IVR 2014.06.30 10-Q
Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
_______________________________________________ 
FORM 10-Q 
_______________________________________________
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
OR 
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 001-34385

(Exact Name of Registrant as Specified in Its Charter)
_______________________________________________
Maryland
 
26-2749336
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
1555 Peachtree Street, N.E., Suite 1800
Atlanta, Georgia
 
30309
(Address of Principal Executive Offices)
 
(Zip Code)
(404) 892-0896
(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  ý    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, 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  ý    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
 
ý
 
  
Accelerated filer
 
o
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 of the Exchange Act). Yes  o    No  ý
As of August 1, 2014, there were 123,095,889 outstanding shares of common stock of Invesco Mortgage Capital Inc.

 
 
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC.
TABLE OF CONTENTS
 
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Unaudited Consolidated Statements of Equity for the six months ended June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.

Table of Contents


PART I
ITEM 1.
FINANCIAL STATEMENTS
INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
  
As of
$ in thousands, except per share amounts
June 30,
2014
 
December 31,
2013
 
(Unaudited)
 
 
ASSETS
 
Mortgage-backed securities, at fair value
18,247,789

 
17,348,657

Residential loans, held-for-investment, net of loan loss reserve
2,310,686

 
1,810,262

Commercial loans, held-for-investment, net of loan loss reserve
95,585

 
64,599

Cash and cash equivalents
126,128

 
210,612

Due from counterparties
30,413

 
1,500

Investment related receivable
399,499

 
515,404

Investments in unconsolidated ventures, at fair value
44,030

 
44,403

Accrued interest receivable
69,261

 
68,246

Derivative assets, at fair value
70,190

 
262,059

Deferred securitization and financing costs
13,280

 
13,894

Other investments
18,500

 
10,000

Other assets
879

 
1,343

Total assets (1)
21,426,240

 
20,350,979

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Repurchase agreements
14,723,223

 
15,451,675

Secured loans
625,000

 
—

Asset-backed securities
2,016,923

 
1,643,741

Exchangeable senior notes
400,000

 
400,000

Derivative liability, at fair value
268,600

 
263,204

Dividends and distributions payable
64,972

 
66,087

Investment related payable
670,149

 
28,842

Accrued interest payable
25,393

 
26,492

Collateral held payable
14,199

 
52,698

Accounts payable and accrued expenses
2,266

 
4,304

Due to affiliate
9,904

 
10,701

Total liabilities (1)
18,820,629

 
17,947,744

Equity:
 
 
 
Preferred Stock, par value $0.01 per share; 50,000,000 shares authorized, 7.75% series A cumulative redeemable, 5,600,000 shares issued and outstanding ($140,000 aggregate liquidation preference) at June 30, 2014 and December 31, 2013, respectively
135,356

 
135,356

Common Stock, par value $0.01 per share; 450,000,000 shares authorized; 123,094,376 and 124,510,246 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively
1,231

 
1,245

Additional paid in capital
2,531,739

 
2,552,464

Accumulated other comprehensive income (loss)
355,093

 
(156,993
)
Retained earnings (distributions in excess of earnings)
(447,542
)
 
(155,957
)
Total shareholders’ equity
2,575,877

 
2,376,115

Non-controlling interest
29,734

 
27,120

Total equity
2,605,611

 
2,403,235

Total liabilities and equity
21,426,240

 
20,350,979

(1)
The Company's consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations and liabilities of the VIEs for which creditors do not have recourse to the primary beneficiary (IAS Asset I LLC, an indirect subsidiary of the Company). As of June 30, 2014 and December 31, 2013, total assets of the consolidated VIEs were $2,322,093 and $1,819,295, respectively, and total liabilities of the consolidated VIEs were $2,022,948 and $1,648,400, respectively. Refer to Note 3 - "Variable Interest Entities" for further discussion.

The accompanying notes are an integral part of these consolidated financial statements.

 
1
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
$ in thousands, except per share data
2014
 
2013
 
2014
 
2013
Interest Income
 
 
 
 
 
 
 
Mortgage-backed securities
151,920

 
168,736

 
303,659

 
329,080

Residential loans
20,471

 
6,889

 
38,175

 
7,026

Commercial loans
2,061

 
60

 
3,680

 
60

Total interest income
174,452

 
175,685

 
345,514

 
336,166

Interest Expense
 
 
 
 
 
 
 
Repurchase agreements
47,822

 
68,463

 
96,893

 
134,792

Secured loans
176

 
—

 
176

 
—

Exchangeable senior notes
5,613

 
5,622

 
11,220

 
6,782

Asset-backed securities
15,826

 
5,377

 
29,761

 
5,456

Total interest expense
69,437

 
79,462

 
138,050

 
147,030

Net interest income
105,015

 
96,223

 
207,464

 
189,136

Provision for loan losses
(50
)
 
663

 
157

 
663

Net interest income after provision for loan losses
105,065

 
95,560

 
207,307

 
188,473

Other Income (loss)
 
 
 
 
 
 
 
Gain (loss) on sale of investments, net
(20,766
)
 
5,692

 
(32,484
)
 
12,404

Equity in earnings and fair value change in unconsolidated ventures
3,894

 
2,157

 
4,335

 
3,747

Gain (loss) on interest rate derivative instruments, net
(167,816
)
 
53,314

 
(319,128
)
 
51,311

Realized and unrealized credit default swap income
292

 
180

 
621

 
531

Total other income (loss)
(184,396
)
 
61,343

 
(346,656
)
 
67,993

Expenses
 
 
 
 
 
 
 
Management fee – related party
9,327

 
10,807

 
18,662

 
21,161

General and administrative
3,739

 
3,043

 
6,935

 
4,587

Total expenses
13,066

 
13,850

 
25,597

 
25,748

Net income (loss)
(92,397
)
 
143,053

 
(164,946
)
 
230,718

Net income (loss) attributable to non-controlling interest
(1,057
)
 
1,493

 
(1,879
)
 
2,455

Net income (loss) attributable to Invesco Mortgage Capital Inc.
(91,340
)
 
141,560

 
(163,067
)
 
228,263

Dividends to preferred shareholders
2,712

 
2,713

 
5,425

 
5,425

Net income (loss) attributable to common shareholders
(94,052
)
 
138,847

 
(168,492
)
 
222,838

Earnings (loss) per share:
 
 
 
 
 
 
 
Net income (loss) attributable to common shareholders
 
 
 
 
 
 
 
Basic
(0.76
)
 
1.03

 
(1.37
)
 
1.69

Diluted
(0.76
)
 
0.95

 
(1.37
)
 
1.61

Dividends declared per common share
0.50

 
0.65

 
1.00

 
1.30

The accompanying notes are an integral part of these consolidated financial statements.


 
2
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Three Months Ended 
 June 30,
 
Six Months Ended 
 June 30,
$ in thousands, except per share data
2014
 
2013
 
2014
 
2013
Net income (loss)
(92,397
)
 
143,053

 
(164,946
)
 
230,718

Other comprehensive income (loss)
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-back securities
 
 
 
 
 
 
 
Change in fair value
273,222

 
(705,300
)
 
442,689

 
(768,723
)
Reclassification adjustments for (gain) loss included in gain (loss) on sale of investments, net
20,766

 
(5,692
)
 
32,484

 
(12,404
)
Unrealized gain (loss) on mortgage-backed securities, net
293,988

 
(710,992
)
 
475,173

 
(781,127
)
Unrealized gain (loss) on derivatives
 
 
 
 
 
 
 
Change in fair value
—

 
274,660

 
—

 
257,489

Reclassification adjustments for loss included in gain (loss) on interest rate derivative instruments, net
—

 
37,409

 
—

 
72,970

Reclassification adjustments for loss included in repurchase agreements interest expense
21,532

 
—

 
42,828

 
—

Unrealized gain on derivatives, net
21,532

 
312,069

 
42,828

 
330,459

Total Other comprehensive income (loss)
315,520

 
(398,923
)
 
518,001

 
(450,668
)
Comprehensive income
223,123

 
(255,870
)
 
353,055

 
(219,950
)
Less: Comprehensive (income) loss attributable to non-controlling interest
(2,553
)
 
2,662

 
(4,036
)
 
2,258

Less: Dividends to preferred shareholders
(2,712
)
 
(2,713
)
 
(5,425
)
 
(5,425
)
Comprehensive income attributable to common shareholders
217,858

 
(255,921
)
 
343,594

 
(223,117
)
The accompanying notes are an integral part of these consolidated financial statements.


