IVR 2013.09.30 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 September 30, 2013
OR 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                  to                 
Commission file number 001-34385
_______________________________________________
 INVESCO MORTGAGE CAPITAL INC.
(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  ¨
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  ¨
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
 
¨
Non-Accelerated filer
 
¨  (Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of October 29, 2013, there were 135,225,647 outstanding shares of common stock of Invesco Mortgage Capital Inc.


 
 
 

Table of Contents


INVESCO MORTGAGE CAPITAL INC.
TABLE OF CONTENTS
 
 
 
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
September 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
ASSETS
 
Mortgage-backed securities, at fair value
18,811,679

 
18,470,563

Residential loans, held-for-investment, net of loan loss reserve
1,532,389

 
—

Commercial loans, held-for-investment, net of loan loss reserve
17,388

 
—

Cash and cash equivalents
199,095

 
286,474

Due from counterparties
8,119

 
—

Investment related receivable
8,912

 
41,429

Investments in unconsolidated ventures, at fair value
42,276

 
35,301

Accrued interest receivable
71,198

 
62,977

Derivative assets, at fair value
188,509

 
6,469

Deferred securitization and financing costs
14,033

 
—

Other investments
10,000

 
10,000

Other assets
1,883

 
1,547

Total assets (1)
20,905,481

 
18,914,760

LIABILITIES AND EQUITY
 
 
 
Liabilities:
 
 
 
Repurchase agreements
15,897,612

 
15,720,460

Asset-backed securities issued
1,411,897

 
—

Exchangeable senior notes
400,000

 
—

Derivative liability, at fair value
316,670

 
436,440

Dividends and distributions payable
71,037

 
79,165

Investment related payable
201,203

 
63,715

Accrued interest payable
19,554

 
15,275

Collateral held payable
21,045

 
—

Accounts payable and accrued expenses
3,885

 
877

Due to affiliate
11,457

 
9,308

Total liabilities (1)
18,354,360

 
16,325,240

Equity:
 
 
 
Preferred Stock: par value $0.01 per share, 50,000,000 shares authorized; 7.75% series A cumulative redeemable, $25 liquidation preference, 5,600,000 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
135,356

 
135,362

Common Stock: par value $0.01 per share, 450,000,000 shares authorized; 135,224,162 and 116,195,500 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
1,352

 
1,162

Additional paid in capital
2,712,790

 
2,316,290

Accumulated other comprehensive income (loss)
(315,469
)
 
86,436

Retained earnings (distributions in excess of earnings)
(9,912
)
 
18,848

Total shareholders’ equity
2,524,117

 
2,558,098

Non-controlling interest
27,004

 
31,422

Total equity
2,551,121

 
2,589,520

Total liabilities and equity
20,905,481

 
18,914,760

(1)
Our 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 Invesco Mortgage Capital Inc.). At September 30, 2013 and December 31, 2012, total assets of the consolidated VIEs were $1,540,150 and $0, respectively, and total liabilities of the consolidated VIEs were $1,415,784 and $0, respectively. See Note 3 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 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands, except per share data
2013
 
2012
 
2013
 
2012
Interest Income
 
 
 
 
 
 
 
Mortgage-backed securities
157,539

 
140,477

 
486,619

 
421,442

Residential loans
13,417

 
—

 
20,443

 
—

Commercial loans
372

 
—

 
432

 
—

Total interest income
171,328

 
140,477

 
507,494

 
421,442

Interest Expense
 
 
 
 
 
 
 
Repurchase agreements
73,695

 
60,327

 
208,487

 
172,312

Exchangeable senior note
5,621

 
—

 
12,403

 
—

Asset-backed securities issued
10,266

 
—

 
15,722

 
—

Total interest expense
89,582

 
60,327

 
236,612

 
172,312

Net interest income
81,746

 
80,150

 
270,882

 
249,130

Provision for loan losses
87

 
—

 
751

 
—

Net interest income after provision for loan losses
81,659

 
80,150

 
270,131

 
249,130

Other Income (loss)
 
 
 
 
 
 
 
Gain (loss) on sale of investments, net
(69,323
)
 
12,836

 
(56,919
)
 
24,978

Equity in earnings and fair value change in unconsolidated ventures
1,422

 
3,262

 
5,169

 
6,231

Realized and unrealized gain (loss) on interest rate derivative instruments
(6,887
)
 
(808
)
 
44,424

 
(2,851
)
Realized and unrealized credit default swap income
297

 
1,348

 
828

 
2,694

Total other income (loss)
(74,491
)
 
16,638

 
(6,498
)
 
31,052

Expenses
 
 
 
 
 
 
 
Management fee – related party
10,945

 
9,053

 
32,106

 
26,372

General and administrative
2,259

 
959

 
6,845

 
3,132

Total expenses
13,204

 
10,012

 
38,951

 
29,504

Net income (loss)
(6,036
)
 
86,776

 
224,682

 
250,678

Net income (loss) attributable to non-controlling interest
(63
)
 
1,026

 
2,392

 
3,025

Net income (loss) attributable to Invesco Mortgage Capital Inc.
(5,973
)
 
85,750

 
222,290

 
247,653

Dividends to preferred shareholders
2,713

 
2,682

 
8,138

 
2,682

Net income (loss) attributable to common shareholders
(8,686
)
 
83,068

 
214,152

 
244,971

Earnings (loss) per share:
 
 
 
 
 
 
 
Net income (loss) attributable to common shareholders
 
 
 
 
 
 
 
Basic
(0.06
)
 
0.72

 
1.61

 
2.12

Diluted
(0.06
)
 
