11
%
 
5.12
%
 
3.34
%
Total interest expense including net interest cost of Swaps (6)
 
$
6,667

 
$
5,361

 
$
1,126

 
$
13,154

Effective cost of funds (6)
 
1.35
%
 
1.82
%
 
3.62
%
 
1.60
%
Net interest income including net interest cost of Swaps
 
$
9,163

 
$
16,804

 
$
2,497

 
$
28,464

Effective net interest rate spread (6)
 
1.57
%
 
4.11
%
 
4.69
%
 
2.74
%
(1) 
Other credit investments were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Reflects the average unpaid principal balance.
(Notes continued on next page.)


55


(Notes continued.)
(4) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(5) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, those costs are included in gain/(loss) on derivative instruments in our consolidated statement of operations.
(6) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by the securities that we retained in the securitization transaction. These bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
As of June 30, 2016, our repurchase agreement borrowings collateralized by Agency RMBS had initial terms of up to two months with haircut (or, the percentage by which the collateral value is contractually required to exceed the loan amount) requirements ranging from 3.0% to 5.0% and financing rates from 0.65% to 0.74%; our repurchase agreement borrowings collateralized by non-Agency RMBS and other investment securities had initial terms of up to twenty four months with haircut requirements ranging from 10.0% to 40.0% and financing rates from 1.44% to 2.95%.
The following table presents the cost of funds and effective cost of funds for our repurchase agreement borrowings by type of collateral pledged for the periods presented:
Table 7
 
Three Months Ended June 30,
 
 
2016
 
2015
Collateral Pledged:
 
Cost of
Funds
 
Effective
Cost of
Funds(1)
 
Cost of
Funds
 
Effective
Cost of
Funds(1)
Agency RMBS
 
0.68
%
 
0.88
%
 
0.38
%
 
1.35
%
Non-Agency RMBS and other credit investments(2)
 
2.10

 
2.10

 
1.82

 
1.82

Securitized mortgage loans(3)
 
3.21

 
3.59

 
3.19

 
3.62

Total
 
1.34
%
 
1.47
%
 
1.00
%
 
1.6
%
(1) 
The effective cost of funds for the periods presented includes interest expense for the periods and the net interest component for Swaps during the periods of $807 and $4,920, respectively. While we have not elected to apply hedge accounting for our Swaps, we view such instruments as an economic hedge against the impact of increases in interest rates on our borrowing costs. (See “Non-GAAP Financial Measures,” below.)
(2) 
For the periods presented, other credit investments were comprised of other investment securities and other investments.
(3) 
The non-Agency RMBS associated with our securitization transactions are eliminated in consolidation with the associated VIEs and the mortgage loans in the VIEs are consolidated by us. The interest expense on repurchase agreement borrowings associated with non-Agency RMBS associated with our securitization transactions are included with the cost of funds for our securitized mortgage loans.
Gains/(Losses) on Derivative Instruments
The following table presents components of our gain/(loss) on derivative instruments for the periods presented:
Table 8
 
Three Months Ended June 30,
Components of Gain/(Loss) on Derivative Instruments
 
2016
 
2015
Net interest payments/accruals on Swaps(1)
 
$
(807
)
 
$
(4,920
)
Loss on the termination of Swaps, net(1)
 
(5,871
)
 
—

Losses on the termination and expiration of Swaptions, net(1)
 
(12,100
)
 
(6,170
)
Losses on settlement of TBA Contracts, net(1)
 
(600
)
 
—

Change in fair value of Swaps(2)
 
6,493

 
14,769

Change in fair value of Swaptions, net(2)
 
12,661

 
8,879

Change in fair value of TBA Contracts(2)
 
(7,646
)
 
(95
)
Total
 
$
(7,870
)
 
$
12,463

(1) 
Amounts are realized.
(2) 
Amounts are unrealized.
In general, we expect that changes in the fair value of our derivative instruments will generally move inversely to changes in the fair value of our Agency pass-through RMBS, however changes in the value of derivatives relative to our Agency pass-


56


through RMBS may not off-set entirely. We note that the terms and benchmark interest rates associated with Swaps and Swaptions, which we had historically used as economic hedges, are not matched with our investments and that the notional amount of our derivatives is not equal to our investments. Further the value of our Swaps and Swaptions do not mitigate the impact of spread widening, which occurs when market spreads widen between the yield on RMBS relative to certain benchmark interest rates. During the three months ended June 30, 2016, we migrated from Swaps and Swaptions to Short TBA Contracts. We expect that our Short TBA Contracts, among other things, will mitigate the economic impact of changes in interest rates on our Agency RMBS portfolio. We realized aggregate net losses of $17,971 on terminations of Swaps and Swaptions, of which $17,535 was reflected in net unrealized losses on such instruments at March 31, 2016. (For a breakout of the components of our realized and unrealized gains and losses on our derivative instruments, see Notes 11(d) and 11(e) to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q.) The timing and amount of realized and unrealized gains/(losses) associated with our derivative instruments cannot be predicted, as the value of such instruments generally moves inversely with changes in interest rates which cannot be predicted with any certainty. (For more information about derivative instruments we held at June 30, 2016 and December 31, 2015, see Note 11 to the consolidated financial statements included under Item 1 of Part I of this Quarterly Report on Form 10-Q.) The following table presents the notional amount and estimated fair value for each of our derivative instrument types at June 30, 2016 and December 31, 2015:
Table 9
 
June 30, 2016
 
December 31, 2015
 
 
Notional Amount
 
Estimated Fair Value
 
Notional Amount
 
Estimated Fair Value
Swaps - assets
 
$
—

 
$
—

 
$
693,000

 
$
3,103

Swaptions - assets
 
—

 
—

 
875,000

 
1,244

Swaptions - (liabilities)
 
—

 
—

 
300,000

 
(10,237
)
Swaps - (liabilities)
 
42,000

 
(1,274
)
 
994,000

 
(3,381
)
TBA Contracts - (liabilities)
 
868,000

 
(7,268
)
 
100,000

 
(195
)
Total derivative instruments, net
 
$
910,000

 
$
(8,542
)
 
$
2,962,000

 
$
(9,466
)
The following tables present our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the periods presented: (See “Non-GAAP Financial Measures,” below.)
Table 10
 
Repurchase Borrowings on Agency RMBS
 
Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1)
 
Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2)
 
Total
Three Months Ended June 30, 2016
 
 
 
 
 
 
 
 
Effective interest expense
 
$
3,080

 
$
5,070

 
$
900

 
$
9,050

Effective cost of funds
 
0.88
%
 
2.10
%
 
3.59
%
 
1.47
%
Effective net interest income
 
$
6,984

 
$
13,253

 
$
2,330

 
$
22,567

Effective net interest rate spread
 
1.74
%
 
3.75
%
 
4.78
%
 
2.82
%
Three Months Ended June 30, 2015
 
 
 
 
 
 
 
 
Effective interest expense
 
$
6,667

 
$
5,361

 
$
1,126

 
$
13,154

Effective cost of funds
 
1.35
%
 
1.82
%
 
3.62
%
 
1.60
%
Effective net interest income
 
$
9,163

 
$
16,804

 
$
2,497

 
$
28,464

Effective net interest rate spread
 
1.57
%
 
4.11
%
 
4.69
%
 
2.74
%
(1) 
Other credit investments were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments.
(2) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.


57


Realized and Unrealized Gains/(Losses) on Investments and Securitized Debt
During the three months ended June 30, 2016 and 2015, we sold Agency RMBS of $174,245 and $792,820, respectively, realizing net gains/(losses) of $273 and ($4,276), respectively. During the three months ended June 30, 2016, we did not sell any non-Agency RMBS, and we sold non-Agency RMBS of $29,056 realizing net losses of $254 during the three months ended June 30, 2015.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, mortgage loan pools, other investment securities and securitized debt and, as a result, record changes in the estimated fair value of such instruments in earnings.
The following table presents amounts related to realized gains and losses, OTTI recognized and changes in estimated fair value of our assets and liabilities carried at fair value for the three months ended June 30, 2016 and June 30, 2015:
Table 11
 
Three Months Ended June 30,
 
 
2016
 
2015
Realized gain on sale of RMBS, net
 
$
273

 
$
(4,530
)
Realized gain on sale of other investment securities, net
 
—

 
102

Unrealized gain/(loss) on RMBS, net
 
7,599

 
(41,266
)
OTTI recognized
 
(5,012
)
 
(197
)
Realized loss on derivatives, net (1)
 
(19,378
)
 
(11,090
)
Unrealized gain on derivatives, net
 
11,508

 
23,553

Unrealized gain/(loss) on other investment securities
 
3,726

 
(2,540
)
Unrealized gain/(loss) on securitized mortgage loans, net
 
5,751

 
(1,896
)
Unrealized gain on securitized debt
 
20

 
1,001

Total
 
$
4,487

 
$
(36,863
)
(1) 
Realized losses on derivatives include net interest payments/accruals on Swaps, net losses on the termination and expiration of Swaptions and net losses on the settlement of TBA Contracts.
Expenses
General and Administrative Expenses and Merger Costs: We reimburse our Manager for our allocable share of the compensation of our Chief Financial Officer/Treasurer/Secretary based on the percentage of his time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, Board fees and expenses, compliance related costs, corporate insurance, and miscellaneous other operating costs. Costs for our third-party investment accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $3,664 and $3,655 for the three months ended June 30, 2016 and 2015, respectively. In addition we incurred Merger related expenses of $1,321 for the three months ended June 30, 2016, comprised primarily of legal fees. (See “Merger Agreement,” discussed above.)
Management Fee Expense: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of adjusted stockholders’ equity as defined in the Management Agreement, per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel, who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fees of $2,493 and $2,895 for the three months ended June 30, 2016 and 2015, respectively.
The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 13(a) to the consolidated financial statements included under Item 1 of Part I of this Quarterly Report Form 10-Q.
Six Months Ended June 30, 2016 compared to the Six Months Ended June 30, 2015
For the six months ended June 30, 2016, we had net income of $7,264, or $0.00 per basic share and diluted common share, compared to net income of $11,375, or $0.13 per basic share and diluted common share, for the six months ended June