 
3
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EQUITY
For the six months ended June 30, 2014
(Unaudited)
 
 
 
 
Attributable to Common Shareholders
 
 
 
 
 
 
 
 
 
 
Additional
Paid in
Capital
 
Accumulated
Other
Comprehensive
Income (loss)
 
Retained
Earnings
(Distributions
in excess of
earnings)
 
Total
Shareholders’
Equity
 
Non-
Controlling
Interest
 
 
 
 
 
 
 
 
 
 
$ in thousands, except
per share amounts
Preferred Stock
 
Common Stock
 
Total
Equity
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
 
 
Balance at January 1, 2014
5,600,000

 
135,356

 
124,510,246

 
1,245

 
2,552,464

 
(156,993
)
 
(155,957
)
 
2,376,115

 
27,120

 
2,403,235

Net loss
—

 
—

 


 


 
—

 
—

 
(163,067
)
 
(163,067
)
 
(1,879
)
 
(164,946
)
Other comprehensive income
—

 
—

 
—

 
—

 
—

 
512,086

 
—

 
512,086

 
5,915

 
518,001

Proceeds from issuance of common stock, net of offering costs
—

 
—

 
8,235

 
—

 
135

 
—

 
—

 
135

 
—

 
135

Repurchase of shares of common stock
—

 
—

 
(1,438,213
)
 
(14
)
 
(21,114
)
 
—

 
—

 
(21,128
)
 
—

 
(21,128
)
Stock awards
—

 
—

 
14,108

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Common stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(123,093
)
 
(123,093
)
 
—

 
(123,093
)
Common unit dividends
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(1,425
)
 
(1,425
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(5,425
)
 
(5,425
)
 
—

 
(5,425
)
Amortization of equity-based compensation
—

 
—

 
—

 
—

 
254

 
—

 


 
254

 
3

 
257

Balance at June 30, 2014
5,600,000

 
135,356

 
123,094,376

 
1,231

 
2,531,739

 
355,093

 
(447,542
)
 
2,575,877

 
29,734

 
2,605,611

The accompanying notes are an integral part of this consolidated financial statement.


 
4
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
  
Six Months Ended June 30,
$ in thousands
2014
 
2013
Cash Flows from Operating Activities
 
 
 
Net income (loss)
(164,946
)
 
230,718

Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Amortization of mortgage-backed securities premiums and discounts, net
66,983

 
97,379

Amortization of residential loan and asset-backed securities premiums (discount)
1,278

 
164

Amortization of commercial loan origination fees
—

 
(9
)
Origination fee received net of cost paid
—

 
145

Provision for loan losses
157

 
663

Unrealized (gain) loss on interest rate derivative instruments
181,621

 
(24,152
)
Unrealized loss on credit default swap
107

 
568

(Gain) loss on sale of mortgage-backed securities
32,484

 
(12,404
)
(Gain) loss on interest rate derivative instruments
33,861

 
(27,159
)
Equity in earnings and fair value change in unconsolidated ventures
(4,335
)
 
(3,747
)
Amortization of equity-based compensation
257

 
186

Amortization of deferred securitization and financing costs
1,459

 
857

Amortization of deferred swap losses from de-designation
42,828

 
—

Non cash interest income capitalized in commercial loans
(768
)
 
—

Changes in operating assets and liabilities:
 
 
 
(Increase) decrease in accrued interest receivable
(917
)
 
(15,011
)
(Increase) decrease in other assets
464

 
(655
)
Increase (decrease) in accrued interest payable
(1,099
)
 
8,319

Increase (decrease) in due to affiliate
(797
)
 
2,419

Increase (decrease) in accounts payable and accrued expenses
(2,038
)
 
1,213

Net cash provided by operating activities
186,599

 
259,494

Cash Flows from Investing Activities
 
 
 
Purchase of mortgage-backed securities
(3,104,313
)
 
(6,114,762
)
Distributions from investment in unconsolidated ventures, net
4,708

 
2,633

Change on investment in other assets
(8,500
)
 
—

Principal payments from mortgage-backed securities
878,516

 
1,572,612

Proceeds from sale of mortgage-backed securities
2,451,742

 
1,407,453

Payment of premiums for interest rate swaptions
(7,738
)
 
(49,446
)
Proceeds from termination of interest rate swaptions
—

 
47,855

Payments for termination of futures contracts and TBA
(10,586
)
 
—

Purchase of residential loans
(557,763
)
 
(1,562,819
)
Principal payments from residential loans
55,213

 
8,636

Principal payments from commercial loans
401

 
—

Origination and advances of commercial loans, net of origination fees
(30,619
)
 
(9,070
)
Net cash used in investing activities
(328,939
)
 
(4,696,908
)
Cash Flows from Financing Activities
 
 
 
Proceeds from issuance of common stock
135

 
396,503

Repurchase of common stock
(21,128
)
 
—

Cost of issuance of preferred stock
—

 
(6
)
Due from counterparties
(27,190
)
 
—

Collateral held payable
(32,705
)
 
91,368

Proceeds from repurchase agreements
74,527,163

 
96,451,813

Principal repayments of repurchase agreements
(75,255,615
)
 
(94,265,538
)
Proceeds from issuance of exchangeable senior notes
—

 
400,000

Proceeds from asset-backed securities
422,466

 
1,440,755

Principal repayments of asset-backed securities
(48,367
)
 
(8,413
)
Proceeds from issuance of secured loans
1,585,247

 
—

Principal repayments on secured loans
(960,247
)
 
—

Payments of deferred costs
(845
)
 
(15,551
)
Payments of dividends and distributions
(131,058
)
 
(170,214
)
Net cash provided by financing activities
57,856

 
4,320,717

Net change in cash and cash equivalents
(84,484
)
 
(116,697
)
Cash and cash equivalents, beginning of period
210,612

 
286,474

Cash and cash equivalents, end of period
126,128

 
169,777

Supplement Disclosure of Cash Flow Information
 
 
 
Interest paid
95,066

 
138,204

Non-cash Investing and Financing Activities Information
 
 
 
Net change in unrealized gain (loss) on mortgage-backed securities and hedged derivatives
475,173

 
(450,668
)
Dividends and distributions declared not paid
64,972

 
91,528

(Receivable) / payable for mortgage-backed securities sold / purchased, net
749,469

 
(921,299
)
Repurchase agreements, not settled
—

 
(27,842
)
Collateral held payable, not settled
(5,794
)
 
—

Net change in due from counterparties
(1,723
)
 
—

The accompanying notes are an integral part of these consolidated financial statements.