0.72

 
1.56

 
2.12

Dividends declared per common share
0.50

 
0.65

 
1.80

 
1.95

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 (LOSS)
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
$ in thousands, except per share data
2013
 
2012
 
2013
 
2012
Net income (loss)
(6,036
)
 
86,776

 
224,682

 
250,678

Other comprehensive income (loss)
 
 
 
 
 
 
 
Unrealized gain (loss) on mortgage-back securities
 
 
 
 
 
 
 
Change in fair value
(10,724
)
 
322,647

 
(846,292
)
 
603,710

Reclassification adjustments for (gain) loss included in gain (loss) on sale of investments
85,754

 
(5,824
)
 
140,195

 
(17,401
)
Unrealized gain (loss) on mortgage-backed securities, net
75,030

 
316,823

 
(706,097
)
 
586,309

Unrealized gain (loss) on derivatives
 
 
 
 
 
 
 
Change in fair value
(74,098
)
 
(60,716
)
 
183,391

 
(181,280
)
Reclassification adjustments for loss included in unrealized gain (loss) on interest rate derivative instruments
43,583

 
35,763

 
116,553

 
107,051

Unrealized gain (loss) on derivatives, net
(30,515
)
 
(24,953
)
 
299,944

 
(74,229
)
Total Other comprehensive income (loss)
44,515

 
291,870

 
(406,153
)
 
512,080

Comprehensive income (loss)
38,479

 
378,646

 
(181,471
)
 
762,758

Less: Comprehensive income (loss) attributable to non-controlling interest
(402
)
 
(4,585
)
 
1,856

 
(9,271
)
Less: Dividends to preferred shareholders
(2,713
)
 
(2,682
)
 
(8,138
)
 
(2,682
)
Comprehensive income (loss) attributable to common shareholders
35,364

 
371,379

 
(187,753
)
 
750,805

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 nine months ended September 30, 2013
(Unaudited)
 
 
 
 
Attributable to Common Shareholders
 
 
 
 
 
 
 
 
 
 
Additional
Paid in
 
Accumulated
Other
Comprehensive
 
Retained Earnings (Distributions
in excess of
 
Total
Shareholders’
 
Non-
Controlling
 
 
 
 
 
 
 
 
 
 
$ in thousands, except
per share amounts
Preferred Stock
 
Common Stock
 
Total
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Income (loss)
 
earnings)
 
Equity
 
Interest
 
Equity
Balance at January 1, 2013
5,600,000

 
135,362

 
116,195,500

 
1,162

 
2,316,290

 
86,436

 
18,848

 
2,558,098

 
31,422

 
2,589,520

Net income
—

 
—

 
—

 
—

 
—

 
—

 
222,290

 
222,290

 
2,392

 
224,682

Other comprehensive loss
—

 
—

 
—

 
—

 
—

 
(401,905
)
 
—

 
(401,905
)
 
(4,248
)
 
(406,153
)
Proceeds from issuance of common stock, net of offering costs
—

 
—

 
19,015,269

 
190

 
396,227

 
—

 
—

 
396,417

 
—

 
396,417

(Cost) proceeds from issuance of preferred stock, net of offering costs
—

 
(6
)
 
—

 
—

 
—

 
—

 
—

 
(6
)
 
—

 
(6
)
Stock awards
—

 
—

 
13,393

 
—

 
—

 
—

 
—

 
—

 
—

 
—

Common stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(242,912
)
 
(242,912
)
 
—

 
(242,912
)
Common unit dividends
—

 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(2,565
)
 
(2,565
)
Preferred stock dividends
—

 
—

 
—

 
—

 
—

 
—

 
(8,138
)
 
(8,138
)
 
—

 
(8,138
)
Amortization of equity-based compensation
—

 
—

 
—

 
—

 
273

 
—

 
—

 
273

 
3

 
276

Balance at September 30, 2013
5,600,000

 
135,356

 
135,224,162

 
1,352

 
2,712,790

 
(315,469
)
 
(9,912
)
 
2,524,117

 
27,004

 
2,551,121

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)
  
Nine Months Ended September 30,
$ in thousands
2013
 
2012
Cash Flows from Operating Activities
 
 
 
Net income
224,682

 
250,678

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of mortgage-backed securities premiums and discounts, net
145,112

 
94,722

Amortization of residential loan and asset-backed securities premiums
117

 
—

Amortization of commercial loan origination fees
(21
)
 
—

Origination fee received
145

 
—

Provision for loan losses
751

 
—

Unrealized loss on interest rate derivative instruments
21,810

 
2,851

Unrealized (gain) loss on credit default swap
743

 
(406
)
(Gain) loss on sale of mortgage-backed securities
56,919

 
(24,978
)
Gain on termination of interest rate swaptions
(66,234
)
 
—

Equity in earnings and fair value change in unconsolidated ventures
(5,169
)
 
(6,231
)
Amortization of equity-based compensation
276

 
257

Amortization of deferred securitization and financing costs
1,647

 
—

Changes in operating assets and liabilities:
 
 
 
Increase in accrued interest receivable
(8,538
)
 
(7,592
)
Increase in other assets
(391
)
 
(165
)
Increase (decrease) in accrued interest payable
4,279

 
(568
)
Increase in due to affiliate
2,149

 
428

Increase in accounts payable and accrued expenses
3,061

 
64

Net cash provided by operating activities
381,338

 
309,060

Cash Flows from Investing Activities
 
 
 
Purchase of mortgage-backed securities
(6,923,130
)
 
(6,354,428
)
(Contributions) distributions from investment in unconsolidated ventures, net
(1,806
)
 