58


30, 2015. Our results of operations for the six months ended June 30, 2016 and June 30, 2015 were significantly impacted by other losses of $24,838 and $40,286, respectively as discussed below.
Net Interest Income
Our net interest income was $49,554 for the six months ended June 30, 2016 compared to $64,848 for the comparative period in 2015. For the six months ended June 30, 2016 and June 30, 2015, we earned interest income of $66,478 and $80,913, respectively, and incurred interest expense of $16,924 and $16,065, respectively, which expense was primarily related to our borrowings under repurchase agreements. At June 30, 2016, we had securitized debt with a contractual balance of $13,382 with a fixed stated interest rate of 4.00%.
For the six months ended June 30, 2016, we had average debt-to-equity of 3.74 times, compared to 4.10 times for the six months ended June 30, 2015. This decrease in leverage reflects our use of lower leverage on our Agency and non-Agency RMBS. Our interest rate spread and net interest margin were 2.97% and 3.20% for the six months ended June 30, 2016, respectively, compared to 3.33% and 3.41%, respectively, for the six months ended June 30, 2015, as the yields on our earning assets declined and interest rates on our borrowings increased.
The impact of our Swaps is not reflected in our net interest rate spread and net interest margin. However, when making investment decisions, we consider our effective cost of borrowings, which includes the net interest component of our Swaps. (See Tables 14, 21 and 22 below.)
The yield on our Agency RMBS for the six months ended June 30, 2016 decreased to 2.76% from 2.93% for six months ended June 30, 2015. This decrease primarily reflects our migration to Agency RMBS backed by ARMs and lower coupon fixed rate bonds. Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS to vary significantly over time. In addition, changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income recognized in future periods on such investments.
The following tables present certain information regarding our interest-earning assets, interest-bearing liabilities and the components of our net interest income for the six months ended June 30, 2016 and 2015:
Table 12
 
 
 
 
Six Months Ended June 30, 2016
Collateral
 
Agency
 
Non-Agency and Other Credit Investments (1)
 
Securitized
Mortgage
Loans
 
Total
Average balance (2)
 
$
1,613,024

 
$
1,322,761

 
$
156,770

 
$
3,092,555

Total interest income
 
$
22,286

 
$
37,696

 
$
6,496

 
$
66,478

Yield on average assets
 
2.76
%
 
5.70
%
 
8.29
%
 
4.30
%
Average balance of associated repurchase agreements
 
$
1,457,770

 
$
993,031

 
$
87,046

 
$
2,537,847

Average balance of securitized debt
 
$
—

 
$
—

 
$
16,460

 
$
16,460

Total interest expense
 
$
4,833

 
$
10,413

 
$
1,678

 
$
16,924

Average cost of funds (3) (4)
 
0.66
%
 
2.10
%
 
3.24
%
 
1.33
%
Net interest income
 
$
17,452

 
$
27,284

 
$
4,818

 
$
49,554

Net interest rate spread
 
2.10
%
 
3.60
%
 
5.05
%
 
2.97
%
Total interest expense including net interest cost of Swaps
 
$
7,989

 
$
10,413

 
$
1,883

 
$
20,285

Effective cost of funds (6)
 
1.10
%
 
2.10
%
 
3.64
%
 
1.59
%
Net interest income including net interest cost of Swaps
 
$
14,297

 
$
27,283

 
$
4,613

 
$
46,193

Effective net interest rate spread (5)
 
1.67
%
 
3.60
%
 
4.65
%
 
2.71
%
(Tables and notes continued on next page.)


59


(Tables and notes continued.)
Table 13
 
 
 
 
Six Months Ended June 30, 2015
Collateral
 
Repurchase Borrowings on Agency RMBS
 
Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1)
 
Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2)
 
Total
Average balance (2)
 
$
2,194,127

 
$
1,447,923

 
$
145,164

 
$
3,787,214

Total interest income
 
$
32,351

 
$
42,772

 
$
5,790

 
$
80,913

Yield on average assets
 
2.93
%
 
5.88
%
 
9.56
%
 
4.31
%
Average balance of associated repurchase agreements
 
$
2,010,378

 
$
1,133,198

 
$
92,443

 
$
3,236,019

Average balance of securitized debt
 
$
—

 
$
—

 
$
29,995

 
$
29,995

Total interest expense
 
$
3,761

 
$
10,527

 
$
1,777

 
$
16,065

Average cost of funds (3) (4) (5)
 
0.37
%
 
1.85
%
 
2.89
%
 
0.98
%
Net interest income
 
$
28,590

 
$
32,245

 
$
4,013

 
$
64,848

Net interest rate spread
 
2.56
%
 
4.03
%
 
6.67
%
 
3.33
%
Total interest expense including net interest cost of Swaps
 
$
13,376

 
$
10,527

 
$
2,046

 
$
25,949

Effective cost of funds (6)
 
1.32
%
 
1.85
%
 
3.32
%
 
1.58
%
Net interest income including net interest cost of Swaps
 
$
18,975

 
$
32,245

 
$
3,744

 
$
54,964

Effective net interest rate spread (5)
 
1.61
%
 
4.03
%
 
6.24
%
 
2.73
%
(1) 
Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the periods presented.
(2) 
Amount reflects amortized cost, which does not include unrealized gains and losses.
(3) 
Cost of funds by investment type is based on the underlying investment type of the assets pledged as collateral.
(4) 
Cost of funds does not include accrual and settlement of interest associated with derivative instruments. In accordance with GAAP, such costs are included in “Gain/(loss) on derivative instruments, net” in our consolidated statements of operations.
(5) 
The effective cost of funds for the securitized mortgage loans reflects the cost of our securitized debt and repurchase agreement borrowings collateralized by one of the subordinate securities that we retained in the securitization transaction as well as the associated net interest component of Swaps. These subordinate bonds do not appear on our financial statements, as they were eliminated in consolidation. (See “Non-GAAP Financial Measures,” below.)
(6) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.
Swaps and Swaptions
While we have historically viewed our Swaps and Swaptions as economic hedges against increases in future market interest rates associated with our repurchase agreement borrowings, we have not elected hedge accounting under GAAP. Alternatively, we present the “effective cost of funds” to reflect our interest expense adjusted to include the interest component for our Swaps that would be reported had we elected and qualified for hedge accounting for such instruments. We believe that the presentation of our effective cost of funds, which is a non-GAAP financial measure, is useful for investors as it presents our borrowing costs as viewed by us. (See “Non-GAAP Financial Measures,” below and Note 11 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)


60


The following table presents our effective interest expense, effective cost of funds, effective net interest income and effective net interest rate spread, which amounts are non-GAAP financial measures as they include the net interest component of our Swaps, for the six months ended June 30, 2016 and June 30, 2015. (See Tables 21 and 22, below.)
Table 14
 
 
 
 
 
 
 
 
Six Months Ended June 30, 2016
 
Repurchase Borrowings on Agency RMBS
 
Repurchase Borrowings on Non-Agency RMBS and Other Credit Investments(1)
 
Repurchase Borrowings and Securitized Debt Associated with Securitized Mortgage Loans (2)
 
Total
Effective interest expense
 
$
7,989

 
$
10,413

 
$
1,883

 
$
20,285

Effective cost of funds
 
1.10
%
 
2.10
%
 
3.64
%
 
1.59
%
Effective net interest income
 
$
14,297

 
$
27,283

 
$
4,613

 
$
46,193

Effective net interest rate spread
 
2.10
%
 
3.60
%
 
5.05
%
 
2.97
%
Six Months Ended June 30, 2015
 
 
 
 
 
 
 
 
Effective interest expense
 
$
13,376

 
$
10,527

 
$
2,046

 
$
25,949

Effective cost of funds
 
1.32
%
 
1.85
%
 
3.32
%
 
1.58
%
Effective net interest income
 
$
18,975

 
$
32,245

 
$
3,744

 
$
54,964

Effective net interest rate spread
 
1.61
%
 
4.03
%
 
6.24
%
 
2.73
%
(1) 
Other credit investments presented were comprised of investments in Agency Risk Sharing Securities, SBC-MBS and other investments for the periods presented.
(2) 
Our securitized debt and repurchase borrowings associated with non-Agency RMBS issued through our securitizations are legally collateralized by the securities pledged. However, such securities are eliminated from our consolidated balance sheet and the securitized mortgage loans are presented.
Realized and Unrealized Gains/(Losses) on Investments and Securitized Debt
During the six months ended June 30, 2016 and 2015, we sold Agency RMBS of $580,967 and $1,275,059, respectively, realizing net gains/(losses) of ($539) and $185, respectively, and sold non-Agency RMBS of $66,077 and $179,496, respectively, realizing net gains of $1,134 and $3,823, respectively. From time to time we sell certain securities to balance our portfolio to address actual and anticipated market conditions.
We have elected the fair value option for all of our RMBS, securitized mortgage loans, other investment securities and securitized debt and given that we do not apply hedge accounting, our derivatives are carried at fair value. As a result, we record the change in estimated fair value of each of these instruments in earnings.


