Western Asset Mortgage Capital Corp - Quarter Report: 2022 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| ☒ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 | ||||
For the quarterly period ended March 31, 2022
| ☐ | 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: 001-35543
Western Asset Mortgage Capital Corporation
(Exact name of Registrant as specified in its charter)
| Delaware | 27-0298092 | |||||||
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) | |||||||
Western Asset Mortgage Capital Corporation
47 W 200 South, Suite 200
Salt Lake City, Utah 84101
(Address of Registrant’s principal executive offices)
(801) 952-3390
(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 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 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | o | Accelerated filer | x | |||||||||||
| Non-accelerated filer | o | Smaller reporting company | x | |||||||||||
| Emerging growth company | ☐ | |||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Securities Exchange Act of 1934). Yes ☐ No ý
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered | ||||||||||||
| Common Stock, $0.01 par value | WMC | New York Stock Exchange | ||||||||||||
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
As of May 5, 2022 there were 60,380,105 shares, par value $0.01, of the registrant’s common stock outstanding.
TABLE OF CONTENTS
| Page | ||||||||
Part I
ITEM I. Financial Statements
Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Balance Sheets
(in thousands—except share and per share data)
(Unaudited)
| March 31, 2022 | December 31, 2021 | ||||||||||
| Assets: | |||||||||||
| Cash and cash equivalents | $ | 42,849 | $ | 40,193 | |||||||
| Restricted cash | 257 | 260 | |||||||||
Agency mortgage-backed securities, at fair value ($300 and $1,172 pledged as collateral, at fair value, respectively) | 940 | 1,172 | |||||||||
Non-Agency mortgage-backed securities, at fair value ($142,665 and $123,947 pledged as collateral, at fair value, respectively) | 169,497 | 133,127 | |||||||||
Other securities, at fair value ($49,040 and $51,648 pledged as collateral, at fair value, respectively) | 49,040 | 51,648 | |||||||||
Residential Whole Loans, at fair value ($1,002,710 and $1,023,502 pledged as collateral, at fair value, respectively) | 1,002,710 | 1,023,502 | |||||||||
Residential Bridge Loans, at fair value ($5,129 and $5,207 pledged as collateral, at fair value, respectively) | 5,350 | 5,428 | |||||||||
| Securitized commercial loans, at fair value | 1,288,943 | 1,355,808 | |||||||||
Commercial Loans, at fair value ($101,435 and $101,459 pledged as collateral, at fair value, respectively) | 128,495 | 130,572 | |||||||||
| Investment related receivable | 20,882 | 22,133 | |||||||||
| Interest receivable | 10,960 | 11,823 | |||||||||
| Due from counterparties | 8,819 | 4,565 | |||||||||
| Derivative assets, at fair value | 3,602 | 105 | |||||||||
| Other assets | 2,265 | 45,364 | |||||||||
Total Assets (1) | $ | 2,734,609 | $ | 2,825,700 | |||||||
| Liabilities and Equity: | |||||||||||
| Liabilities: | |||||||||||
| Repurchase agreements, net | $ | 342,380 | $ | 617,189 | |||||||
| Convertible senior unsecured notes, net | 116,347 | 119,168 | |||||||||
Securitized debt, net ($1,654,333 and $1,344,370 at fair value and $171,013 and $180,116 held by affiliates, respectively) | 2,092,482 | 1,863,488 | |||||||||
Interest payable (includes $699 and $699 on securitized debt held by affiliates, respectively) | 8,241 | 10,272 | |||||||||
| Derivative liability, at fair value | 2,335 | 602 | |||||||||
| Accounts payable and accrued expenses | 2,277 | 4,842 | |||||||||
| Payable to affiliate | 2,691 | 1,925 | |||||||||
| Dividend payable | 2,415 | 3,623 | |||||||||
| Other liabilities | 291 | 262 | |||||||||
Total Liabilities (2) | 2,569,459 | 2,621,371 | |||||||||
| Commitments and contingencies (Note 15) | |||||||||||
| Stockholders’ Equity: | |||||||||||
Common stock: $0.01 par value, 500,000,000 shares authorized, 60,380,105 and 60,380,105 outstanding, respectively | 609 | 609 | |||||||||
Preferred stock, $0.01 par value, 100,000,000 shares authorized and no shares outstanding | — | — | |||||||||
Treasury stock, at cost, 579,808 and 579,808 shares held, respectively | (1,665) | (1,665) | |||||||||
| Additional paid-in capital | 918,325 | 918,146 | |||||||||
| Retained earnings (accumulated deficit) | (752,263) | (723,981) | |||||||||
| Total Stockholders’ Equity | 165,006 | 193,109 | |||||||||
| Non-controlling interest | 144 | 11,220 | |||||||||
| Total Equity | 165,150 | 204,329 | |||||||||
| Total Liabilities and Equity | $ | 2,734,609 | $ | 2,825,700 | |||||||
See notes to unaudited consolidated financial statements.
Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Balance Sheets (Continued)
(in thousands — except share and per share data)
(Unaudited)
| March 31, 2022 | December 31, 2021 | ||||||||||
(1) Assets of consolidated VIEs included in the total assets above: | |||||||||||
| Cash and cash equivalents | $ | — | $ | 266 | |||||||
| Restricted cash | 257 | 260 | |||||||||
Residential Whole Loans, at fair value ($1,002,710 and $1,023,502 pledged as collateral, at fair value, respectively) | 1,002,710 | 1,023,502 | |||||||||
Residential Bridge Loans, at fair value ($5,129 and $5,207 pledged as collateral, at fair value, respectively) | 5,129 | 5,207 | |||||||||
| Securitized commercial loans, at fair value | 1,288,943 | 1,355,808 | |||||||||
Commercial Loans, at fair value ($14,362 and $14,362 pledged as collateral, at fair value, respectively) | 14,362 | 14,362 | |||||||||
| Investment related receivable | 20,836 | 22,087 | |||||||||
| Interest receivable | 9,539 | 10,572 | |||||||||
| Total assets of consolidated VIEs | $ | 2,341,776 | $ | 2,432,064 | |||||||
(2) Liabilities of consolidated VIEs included in the total liabilities above: | |||||||||||
Securitized debt, net ($1,654,333 and $1,344,370 at fair value and $171,013 and $180,116 held by affiliates, respectively) | $ | 2,092,482 | $ | 1,863,488 | |||||||
Interest payable (includes $699 and $699 on securitized debt held by affiliates, respectively) | 7,222 | 6,480 | |||||||||
| Accounts payable and accrued expenses | 75 | 78 | |||||||||
| Other liabilities | 257 | 260 | |||||||||
| Total liabilities of consolidated VIEs | $ | 2,100,036 | $ | 1,870,306 | |||||||
See notes to unaudited consolidated financial statements.
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Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Operations
(in thousands—except share and per share data)
(Unaudited)
| For the three months ended March 31, 2022 | For the three months ended March 31, 2021 | ||||||||||
| Net Interest Income | |||||||||||
| Interest income | $ | 35,642 | $ | 46,017 | |||||||
Interest expense (includes $3,443 and $3,693 on securitized debt held by affiliates, respectively) | 31,359 | 36,769 | |||||||||
| Net Interest Income | 4,283 | 9,248 | |||||||||
| Other Income (Loss) | |||||||||||
| Realized gain (loss), net | 12,145 | (5,725) | |||||||||
| Unrealized gain (loss), net | (38,903) | 9,050 | |||||||||
| Gain (loss) on derivative instruments, net | 6,936 | 26 | |||||||||
| Other, net | (145) | (28) | |||||||||
| Other Income (Loss) | (19,967) | 3,323 | |||||||||
| Expenses | |||||||||||
| Management fee to affiliate | 1,100 | 1,477 | |||||||||
| Other operating expenses | 296 | 392 | |||||||||
| Transaction costs | 2,611 | — | |||||||||
| General and administrative expenses: | |||||||||||
| Compensation expense | 498 | 708 | |||||||||
| Professional fees | 1,256 | 879 | |||||||||
| Other general and administrative expenses | 736 | 1,062 | |||||||||
| Total general and administrative expenses | 2,490 | 2,649 | |||||||||
| Total Expenses | 6,497 | 4,518 | |||||||||
| Income (loss) before income taxes | (22,181) | 8,053 | |||||||||
| Income tax provision | 56 | 98 | |||||||||
| Net income (loss) | (22,237) | 7,955 | |||||||||
| Net income attributable to non-controlling interest | 3,616 | 2 | |||||||||
| Net income (loss) attributable to common stockholders and participating securities | $ | (25,853) | $ | 7,953 | |||||||
| Net income (loss) per Common Share — Basic | $ | (0.43) | $ | 0.13 | |||||||
| Net income (loss) per Common Share — Diluted | $ | (0.43) | $ | 0.13 | |||||||
.
See notes to unaudited consolidated financial statements.