19,370

Principal payments from mortgage-backed securities
2,309,117

 
1,827,398

Proceeds from sale of mortgage-backed securities
3,507,011

 
1,605,902

Payment of premiums for interest rate derivative instruments
(72,723
)
 
(2,140
)
Proceeds from termination of interest rate swaptions
114,538

 
—

Purchase of residential loans
(1,562,818
)
 
—

Principal payments from residential loans
28,464

 
—

Origination of commercial loans, net of origination fees
(17,195
)
 
—

Net cash used in investing activities
(2,618,542
)
 
(2,903,898
)
Cash Flows from Financing Activities
 
 
 
Proceeds from issuance of common stock
396,417

 
103

(Cost) proceeds (of) from issuance of preferred stock
(6
)
 
135,535

Due from counterparties
(8,182
)
 
57,172

Collateral held payable
21,045

 
—

Proceeds from repurchase agreements
140,364,041

 
111,725,441

Principal repayments of repurchase agreements
(140,159,048
)
 
(109,101,978
)
Proceeds from issuance of exchangeable senior notes
400,000

 
—

Proceeds from issuance of asset-backed securities
1,440,755

 
—

Principal repayments of asset-backed securities
(27,778
)
 
—

Payments of deferred costs
(15,676
)
 
—

Payments of dividends and distributions
(261,743
)
 
(227,811
)
Net cash provided by financing activities
2,149,825

 
2,588,462

Net change in cash
(87,379
)
 
(6,376
)
Cash, beginning of period
286,474

 
197,224

Cash and cash equivalents, end of period
199,095

 
190,848

Supplement Disclosure of Cash Flow Information
 
 
 
Interest paid
231,782

 
172,879

Non-cash Investing and Financing Activities Information
 
 
 
Net change in unrealized gain (loss) on mortgage-backed securities and derivatives
(406,153
)
 
512,080

Net change in unconsolidated ventures
—

 
—

Net change in due from counterparties
63

 
3,851

Dividends and distributions declared not paid
71,037

 
78,628

(Receivable) / payable for mortgage-backed securities sold / purchased, net
150,733

 
(672,589
)
Repurchase agreements, not settled
(27,842
)
 
—

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 issued or guaranteed by a U.S. government Agency (“non-Agency RMBS”), commercial mortgage-backed securities (“CMBS”), and residential and commercial mortgage loans. 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 September 30, 2013, the Company owned 99% of the Operating Partnership, and Invesco Investments (Bermuda) Ltd., a direct, wholly-owned subsidiary of Invesco, owned the remaining 1.0%.
The Company finances its Agency RMBS, non-Agency RMBS and CMBS investments through short-term borrowings structured as repurchase agreements. The Company has secured commitments with a number of repurchase agreement counterparties. The Company finances its residential loans through the issuance of asset-backed securities. In addition, the Company may use other sources of financing including committed borrowing facilities and other private financing.
The Company is 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 (“Code”). 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, 2012, which was filed with the SEC on March 1, 2013. The results of operations for the period ended September 30, 2013 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, its subsidiaries and VIEs in which the Company is deemed the primary beneficiary. The underlying loans owned by the VIEs are shown under residential loans on our consolidated balance sheets. The asset-backed securities (“ABS”) issued to third parties by the VIEs are shown under asset-backed securities issued. In our consolidated statements of operations, we record interest 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 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


 
6
 

Table of Contents


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 an entity’s involvement with the design of the VIE.
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 September 30, 2013, 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 its counterparties.
Underwriting Commissions and Offering Costs
Underwriting commissions and direct costs incurred in connection with the Company’s initial public offering (“IPO”) and subsequent 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 interest 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 to interest expense using the effective interest method, based upon actual repayments of the associated beneficial interest 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 and CMBS investment portfolio 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 or CMBS through repurchase agreements with the same counterparty from whom such assets were purchased, the Company accounts for the purchase commitment and repurchase agreement on a net basis and records a forward commitment to purchase such assets as a derivative instrument if the transaction does not comply 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.
If the transaction complies with the criteria for gross presentation, 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. 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 and non-Agency RMBS as a mortgage related receivable from the counterparty on its consolidated balance sheets.


 
7
 

Table of Contents


Asset-Backed Debt Securities
Asset-backed debt securities 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 would be 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.
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 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 irrevocably 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 or CMBS as part of its overall management of its investment portfolio and therefore classifies its RMBS 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. When


 
8
 

Table of Contents


applicable, included with available-for-sale securities are forward purchase commitments on to-be-announced securities (“TBA”). The Company records TBA purchases on the trade date and the corresponding payable is recorded as an outstanding liability as a payable for investments purchased until the settlement date of the transaction. This payable is presented in the “Investment related payable” line item on the consolidated balance sheets.
The Company considers its portfolio of Agency RMBS to be of high credit quality under the accounting guidance. For non-Agency RMBS 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 evaluates 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 and an expected yield. The Company places reliance on this internal model in determining credit quality and the corresponding accounting treatment.
While non-Agency RMBS 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.
For debt securities, the amount of the other-than-temporary impairment related to a credit loss or impairments on securities that the Company has the intent or for which it is more likely than not that the Company will need to sell before recoveries are recognized in earnings and reflected as a reduction in the cost basis of the security. 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 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 include mezzanine loans owned by the Company 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 available-for-sale securities in the consolidated statements of operations.