61


The following table presents amounts related to realized gains and losses as well as changes in estimated fair value of our RMBS, securitized mortgage loans, securitized debt, other investment securities and derivative instruments, all of which are included in our consolidated statements of operations, for the six months ended June 30, 2016 and June 30, 2015:
Table 15
 
Six Months Ended
 
 
June 30, 2016
 
June 30, 2015
Realized gain on sale of RMBS, net
 
$
595

 
$
4,008

Realized gain/(loss) on sale of other investment securities, net
 
(26
)
 
102

Unrealized gain on RMBS, net
 
11,280

 
(26,486
)
OTTI recognized
 
(5,707
)
 
(2,772
)
Realized gain/(loss) on derivatives, net (1)
 
(45,220
)
 
(21,893
)
Unrealized gain/(loss) on derivatives, net (2)
 
8,876

 
7,835

Unrealized (loss) on other investment securities
 
3,418

 
(2,569
)
Unrealized gain/(loss) on securitized mortgage loans, net
 
1,992

 
466

Unrealized gain on securitized debt
 
22

 
1,014

Total
 
$
(24,770
)
 
$
(40,295
)
(1) 
For the six months ended June 30, 2016 and June 30, 2015 amounts include net interest payments (made)/received, including accrued amounts, associated with our Swaps, realized losses on terminations and expirations of Swaptions and losses on settlement of TBA Contracts. (For detailed information about these items, see Note 11(d) to the consolidated financial statements included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)
(2) 
For the six months ended June 30, 2016 and June 30, 2015, we recognized net unrealized gains/(losses) of $5,859 and ($707), respectively, related to the change in fair value of our Swaps, $10,090 and $9,181, respectively, related to the change in fair value of our Swaptions and ($7,073) and($639), respectively, related to the change in fair value of our TBA Contracts.
At June 30, 2016, we had Swaps with an aggregate notional amount of $42,000, a weighted average fixed pay rate of 1.53% and a weighted average term to maturity of 4.0 years. We had no Swaptions at June 30, 2016, as all Swaptions outstanding at March 31, 2016 were terminated or allowed to expire during the three months ended June 30, 2016.
Expenses
General and Administrative Expenses: We are responsible for our operating expenses, which include the cost of data and analytical systems, outsourced accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, Board fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. We reimburse our Manager, or its affiliates, for our allocable share of the compensation of our Chief Financial Officer based on the percentage of his time spent on our affairs and for other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs. Costs we incur for our third-party accounting services and clearing costs we incur for security and repurchase transactions vary based on the size of our portfolio and transaction activity. We incurred general and administrative expenses of $7,238 and $7,505 for the six months ended June 30, 2016 and 2015, respectively. In addition we incurred Merger related expenses of $4,936 for the six months ended June 30, 2016. (See “Merger Agreement,” discussed above.)
Management Fee: Under the terms of the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement), per annum. Our Manager uses the proceeds from the management fee, in part, to pay compensation to certain of its officers and personnel who, notwithstanding that certain of them also are our officers, will receive no cash compensation directly from us. Pursuant to our Management Agreement, we incurred management fee expenses of $5,278 and $5,682 for the six months ended June 30, 2016 and June 30, 2015, respectively.
The management fees, expense reimbursements and the relationship with our Manager are discussed further in Note 13(c) to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.
Dividends
We have had 6,900,000 shares of Preferred Stock outstanding since September 20, 2012. No dividends may be paid on our common stock unless full cumulative dividends have been paid on our Preferred Stock, all of which have been paid to date.


62


The following table presents cash dividends we have declared on our Preferred Stock from January 1, 2015 through June 30, 2016:
Table 16
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
June 16, 2016
 
June 30, 2016
 
July 29, 2016
 
$
0.50

March 17, 2016
 
March 31, 2016
 
April 29, 2016
 
$
0.50

December 17, 2015
 
December 31, 2015
 
January 30, 2016
 
$
0.50

September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.50

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

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

The following table presents cash dividends we declared on our common stock from January 1, 2015 through June 30, 2016:
Table 17
 
 
 
 
 
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per Share
June 16, 2016
 
June 30, 2016
 
July 29, 2016
 
$
0.48

March 17, 2016
 
March 31, 2016
 
April 29, 2016
 
$
0.48

December 17, 2015
 
December 31, 2015
 
January 30, 2016
 
$
0.48

September 17, 2015
 
September 30, 2015
 
October 30, 2015
 
$
0.48

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

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

Liquidity and Capital Resources
General
To maintain our qualification as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our net taxable income, excluding net capital gains. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations.
Our principal sources of cash generally consist of borrowings under repurchase agreements, payments of principal and interest received on the RMBS portfolios, cash generated from operating results and, depending on market conditions, proceeds from capital market transactions, which to date have reflected issuances of common and preferred stock (collectively our “capital stock”). As part of managing our investment portfolio, we may also generate cash through sales of RMBS. Cash is needed to fund our ongoing obligations, make payments of principal and interest on repurchase agreement borrowings, purchase target assets, meet margin calls, make dividend distributions to stockholders and for other general business and operating purposes. In light of the pending Merger, the terms of certain borrowings at June 30, 2016 were shorter than previous terms.
Our primary sources of cash for the six months ended June 30, 2016 consisted of proceeds from repurchase facility borrowings, proceeds from sales of Agency and non-Agency RMBS and payments of principal and interest we received on our investment portfolio.
Under our repurchase agreements, lenders retain the right to mark the collateral pledged to estimated fair value. A reduction in the value of the collateral pledged will require us to provide additional securities or cash as collateral. As part of our risk management process, our Manager closely monitors our liquidity position and subjects our balance sheet to scenario testing designed to assess our liquidity in the face of different economic and market developments.
We believe we have adequate financial resources to meet our obligations, including margin calls, as they come due, to actively hold and acquire our target assets, to fund dividends we declare on our capital stock and to pay our operating expenses. However, should the value of our pledged assets suddenly decrease, significant margin calls on repurchase agreement borrowings could result and our liquidity position could be materially and adversely affected. Further, should market liquidity tighten, our repurchase agreement counterparties could increase the percentage by which the collateral value is required to exceed the loan amount on new financings, reducing our ability to use leverage. Access to financing may also be negatively


63


impacted by the ongoing volatility in the global financial markets, potentially adversely impacting our current or potential lenders’ ability to provide us with financing.
Stock Repurchase Plan
On November 6, 2013, the Board authorized the Repurchase Program to repurchase up to $50,000 of our outstanding common stock. Such authorization does not have an expiration date. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program may be made at times and in amounts as we deem appropriate, using available cash resources. Shares of common stock repurchased by us under the Repurchase Program are canceled and, until reissued by us, are deemed to be authorized but unissued shares of our common stock. The Repurchase Program may be suspended or discontinued by the Board at any time and without prior notice. Through June 30, 2016, we repurchased 360,800 shares of common stock at an average cost per share of $13.86, all of which were purchased during the three months ended September 30, 2015. At June 30, 2016, $45,000 of common stock remained authorized for future share repurchases under the Repurchase Program.
Investing Activity
During the six months ended June 30, 2016, we (i) invested $7,863 associated with our Seller Financing Program; (ii) received prepayments and scheduled principal amortization of $91,925 for Agency RMBS, $109,365 for non-Agency RMBS and $472 associated with our Seller Financing Program; and (iii) sold Agency RMBS of $580,967 realizing aggregate net losses of $539 and sold $66,077 of non-Agency RMBS realizing net gains of $1,134.
We receive interest-only payments with respect to the notional amount of Agency IO, Agency Inverse IO, and SBA-IO. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of assets. Unlike Agency RMBS, the market prices of an IO generally have a positive correlation to changes in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an IO will decrease, which in turn is expected to increase the cash flow and the value of such securities; inverse results are expected with respect to decreases in market interest rates. In addition to viewing Agency IO as attractive investments, we also view such instruments as an economic hedge, in part, against the impact that an increase in market interest rates would have on our Agency RMBS. However, given that we had Agency IO with an aggregate notional balance of $515,081, the overall impact of Agency IO in off-setting the impact of increases in interest rates on the value of our Agency RMBS portfolio is minimal. During the six months ended June 30, 2016, we sold all of our $6,633 of Agency Inverse IO securities, realizing an aggregate net loss of $136.
As of June 30, 2016, our non-Agency RMBS consisted primarily of RMBS backed by seasoned Subprime mortgages and, to a lesser extent, Alt-A and Option ARMs. The average cost basis of our non-Agency RMBS portfolio was 83.5% of par as of June 30, 2016. (For additional information about our RMBS portfolios as of June 30, 2016, see Note 4 to the consolidated financial statements included under Item 1 of Part I of this Quarterly Report on Form 10-Q.)
Financing Activity
We use repurchase agreements to finance a substantial majority of our Agency RMBS, non-Agency RMBS and other investment securities with such securities pledged as collateral to secure such borrowings. At June 30, 2016, we had outstanding repurchase agreement borrowings with 16 counterparties totaling $2,269,853. We continue to have available capacity under our repurchase agreements; however, our repurchase agreements are generally uncommitted and renewable at the discretion of our lenders. As of June 30, 2016, we had master repurchase agreements with 24 counterparties.


64


The following table presents certain information about our borrowings for the periods presented:
Table 18
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Repurchase Agreements
 
Securitized Debt (1)
Quarter Ended
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at
Month-End
June 30, 2016
 
$
2,443,914

 
$
2,269,853

 
$
2,499,101

 
$
15,010

 
$
13,382

 
$
14,873

March 31, 2016
 
$
2,631,778

 
$
2,549,708

 
$
2,608,161

 
$
17,909

 
$
16,486

 
$
18,056

December 31, 2015
 
$
2,898,737

 
$
2,898,347

 
$
2,913,423

 
$
20,566

 
$
18,904

 
$
20,840

September 30, 2015
 
$
3,047,811

 
$
3,011,025

 
$
3,071,188

 
$
24,708

 
$
21,351

 
$
24,730

June 30, 2015
 
$
3,215,482

 
$
3,177,679

 
$
3,240,446

 
$
28,582

 
$
25,828

 
$
28,883

March 31, 2015
 
$
3,217,137

 
$
3,303,385

 
$
3,303,385

 
$
31,321

 
$
29,240

 
$
31,026

(1) 
The balances presented for securitized debt reflect the balance of such debt, which does not reflect the impact of changes in the fair value of such liability.
The following table presents information about our borrowings by type of collateral pledged, and the fair value of collateral pledged as of the dates presented and the weighted average interest rate, the cost of funds and effective cost of funds for the quarterly periods then ended:
Table 19
 
 
 
 
 
 
 
 
Quarterly Period Ended:
 
Principal Balance  of Borrowing
 
Fair Value of Collateral Pledged (1)
 