 
5
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 – Organization and Business Operations
Invesco Mortgage Capital Inc. (the “Company”) is a Maryland corporation focused on investing in, financing and managing residential and commercial mortgage-backed securities and mortgage loans. The Company invests in residential mortgage-backed securities (“RMBS”) for which a U.S. government agency such as the Government National Mortgage Association (“Ginnie Mae”), the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) guarantees payments of principal and interest on the securities (collectively “Agency RMBS”). The Company’s Agency RMBS investments include mortgage pass-through securities and collateralized mortgage obligations (“CMOs”). The Company also invests in RMBS that are not guaranteed by a U.S. government Agency (“non-Agency RMBS”), credit risk transfer securities issued by government-sponsored enterprises ("GSE CRT"), commercial mortgage-backed securities (“CMBS”), residential and commercial mortgage loans, and other real estate-related financing agreements. The Company is externally managed and advised by Invesco Advisers, Inc. (the “Manager”), a registered investment adviser and an indirect, wholly-owned subsidiary of Invesco Ltd. (“Invesco”), a leading independent global investment management firm.
The Company conducts its business through IAS Operating Partnership LP (the “Operating Partnership”) as its sole general partner. As of June 30, 2014, the Company owned 98.9% of the Operating Partnership, and Invesco Investments (Bermuda) Ltd., a direct, wholly-owned subsidiary of Invesco, owned the remaining 1.1%. The Company has one operating segment.
The Company finances its Agency RMBS, non-Agency RMBS, GSE CRT and CMBS investments primarily through short-term borrowings structured as repurchase agreements and secured loans. The Company has secured commitments with a number of repurchase agreement counterparties. The Company finances its residential loans held-for-investment through asset-backed securities ("ABS") issued by securitization trusts for which the Company has determined it is the primary beneficiary. In addition, the Company may use other sources of financing including committed borrowing facilities and other private financing.
The Company elected to be taxed as a real estate investment trust (“REIT”) for U.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986, as amended, commencing with the Company's taxable year ended December 31, 2009. To maintain the Company’s REIT qualification, the Company is generally required to distribute at least 90% of its taxable income to its shareholders annually.

Note 2 – Summary of Significant Accounting Policies
Basis of Quarterly Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, promulgated by the Securities and Exchange Commission (the “SEC”). In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position and the results of operations of the Company for the interim periods presented have been included. Certain disclosures included in the Company’s annual report on Form 10-K are not required to be included on an interim basis in the company’s quarterly reports on Forms 10-Q. The Company has condensed or omitted these disclosures. The interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2013, which was filed with the SEC on March 3, 2014. The results of operations for the period ended June 30, 2014 are not necessarily indicative of the results to be expected for the full year or any other future period.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. The consolidated financial statements also include the consolidation of certain securitization trusts that meet the definition of a variable interest entity ("VIE") if the Company is deemed the primary beneficiary. These trusts hold pools of residential mortgage loans and each trust issues series of ABS payable from the cash flows generated by the underlying pools of residential mortgage loans. Generally, a portion of the ABS issued by these trusts is sold to unaffiliated third parties and the balance is purchased by the Company. The underlying loans owned by the securitization trusts are classified as residential loans held for investment on the Company's consolidated balance sheets. The ABS issued to third parties by the securitization trusts are recorded as liabilities and shown as asset-backed securities. In the Company's consolidated statements of operations, the Company records interest

 
6
 

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income on the residential loans owned by the VIEs and interest expense on the ABS issued by the VIEs. All intercompany balances and transactions have been eliminated.
Variable Interest Entity
A VIE is an entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or where investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events. The entity that consolidates a VIE is known as its primary beneficiary and is generally the entity with (i) the power to direct the activities that most significantly impact the VIE’s economic performance, and (ii) the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE. For VIEs that do not have substantial ongoing activities, the power to direct the activities that most significantly impact the VIE’s economic performance may be determined by a company's involvement with the design of the VIE.
In determining if a securitized trust should be consolidated, the Company evaluates whether it is a VIE and, if so, whether the Company’s direct involvement in the VIE reflects a controlling financial interest that would result in the Company being deemed the primary beneficiary. The Company reassesses its initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events. The Company has consolidated the underlying assets and liabilities of the securitization trusts for which the Company is considered the primary beneficiary, at their fair value and, as such, no gain or loss was recorded upon consolidation. The securitizations are non-recourse financing for the residential mortgage loans held-for-investment. The senior securities issued by the securitization trusts sold to unaffiliated third parties are presented in the consolidated balance sheets as "Asset-backed securities."
Use of Estimates
The accounting and reporting policies of the Company conform to U.S. GAAP. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Examples of estimates include, but are not limited to, estimates of the fair values of financial instruments, interest income on mortgage-backed securities (“MBS”), allowance for loan losses and other-than-temporary impairment charges. Actual results may differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments that have original or remaining maturity dates of three months or less when purchased to be cash equivalents. At June 30, 2014, the Company had cash and cash equivalents, including amounts restricted, in excess of the FDIC deposit insurance limit of $250,000 per institution. The Company mitigates its risk of loss by actively monitoring the counterparties.
Due from Counterparties / Collateral Held Payable
Due from counterparties represents cash posted with the Company's counterparties as collateral for the Company’s interest rate derivatives and repurchase agreements. Collateral held payable represents cash posted with the Company by its counterparties as collateral under the Company’s interest rate derivatives and repurchase agreements. In addition, Collateral held payable may include non-cash collateral in which the Company has the obligation to return the collateral upon the Company either selling or pledging the non-cash collateral. To the extent the Company receives collateral other than cash from its counterparties such assets are not included in the Company’s consolidated balance sheets. Notwithstanding the foregoing, if the Company either sells such assets or pledges the assets as collateral pursuant to a repurchase agreement, the cash received and the corresponding liability is reflected on the consolidated balance sheets.
Underwriting Commissions and Offering Costs
Underwriting commissions and direct costs incurred in connection with the Company’s stock offerings are reflected as a reduction of additional paid-in-capital.
Deferred Costs
Included in deferred costs are costs associated with the issuance of beneficial interests by consolidated VIEs incurred by the Company and costs incurred in connection with the issuance by the Company of its exchangeable senior notes. These costs may include underwriting, rating agency, legal, accounting and other fees. These deferred costs are amortized as an adjustment

 
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to interest expense using the effective interest method, based upon actual repayments of the associated beneficial interests issued to third parties and over the stated legal maturity of the exchangeable senior notes.
Repurchase Agreements
The Company finances its Agency RMBS, non-Agency RMBS, GSE CRT and CMBS investment portfolio primarily through the use of repurchase agreements. Repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, including accrued interest, as specified in the respective agreements.
In instances where the Company acquires Agency RMBS, non-Agency RMBS, GSE CRT or CMBS through repurchase agreements with the same counterparty from whom such assets were purchased, the Company records the assets and the related financing on a gross basis on its consolidated balance sheets, and the corresponding interest income and interest expense in its consolidated statements of operations if the transaction complies with the criteria for gross presentation. All of the following criteria must be met for gross presentation in the circumstance where the repurchase assets are financed with the same counterparty:
•
the initial transfer of and repurchase financing cannot be contractually contingent;
•
the repurchase financing entered into between the parties provides full recourse to the transferee and the repurchase price is fixed;
•
the financial asset has an active market and the transfer is executed at market rates; and
•
the repurchase agreement and financial asset do not mature simultaneously.
The Company currently reflects all proceeds from repurchase agreements borrowings and repayment of repurchase agreement borrowings on a gross basis on the consolidated statements of cash flows. If the transaction does not comply with the criteria for gross presentation, the Company would account for the purchase commitment and repurchase agreement on a net basis and record a forward commitment to purchase such assets as a derivative instrument. Forward commitments are recorded at fair value with subsequent changes in fair value recognized in income. Additionally, the Company records the cash portion of its investment in Agency RMBS, non-Agency RMBS, GSE CRT and CMBS as a mortgage related receivable from the counterparty on its consolidated balance sheets.
Secured Loans
In March 2014, the Company’s wholly-owned subsidiary, IAS Services LLC, became a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”). As a member of the FHLBI, IAS Services LLC may borrow funds from the FHLBI in the form of secured loans.
As of June 30, 2014, IAS Services LLC had secured loans from the FHLBI with short-term maturities. FHLBI advances are treated as secured financing transactions and are carried at their contractual amounts.
Asset-Backed Securities
ABS are recorded at principal balance net of unamortized premiums or discounts.
Fair Value Measurements
The Company discloses the fair value of its financial instruments according to a fair value hierarchy (Levels 1, 2, and 3, as defined). In accordance with U.S. GAAP, the Company is required to provide enhanced disclosures regarding instruments in the Level 3 category (which require significant management judgment), including a separate reconciliation of the beginning and ending balances for each major category of assets and liabilities.
To determine fair value of its financial instruments, the Company generally obtains one price per instrument from its primary valuation service. If this service cannot provide a price, the Company will seek a value from other vendors. The valuation services use various observable inputs which may include a combination of benchmark yields, trades, broker/dealer quotes, issuer spreads, bids, offers and benchmark securities to determine prices. Both the Company and the pricing vendor continuously monitor market indicators and economic events to determine if any may have an impact on the valuations.
Overrides of prices from pricing vendors are rare in the current market environment and with the assets the Company holds. Examples of instances that would cause an override include if the Company recently traded the same security or there is an indication of market activity that would cause the vendor price to be unreliable. In the rare instance where a price is adjusted, the Company has a control process to monitor the reason for such adjustment.