 
9
 

Table of Contents


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. 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 estimation, including the interest rate and timing of principal payments (prepayments, repurchases, defaults and liquidations), the timing and amount of expected credit losses, 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 or has been individually impaired, 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 or individually impaired 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 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 — Allowance for Loan Losses
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. Reviews are performed at least quarterly. The following factors are considered in evaluating 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 — Allowance for Loan Losses
For commercial loans classified as held-for-investment, we establish a specific allowance for loan losses for loans we have determined to be impaired at the reporting date. An individual loan is considered impaired when it is deemed probable that we 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 formal review of each commercial loan in the portfolio to determine whether the loan is impaired. Reviews are performed at least quarterly. We consider 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 we consider 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 our loans, and the supply and demand of competing projects in the sub-market in which the subject property is located; and


 
10
 

Table of Contents


•
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 our 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.
Dividends and Distributions Payable
Dividends and distributions payable represent dividends declared at the consolidated balance sheet date which are payable to common shareholders, preferred shareholders and distributions declared at the consolidated balance sheet date which are payable to non-controlling interest common unit holders 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 use 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 (Loss)
Comprehensive income (loss) 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 and changes in the fair value of derivatives 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,


 
11
 

Table of Contents


that are intended to economically hedge certain of its risk, even though hedge accounting does not apply or the Company elects not to apply hedge accounting under U.S. GAAP.
Income Taxes
The Company is taxed as a REIT. Accordingly, the Company is generally not 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 currently has no uncertain tax positions.
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 restricted 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 Share Purchase Plan
The Company has implemented a dividend reinvestment and share 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
In January 2013, the FASB issued Accounting Standards Update 2013-01, “Clarifying the Scope of Disclosure about Offsetting Assets and Liabilities” (“ASU 2013-01”). ASU 2013-01 clarified Accounting Standard Update 2011-11, “Disclosures about Offsetting Assets and Liabilities” which was issued in December 2011. Entities will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transaction subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements. The objective of this disclosure is to facilitate comparison between those entities that prepare their financial statements on a basis of U.S. GAAP basis and those entities that prepare their financial statements on the basis of International Financial Reporting Standards


 
12
 

Table of Contents


(IFRS). The guidance was effective for periods beginning on or after January 1, 2013, and interim periods within those annual periods. The additional disclosure requirements were incorporated into Note 10 “Offsetting Assets and Liabilities”.
In February 2013, the FASB issued Accounting Standards Update 2013-02, “Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income” (“ASU 2013-02”), which adds new disclosure requirements for items reclassified out of accumulated other comprehensive income. ASU 2013-02 does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements and is effective prospectively for reporting periods beginning after December 15, 2012. ASU 2013-02 increased our disclosures related to items reclassified out of accumulated other comprehensive income, but did not have an effect on our consolidated financial statements.
Recent Accounting Pronouncements Not Yet Adopted
None

Note 3 – Variable Interest Entities
During the nine months ended September 30, 2013, the Company purchased through its indirect subsidiary an interest in four securitization trusts (none during the quarter ended September 30, 2013) which the Company determined it is the primary beneficiary. The trusts initially held pools of 1,926 fixed rate residential mortgage loans having an initial aggregate principal balance of $1.5 billion and issued a series of ABS having an aggregate original principal amount of $1.5 billion payable from the cash flows generated by the pools of residential mortgage loans. $1.4 billion of ABS was sold to unaffiliated third parties and the balance was purchased by the Company. The Company's interests in the trusts consist of classes of such ABS having an aggregate original principal balance of $112.3 million, which are either subordinate in payment priority, pay interest only, or are payable from certain designated cash flows from the loans. The Company subsequently sold $5.8 million of the original principal balance to a third party.
In determining if a securitized trust should be consolidated, the Company evaluated whether it was 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 concluded that its interest in the securitized trusts purchased during the nine months ended September 30, 2013 were VIEs because such interests included the power to direct the activities that most significantly impact the economic performance of the VIEs and the obligation to absorb losses or right to receive benefits that are potentially significant to the VIEs. Accordingly, for financial statement reporting purposes, the Company consolidated the underlying assets and liabilities of the securitization trusts at their fair value and, as such, no gain or loss was recorded upon consolidation. The securitizations are non-recourse financing of the residential mortgage loans held-for-investment. The senior securities issued by the securitization trusts and not purchased by the Company, which were sold to unaffiliated third parties, are presented in the consolidated balance sheets as “Asset-backed securities issued.”
The Company is not contractually required and has not provided any additional financial support to the VIEs for the period ended September 30, 2013. The following table presents a summary of the assets and liabilities of the VIEs. Intercompany balances have been eliminated for purposes of this presentation.
 
$ in thousand
September 30, 2013
 
December 31, 2012
Residential loans, held-for-investment
1,532,389

 
—

Accrued interest receivable
4,696

 
—

Deferred costs
3,065

 
—

Total assets
1,540,150

 
—

Accrued interest and accrued expenses payable
3,887

 
—

Asset-backed securities issued
1,411,897

 
—

Total liabilities
1,415,784

 
—


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 dealer or third-party pricing service, or such data appears unreliable, the Company may estimate the fair value of the security using a variety of 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.