Weighted Average Cost of Funds
 
Effective Cost of Funds (2)
June 30, 2016
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,253,520

 
$
1,312,753

 
0.68
%
 
0.88
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
933,519

 
1,208,661

 
2.10

 
2.10

Securitized mortgage loans repurchase borrowings (3)
 
82,814

 
118,443

 
2.85

 
3.30

Total repurchase borrowings
 
2,269,853

 
2,639,857

 
1.32

 
1.45

Securitized debt 
 
13,382

 
93,370

 
5.10

 
5.10

Total
 
$
2,283,235


$
2,733,227

 
1.34
%
 
1.47
%
March 31, 2016
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,467,722

 
$
1,542,699

 
0.64
%
 
1.28
%
Non-Agency RMBS and other investment securities repurchase borrowings
 
996,311

 
1,305,208

 
2.07

 
2.07

Securitized mortgage loans repurchase borrowings (3)
 
85,675

 
119,442

 
2.94

 
3.33

Total repurchase borrowings
 
2,549,708

 
2,967,349

 
1.28

 
1.66

Securitized debt 
 
16,486

 
88,552

 
4.74

 
4.74

Total
 
$
2,566,194

 
$
3,055,901

 
1.30
%
 
1.68
%
June 30, 2015
 
 
 
 
 
 
 
 
Agency RMBS repurchase borrowings
 
$
1,868,994

 
$
1,955,767

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

 
1,577,653

 
1.82

 
1.82

Securitized mortgage loans repurchase borrowings (3)
 
93,602

 
128,933

 
2.76

 
3.33

Total repurchase borrowings
 
3,177,679

 
3,662,353

 
0.97

 
1.57

Securitized debt
 
25,828

 
98,223

 
4.60

 
4.60

Total
 
$
3,203,507

 
$
3,760,576

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

 
$
2,192,291

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

 
1,492,830

 
1.88

 
1.88

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

 
130,672

 
2.15

 
3.08

Total repurchase borrowings
 
3,303,385

 
3,815,793

 
0.93

 
1.52

Securitized debt
 
29,240

 
101,261

 
4.69

 
4.69

Total
 
$
3,332,625

 
$
3,917,054

 
0.96
%
 
1.58
%

(Notes continued on the next page.)


65


(Notes continued.)
(1) 
Includes cash collateral pledged for Agency RMBS, non-Agency RMBS and other investment securities. (See Note 9 to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)
(2) 
The effective cost of funds for the quarterly periods are calculated on an annualized basis and adjusts interest expense to include the net interest component for Swaps. (See “Non-GAAP Financial Measures,” below.)
(3) 
Repurchase agreements collateralized by securitized mortgage loans represent borrowings associated with non-Agency RMBS retained in connection with our 2013 and 2015 securitizations. Non-Agency RMBS were eliminated in consolidation with the VIE associated with such securitizations, and as a result are not included in our consolidated balance sheet. (See Notes 5 and 14 to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)
At June 30, 2016, haircuts ranged from 3% to 5% for our repurchase borrowings secured by Agency RMBS and 10.0% to 40.0% for repurchase borrowings secured by non-Agency RMBS and other investment securities. Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call. Margin calls are satisfied when we pledge additional collateral in the form of securities and/or cash to the lender. We have met all margin calls to date.
Certain repurchase agreements and other transactional agreements subject us to financial covenants. An event of default or termination event would give certain of our counterparties the option to terminate all existing repurchase transactions with us and require amounts due to the counterparties by us to be payable immediately. We were in compliance with all of our financial covenants through June 30, 2016. At June 30, 2016, RMBS and other investment securities pledged as collateral to lenders as security for repurchase agreements totaled $2,639,857 (including securities that are eliminated in consolidation with VIEs) and RMBS held as a component of clearing margin totaled $3,383. Cash collateral held by counterparties is reported on our balance sheet as “Restricted cash” and, at June 30, 2016, was comprised of $14,658 provided in connection with repurchase borrowings and $9,605 provided in connection with derivative contracts.
Cash Flows and Liquidity for the Three Months Ended June 30, 2016
Our cash and cash equivalents decreased by $15,976 during the six months ended June 30, 2016, reflecting $624,778 used by financing activities, $18,551 provided by operating activities and $590,251 provided by investing activities. We held cash and cash equivalents of $104,168 at June 30, 2016. (See “Consolidated Statements of Cash Flows,” included under Item 1 of Part I of this Quarterly Report on Form 10-Q.)
Contractual Obligations and Commitments
The following table summarizes the effect on our liquidity and cash flows of our contractual obligations for principal and interest as of June 30, 2016:
Table 20
 
 
 
 
 
 
 
 
 
 
 
 
Less than  1
year
 
1 to 3
years
 
3 to 5
years
 
More than
5 years
 
Total
Borrowings under repurchase agreements (1) 
 
$
2,269,853

 
$
—

 
$
—

 
$
—

 
$
2,269,853

Interest on repurchase agreements borrowings (2) 
 
6,851

 
—

 
—

 
—

 
6,851

Total
 
$
2,276,704

 
$
—

 
$
—

 
$
—

 
$
2,276,704

(1) 
Amounts presented reflects the principal balance of our repurchase borrowings and do not include associated deferred financing costs of $3.
(2) 
Interest expense is calculated based on the interest rate in effect at June 30, 2016 and includes all interest expense incurred and expected to be incurred in the future through the contractual maturity of the associated repurchase agreement.
The table above does not include amounts due under the Management Agreement as such obligations, discussed below, do not have fixed and determinable payments, or our anticipated dividend on our Preferred Stock. (See Notes 13(a) and 16(b) to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q for a discussion with respect to our Management Agreement and Preferred Stock.) At June 30, 2016, we had securitized debt with a balance of $13,382 (and a fair value of $13,407) with a contractual interest rate of 4.00%. Our securitized debt is not included in the table above, as such debt is non-recourse to us and is only paid to the extent that the mortgage loans (in the securitization trust) collateralizing the debt pay.
(a) Merger Agreement
On February 26, 2016, we entered into a Merger Agreement, under which we will be acquired by ARI for an aggregate purchase price equal to 89.25% of AMTG’s Pricing Date Book Value, plus the assumption of $172,500 of AMTG’s Preferred


66


Stock. AMTG’s Pricing Date Book Value, and therefore the actual purchase price payable, will be subject to adjustment in the event that the closing of the transactions contemplated by the Merger Agreement does not occur by September 5, 2016. The aggregate number of shares of ARI common stock issuable under the Merger Agreement is limited to 13,400,000 shares at a value of $16.75 per share, and the remainder of the consideration will be paid in cash. Based upon the Pricing Date Book Value of $15.52 per share, upon closing of the merger transaction, each outstanding share of AMTG common stock will be converted into the right to receive (i) $6.86 in cash, without interest and (ii) 0.417571 shares of ARI common stock, reflecting an aggregate purchase price value of $616,151, based upon the closing price of ARI common stock on the NYSE on July 22, 2016, including the assumption of the $172,500 (liquidation preference) of our Preferred Stock; provided, however that the cash portion of the merger consideration may be subject to certain adjustments, as discussed above. In addition, each share of AMTG Preferred Stock will be converted into one share of preferred stock, par value $0.01 per share, of a newly-designated series of ARI preferred stock, which is expected to be designated as 8.00% Series C Cumulative Redeemable Perpetual Preferred Stock.
The Merger Agreement and related transactions were approved by all of the members of the Board (with the exception of Mark Biderman, who recused himself) upon the unanimous recommendation of a special committee of independent directors of our Board. Consummation of the merger transaction is subject to the satisfaction of customary closing conditions, including the registration and listing of the shares of ARI stock that will be issued in the merger transaction and the approval and adoption of the Merger Agreement by the holders of a majority of the shares of AMTG common stock entitled to vote on the transaction, including a majority of the votes entitled to be cast by persons unaffiliated with Apollo. ARI stockholder approval is not required in connection with the Merger. On July 27, 2016, we filed a definitive proxy statement/prospectus with the SEC and mailed such statement to our stockholders and ARI filed a definitive proxy statement/prospectus relating to the proposed transaction. The proxy statement/prospectus contains additional information regarding the proposed transaction, including risks associated with the proposed transaction.
(b) Letter Agreement with Manager
Concurrently with the execution of the Merger Agreement, we entered into a Side Letter with our Manager, pursuant to which the Manager agreed to perform such services and activities as may be necessary to enable us to consummate the Merger and other transactions contemplated by the Merger Agreement. In addition, our Manager acknowledged that, as a result of the transactions contemplated by the Merger Agreement, the Management Agreement will be assigned to ARI and such assignment will not give rise to a termination fee under the Management Agreement.
For additional details regarding the terms and conditions of the Merger Agreement and related matters, refer to the definitive proxy statement/prospectus filed with the SEC and mailed to our stockholders on July 27, 2016, and to the Merger Agreement and other documentation filed as annexes thereto. The joint proxy statement/prospectus contains additional information regarding the proposed transaction, including risks associated with the proposed transaction.
Management Agreement
Pursuant to the Management Agreement, our Manager is entitled to a management fee calculated and payable quarterly in arrears in an amount equal to 1.5% of our stockholders’ equity (as defined in the Management Agreement) per annum. Our management fee is used, in part, to pay compensation to officers and personnel of the Manager who may also be our officers, but receive no cash compensation directly from us. We reimburse our Manager and/or its affiliates for the allocable share of the compensation of (1) our Chief Financial Officer/Treasurer/Secretary based on the percentage of such officer’s time spent on our affairs and (2) other corporate finance, tax, accounting, legal, risk management, operations, compliance and other non-investment professional personnel of our Manager or its affiliates who spend all or a portion of their time managing our affairs based on the percentage of time devoted by such personnel to our affairs. We are responsible for our operating expenses, which include the cost of data and analytical systems, legal, accounting, due diligence, prime brokerage and banking fees, professional services, including auditing and legal fees, Board fees and expenses, compliance related costs, corporate insurance and miscellaneous other operating costs. To the extent that our Manager or its affiliates pay for services provided on our behalf, we are required to reimburse our Manager and/or its affiliates for such items. Expense reimbursements to our Manager and/or its affiliates are made in cash generally on a monthly basis in arrears. Our reimbursement obligation is not subject to any dollar limitation.
Our Management Agreement currently runs through July 27, 2017, with automatic one year renewals thereafter provided that the independent directors of the Board do not provide notice of termination. The Management Agreement may be terminated upon the affirmative vote of at least two-thirds of our independent directors based upon (1) unsatisfactory performance by our Manager that is materially detrimental to us or (2) a determination that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination based on unfair fees by accepting a mutually