 
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To gain comfort that vendor prices are representative of current market information, the Company compares the transaction prices of security purchases and sales to the valuation levels provided by the vendors. Price differences exceeding pre-defined tolerance levels are identified and investigated and may be challenged. Trends are monitored over time and if there are indications that the valuations are not comparable to market activity, the vendors are asked to provide detailed information regarding their methodology and inputs. Transparency tools are also available from the vendors which help clients observe data points and/or market inputs used for pricing securities.
In addition, the Company performs due diligence procedures on all vendors on at least an annual basis. A questionnaire is sent to vendors which requests information such as changes in methodologies, business recovery preparedness, internal controls and confirmation that evaluations are generated based on market data. Physical visits are also made to each vendor’s office.
As described in Note 11 - “Financial Instruments,” the Company evaluates the source used to provide the market price for each security and makes a determination on its categorization within the fair value hierarchy. If the price of a security is obtained from quoted prices for identical instruments in active markets, the security is classified as a level 1 security. If the price of a security is obtained from quoted prices for similar instruments or model-derived valuations whose inputs are observable, the security is classified as a level 2 security. If the inputs appear to be unobservable, the security would be classified as a level 3 security.
Additionally, U.S. GAAP permits entities to choose to measure many financial instruments and certain other items at fair value (the “fair value option”). Unrealized gains and losses on items for which the fair value option has been elected are recognized in earnings at each subsequent reporting date.
The Company elected the fair value option for its investments in unconsolidated ventures. The Company has the one-time option to elect fair value for these financial assets on the election date. The changes in the fair value of these instruments are recorded in equity in earnings and fair value change in unconsolidated ventures in the consolidated statements of operations.
For assets representing available-for-sale investment securities, any change in fair value is reported through consolidated other comprehensive income (loss) with the exception of impairment losses, which are recorded in the consolidated statements of operations.
Securities
The Company designates securities as held-to-maturity, available-for-sale, or trading depending on its ability and intent to hold such securities to maturity. Trading and securities available-for-sale are reported at fair value, while securities held-to-maturity are reported at amortized cost. Although the Company generally intends to hold most of its RMBS and CMBS until maturity, the Company may, from time to time, sell any of its RMBS, GSE CRT or CMBS as part of its overall management of its investment portfolio and therefore classifies its RMBS, GSE CRT and CMBS as available-for-sale securities.
All securities classified as available-for-sale are reported at fair value, based on market prices from third-party sources, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity.
The Company considers its portfolio of Agency RMBS to be of high credit quality under applicable accounting guidance. For non-Agency RMBS, GSE CRT and CMBS, the Company does not rely on ratings from third party agencies to determine the credit quality of the investment. To determine expected future losses, the Company uses internal models that analyze the individual loans underlying each security and evaluate factors including, but not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration to estimate the expected future cash flows. The Company places reliance on this internal model in determining credit quality and the corresponding accounting treatment.
While non-Agency RMBS, GSE CRT and CMBS with expected future losses are generally purchased at a discount to par, the potential for a significant adverse change in expected cash flows remains. The Company therefore considers each security for other-than-temporary impairment at least quarterly and more frequently when economic or market conditions warrant such evaluation.
The determination of whether a security is other-than-temporarily impaired involves judgments and assumptions based on subjective and objective factors. Consideration is given to (i) the length of time and the extent to which the fair value has been less than cost, (ii) the financial condition and near-term prospects of recovery in fair value of the security, and (iii) the Company’s intent and ability to retain its investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value.

 
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For debt securities, the Company recognizes in earnings and reflects as a reduction in the cost basis of the security the amount of any other-than-temporary impairment related to credit losses or impairments on securities that the Company has the intent to sell or for which it is more likely than not that the Company will need to sell before recoveries. The amount of the other-than-temporary impairment on debt securities related to other factors is recorded consistent with changes in the fair value of all other available-for-sale securities as a component of consolidated shareholders’ equity in other comprehensive income or loss with no change to the cost basis of the security.
Residential Loans Held-For-Investment
Loans held-for-investment include securitized residential mortgage loans held by VIEs in which the Company has determined it is the primary beneficiary and which are included in the Company's consolidated balance sheets, and are carried at unpaid principal balance net of any premiums and allowance for loan losses. The Company expects that it will be required to continue to consolidate the VIEs in which such loans are held and generally does not have the authority to sell the residential loans held in the VIEs.
Commercial Loans Held-For-Investment
Commercial loans held-for-investment by the Company are carried at cost, net of any allowance for loan losses. An allowance for loan losses will be recognized only if past and current events indicate it is probable that all amounts due will not be collected according to the terms of the loan agreement.
Interest Income Recognition
Securities
Interest income on available-for-sale MBS, which includes accretion of discounts and amortization of premiums on such MBS, is recognized over the life of the investment using the effective interest method. Management estimates, at the time of purchase, the future expected cash flows and determines the effective interest rate based on these estimated cash flows and the Company’s purchase price. As needed, these estimated cash flows are updated and a revised yield is computed based on the current amortized cost of the investment. In estimating these cash flows, there are a number of assumptions that are subject to uncertainties and contingencies, including the rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the pass through or coupon rate and interest rate fluctuations. In addition, management must use its judgment to estimate interest payment shortfalls due to delinquencies on the underlying mortgage loans. These uncertainties and contingencies are difficult to predict and are subject to future events that may impact management’s estimates and its interest income. Security transactions are recorded on the trade date. Realized gains and losses from security transactions are determined based upon the specific identification method and recorded as gain (loss) on sale of investments, net in the consolidated statements of operations.
Residential Loans
Interest income from the Company’s residential loans is recognized on an accrual basis with the related premiums being amortized into interest income using the effective interest method over the weighted average life of these loans. In estimating these cash flows, there are a number of assumptions that are subject to estimation, including the interest rate and timing of principal payments (prepayments, repurchases, defaults and liquidations) and other factors. Coupon interest is recognized as revenue when earned and deemed collectible or until a loan becomes more than 90 days past due, at which point the loan is placed on nonaccrual status. Interest previously accrued for loans that have been placed on non-accrual status is reversed against interest income in the period it becomes nonaccrual. Residential loans delinquent more than 90 days or in foreclosure are characterized as delinquent. Cash principal and interest that is advanced from servicers subsequent to a loan becoming greater than 90 days past due is recorded as a liability due to the servicer. When a delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternately, nonaccrual loans may be placed back on accrual status if restructured and after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.
Commercial Loans
Interest is recognized as revenue when earned and deemed collectible, or until a loan becomes past due based on the terms of the loan agreement, with the related originating fees, net of origination cost, being amortized into interest income using the effective interest method over the life of the loan. Interest received subsequent to a loan becoming past due or impaired is used to reduce the outstanding loan principal balance. When a delinquent loan previously placed on nonaccrual status has cured, meaning all delinquent principal and interest have been remitted by the borrower, the loan is placed back on accrual status. Alternately, loans that have been individually impaired may be placed back on accrual status if restructured and