 
13
 

Table of Contents


The following tables present certain information about the Company’s investment portfolio as of September 30, 2013 and December 31, 2012.
September 30, 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
1,722,520

 
89,091

 
1,811,611

 
28,193

 
1,839,804

 
4.02
%
 
2.24
%
 
2.35
%
30 year fixed-rate
8,689,193

 
579,210

 
9,268,403

 
(246,644
)
 
9,021,759

 
3.95
%
 
2.64
%
 
2.84
%
ARM
197,033

 
(468
)
 
196,565

 
1,335

 
197,900

 
2.73
%
 
2.55
%
 
2.41
%
Hybrid ARM
977,583

 
(3,512
)
 
974,071

 
3,236

 
977,307

 
2.56
%
 
2.39
%
 
2.19
%
Total Agency pass-through
11,586,329

 
664,321

 
12,250,650

 
(213,880
)
 
12,036,770

 
3.82
%
 
2.56
%
 
2.73
%
Agency-CMO(4)
1,491,381

 
(1,004,321
)
 
487,060

 
(4,416
)
 
482,644

 
2.80
%
 
3.16
%
 
2.31
%
Non-Agency RMBS(5)
4,344,281

 
(646,859
)
 
3,697,422

 
11,589

 
3,709,011

 
3.67
%
 
3.76
%
 
4.63
%
CMBS(6)
4,585,928

 
(2,027,009
)
 
2,558,919

 
24,335

 
2,583,254

 
3.50
%
 
4.68
%
 
4.60
%
Total
22,007,919

 
(3,013,868
)
 
18,994,051

 
(182,372
)
 
18,811,679

 
3.66
%
 
3.10
%
 
3.34
%
 
(1)
Net weighted average coupon (“WAC”) as of September 30, 2013 is presented net of servicing and other fees.
(2)
Average yield is based on amortized costs as of September 30, 2013 and incorporates future prepayment and loss assumptions.
(3)
Average yield is based on average amortized costs for the three months ended September 30, 2013 and incorporates future prepayment and loss assumptions.
(4)
Included in the Agency-CMO are interest-only securities which represent 16.4% of the balance based on fair value.
(5)
The non-Agency RMBS held by the Company is 61.0% variable rate, 34.3% fixed rate, and 4.7% floating rate based on fair value.
(6)
Included in the CMBS are interest-only securities and commercial real estate mezzanine loan pass-through certificates which represent 8.0% and 1.8% of the balance based on fair value, respectively.
December 31, 2012
$ 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
1,964,999

 
102,058

 
2,067,057

 
63,839

 
2,130,896

 
4.09
%
 
2.37
%
 
2.37
%
30 year fixed-rate
9,168,196

 
601,592

 
9,769,788

 
238,949

 
10,008,737

 
4.21
%
 
2.89
%
 
2.88
%
ARM
109,937

 
3,464

 
113,401

 
2,365

 
115,766

 
3.15
%
 
2.06
%
 
2.02
%
Hybrid ARM
556,790

 
13,493

 
570,283

 
16,885

 
587,168

 
3.19
%
 
2.18
%
 
2.22
%
Total Agency pass-through
11,799,922

 
720,607

 
12,520,529

 
322,038

 
12,842,567

 
4.13
%
 
2.77
%
 
2.75
%
Agency-CMO(4)
1,322,043

 
(819,530
)
 
502,513

 
1,926

 
504,439

 
2.89
%
 
2.35
%
 
1.51
%
Non-Agency RMBS(5)
3,339,683

 
(308,885
)
 
3,030,798

 
48,238

 
3,079,036

 
4.20
%
 
4.61
%
 
4.80
%
CMBS(6)
1,868,928

 
24,070

 
1,892,998

 
151,523

 
2,044,521

 
5.27
%
 
4.96
%
 
4.82
%
Total
18,330,576

 
(383,738
)
 
17,946,838

 
523,725

 
18,470,563

 
4.17
%
 
3.30
%
 
3.27
%
 
(1)
Net WAC as of December 31, 2012 is presented net of servicing and other fees.
(2)
Average yield based on amortized cost as of December 31, 2012 incorporates future prepayment and loss assumptions.


 
14
 

Table of Contents


(3)
Average yield based on average amortized cost for the three months ended December 31, 2012 incorporates future prepayment and loss assumptions.
(4)
Included in Agency-CMO are interest-only securities which represent 14.1% of the balance based on fair value.
(5)
The non-Agency RMBS held by the Company is 79.2% variable rate, 15.5% fixed rate, and 5.3% floating rate based on fair value.
(6)
Included in the CMBS are interest-only securities and commercial real estate mezzanine loan pass-through certificates which represent 0% and 1.1% of the balance based on fair value, respectively.
The following table summarizes our non-Agency RMBS portfolio by asset type as of September 30, 2013 and December 31, 2012, respectively:
 
$ in thousands
September 30, 2013
 
% of Non-Agency
 
December 31, 2012
 
% of Non-Agency
Re-REMIC Senior
1,475,475

 
39.8
%
 
1,844,209

 
59.9
%
Prime
1,383,923

 
37.3
%
 
754,161

 
24.5
%
Alt-A
822,815

 
22.2
%
 
468,181

 
15.2
%
Subprime
26,798

 
0.7
%
 
12,485

 
0.4
%
Total Non-Agency
3,709,011

 
100.0
%
 
3,079,036

 
100.0
%
The following table summarizes certain characteristics of our senior Re-REMIC holdings as of September 30, 2013 and December 31, 2012:
 
  
 
Percentage of Re-REMIC holdings at Fair Value
Re-REMIC Subordination(1)
 
September 30, 2013
 
December 31, 2012
0-10
 
3.9
%
 
2.1
%
10-20
 
3.5
%
 
3.2
%
20-30
 
14.2
%
 
15.0
%
30-40
 
25.5
%
 
27.0
%
40-50
 
39.5
%
 
40.4
%
50-60
 
8.6
%
 
7.6
%
60-70
 
4.8
%
 
4.7
%
Total
 
100.0
%
 
100.0
%
 
(1)
Subordination refers to the credit enhancement provided to the senior Re-REMIC tranche by the junior Re-REMIC tranche or tranches in a resecuritization. This figure reflects the percentage of the balance of the underlying security represented by the 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 senior Re-REMIC tranche.
The components of the carrying value of the Company’s investment portfolio at September 30, 2013 and December 31, 2012 are presented below:
 