67


acceptable reduction of management fees agreed to by at least two-thirds of our independent directors. Our Manager must be provided with written notice of any such termination at least 180 days prior to the expiration of the then existing term and will be paid a termination fee equal to three times the sum of the average annual management fee during the 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination. In addition, our Manager acknowledged that, as a result of the transactions contemplated by the Merger Agreement, the Management Agreement will be assigned to ARI and such assignment will not give rise to a termination fee under the Management Agreement.
Off-Balance Sheet Arrangements
We do not have any material off-balance sheet arrangements. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment to provide additional funding to any such entities.
Dividends on Our Capital Stock (Amounts presented under this topic are not in thousands.)
We have outstanding 6,900,000 shares of Preferred Stock, which entitles holders to receive dividends at an annual rate of 8.0% of the liquidation preference of $25.00 per share, or $2.00 per share per annum. The dividends on Preferred Stock are cumulative and payable quarterly in arrears. Except under certain limited circumstances, the Preferred Stock is generally not convertible into or exchangeable for any other property or any other of our securities at the election of the holders. After September 20, 2017, we may, at our option, redeem the shares at a redemption price of $25.00, plus any accrued unpaid distribution through the date of the redemption. No dividends may be paid on our common stock unless full cumulative dividends have been paid on the Preferred Stock, all of which have been paid to date.
We intend to make regular quarterly dividend distributions to holders of our common stock subject to restrictions contained in the Merger Agreement. U.S. Federal income tax law generally requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains and without regard to the deduction for dividends paid, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We have historically paid quarterly dividends on our Common Stock in an amount at least equal to our net taxable income, pursuant to the Merger Agreement, we may not declare a dividend on our common stock during the three months ended September 30, 2016, but expect to declare a quarterly dividend on our Preferred Stock in the event that the Merger does not close prior to September 30, 2016. Before we pay any dividend, whether for U.S. Federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debts payable. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. (See “Variances between GAAP Income and Taxable Income,” above.)
Non-GAAP Financial Measures
We have included in this Form 10-Q disclosures about our “operating earnings,” “operating earnings per common share” and “effective cost of funds” which disclosures constitute non-GAAP financial measures within the meaning of Regulation G promulgated by the SEC. We believe that the non-GAAP financial measures presented, when considered together with GAAP financial measures, provide information that is useful to investors in understanding our operating results. An analysis of any non-GAAP financial measures should be made in conjunction with results presented in accordance with GAAP.
Operating earnings and operating earnings per common share presented exclude, as applicable: (i) certain realized and unrealized gains and losses recognized through earnings; (ii) non-cash equity compensation; (iii) one-time events pursuant to changes in GAAP; and (iv) certain other non-cash charges. Operating Earnings is a non-GAAP financial measure that is used by us to assess our business results.
While we have not elected hedge accounting under GAAP for our Swaps, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates. To present for investors how we view our Swaps, we provide the “effective cost of funds” which is comprised of GAAP interest expense plus the interest expense component for our Swaps. The interest expense component of our Swaps reflects the net interest payments made or accrued on our Swaps. We believe that the presentation of the effective cost of funds is useful for investors, as it presents borrowing costs as viewed by us.
We believe that the non-GAAP measures we present provide investors and other readers of this Quarterly Report on Form 10-Q with useful measures to assess the performance of our ongoing business and useful supplemental information to both management and investors in evaluating our financial results. The primary limitation associated with operating earnings as a measure of our financial performance over any period is that it excludes, except for the net interest component of Swaps, the


68


effects of net realized and unrealized gains/(losses) from investments and derivative instruments. Our presentation of operating earnings may not be comparable to similarly-titled measures of other companies, who may use different definitions or calculations for such term. As a result, operating earnings should not be considered as a substitute for our GAAP net income as a measure of our financial performance or any measure of our liquidity under GAAP.
A reconciliation of the GAAP items discussed above to their non-GAAP measures presented in this Quarterly Report on Form 10-Q are as follows:
Table 21
 
Three Months Ended
 
 
June 30, 2016
 
June 30, 2015
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
8,243

 
1.34
%
 
$
8,234

 
1.00
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest component of Swaps
 
807

 
0.13

 
4,920

 
0.60

Effective cost of funds
 
$
9,050

 
1.47
%
 
$
13,154

 
1.60
%
Average balance of borrowings
 
$
2,443,914

 
 
 
$
3,215,482

 
 
 
 
 
Six Months Ended
 
 
June 30, 2016
 
June 30, 2015
 
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds
Interest expense
 
$
16,924

 
1.33
%
 
$
16,065

 
0.98
%
Adjustment:
 
 
 
 
 
 
 
 
Net interest component of Swaps
 
3,361

 
0.26

 
9,884

 
0.60

Effective cost of funds
 
$
20,285

 
1.59
%
 
$
25,949

 
1.58
%
Average balance of borrowings
 
$
2,537,846

 
 
 
$
3,236,019

 
 
 

Table 22
 
Three Months Ended
 
 
June 30, 2016
 
June 30, 2015
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
31,617

 
4.29
%
 
$
41,618

 
4.34
%
Less: effective interest expense/effective cost of funds (1)
 
9,050

 
1.47

 
13,154

 
1.60

Effective net interest income
 
$
22,567

 
2.82
%
 
$
28,464

 
2.74
%
Average balance of interest-earning assets
 
$
2,945,863

 
 
 
$
3,797,828

 
 
 
 
 
Six Months Ended
 
 
June 30, 2016
 
June 30, 2015
 
 
Reconciliation
 
Yield/Effective Cost of Funds/Spread
 
Reconciliation
 
Cost of Funds/Effective Cost of Funds/Spread
Interest income
 
$
66,478

 
4.30
%
 
$
80,913

 
4.31
%
Less: effective interest expense/effective cost of funds (1)
 
20,285

 
1.59

 
25,949

 
1.58

Effective net interest income
 
$
46,193

 
2.71
%
 
$
54,964

 
2.73
%
Average balance of interest-earning assets
 
$
3,092,555

 
 
 
$
3,787,214

 
 
 
(1) 
As reconciled above in Table 21.


69


The following table presents the reconciliation from net income/(loss) allocable to common stockholders to operating earnings:
Table 23
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2016
 
2015 (1)
 
2016
 
2015 (1)
Net income/(loss) allocable to common stockholders
 
$
16,726

 
$
(13,635
)
 
$
144

 
$
4,168

Adjustments to arrive at operating earnings:
 
 
 
 
 
 
 
 
Realized (gain)/loss on sale of RMBS, net
 
(273
)
 
4,530

 
(595
)
 
(4,008
)
Realized (gain)/loss on sale of other investment securities, net
 
—

 
(102
)
 
26

 
(102
)
Unrealized (gain)/loss on RMBS, net
 
(7,599
)
 
41,266

 
(11,280
)
 
26,486

OTTI recognized
 
5,012

 
197

 
5,707

 
2,772

Unrealized (gain) on derivative instruments, net
 
(11,508
)
 
(23,553
)
 
(8,876
)
 
(7,835
)
Unrealized (gain)/loss on securitized mortgage loans, net
 
(5,751
)
 
1,896

 
(1,992
)
 
(466
)
Unrealized (gain) on securitized debt
 
(20
)
 
(1,001
)
 
(22
)
 
(1,014
)
Unrealized (gain)/loss on other investment securities
 
(3,726
)
 
2,540

 
(3,418
)
 
2,569

Non-cash stock-based compensation expense
 
194

 
304

 
302

 
797

Realized loss on Swap and Swaption terminations, net
 
17,971

 
6,170

 
42,923

 
10,032

Realized (gain)/loss on settlement of TBA Contracts
 
600

 
—

 
(1,064
)
 
1,977

Tax amortization of (loss) on Swaption terminations and expirations, net
 
(1,021
)
 
(620
)
 
(1,860
)
 
(1,058
)
Total adjustments to arrive at operating earnings
 
(6,121
)
 
31,627

 
19,851

 
30,150

Operating earnings
 
$
10,605

 
$
17,992

 
$
19,995

 
$
34,318

Basic and diluted operating earnings per share
 
$
0.33

 
$
0.56

 
$
0.63

 
$
1.07

Merger related expenses
 
$
1,321

 
$
—

 
$
4,936

 
$
—

Operating earnings excluding merger related costs
 
$
11,926

 
$
17,992

 
$
24,931

 
$
34,318

Basic and diluted operating earnings per share, excluding merger related costs
 
$
0.37

 
$
0.56

 
$
0.78

 
$
1.07

Weighted average common shares outstanding- basic (2)
 
31,857

 
32,048

 
31,846

 
32,047

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


70


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


71


The following table presents information about our non-Agency RMBS and the mortgages underlying such securities at June 30, 2016. Information presented with respect to weighted average original loan-to-value, weighted average credit score reported by Fair Isaac Corporation (or, FICO), and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 24
 
 
 
Year of Securitization (1)
 
 
 