 
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after the loan is considered re-performing. A restructured loan is considered re-performing when the loan has been current for at least 12 months.
Allowance for Loan Losses
Residential Loans
For residential loans classified as held-for-investment, an allowance for loan losses is established based on the Company's estimate of credit losses. In calculating the allowance for loan losses, the Company assesses expected losses by estimating the probability of default and expected loss severities on the loans. The following factors are considered in the quarterly evaluation of the allowance for loan losses:
•
Loan-to-value ratios, property values, credit scores, occupancy status, geographic concentration and other observable data available from third party providers;
•
Historical prepayments, default rates and loss severities; and
•
Trends in delinquencies, loan liquidations, foreclosure timelines, liquidation expenses, servicer advances of delinquent principal and interest, and other observable data related to the servicing of the loans.
Commercial Loans
For commercial loans classified as held-for-investment, the Company establishes a specific allowance for loan losses for loans the Company has determined to be impaired at the reporting date. An individual loan is considered impaired when it is deemed probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan.
The Company's methodology for assessing the adequacy of the allowance for loan losses begins with a quarterly formal review of each commercial loan in the portfolio to determine whether the loan is impaired. The Company generally considers the following factors in evaluating each loan:
•
Loan-to-value ratios upon origination or acquisition of the loan;
•
The most recent financial information available for each loan and associated properties, including net operating income, debt service coverage ratios, occupancy rates, rent rolls, as well as any other loss factors the Company considers relevant, such as, but not limited to, specific loan trigger events that would indicate an adverse change in expected cash flows or payment delinquency;
•
Economic trends, both macroeconomic as well as those directly affecting the properties associated with the loans, and the supply and demand of competing projects in the sub-market in which the subject property is located; and
•
The loan sponsor or borrowing entity’s ability to ensure that properties associated with the loan are managed and operated sufficiently.
Where an individual commercial loan is deemed to be impaired, the Company records an allowance to reduce the carrying value of the loan to the current present value of expected future cash flows discounted at the loan’s effective rate, with a corresponding charge to provision for loan losses on the Company's consolidated statements of operations.
Investments in Unconsolidated Ventures
The Company has investments in unconsolidated ventures. In circumstances where the Company has a non-controlling interest but is deemed to be able to exert significant influence over the affairs of the enterprise, the Company utilizes the equity method of accounting. Under the equity method of accounting, the initial investment is increased each period for additional capital contributions and a proportionate share of the entity’s earnings and decreased for cash distributions and a proportionate share of the entity’s losses.
The Company elected the fair value option for its investments in unconsolidated ventures. The election was made upon initial recognition in the financial statements. The Company has elected the fair value option for the purpose of enhancing the transparency of its financial condition. The Company measures the fair value on the basis of the net asset value per share of the investments.

 
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Dividends and Distributions Payable
Dividends and distributions payable represent dividends declared at the balance sheet date which are payable to common shareholders and preferred shareholders, and distributions declared at the balance sheet date which are payable to the non-controlling interest common unit holder of the Operating Partnership, respectively.
Earnings (Loss) per Share
The Company calculates basic earnings (loss) per share by dividing net income attributable to common shareholders for the period by weighted-average shares of the Company’s common stock outstanding for that period. Diluted earnings per share takes into account the effect of dilutive instruments, such as units of limited partnership interest in the Operating Partnership (“OP Units”), exchangeable debt, and unvested restricted stock, but uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted-average number of shares outstanding.
Comprehensive Income
Comprehensive income is comprised of net income, as presented in the consolidated statements of operations, adjusted for changes in unrealized gains or losses on available for sale securities, changes in the fair value of derivatives accounted for as cash flow hedges and amortization of deferred swap losses resulting from the de-designation of derivatives previously accounted for as cash flow hedges.
Accounting for Derivative Financial Instruments
U.S. GAAP provides disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (i) how and why an entity uses derivative instruments; (ii) how derivative instruments and related hedged items are accounted for; and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. U.S. GAAP requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.
The Company records all derivatives on the consolidated balance sheets at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives may also be designated as hedges of the foreign currency exposure of a net investment in a foreign operation. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts, such as credit default swaps, that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting under U.S. GAAP.
Effective December 31, 2013, the Company voluntarily discontinued hedge accounting for its interest rate swap agreements by de-designating the interest rate swaps as cash flow hedges. No interest rate swaps were terminated in conjunction with this action, and the Company’s risk management and hedging practices were not impacted. However, the Company’s accounting for these transactions will change prospectively. All of the Company’s interest rate swaps had previously been accounted for as cash flow hedges under the applicable guidance. As a result of discontinuing hedge accounting, beginning January 1, 2014, changes in the fair value of the interest rate swap agreements are recorded in gain (loss) on interest rate derivative instruments, net in the Company’s consolidated statements of operations, rather than in accumulated other comprehensive income (loss) (“AOCI”). Also, net interest paid or received under the interest rate swaps, which up through December 31, 2013 was recognized in interest expense, is now recognized in gain (loss) on interest rate derivative instruments, net on the Company's consolidated statements of operations. The interest rate swaps continue to be reported as assets or liabilities on the Company’s consolidated balance sheets at their fair value.
As long as the forecasted transactions that were being hedged (i.e., rollovers of the Company’s repurchase agreement borrowings) are still expected to occur, the balance in AOCI from the interest rate swap activity up through December 31, 2013 will remain in AOCI and be recognized in the Company’s consolidated statements of operations as interest expense over the remaining term of the interest rate swaps. Refer to Note 9 - "Derivatives and Hedging Activities" for further information.

 
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The Company evaluates the terms and conditions of its holdings of swaptions, futures contracts and to-be-announced ("TBA") securities to determine if an instrument has the characteristics of an investment or should be considered a derivative under U.S. GAAP. Accordingly swaptions, futures contracts and TBAs having the characteristics of derivatives are accounted for at fair value with such changes recognized in gain (loss) on derivative instruments, net in the consolidated statements of operations. The fair value of these swaptions, futures contracts and TBAs is included in derivative asset or derivative liability on the consolidated balance sheets.
Income Taxes
The Company elected to be taxed as a REIT, commencing with the Company's taxable year ended December 31, 2009. Accordingly, the Company will generally not be subject to U.S. federal and applicable state and local corporate income tax to the extent that the Company makes qualifying distributions to its common shareholders, and provided the Company satisfies on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income, distribution and stock ownership tests. If the Company fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to U.S. federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the Company lost its REIT qualification. Accordingly, the Company’s failure to qualify as a REIT could have a material adverse impact on its results of operations and amounts available for distribution to its shareholders.
A REIT’s dividend paid deduction for qualifying dividends to the Company’s shareholders is computed using its taxable income as opposed to net income reported on the consolidated financial statements. Taxable income, generally, will differ from net income because the determination of taxable income is based on tax regulations and not financial accounting principles.
The Company may elect to treat certain of its future subsidiaries as taxable REIT subsidiaries (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. A TRS is subject to U.S. federal, state and local corporate income taxes.
If a TRS generates net income, the TRS can declare dividends to the Company which will be included in its taxable income and necessitate a distribution to its shareholders. Conversely, if the Company retains earnings at a TRS level, no distribution is required and the Company can increase book equity of the consolidated entity. The Company has no adjustments regarding its tax accounting treatment of any uncertainties. The Company expects to recognize interest and penalties related to uncertain tax positions, if any, as income tax expense, which will be included in general and administrative expense.
Share-Based Compensation
The Company has adopted an equity incentive plan under which its independent directors, as part of their compensation for serving as directors, are eligible to receive quarterly stock awards. In addition, the Company may compensate the officers and employees of the Manager and its affiliates under this plan pursuant to the management agreement.
Share-based compensation arrangements include share options, restricted share awards, performance-based awards, share appreciation rights, and employee share purchase plans. Compensation costs relating to share-based payment transactions are recognized in the consolidated financial statements, based on the fair value of the equity or liability instruments issued on the date of grant, for awards to the Company’s independent directors. Compensation related to stock awards to officers and employees of the Manager and its affiliates is recorded at the estimated fair value of the award during the vesting period. The Company makes an upward or downward adjustment to compensation expense for the difference in the fair value at the date of grant and the date the award is earned.
Dividend Reinvestment and Stock Purchase Plan
The Company has implemented a dividend reinvestment and stock purchase plan (the “DRSPP”). Under the terms of the DRSPP, shareholders who participate in the DRSPP may purchase shares of common stock directly from the Company. DRSPP participants may also automatically reinvest all or a portion of their dividends for additional shares of common stock.
Reclassifications
The presentation of certain prior period reported amounts has been reclassified to be consistent with the current presentation. Such reclassifications had no impact on net income or equity attributable to common shareholders.
Recent Accounting Pronouncements
None