$ in thousands
September 30, 2013
 
December 31, 2012
Principal balance
22,007,919

 
18,330,576

Unamortized premium
758,256

 
788,716

Unamortized discount
(3,772,124
)
 
(1,172,454
)
Gross unrealized gains
284,631

 
563,093

Gross unrealized losses
(467,003
)
 
(39,368
)
Fair value
18,811,679

 
18,470,563



 
15
 

Table of Contents


The following table summarizes certain characteristics of the Company’s investment portfolio, at fair value, according to estimated weighted average life classifications as of September 30, 2013 and December 31, 2012:
 
$ in thousands
September 30, 2013
 
December 31, 2012
Less than one year
28,125

 
70,044

Greater than one year and less than five years
5,625,403

 
13,146,577

Greater than or equal to five years
13,158,151

 
5,253,942

Total
18,811,679

 
18,470,563

The following tables present the gross unrealized losses and estimated fair value of the Company’s MBS by length of time that such securities have been in a continuous unrealized loss position at September 30, 2013 and December 31, 2012, respectively:
September 30, 2013
 
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
155,656

 
(3,048
)
 
11,583

 
(319
)
 
167,239

 
(3,367
)
30 year fixed-rate
6,274,314

 
(308,170
)
 
79,392

 
(1,300
)
 
6,353,706

 
(309,470
)
ARM
34,431

 
(449
)
 
—

 
—

 
34,431

 
(449
)
Hybrid ARM
381,312

 
(2,818
)
 
—

 
—

 
381,312

 
(2,818
)
Total Agency pass-through
6,845,713

 
(314,485
)
 
90,975

 
(1,619
)
 
6,936,688

 
(316,104
)
Agency-CMO
228,820

 
(11,884
)
 
12,810

 
(4,263
)
 
241,630

 
(16,147
)
Non-Agency RMBS
1,434,914

 
(58,969
)
 
379,751

 
(9,708
)
 
1,814,665

 
(68,677
)
CMBS
1,127,151

 
(66,075
)
 
—

 
—

 
1,127,151

 
(66,075
)
Total
9,636,598

 
(451,413
)
 
483,536

 
(15,590
)
 
10,120,134

 
(467,003
)
December 31, 2012
 
  
Less than 12 Months
 
12 Months or More
 
Total
$ in thousands
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Agency RMBS:
 
 
 
 
 
 
 
 
 
 
 
15 year fixed-rate
31,269

 
(279
)
 
—

 
—

 
31,269

 
(279
)
30 year fixed-rate
1,763,113

 
(6,469
)
 
78,640

 
(832
)
 
1,841,753

 
(7,301
)
Total Agency pass-through
1,794,382

 
(6,748
)
 
78,640

 
(832
)
 
1,873,022

 
(7,580
)
Agency-CMO
31,719

 
(7,796
)
 
10,770

 
(2,812
)
 
42,489

 
(10,608
)
Non-Agency RMBS
516,744

 
(6,005
)
 
490,503

 
(12,895
)
 
1,007,247

 
(18,900
)
CMBS
187,349

 
(1,267
)
 
52,813

 
(1,013
)
 
240,162

 
(2,280
)
Total
2,530,194

 
(21,816
)
 
632,726

 
(17,552
)
 
3,162,920

 
(39,368
)
Gross unrealized losses on the Company’s Agency RMBS were $316.1 million at September 30, 2013. Due to the inherent credit quality of Agency RMBS, the Company determined that at September 30, 2013, any unrealized losses on its Agency RMBS portfolio are temporary.
Gross unrealized losses on the Company’s MBS-CMO, non-Agency RMBS, and CMBS were $150.9 million at September 30, 2013. 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.


 
16
 

Table of Contents


The following table presents the impact of the Company’s MBS on its accumulated other comprehensive income for the three and nine months ended September 30, 2013 and 2012.
 
$ in thousands
Three Months 
 ended 
 September 30, 2013
 
Three Months 
 ended 
 September 30, 2012
 
Nine Months 
 ended 
 September 30, 2013
 
Nine Months 
 ended 
 September 30, 2012
Accumulated other comprehensive income from investment securities:
 
 
 
 
 
 
 
Unrealized gain on MBS at beginning of period
(257,402
)
 
268,269

 
523,725

 
(1,217
)
Unrealized gain (loss) on MBS, net
75,030

 
316,823

 
(706,097
)
 
586,309

Balance at the end of period
(182,372
)
 
585,092

 
(182,372
)
 
585,092

During the three months ended September 30, 2013 and 2012, the Company reclassified $85.8 million of net unrealized losses and $5.8 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 nine months ended September 30, 2013 and 2012, the Company reclassified $140.2 million of net unrealized losses and $17.4 million of net unrealized gains, respectively from other comprehensive income into gain 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 nine months ended September 30, 2013 and 2012.
The following table presents components of interest income on the Company’s MBS portfolio for the three and nine months ended September 30, 2013 and 2012.
For the three months ended September 30, 2013 
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
126,685

 
(40,578
)
 
86,107

Non-Agency
39,479

 
2,895

 
42,374

CMBS
39,167

 
(10,050
)
 
29,117

Other
(59
)
 
—

 
(59
)
Totals
205,272

 
(47,733
)
 
157,539



 
17
 

Table of Contents


For the nine months ended September 30, 2013
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
412,945

 
(132,648
)
 
280,297

Non-Agency
117,215

 
6,038

 
123,253

CMBS
101,487

 
(18,502
)
 