 
2015
 
2014
 
2007
 
2006
 
2005
 
2004
 
2003 & 
Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of Securities
 
3

 
4

 
9

 
33

 
54

 
55

 
35

 
193

Carrying Value/Estimated Fair Value
 
$
60,236

 
$
92,571

 
$
55,193

 
$
214,938

 
$
345,267

 
$
213,973

 
$
98,323

 
$
1,080,501

Amortized Cost
 
$
60,330

 
$
92,858

 
$
47,550

 
$
202,671

 
$
348,898

 
$
210,628

 
$
95,728

 
$
1,058,663

Current Par Value
 
$
60,631

 
$
93,321

 
$
81,455

 
$
269,236

 
$
422,701

 
$
234,528

 
$
106,412

 
$
1,268,284

Carrying Value to Current Par
 
99.35
%
 
99.20
%
 
67.76
%
 
79.83
%
 
81.68
%
 
91.24
%
 
92.40
%
 
85.19
%
Amortized Cost to Current Par
 
99.50
%
 
99.50
%
 
58.38
%
 
75.28
%
 
82.54
%
 
89.81
%
 
89.96
%
 
83.47
%
Net Weighted Average Coupon
 
3.18
%
 
3.32
%
 
1.88
%
 
1.08
%
 
1.22
%
 
1.79
%
 
2.37
%
 
1.68
%
Collateral Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted Average Loan Age (in months)
 
100

 
106

 
113

 
121

 
132

 
144

 
164

 
130

Weighted Average Original Loan-to-Value
 
88.58
%
 
78.59
%
 
78.87
%
 
78.90
%
 
79.89
%
 
79.61
%
 
81.79
%
 
80.13
%
Weighted Average Original FICO
 
639

 
581

 
689

 
666

 
663

 
646

 
602

 
645

Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
60+ Days Delinquent
 
25.54
%
 
53.33
%
 
22.94
%
 
24.19
%
 
23.91
%
 
20.67
%
 
23.30
%
 
25.83
%
Average Credit Enhancement (2)
 
49.04
%
 
52.80
%
 
1.10
%
 
21.30
%
 
30.15
%
 
28.20
%
 
23.81
%
 
28.94
%
3 Month CPR (3)
 
11.19
%
 
6.71
%
 
5.84
%
 
6.24
%
 
6.05
%
 
6.07
%
 
5.87
%
 
6.48
%
(1) 
Certain of our non-Agency RMBS have been resecuritized; however, the vintage and information presented is based on the initial year of securitization and the data available at that time.
(2) 
Credit enhancement is expressed as a percentage of all outstanding mortgage loan collateral. Our RMBS may incur losses if credit enhancement is reduced to zero.
(3) 
Amounts presented reflect the weighted average monthly performance for the three months ended June 30, 2016.


72


The following table presents certain characteristics about our securitized mortgage loans, all of which are first liens, at June 30, 2016. Information presented with respect to weighted average original loan-to-value, weighted average FICO score, and other information is aggregated based on information reported at the time of mortgage origination and, as such, do not reflect the impact of the general decline in home prices or changes in a mortgagee’s credit score.
Table 25
 
Year of Origination
 
 
 
 
2009
 
2008
 
2007
 
2006
 
2005
 
2004 & Prior
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of loans
 
3

 
60

 
646

 
150

 
95

 
278

 
1,232

Current unpaid principal balance
 
$
464

 
$
12,412

 
$
120,872

 
$
24,193

 
$
13,600

 
$
20,816

 
$
192,357

Loan Attributes:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted Average Loan Age (in months)
 
83

 
99

 
108

 
116

 
130

 
163

 
116

Weighted Average Original-Loan-to-Value
 
72.81
%
 
73.45
%
 
80.32
%
 
81.82
%
 
76.28
%
 
83.83
%
 
80.14
%
Weighted average original FICO
 
519

 
624

 
632

 
615

 
652

 
618

 
628

Net Weighted Average Original Coupon Rate
 
7.30
%
 
6.32
%

5.77
%

5.93
%

5.33
%

6.55
%

5.88
%
Performance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current
 
—
%
 
65.37
%
 
75.30
%
 
79.50
%
 
80.26
%
 
70.78
%
 
74.87
%
30 day delinquent
 
76.07
%
 
12.31
%
 
9.26
%
 
7.90
%
 
6.97
%
 
10.63
%
 
9.43
%
60 days delinquent
 
—
%
 
—
%
 
3.10
%
 
2.97
%
 
3.56
%
 
6.88
%
 
3.32
%
90+ days delinquent
 
—
%
 
16.40
%
 
6.33
%
 
4.72
%
 
3.69
%
 
5.01
%
 
6.43
%
Bankruptcy/foreclosure
 
23.93
%
 
5.92
%
 
6.01
%
 
4.91
%
 
5.52
%
 
6.70
%
 
5.95
%
The following table presents the fair value of our non-Agency RMBS at June 30, 2016, by original purchase price as a percentage of our par value by year of acquisition:
Table 26
 
Year of Acquisition
 
 
 
 
Acquisition Price (1)
 
2016
 
2015
 
2014
 
2013
 
2012 and Prior
 
Total
 
Percent of Total
>100%
 
$
—

 
$
4,245

 
$
1,488

 
$
1,376

 
$
—

 
$
7,109

 
0.7
%
100% to 95%
 
18,832

 
85,503

 
75,495

 
15,878

 
4,748

 
200,456

 
18.5

<95% to 85%
 
9,189

 
105,663

 
70,406

 
119,372

 
24,693

 
329,323

 
30.5

<85% to 75%
 
5,722

 
10,644

 
69,412

 
116,083

 
48,312

 
250,173

 
23.2

<75% to 65%
 
13,159

 
5,611

 
19,841

 
49,260

 
68,565

 
156,436

 
14.5

<65%
 
—

 
6,733

 
8,566

 
8,591

 
113,114

 
137,004

 
12.6

Total
 
$
46,902

 
$
218,399

 
$
245,208

 
$
310,560

 
$
259,432

 
$
1,080,501

 
100.0
%
(1) 
Prices are expressed as a percentage of par value.


73


The mortgages underlying our non-Agency RMBS are located in various states across the U.S. The following table presents the five largest concentrations by state for the mortgages collateralizing our non-Agency RMBS at June 30, 2016 based on fair value:
Table 27
 
 
Property Location
 
Percent (1)
California
 
28.8
%
New York
 
10.4

Florida
 
8.5

New Jersey
 
5.0

Texas
 
4.9

Other (2) 
 
42.4

Total
 
100.0
%
(1) 
Percentages are weighted to reflect our proportional share for each of the securities we own.
(2) 
Includes mortgages on properties located in each of the remaining 45 states and the District of Columbia, with no state concentration exceeding 3.4% of the total.
The following table presents certain information about the mortgage loans underlying our non-Agency RMBS at June 30, 2016:
Table 28
 
 
 
 
Underlying Mortgage Loan Collateral Type
 
Market Value
 
Percent of Total
Subprime
 
$
726,212

 
67.2
%
Alt-A
 
141,602

 
13.1

Option ARMs
 
212,687

 
19.7

Total
 
$
1,080,501

 
100.0
%
The following table presents the five largest state concentrations, in the aggregate, for mortgage loans included in our securitizations based on principal balance at June 30, 2016:
Table 29
 
 
 
 
Property Location
 
Principal Balance
 
Total Concentration
Florida
 
$
35,635

 
17.8
%
California
 
35,355

 
17.7

Maryland
 
16,287

 
8.1

Texas
 
12,370

 
6.2

New Jersey
 
10,898

 
5.4

Other states and the District of Columbia
 
89,594

 
44.8

Total
 
$
200,139

 
100.0
%
Interest Rate Risk
Interest rates are sensitive to many factors, including fiscal and monetary policies, domestic and international economic and political considerations, as well as other factors, all of which are beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, resecuritizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances, in addition to transaction or asset specific funding arrangements.
Subject to maintaining our qualification as a REIT for U.S. Federal income tax purposes, we utilize derivative financial instruments to mitigate the impact of increases in interest rates. Increases in interest rates may impact the cost of our repurchase borrowings and reduce the value of our Agency RMBS. Our hedges are not designed to protect against market value fluctuations in our assets caused by changes in the spread between our investments and other benchmark rates such as Swaps and U.S. Treasury bonds. Therefore, the risk of adverse spread changes is inherent to our business. Our asset composition and general market conditions may cause the amount of interest rate protection provided by our derivatives to vary


74


considerably over time. We also may utilize a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our fixed-rate Agency pass-through RMBS to decrease; (iii) coupons on our variable rate investment assets to reset to higher interest rates; (iv) prepayments on our RMBS, mortgages and securitized mortgage loans to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS and mortgage and securitized mortgage loans; (v) the value of our Agency IO securities to increase; and (vi) the value of our Short TBA Contracts and Swaps to increase. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs, as well as other conditions in the market place will further impact our results of operations and financial condition.
Interest Rate Cap Risk
Certain of our RMBS and securitized mortgage loans are subject to interest rate caps, which could cause such assets to acquire characteristics similar to fixed-rate securities if interest rates were to rise above the cap levels. Interim interest rate caps limit the amount that interest rates on a particular instrument can adjust periodically. Lifetime interest rate caps limit the amount interest rates can adjust upward from inception through maturity of a particular instrument. Investments that are subject to caps could result in us receiving income on such investments that is less than the interest expense we may incur on borrowings to finance such investments. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under “Interest Rate Risk.”
Interest Rate Effects on Estimated Fair Value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of our assets. We face the risk that the market value of our assets will increase or decrease differently from our derivative instruments.
The impact of changing interest rates on estimated fair value can change significantly when interest rates change materially. Accordingly, changes in actual interest rates may have a material adverse effect on us. Therefore, the volatility in the estimated fair value of our assets could increase significantly in the event that interest rates change materially. In addition, other factors impact the estimated fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions.
Our RMBS are carried at their estimated fair value with unrealized gains and losses included in earnings. The estimated fair value of these securities fluctuates primarily due to changes in interest rates, and with respect to our non-Agency RMBS, credit changes, and other factors. Generally, in a rising interest rate environment, the estimated fair value of our RMBS portfolio, on a net basis, would generally be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of these securities would generally be expected to increase.
Our securitized mortgage loans are carried at their estimated fair value with unrealized gains and losses included in earnings. Such assets, which are credit sensitive, are comprised of both ARMs and fixed rate mortgage loans. As a result, changes in the fair value of our securitized mortgage loans are expected to also be impacted by delinquencies, changes in housing prices, jobless rates and other factors.
Our Agency pass-through RMBS, which comprise the substantial majority of our Agency portfolio, are primarily fixed- rate securities. In general, as market interest rates increase the market prices for fixed-rate securities generally decrease; conversely, as market interest rates decrease the market prices for fixed-rate securities generally increase. We monitor the duration (or, the measure of sensitivity of the price of fixed income securities to changes in interest rates) of our Agency RMBS and derivatives, using empirical data as well as third-party models and may adjust our portfolio to maintain duration at a level that we believe is prudent in the current or anticipated interest rate environment. However, we believe that our Short TBA Contracts at June 30, 2016 will substantially off-set market value changes associated with our fixed-rate Agency RMBS. In a rising interest rate environment, the weighted average life of our Agency RMBS could extend significantly beyond the terms of our Swaps or other hedging instruments. This could have a negative impact on our results from operations, as borrowing costs would no longer be fixed beyond the term of the hedging instrument while the income earned on the remaining Agency RMBS would remain fixed for a period of time. In extreme situations, we may be forced to sell assets to maintain adequate liquidity, which could cause us to incur losses. Variations in models and methodologies in measuring duration may produce differing results for the same securities or portfolio.