 
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Recent Accounting Pronouncements Not Yet Adopted
In April 2014, the Financial Accounting Standards Board issued updated guidance that changes the requirements for reporting discontinued operations. Under the new guidance, a discontinued operation is defined as a component of an entity or group of components of an entity that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. The guidance is effective for annual periods beginning on or after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015. Early adoption is permitted but only for disposals (or classifications as held for sale) that have not been reported in financial statements previously issued or available for issue. The new guidance is not expected to have a material impact on the Company’s consolidated financial statements.
In June 2014, the Financial Accounting Standards Board issued guidance that changes the accounting for repurchase-to-maturity transactions and repurchase financing arrangements. The new guidance aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. These transactions would all be accounted for as secured borrowings. The guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement, which has resulted in outcomes referred to as off-balance-sheet accounting. In addition, the guidance requires additional disclosures. The guidance is effective for the first interim or annual period beginning after December 15, 2014. Earlier application for a public company is prohibited. The new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

Note 3 – Variable Interest Entities
During the three months ended June 30, 2014, the Company purchased and consolidated a controlling interest in a securitization trust. The following table presents a summary of the assets and liabilities of the VIEs as of June 30, 2014 and December 31, 2013. Intercompany balances have been eliminated for purposes of this presentation.
 
$ in thousands
June 30, 2014
 
December 31, 2013
Residential loans, held-for-investment
2,310,686

 
1,810,262

Accrued interest receivable
7,416

 
5,647

Deferred costs
3,991

 
3,386

Total assets
2,322,093

 
1,819,295

Accrued interest and accrued expenses payable
6,025

 
4,659

Asset-backed securities
2,016,923

 
1,643,741

Total liabilities
2,022,948

 
1,648,400

The Company is not contractually required and has not provided any additional financial support to the VIEs for the period ended June 30, 2014. Refer to Note 8 - "Borrowings" for additional details on the ABS.
On June 13, 2014, the Company committed to purchase securities of a securitization trust to be issued in August 2014. The newly formed securitization is expected to issue a series of ABS having an aggregate original principal amount of approximately $401.3 million, of which the Company intends to retain approximately $30.1 million. The Company's preliminary assessment is that it is the primary beneficiary and will consolidate the securitized trust upon the completion of the transaction. As of June 30, 2014, the Company has recorded the purchase and sale of the MBS as an unsettled trade, presented in investment related payable and investment related receivable on the consolidated balance sheets, respectively, with the resulting net MBS included in Mortgage-backed securities on the consolidated balance sheets.
The Company also purchases interests in securitization trusts, for which the Company has determined it is not the primary beneficiary. These investments are accounted for as available-for-sale MBS as described in Note 2 - "Summary of Significant Accounting Policies." As of June 30, 2014 and December 31, 2013, the carrying amount of the investment in the VIEs for which we are not considered the primary beneficiary was $62.6 million and $155.4 million, respectively. The Company’s maximum exposure to loss on these investments is limited to the amount of its investment. Refer to Note 4 - "Mortgage-Backed Securities" for additional details regarding the carrying amounts and classifications of these investments.

Note 4 – Mortgage-Backed Securities
All of the Company’s MBS are classified as available-for-sale and, as such, are reported at fair value, which is determined by obtaining valuations from an independent source. If the fair value of a security is not available from a third-party pricing service, or such data appears unreliable, the Company may estimate the fair value of the security using a variety of

 
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methods including other pricing services, repurchase agreement pricing, discounted cash flow analysis, matrix pricing, option adjusted spread models and other fundamental analysis of observable market factors.
The following tables present certain information about the Company’s MBS portfolio as of June 30, 2014 and December 31, 2013.
June 30, 2014
$ in thousands
Principal
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Net
Weighted
Average
Coupon (1)
 
Period-
end
Weighted
Average
Yield (2)
 
Quarterly
Weighted
Average
Yield (3)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
1,395,263

 
69,737

 
1,465,000

 
30,999

 
1,495,999

 
4.04
%
 
2.60
%
 
2.57
%
30 year fixed-rate
5,848,240

 
394,803

 
6,243,043

 
(3,048
)
 
6,239,995

 
4.17
%
 
3.01
%
 
3.03
%
ARM
545,715

 
9,431

 
555,146

 
6,138

 
561,284

 
2.86
%
 
2.55
%
 
2.29
%
Hybrid ARM
2,555,585

 
37,078

 
2,592,663

 
20,674

 
2,613,337

 
2.79
%
 
2.52
%
 
2.23
%
Total Agency pass-through
10,344,803

 
511,049

 
10,855,852

 
54,763

 
10,910,615

 
3.74
%
 
2.81
%
 
2.75
%
Agency-CMO(4)
1,789,639

 
(1,270,882
)
 
518,757

 
(8,322
)
 
510,435

 
2.57
%
 
4.46
%
 
3.42
%
Non-Agency RMBS(5)(6)(7)
3,816,728

 
(632,014
)
 
3,184,714

 
97,811

 
3,282,525

 
3.63
%
 
4.14
%
 
4.70
%
GSE CRT(8)
431,000

 
28,798

 
459,798

 
46,837

 
506,635

 
5.17
%
 
4.07
%
 
4.04
%
CMBS(9)
4,928,396

 
(2,023,533
)
 
2,904,863

 
132,716

 
3,037,579

 
3.52
%
 
4.56
%
 
4.54
%
Total
21,310,566

 
(3,386,582
)
 
17,923,984

 
323,805

 
18,247,789

 
3.60
%
 
3.41
%
 
3.36
%
 
(1)
Net weighted average coupon (“WAC”) as of June 30, 2014 is presented net of servicing and other fees.
(2)
Period-end weighted average yield is based on amortized cost as of June 30, 2014 and incorporates future prepayment and loss assumptions.
(3)
Quarterly weighted average portfolio yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the Company's average of the amortized cost of the investments. All yields are annualized.
(4)
Included in Agency-CMO are interest-only securities, which represent 23.6% of the balance based on fair value.
(5)
Included in non-Agency RMBS are securities of $26.0 million for a future securitization not yet settled.
(6)
Non-Agency RMBS held by the Company is 63.4% variable rate, 30.9% fixed rate, and 5.7% floating rate based on fair value (excluding securities for a future securitization not yet settled).
(7)
Of the total discount in non-Agency RMBS, $390.5 million is non-accretable.
(8)
GSE CRT are general obligations of Fannie Mae or Freddie Mac that are structured to provide credit protection to the GSE issuer with respect to defaults and other credit events within reference pools of residential mortgage loans that collateralize MBS issued and guaranteed by such GSE.
(9)
Included in the CMBS are interest-only securities and commercial real estate mezzanine loan pass-through certificates which represent 6.2% and 1.5% of the balance based on fair value, respectively.