82,985

Other
84

 
—

 
84

Totals
631,731

 
(145,112
)
 
486,619

For the three months ended September 30, 2012
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
132,520

 
(42,479
)
 
90,041

Non-Agency
26,477

 
4,149

 
30,626

CMBS
20,330

 
(477
)
 
19,853

Other
(43
)
 
—

 
(43
)
Totals
179,284

 
(38,807
)
 
140,477

For the nine months ended September 30, 2012
$ in thousands
Coupon
Interest
 
Net (Premium
Amortization)/Discount
Accretion
 
Interest
Income
Agency
382,226

 
(109,717
)
 
272,509

Non-Agency
79,903

 
15,204

 
95,107

CMBS
54,146

 
(209
)
 
53,937

Other
(111
)
 
—

 
(111
)
Totals
516,164

 
(94,722
)
 
421,442


Note 5 – Residential Loans Held-for-Investment
The following table details the carrying value for residential loans held-for-investment at September 30, 2013 and December 31, 2012. These loans are held by the VIEs which the Company consolidates.
 
$ in thousands
September 30, 2013
 
December 31, 2012
Principal balance
1,498,726

 
—

Unamortized premium, net
34,414

 
—

Recorded investment
1,533,140

 
—

Allowance for loan losses
(751
)
 
—

Carrying value
1,532,389

 
—

We consider a number of factors when evaluating the credit risks associated with our residential loans held-for-investment portfolio, including but not limited to year of origination, delinquency status and geographic concentration.


 
18
 

Table of Contents


The following table displays certain characteristics of the Company's residential loans held-for-investment at September 30, 2013 by year of origination.  
$ in thousands
2013
 
2012
 
2011
 
2010
 
2009
 
Total
Portfolio Characteristics:
 
 
 
 
 
 
 
 
 
 
 
Number of Loans
1,299

 
600

 
—

 
—

 
5

 
1,904

Current Principal Balance
992,778

 
503,747

 
—

 
—

 
2,201

 
1,498,726

Net Weighted Average Coupon Rate
3.48
%
 
3.50
%
 
—

 
—

 
3.54
%
 
3.49
%
Weighted Average Maturity (years)
29.52

 
29.28

 
—

 
—

 
25.81

 
29.43

Current Performance:
 
 
 
 
 
 
 
 
 
 
 
Current
991,339

 
502,918

 
—

 
—

 
2,201

 
1,496,458

30 Day Delinquent
1,439

 
829

 
—

 
—

 
—

 
2,268

60 Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

90+ Days Delinquent
—

 
—

 
—

 
—

 
—

 
—

Bankruptcy/Foreclosure
—

 
—

 
—

 
—

 
—

 
—

Total
992,778

 
503,747

 
—

 
—

 
2,201

 
1,498,726

The following table presents the five largest geographic concentrations of the Company’s residential loans at September 30, 2013 based on principal balance outstanding:
 
State
Percent
California
49.9
%
Illinois
5.9
%
Massachusetts
5.7
%
Virginia
4.3
%
Maryland
4.2
%
Other states (none greater than 4%)
30.0
%
Total
100.0
%
The following table presents future minimum annual principal payments under the residential loans held-for-investment at September 30, 2013:
 
$ in thousands
 
Scheduled Principal
September 30, 2013
Within one year
27,331

One to three years
57,835

Three to five years
62,340

Greater than or equal to five years
1,351,220

Total
1,498,726

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 nine months ended September 30, 2013:
$ in thousands
September 30, 2013
Balance at beginning of period
—

Charge-offs, net
—

Provision for loan losses
751

Balance at end of period
751

During the quarter ended September 30, 2013 there were no charge-offs of residential loans.



 
19
 

Table of Contents


Note 6 – Commercial Loans Held-for-Investment
Commercial loans held-for-investment includes mezzanine loans originated by the Company. These loans are secured by the borrower’s ownership interest in a single purpose entity that owns commercial property, rather than a lien on the commercial property. As of September 30, 2013, the Company had one outstanding commercial loan which was newly originated and was not delinquent on payment. The loan was not impaired and no allowance for loan loss has been recorded.

Note 7 – Investments in Unconsolidated Ventures
The Company’s non-controlling, unconsolidated ownership interests in the following entities are accounted for under the equity method. Capital contributions, distributions, profits and losses of the entities are allocated in accordance with the terms of the entities’ operating agreements. Such allocations may differ from the stated percentage interests, if any, as a result of preferred returns and allocation formulas as described in such agreements. The Company has made the fair value election for its investments in all unconsolidated ventures. The fair value measurement for the investments in unconsolidated ventures is based on the net asset value per share of the investment, or its equivalent.
Invesco Mortgage Recovery Feeder Fund, L.P. and Invesco Mortgage Recovery Loans AIV, L.P.
The Company invested in certain non-Agency RMBS, CMBS and residential and commercial mortgage loans by contributing equity capital to the Invesco Mortgage Recovery Feeder Fund L.P. managed by the Company’s Manager (“Invesco IMRF Fund”) that received financing under the U.S. government’s Public Private Investment Program (“PPIP”). In March 2012, Invesco IMRF Fund returned substantially all of its proceeds and repaid all financing under the PPIP. The Company is awaiting final distribution from the Invesco IMRF Fund. In addition, the Manager identified a whole loan transaction for the Company, which resulted in the Company’s admission into an alternative investment vehicle, the Invesco Mortgage Recovery Loans AIV, L.P. (“AIV”). The Company has a commitment to invest up to $100.0 million in the Invesco IMRF Fund and AIV. As of September 30, 2013, $87.7 million of the Company's commitment has been called, and the Company is committed to fund $12.3 million in additional capital. The Company realized approximately $378,000 (2012: $1.4 million) and $1.3 million (2012: $2.1 million) of equity in earnings for the three and nine months ended September 30, 2013 related to these investments. The Company also had an unrealized gain of $250,000 (2012: $464,000 loss) and an unrealized gain of $1.7 million (2012: $774,000 gain) from these investments for the three and nine months ended September 30, 2013, respectively.
IMRF Loan Portfolio Member LLC
On September 30, 2011, the Company invested in a portfolio of commercial mortgage loans by contributing $16.9 million, net of distributions, of equity capital to IMRF Loan Portfolio Member LLC (“IMRF LLC”), a limited liability company managed by AIV. The Company has fully funded its commitment to IMRF LLC. The Company realized approximately $956,000 (2012: $2.5 million) and $1.0 million (2012: $3.2 million) of equity in earnings for the three and nine months ended September 30, 2013, respectively. The Company also had $163,000 (2012: $191,000) of unrealized depreciation and $1.1 million (2012: $116,000) of unrealized appreciation from these investments for the three and nine months ended September 30, 2013, respectively.