75


Our non-Agency RMBS and securitized mortgage loans, are backed by Hybrids, ARMs and fixed rate mortgage loans. These loans may be performing, re-performing or non-performing and, as such, are more significantly impacted by the performance of the underlying collateral (i.e., credit) than by changes in interest rates.
Under our repurchase agreements, each respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets generally results in the lender initiating a margin call, which we satisfy by pledging additional collateral in the form of securities and/or cash to the lender. In general, decreases in the fair value of our RMBS and MBS will reduce the amount we are able to borrow.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including derivative instruments and net interest income based on our portfolio at June 30, 2016, and assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilizes our Manager’s assumptions, models and estimates, which are based on our Manager’s judgment and experience. For example, given the low level of interest rates at June 30, 2016, we have assumed a floor on repurchase agreement borrowing rates of 25 basis points and we have assumed a floor of six basis points with respect to the variable rate that we receive on our Swaps.
Table 30
 
 
 
 
Basis Point Change in Interest Rates
 
Percentage Change in Projected
Portfolio Value
 
Percentage Change in Projected 
Net Interest Income and Periodic Interest Settlements for Swaps
+100
 
1.05%
 
5.54%
+50
 
1.11%
 
5.27%
(50)
 
(0.52)%
 
(3.17)%
(100)
 
(1.17)%
 
(12.08)%
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at June 30, 2016. The analysis presented utilizes assumptions and estimates based on our Manager’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.
Spread Risk
When the market spread between the yield on our investment securities (comprised of Agency RMBS, non-Agency RMBS and other investment securities) and benchmark interest rates widens, our net stockholders’ equity (or, net book value) could decline if the value of our investment securities falls by more than the offsetting fair value increases on our hedging instruments, creating what we refer to as “spread risk”. The spread risk associated with our investment securities and the resulting fluctuations in fair value of these securities can occur independent of changes in benchmark interest rates and may relate to other factors impacting the mortgage and fixed income markets, such as actual or anticipated monetary policy actions by the U.S. Federal Reserve, changes at or actions taken by GSEs, market liquidity, or changes in required rates of return on different assets. Consequently, while we have historically used Swaps and Swaptions as economic hedges to mitigate the impact of increases in interest rates, such instruments typically will not protect our portfolio value against spread risk. The increase in our TBA Contracts during the three months June 30, 2016 are expected to mitigate the future impact of changes in market interest rates and market spreads on our portfolio.

The table below quantifies the estimated changes in the fair value of our investment securities portfolio (including derivatives and other securities used as economic hedges) and in our net asset value should spreads between our mortgage assets and benchmark interest rates go up or down by 5, 15 and 25 basis points. The estimated impact of spread changes are in addition to our sensitivity to interest rate shocks included in the above interest rate sensitivity table. The table below assumes interest rates and prices on our investment securities as of June 30, 2016. However, our portfolio's sensitivity to spread changes will vary with changes in interest rates and in the size and composition of our investment portfolio. Therefore, actual results could differ materially from our estimates.


76


Table 31
 
 
 
 
Basis Points Change in Spread Shock
 
Percentage Change in Projected
Portfolio Value
 
Estimated Change as a Percentage of Equity
(25)
 
0.80%
 
3.34%
(15)
 
0.48%
 
1.99%
(5)
 
0.16%
 
0.67%
+5
 
(0.16)%
 
(0.66)%
+15
 
(0.47)%
 
(1.97)%
+25
 
(0.78)%
 
(3.28)%
Prepayment Risk
The value of our assets may be affected by prepayment rates on residential mortgage loans. If we acquire residential mortgage loans and mortgage related securities, we anticipate that the residential mortgage loans or the underlying residential mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, the decrease in corresponding prepayments on the mortgage-related securities may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated.
Counterparty Risk
We finance the acquisition of a significant portion of our investments with repurchase agreements. The aggregate of our repurchase agreement financings are reflected as a liability in our consolidated balance sheet. In connection with these financing arrangements, we pledge our securities as collateral to secure the borrowing. The amount of collateral pledged will typically exceed the amount of the borrowing, as lenders apply a haircut. As a result, we are exposed to the counterparty if, during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral. (For additional information about our assets pledged as collateral as of June 30, 2016, see Note 9 to the consolidated financial statements, included under Item 1 of Part I in this Quarterly Report on Form 10-Q.)

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

During the past several years, certain repurchase agreement and derivative counterparties in the U.S. and Europe have experienced financial difficulty and have been either rescued by government assistance or otherwise benefited from accommodative monetary policy of their respective central banks. Certain Swap trades entered into since June 10, 2013 are required to be cleared through a clearinghouse, in accordance with the CFTC Swap clearing rules. Swaps cleared under the CFTC Swap clearing rules generally require that higher initial margin collateral be posted relative to Swaps transacted with individual counterparties.


77


The following table summarizes our exposure to our repurchase agreements and derivative counterparties at June 30, 2016:
Table 32
 
 
 
 
 
 
 
 
 
 
 
 
Number of Counter-parties
 
Repurchase
Agreement
Borrowings
 
Derivatives at
Fair Value
 
Exposure (1)
 
Exposure
as Percent
of Total
Assets
North America:
 
 
 
 
 
 
 
 
 
 
United States
 
7

 
$
1,125,129

 
$
(5,287
)
 
$
207,389

 
6.9
%
Canada (2)
 
1

 
251,459

 


 
72,396

 
2.4

 
 
8

 
1,376,588

 
(5,287
)
 
279,785

 
9.3

Europe: (2)
 
 
 
 
 
 
 
 
 
 
Switzerland
 
2

 
134,578

 
—

 
60,514

 
2.0

United Kingdom
 
1

 
10,897

 
—

 
5,344

 
0.2

Netherlands
 
1

 
239,908

 


 
14,358

 
0.5

France
 
1

 
174,150

 
—

 
22,218

 
0.7

 
 
5

 
559,533

 
—

 
102,434

 
3.4

Asia: (2)
 
 
 
 
 
 
 
 
 
 
Japan
 
3

 
333,732

 
(3,255
)
 
16,361

 
0.5

Total
 
16

 
$
2,269,853

 
$
(8,542
)
 
$
398,580

 
13.2
%
 
(1) 
Represents the amount of cash and/or securities pledged as collateral to counterparties and associated accrued interest receivable less the aggregate of repurchase agreement borrowings, associated accrued interest payable and unrealized loss on Swaps for each counterparty net of collateral pledged to us, and the net fair value of our Swaptions.
(2) 
Includes foreign based counterparties as well as U.S. domiciled subsidiaries of such counterparties, as such transactions are generally entered into with a U.S. domiciled subsidiary of such counterparties.
We extend credit to our Seller Financing Program counterparty through a warehouse line, which is used by the counterparty to fund home purchases and improvements. Subsequent to purchasing and rehabilitating a home, our Seller Financing Program counterparty markets the home for sale, offering seller financing through either a BFT Contract or mortgage loan. Once the Seller Financing Program counterparty completes the transaction cycle, by entering into a BFT Contract or mortgage loan with a home buyer, we have the right of first refusal to purchase the corresponding BFT Contract or mortgage loan. The warehouse line is collateralized by a pledge of the ownership interest in the equity of our Seller Financing Program counterparty which holds title to the real estate properties funded with the warehouse line. At June 30, 2016, we had $3,919 outstanding under our warehouse line. If our Seller Financing Program counterparty becomes distressed, we may have difficulty in taking possession of the properties and completing improvements necessary to market the homes for sale.