 
15
 

Table of Contents


December 31, 2013
$ in thousands
Principal
Balance
 
Unamortized
Premium
(Discount)
 
Amortized
Cost
 
Unrealized
Gain/
(Loss), net
 
Fair
Value
 
Net
Weighted
Average
Coupon (1)
 
Period-
end
Weighted
Average
Yield (2)
 
Quarterly
Weighted
Average
Yield (3)
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
1,637,988

 
83,799

 
1,721,787

 
22,494

 
1,744,281

 
4.02
%
 
2.54
%
 
2.61
%
30 year fixed-rate
6,494,723

 
435,680

 
6,930,403

 
(228,250
)
 
6,702,153

 
4.11
%
 
2.96
%
 
3.13
%
ARM
251,693

 
992

 
252,685

 
597

 
253,282

 
2.80
%
 
2.62
%
 
2.41
%
Hybrid ARM
1,764,472

 
9,470

 
1,773,942

 
(3,384
)
 
1,770,558

 
2.69
%
 
2.46
%
 
2.06
%
Total Agency pass-through
10,148,876

 
529,941

 
10,678,817

 
(208,543
)
 
10,470,274

 
3.82
%
 
2.80
%
 
2.90
%
Agency-CMO(4)
1,532,474

 
(1,051,777
)
 
480,697

 
(6,183
)
 
474,514

 
2.76
%
 
3.82
%
 
3.47
%
Non-Agency RMBS(5)(6)
4,217,230

 
(640,797
)
 
3,576,433

 
30,895

 
3,607,328

 
3.72
%
 
2.80
%
 
4.63
%
GSE CRT
144,500

 
22,163

 
166,663

 
1,318

 
167,981

 
7.13
%
 
5.17
%
 
5.85
%
CMBS(7)
4,630,363

 
(2,032,945
)
 
2,597,418

 
31,142

 
2,628,560

 
3.38
%
 
4.62
%
 
4.51
%
Total
20,673,443

 
(3,173,415
)
 
17,500,028

 
(151,371
)
 
17,348,657

 
3.63
%
 
3.30
%
 
3.51
%
 
(1)
Net WAC as of December 31, 2013 is presented net of servicing and other fees.
(2)
Period-end weighted average yield based on amortized cost as of December 31, 2013 incorporates future prepayment and loss assumptions.
(3)
Quarterly weighted average portfolio yield for the period was calculated by dividing interest income, including amortization of premiums and discounts, by the Company's average of the amortized cost of the investments. All yields are annualized.
(4)
Included in Agency-CMO are interest-only securities, which represent 25.0% of the balance based on fair value.
(5)
Non-Agency RMBS held by the Company is 61.1% variable rate, 33.9% fixed rate, and 5.0% floating rate based on fair value.
(6)
Of the total discount in non-Agency RMBS, $438.1 million is non-accretable.
(7)
Included in the CMBS are interest-only securities and commercial real estate mezzanine loan pass-through certificates which represent 7.5% and 1.0% of the balance based on fair value, respectively.
The following table summarizes the Company's non-Agency RMBS portfolio by asset type as of June 30, 2014 and December 31, 2013, respectively:
$ in thousands
June 30, 2014
 
% of Non-Agency
 
December 31, 2013
 
% of Non-Agency
Re-REMIC
1,295,129

 
39.7
%
 
1,444,376

 
40.0
%
Prime
1,138,352

 
35.1
%
 
1,336,821

 
37.1
%
Alt-A
802,754

 
24.6
%
 
801,919

 
22.2
%
Subprime
20,240

 
0.6
%
 
24,212

 
0.7
%
Total Non-Agency(1)
3,256,475

 
100.0
%
 
3,607,328

 
100.0
%

(1)
Excluded from non-Agency RMBS are securities of $26.0 million for a future securitization not yet settled.

 
16
 

Table of Contents


The following table summarizes certain characteristics of the Company's re-securitization of real estate mortgage investment conduit ("Re-REMIC") holdings as of June 30, 2014 and December 31, 2013:
  
 
Percentage of Re-REMIC Holdings at Fair Value
Re-REMIC Subordination(1)
 
June 30, 2014
 
December 31, 2013
0-10
 
5.4
%
 
4.8
%
10-20
 
3.7
%
 
3.5
%
20-30
 
15.1
%
 
14.7
%
30-40
 
25.3
%
 
25.2
%
40-50
 
36.5
%
 
38.6
%
50-60
 
9.3
%
 
8.5
%
60-70
 
4.7
%
 
4.7
%
Total
 
100.0
%
 
100.0
%
 
(1)
Subordination refers to the credit enhancement provided to the Re-REMIC tranche by any junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying security represented by any junior tranche or tranches at the time of resecuritization. Generally, principal losses on the underlying security in excess of the subordination amount would result in principal losses on the Re-REMIC tranche.
The components of the carrying value of the Company’s MBS portfolio at June 30, 2014 and December 31, 2013 are presented below:
 
$ in thousands
June 30, 2014
 
December 31, 2013
Principal balance
21,310,566

 
20,673,443

Unamortized premium
641,091

 
646,189

Unamortized discount
(4,027,673
)
 
(3,819,604
)
Gross unrealized gains
493,772

 
291,725

Gross unrealized losses
(169,967
)
 
(443,096
)
Fair value
18,247,789

 
17,348,657

The following table summarizes certain characteristics of the Company’s investment portfolio, at fair value, according to estimated weighted average life classifications as of June 30, 2014 and December 31, 2013:
 
$ in thousands
June 30, 2014
 
December 31, 2013
Less than one year
245,994

 
101,251

Greater than one year and less than five years
7,620,772

 
5,958,852

Greater than or equal to five years
10,381,023

 
11,288,554

Total
18,247,789

 
17,348,657



 
17
 

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The following tables present the estimated fair value, the gross unrealized losses and the number of securities of the Company’s MBS by length of time that such securities have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013, respectively:

June 30, 2014
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
1,010

 
(4
)
 
1

 
125,311

 
(1,873
)
 
7

 
126,321

 
(1,877
)
 
8

30 year fixed-rate
23,639

 
(47
)
 
2

 
3,133,497

 
(114,344
)
 
101

 
3,157,136

 
(114,391
)
 
103

ARM
24,699

 
(89
)
 
1

 
13,671

 
(67
)
 
2

 
38,370

 
(156
)
 
3

Hybrid ARM
337,694

 
(1,013
)
 
19

 
28,686

 
(278
)
 
2

 
366,380

 
(1,291
)
 
21

Total Agency pass-through
387,042

 
(1,153
)
 
23

 
3,301,165

 
(116,562
)
 
112

 
3,688,207

 
(117,715
)
 
135

Agency-CMO
309,450

 
(14,490
)
 
22

 
76,203

 
(5,762
)
 
5

 
385,653

 
(20,252
)
 
27

Non-Agency RMBS
262,404

 
(3,940
)
 
30

 
489,584

 
(18,939
)
 
30

 
751,988

 
(22,879
)
 
60

GSE CRT
76,750

 
(228
)
 
2

 
—

 
—

 
—

 
76,750

 
(228
)
 
2

CMBS
141,482

 
(1,562
)
 
13

 
481,510

 
(7,331
)
 
36

 
622,992

 
(8,893
)
 
49

Total
1,177,128

 
(21,373
)
 
90

 
4,348,462

 
(148,594
)
 
183

 
5,525,590

 
(169,967
)
 
273

December 31, 2013
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
 
Fair
Value
 
Unrealized
Losses
 
Number
of
Securities
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
431,527

 
(4,964
)
 
18

 
11,100

 
(259
)
 
1

 
442,627

 
(5,223
)
 
19

30 year fixed-rate
3,710,679

 
(228,167
)
 
126

 
641,259

 
(56,754
)
 
27

 
4,351,938

 
(284,921
)
 
153

ARM
94,447

 
(968
)
 
7

 
—

 
—

 
—

 
94,447

 
(968
)
 
7

Hybrid ARM
1,129,488

 
(9,715
)
 
48

 
—

 
—

 
—

 
1,129,488

 
(9,715
)
 
48

Total Agency pass-through
5,366,141

 
(243,814
)
 
199

 
652,359

 
(57,013
)
 
28

 
6,018,500

 
(300,827
)
 
227

Agency-CMO
311,935

 
(16,599
)
 
13

 
8,883

 
(3,736
)
 
4

 
320,818

 
(20,335
)
 
17

Non-Agency RMBS
1,307,036

 
(58,326
)
 
76

 
91,651

 
(1,726
)
 
8

 
1,398,687

 
(60,052
)
 
84

GSE CRT
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

CMBS
1,118,270

 
(61,882
)
 
84

 
—

 
—

 
—

 
1,118,270

 
(61,882
)
 
84

Total
8,103,382

 
(380,621
)
 
372

 
752,893

 
(62,475
)
 
40

 
8,856,275

 
(443,096
)
 
412

Gross unrealized losses on the Company’s Agency RMBS were $117.7 million at June 30, 2014. Due to the inherent credit quality of Agency RMBS, the Company determined that at June 30, 2014, any unrealized losses on its Agency RMBS portfolio are temporary.
Gross unrealized losses on the Company’s MBS-CMO, non-Agency RMBS, GSE CRT and CMBS were $52.3 million at June 30, 2014. The Company does not consider these unrealized losses to be credit related, but rather due to non-credit related factors such as interest rate spreads, prepayment speeds, and market fluctuations. These investment securities are included in the Company’s assessment for other-than-temporary impairment on at least a quarterly basis.