Note 8 – Borrowings
The Company has entered into repurchase agreements and issued exchangeable senior notes to finance the majority of its portfolio of investments. The following table summarizes certain characteristics of the Company’s borrowings as of September 30, 2013 and December 31, 2012:
 
$ in thousands
September 30, 2013
 
December 31, 2012
 
 
 
 
Weighted
 
 
 
 
 
Weighted
 
 
Weighted
 
Average
 
 
 
Weighted
 
Average
 
 
Average
 
Remaining
 
 
 
Average
 
Remaining
Amount
 
Interest
 
Maturity
 
Amount
 
Interest
 
Maturity
Outstanding
 
Rate
 
(days)
 
Outstanding
 
Rate
 
(days)
Agency RMBS
10,958,730

 
0.37
%
 
18
 
11,713,565

 
0.48
%
 
16
Non-Agency RMBS
2,995,413

 
1.55
%
 
33
 
2,450,960

 
1.75
%
 
23
CMBS
1,943,469

 
1.42
%
 
21
 
1,555,935

 
1.51
%
 
18
Exchangeable Senior Notes
400,000

 
5.00
%
 
1627
 
—

 
—
%
 
0
Total
16,297,612

 
0.83
%
 
60
 
15,720,460

 
0.78
%
 
17


 
20
 

Table of Contents


Repurchase Agreements
The repurchase agreements bear interest at a contractually agreed rate. The repurchase obligations mature and typically reinvest every thirty days to one year. Repurchase agreements are being accounted for as secured borrowings since the Company maintains effective control of the financed assets. Under the repurchase agreements, the respective lender retains the right to mark the underlying collateral to fair value. A reduction in the value of pledged assets would require the Company to provide additional collateral or fund margin calls. In addition, the repurchase agreements are subject to certain financial covenants. The Company was in compliance with these covenants at September 30, 2013.
The following tables summarize certain characteristics of the Company’s repurchase agreements at September 30, 2013 and December 31, 2012:
 
September 30, 2013
 
 
Percent of Total
 
 
$ in thousands
Amount
 
Amount
 
Company MBS
Repurchase Agreement Counterparties
Outstanding
 
Outstanding
 
Held as Collateral
Credit Suisse Securities (USA) LLC
1,701,184

 
10.8
%
 
1,999,024

Citigroup Global Markets Inc.
1,260,176

 
7.9
%
 
1,413,843

Banc of America Securities LLC
1,195,313

 
7.5
%
 
1,324,343

South Street Securities LLC
1,167,095

 
7.3
%
 
1,224,850

Wells Fargo Securities, LLC
1,094,712

 
6.9
%
 
1,263,712

Morgan Stanley & Co. Incorporated
990,095

 
6.2
%
 
1,080,265

Pierpont Securities LLC
841,971

 
5.3
%
 
892,038

JP Morgan Securities Inc.
830,199

 
5.2
%
 
967,291

RBS Securities Inc.
805,749

 
5.1
%
 
931,688

ING Financial Market LLC
683,975

 
4.3
%
 
736,322

Nomura Securities International, Inc.
591,925

 
3.7
%
 
624,060

HSBC Securities (USA) Inc
519,350

 
3.3
%
 
537,185

Industrial and Commercial Bank of China Financial Services LLC
511,155

 
3.2
%
 
540,954

Mitsubishi UFJ Securities (USA), Inc.
489,904

 
3.1
%
 
522,000

Goldman, Sachs & Co.
482,523

 
3.0
%
 
516,843

Scotia Capital
452,067

 
2.8
%
 
476,569

Royal Bank of Canada
437,539

 
2.8
%
 
489,352

Daiwa Capital Markets America Inc
411,106

 
2.6
%
 
424,867

Deutsche Bank Securities Inc.
406,303

 
2.6
%
 
463,227

BNP Paribas Securities Corp.
368,794

 
2.3
%
 
392,547

KGS-Alpha Capital Markets, L.P.
168,750

 
1.1
%
 
180,511

Barclays Capital Inc.
163,548

 
1.0
%
 
174,961

TD Securities
151,918

 
1.0
%
 
165,137

Cantor Fitzgerald & Co.
70,332

 
0.4
%
 
74,077

Mizuho Securities USA Inc.
68,179

 
0.4
%
 
80,734

Guggenheim Liquidity Services, LLC
33,750

 
0.2
%
 
35,599

Total
15,897,612

 
100.0
%
 
17,531,999

 
 
 
 
 
 
December 31, 2012
 
 
Percent of Total