78


We had outstanding balances under repurchase agreements with 16 counterparties at June 30, 2016. The following table presents information with respect to any counterparty for repurchase agreements for which we had greater than 5% of stockholders’ equity at risk in the aggregate at June 30, 2016:
Table 33
 
 
 
 
 
 
 
 
Counterparty
 
Counterparty Rating(1)
 
Amount of Risk(2)
 
Weighted Average Months to Maturity for Repurchase Agreements
 
Percent of Stockholders’ Equity
Wells Fargo (3)
 
AA-/Aa1/AA
 
$
111,321

 
4

 
16.74
%
RBC (4)
 
AA-/Aa3/AA
 
$
72,396

 
1

 
10.89
%
UBS
 
A-/Ba1/A
 
$
34,193

 
1

 
5.14
%
(1) 
The counterparty rating presented is the long-term issuer credit rating as rated at June 30, 2016 by Standard & Poor’s Ratings Services, Moody’s Investor Services, Inc. and Fitch, Inc., respectively. 
(2) 
The amount at risk reflects the difference between (a) the amount loaned to us through repurchase agreements, including interest payable, and (b) the cash and the fair value of the securities pledged by us as collateral, including accrued interest receivable on such securities.
(3) 
Includes amounts at risk with Wells Fargo Bank, N.A. and Wells Fargo Securities, LLC. Counterparty rating is the rating for Wells Fargo Bank, N.A. which represents $91,002 of the total exposure. The remaining exposure is to Wells Fargo Securities, LLC which was rated AA- by Standard & Poor’s Ratings Services as of June 30, 2016.
(4) 
Includes amounts at risk with Royal Bank of Canada and RBC (Barbados) Trading Bank Corporation. Counterparty rating is the rating for Royal Bank of Canada, which represents $30,229 of the total exposure. The remaining exposure is to RBC (Barbados) Trading Bank Corporation which was rated A2 by Moody’s Investor Services, Inc. at June 30, 2016.
We maintain cash deposits with what we believe to be high credit quality financial institutions and invest in money market funds. Money market funds are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other U.S. Government agency. At June 30, 2016, we had cash and cash equivalents of $104,168, which was primarily comprised of deposits with our prime broker domiciled in the U.S., substantially all of which was in excess of applicable insurance limits, and $40,051 invested in a money market fund.
Funding Risk
We have financed a substantial majority of our securities and mortgage loans with repurchase agreement borrowings. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Weakness in the financial markets, the residential mortgage markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.
Liquidity Risk
The assets that comprise our asset portfolio are not traded on an exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than exchange-traded securities. Certain of our assets may from time to time become illiquid, making it difficult for us to sell such assets if the need or desire arises, or sell such assets at prices that are detrimental to us, including in response to changes in economic and other conditions.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation. Our financial statements are prepared in accordance with GAAP and dividends are based upon net ordinary income as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.


79


ITEM 4.
Controls and Procedures.
The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) required by paragraph (b) of Rule 13a-15 or Rule 15d-15, have concluded that as of June 30, 2016, our disclosure controls and procedures were effective to give reasonable assurances to the timely collection, evaluation and disclosure of information relating to the Company that would potentially be subject to disclosure under the Exchange Act and the rules and regulations promulgated thereunder.
During the period ended June 30, 2016, there was no change in our internal control over financial reporting that has materially affected, or was reasonably likely to materially affect, our internal control over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.


80


PART II – OTHER INFORMATION
ITEM 1.
Legal Proceedings
From time to time, the Company may be involved in various claims and legal actions in the ordinary course of business. After the announcement of the execution of the Merger Agreement, two putative class action lawsuits challenging the proposed First Merger (as defined in the Merger Agreement), captioned Aivasian v. Apollo Residential Mortgage, Inc., et al., No. 24-C-16-001532 and Wiener v. Apollo Residential Mortgage, Inc., et al., No. 24-C-16-001837, were filed in the Circuit Court for Baltimore City (the “Court”). A putative class and derivative lawsuit was later filed in the Court captioned Crago v. Apollo Residential Mortgage, Inc., No. 24-C-16-002610. Following a hearing on May 6, 2016, the Court entered orders among other things, consolidating the three actions under the caption In Re Apollo Residential Mortgage, Inc. Shareholder Litigation, Case No.: 24-C-16-002610. The plaintiffs have designated the Crago complaint as the operative complaint. The operative complaint includes both direct and derivative claims, names as defendants the Company, the Board, ARI, Arrow Merger Sub, Inc., Apollo and Athene Holdings LTD. and alleges, among other things, that the members of the Board breached their fiduciary duties to the Company’s stockholders and that the other corporate defendants aided and abetted such fiduciary breaches. The operative complaint further alleges, among other things, that the proposed First Merger involves inadequate consideration, was the result of an inadequate and conflicted sales process, and includes unreasonable deal protection devices that purportedly preclude competing offers. It also alleges that the transactions with Athene are unfair and that the registration statement on Form S-4 filed with the SEC on April 6, 2016 contains materially misleading disclosures and omits certain material information. The operative complaint seeks, among other things, certification of the proposed class, declaratory relief, preliminary and permanent injunctive relief, including enjoining or rescinding the First Merger, unspecified damages, and an award of other unspecified attorneys’ and other fees and costs. On May 6, 2016, counsel for the plaintiffs filed with the Court a stipulation seeking the appointment of interim co-lead counsel, which stipulation was approved by the Court on June 9, 2016. The defendants believe that the claims asserted in the complaints are without merit and intend to vigorously defend the lawsuits.
As has been reported in the press, on May 13, 2016, the Company and our Manager, were among several entities that received subpoenas from the New York State Department of Financial Services requesting documents relating to seller-financed real estate contracts. The Company and our Manager are cooperating fully with the requests.
ITEM 1A.
Risk Factors
For a discussion of our risk factors, see Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015 and “Risk Factors” in our Proxy Statement/Prospectus on Schedule 14A filed on July 27, 2016. There have been no material changes from the risk factors disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2015 and the risk factor section contained in our Proxy Statement/Prospectus on Schedule 14A filed on July 27, 2016. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business and the trading price of our securities.
ITEM 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3.
Defaults Upon Senior Securities
None.
ITEM 4.
Mine Safety Disclosures
Not Applicable.
ITEM 5.
Other Information
None.


81


ITEM 6.
Exhibits
Exhibit No.
  
Description
 
 
 
2.1

 
Agreement and Plan of Merger, dated as of February 26, 2016, by and among Apollo Commercial Real Estate Finance, Inc., Arrow Merger Sub, Inc. and Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 2.1 of the Registrant’s Form 8-K filed on February 26, 2016.
 
 
2.2

 
Amendment No. 1, dated as of June 30, 2016, to the Agreement and Plan of Merger, dated as of February 26, 2016, by and among Apollo Residential Mortgage, Inc, Apollo Commercial Real Estate Finance, Inc. and Arrow Merger Sub, Inc., incorporated by reference to Exhibit 2.1 of the Registrant’s Form 8-K filed on July 1, 2016 (File No.: 001-35246).
 
 
3.1

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

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

  
Amended and Restated Bylaws of Apollo Residential Mortgage, Inc., incorporated by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on February 26, 2016.
 
 
4.1

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

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

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

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

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

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

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

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

 
Form of Restricted Stock Unit Award Agreement, incorporated by reference to Exhibit 10.4 of the Registrant’s Form S-11, as amended (Registration No. 333-172980).
 
 
 
10.8

 
Form of Restricted Stock Unit Award Agreement granted on March 17, 2016, incorporated by reference to Exhibit 10.8 of the Registrant’s Form 10-Q for the quarter ended March 31, 2016.


82


Exhibit No.
  
Description
 
 
 
31.1

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

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

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

  
XBRL Instance Document
 
 
101.SCH

  
XBRL Taxonomy Extension Schema Document
 
 
101.CAL

  
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF

  
XBRL Taxonomy Extension Definition Linkbase Document
 
 
101.LAB

  
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE

  
XBRL Taxonomy Extension Presentation Linkbase Document




83


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
 
 
 
 
 
 
APOLLO RESIDENTIAL MORTGAGE, INC.
 
 
 
 
 
 
 
 
August 9, 2016
 
 
 
 
 
 
 
 
By:
 
/s/ Michael A. Commaroto
 
 
 
 
 Michael A. Commaroto
 
 
 
 
 President and Chief Executive Officer
 
 
 
 
 (Principal Executive Officer)
 
 
 
 
 
 
 
 
By:
 
/s/ Gregory W. Hunt
 
 
 
 
Gregory W. Hunt
 
 
 
 
 Chief Financial Officer
 
 
 
 
 (Principal Financial Officer and Principal Accounting Officer)


84


Exhibit 31.1
CERTIFICATIONS
I, Michael A. Commaroto, certify that:
1.
I have reviewed this report on Form 10-Q of Apollo Residential Mortgage, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: August 9, 2016
 
 
 
 
By:
 
/s/ Michael A. Commaroto
 
 
Name: Michael A. Commaroto
 
 
Title: President and Chief Executive Officer




Exhibit 31.2
CERTIFICATIONS
I, Gregory W. Hunt, certify that:
1.
I have reviewed this report on Form 10-Q of Apollo Residential Mortgage, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: August 9, 2016
 
 
 
 
By:
 
/s/ Gregory W. Hunt
 
 
Name: Gregory W. Hunt
 
 
Title: Chief Financial Officer, Treasurer and Secretary




Exhibit 32.1
Certification of Chief Executive Officer and Chief Financial Officer
Pursuant to
18 U.S.C. Section 1350
as adopted pursuant to
Section 906 of The Sarbanes-Oxley Act of 2002
The undersigned, the President and Chief Executive Officer of Apollo Residential Mortgage, Inc. (the “Company”), hereby certifies on the date hereof, pursuant to 18 U.S.C. 1350(a), as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 (the “Form 10-Q”), filed concurrently herewith by the Company, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and that the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: August 9, 2016
 
 
  
By:
  
/s/ Michael A. Commaroto
 
 
 
  
Name:
Title:
  
Michael A. Commaroto
President and Chief Executive Officer
The undersigned, the Chief Financial Officer, Treasurer and Secretary of Apollo Residential Mortgage, Inc. (the “Company”), hereby certifies on the date hereof, pursuant to 18 U.S.C. 1350(a), as adopted pursuant to Section 906 of The Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 (the “Form 10-Q”), filed concurrently herewith by the Company, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and that the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company. 
 
 
 
 
 
 
 
Date: August 9, 2016
 
 
  
By:
  
/s/ Gregory W. Hunt
 
 
 
  
Name:
Title:
  
Gregory W. Hunt
Chief Financial Officer, Treasurer and Secretary
Pursuant to the Securities and Exchange Commission Release 33-8238, dated June 5, 2003, this certification is being furnished and shall not be deemed filed by the Company for purposes of Section 18 of the Securities Exchange Act of 1934, as amended or incorporated by reference in any registration statement of the Company filed under the Securities Act of 1933, as amended.
A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.



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