 
18
 

Table of Contents


The following table presents the impact of the Company’s MBS on its accumulated other comprehensive income for the three and six months ended June 30, 2014 and 2013.
 
$ in thousands
Three Months 
 ended 
 June 30, 2014
 
Three Months 
 ended 
 June 30, 2013
 
Six Months 
 ended 
 June 30, 2014
 
Six Months 
 ended 
 June 30, 2013
Accumulated other comprehensive income from investment securities:
 
 
 
 
 
 
 
Unrealized gain (loss) on MBS at beginning of period
29,817

 
453,590

 
(151,368
)
 
523,725

Unrealized gain (loss) on MBS, net
293,988

 
(710,992
)
 
475,173

 
(781,127
)
Balance at the end of period
323,805

 
(257,402
)
 
323,805

 
(257,402
)
During the three months ended June 30, 2014 and 2013, the Company reclassified $20.8 million of net unrealized losses and $5.7 million of net unrealized gains, respectively, from other comprehensive income into gain (loss) on sale of investments as a result of the Company selling certain investments.
During the six months ended June 30, 2014 and 2013, the Company reclassified $32.5 million of net unrealized losses and $12.4 million of net unrealized gains, respectively, from other comprehensive income into gain (loss) on sale of investments as a result of the Company selling certain investments.

The Company assesses its investment securities for other-than-temporary impairment on at least a quarterly basis and more frequently when economic or market conditions warrant such evaluation. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either “temporary” or “other-than-temporary.” The Company evaluates each security that has had a fair value less than amortized cost for three or more consecutive months for other-than-temporary impairment. This analysis includes evaluating the individual loans in each security to determine estimated future cash flows. Individual loan characteristics reviewed include, but are not limited to, delinquency status, loan-to-value ratios, borrower credit scores, occupancy status and geographic concentration. To the extent a security is deemed impaired, the amount by which the amortized cost exceeds the security's market value would be considered other-than-temporary impairment.
The Company did not have other-than-temporary impairments for the three and six months ended June 30, 2014 and 2013.
The following table presents components of interest income on the Company’s MBS portfolio for the three and six months ended June 30, 2014 and 2013.
For the three months ended June 30, 2014
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
105,094

 
(27,064
)
 
78,030

Non-Agency
34,917

 
3,733

 
38,650

GSE CRT
4,993

 
(1,361
)
 
3,632

CMBS
41,514

 
(9,901
)
 
31,613

Other
(5
)
 
—

 
(5
)
Total
186,513

 
(34,593
)
 
151,920


 
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Table of Contents


For the three months ended June 30, 2013
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
142,846

 
(46,956
)
 
95,890

Non-Agency
41,325

 
2,001

 
43,326

GSE CRT
—

 
—

 
—

CMBS
35,670

 
(6,252
)
 
29,418

Other
102

 
—

 
102

Total
219,943

 
(51,207
)
 
168,736

For the six months ended June 30, 2014
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
210,577

 
(50,728
)
 
159,849

Non-Agency
70,472

 
4,668

 
75,140

GSE CRT
9,369

 
(1,361
)
 
8,008

CMBS
80,126

 
(19,562
)
 
60,564

Other
98

 
—

 
98

Total
370,642

 
(66,983
)
 
303,659

For the six months ended June 30, 2013
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
286,259

 
(92,069
)
 
194,190

Non-Agency
77,737

 
3,142

 
80,879

GSE CRT
—

 
—

 
—

CMBS
62,320

 
(8,452
)
 
53,868

Other
143

 
—

 
143

Total
426,459

 
(97,379
)
 
329,080


Note 5 – Residential Loans Held-for-Investment
Residential loans held-for-investment includes residential mortgage loans which are secured by a lien on the residential property. The following table details the carrying value for residential loans held-for-investment at June 30, 2014 and December 31, 2013. These loans are held by the seven VIEs, which the Company consolidates.
 
$ in thousands
June 30, 2014
 
December 31, 2013
Principal balance
2,287,914

 
1,783,983

Unamortized premium (discount), net
23,813

 
27,163

Recorded investment
2,311,727

 
1,811,146

Allowance for loan losses
(1,041
)
 
(884
)
Carrying value
2,310,686

 
1,810,262

The Company considers a number of factors when evaluating the credit risks associated with its residential loans held-for-investment portfolio, including but not limited to year of origination, delinquency status, historical losses, geographic concentration and existing economic conditions.

 
20
 

Table of Contents


The following table displays certain characteristics of the Company's residential loans held-for-investment at June 30, 2014 by year of origination.
$ in thousands
2014
 
2013
 
2012
 
2009
 
2008
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
Number of Loans(1)
25

 
2,372

 
602

 
6

 
3

 
3,008

Current Principal Balance
17,392

 
1,768,805

 
497,726

 
1,929

 
2,062

 
2,287,914

Net Weighted Average Coupon Rate
4.82
%
 
3.63
%
 
3.51
%
 
3.84
%
 
6.14
%
 
3.61
%
Weighted Average Maturity (years)
28.78

 
28.91

 
28.53

 
24.96

 
24.16

 
28.82

Current Performance:
 
 
 
 
 
 
 
 
 
 
 
Current
17,392

 
1,768,805

 
496,436

 
1,929

 
2,062

 
2,286,624

30 Day Delinquent
—

 
—

 
1,290

 
—

 
—

 
1,290

60 Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

90+ Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

Bankruptcy/Foreclosure
—

 
—

 
—

 
—

 
—

 
—

Total
17,392

 
1,768,805

 
497,726

 
1,929

 
2,062

 
2,287,914

(1) None for 2011 and 2010
The following table presents the five largest geographic concentrations of the Company’s residential loans held-for-investment at June 30, 2014 based on principal balance outstanding:
State
Percent
California
49.8
%
Illinois
5.5
%
Massachusetts
4.4
%
Maryland
3.9
%
New York
3.8
%
Other states (none greater than 4%)
32.6
%
Total
100.0
%
The following table presents future minimum annual principal payments under the residential loans held-for-investment at June 30, 2014:
$ in thousands
 
Scheduled Principal
June 30, 2014
Within one year
43,190

One to three years
91,573

Three to five years
98,959

Greater than or equal to five years
2,054,192

Total
2,287,914


 
21
 

Table of Contents


Allowance for Loan Losses on Residential Loans
For residential loans held-for-investment, the Company establishes an allowance for loan losses. The following table summarizes the activity in the allowance for loan losses for the six months ended June 30, 2014:
$ in thousands
June 30, 2014
Balance at beginning of period
(884
)
Charge-offs, net
—

Provision for loan losses
(157
)
Balance at end of period
(1,041
)
During the quarter ended June 30, 2014 there were no charge-offs of residential loans.

Note 6 – Commercial Loans Held-for-Investment
Commercial loans held-for-investment include mezzanine loans, first mortgage loans and preferred equity investments purchased or originated by the Company.
As of June 30, 2014, the Company had five commercial loans outstanding which were purchased or originated by the Company (one was originated in 2014) and were not delinquent on payment. Included in the five commercial loans are mezzanine loans with an outstanding carrying value of $52.7 million, inclusive of unamortized fees of