3
Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Equity
(in thousands—except shares and share data)
(Unaudited)
| Three Months Ended March 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Outstanding | Additional Paid-In Capital | Retained Earnings (Accumulated Deficit) | Treasury Stock | Total Stockholders' Equity | Non-Controlling Interest | Total Equity | |||||||||||||||||||||||||||||||||||||||||
| Shares | Par | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | 60,380,105 | $ | 609 | $ | 918,146 | $ | (723,981) | $ | (1,665) | $ | 193,109 | $ | 11,220 | $ | 204,329 | ||||||||||||||||||||||||||||||||
| Equity distribution | — | — | — | — | — | — | (14,690) | (14,690) | |||||||||||||||||||||||||||||||||||||||
| Vesting of restricted stock | — | — | 165 | — | — | 165 | — | 165 | |||||||||||||||||||||||||||||||||||||||
| Net income (loss) | — | — | — | (25,853) | — | (25,853) | 3,616 | (22,237) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared on non-controlling interest | — | — | — | — | — | — | (2) | (2) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared on common stock | — | — | 14 | (2,429) | — | (2,415) | — | (2,415) | |||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | 60,380,105 | $ | 609 | $ | 918,325 | $ | (752,263) | $ | (1,665) | $ | 165,006 | $ | 144 | $ | 165,150 | ||||||||||||||||||||||||||||||||
| Three Months Ended March 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Outstanding | Additional Paid-In Capital | Retained Earnings (Accumulated Deficit) | Treasury Stock | Total Stockholders' Equity | Non-Controlling Interest | Total Equity | |||||||||||||||||||||||||||||||||||||||||
| Shares | Par | ||||||||||||||||||||||||||||||||||||||||||||||
| Balance at December 31, 2020 | 60,812,701 | $ | 609 | $ | 915,458 | $ | (660,377) | $ | (578) | $ | 255,112 | $ | 2 | $ | 255,114 | ||||||||||||||||||||||||||||||||
| Vesting of restricted stock | — | — | 183 | — | — | 183 | — | 183 | |||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | 7,953 | — | 7,953 | 2 | 7,955 | |||||||||||||||||||||||||||||||||||||||
| Dividends declared on non-controlling interest | — | — | — | — | — | — | (2) | (2) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared on common stock | — | — | 18 | (3,667) | — | (3,649) | — | (3,649) | |||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2021 | 60,812,701 | $ | 609 | $ | 915,659 | $ | (656,091) | $ | (578) | $ | 259,599 | $ | 2 | $ | 259,601 | ||||||||||||||||||||||||||||||||
See notes to unaudited consolidated financial statements.
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Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows (in thousands)
(Unaudited)
| For the three months ended March 31, 2022 | For the three months ended March 31, 2021 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income (loss) | $ | (22,237) | $ | 7,955 | |||||||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | |||||||||||
| Premium amortization and (discount accretion), net | 2,228 | (170) | |||||||||
| Interest income earned added to principal of investments | (64) | (174) | |||||||||
| Amortization of deferred financing costs | 653 | 1,367 | |||||||||
| Amortization of discount on convertible senior unsecured notes | 223 | 245 | |||||||||
| Restricted stock amortization | 165 | 182 | |||||||||
| Premium on purchase of Residential Whole Loans | (2,139) | — | |||||||||
| Unrealized (gain) loss, net | 38,903 | (9,050) | |||||||||
| Realized (gain) loss on extinguishment of convertible senior notes | 53 | (240) | |||||||||
| Realized gain on sale of real estate owned ("REO") | (12,198) | — | |||||||||
| Unrealized (gain) loss on derivative instruments, net | (1,655) | 17 | |||||||||
| Realized loss on investments, net | — | 5,965 | |||||||||
| Changes in operating assets and liabilities: | |||||||||||
| Interest receivable | 863 | 456 | |||||||||
| Investment related receivable | — | 177 | |||||||||
| Other assets | 616 | 587 | |||||||||
| Interest payable | (2,031) | (3,128) | |||||||||
| Accounts payable and accrued expenses | (2,563) | (259) | |||||||||
| Payable to affiliate | 766 | (10) | |||||||||
| Other liabilities | 30 | (1) | |||||||||
| Net cash provided by operating activities | 1,613 | 3,919 | |||||||||
| Cash flows from investing activities: | |||||||||||
| Purchase of securities | (39,952) | — | |||||||||
| Proceeds from sale of REO | 54,681 | — | |||||||||
| Principal repayments and basis recovered on securities | 907 | 1,041 | |||||||||
| Purchase of Residential Whole Loans | (116,954) | — | |||||||||
| Principal repayments on Residential Whole Loans | 96,808 | 90,663 | |||||||||
| Principal repayments on commercial loans | 4 | 148 | |||||||||
| Principal repayments on securitized commercial loans | — | 51,167 | |||||||||
| Principal repayments on Residential Bridge Loans | 117 | 2,183 | |||||||||
| Due from counterparties | 100 | — | |||||||||
| Net cash (used in) provided by investing activities | (4,289) | 145,202 | |||||||||
| Cash flows from financing activities: | |||||||||||
| Payment of offering costs | (2) | (24) | |||||||||
| Payments on extinguishment of convertible senior unsecured notes | (3,408) | (6,315) | |||||||||
| Proceeds from repurchase agreement borrowings | 1,000,942 | 726,551 | |||||||||
| Repayments of repurchase agreement borrowings | (1,275,751) | (737,018) | |||||||||
| Proceeds from securitized debt | 397,934 | — | |||||||||
| Repayments of securitized debt | (91,716) | (136,119) | |||||||||
| Payments made for deferred financing costs | — | (2) | |||||||||
| Due from counterparties, net | (4,354) | 1,262 | |||||||||
| Due to counterparties, net | — | (260) | |||||||||
| Increase (decrease) in other liabilities | (3) | (51,802) | |||||||||
| Equity distributions to non-controlling interest | (14,690) | — | |||||||||
| Dividends paid on common stock | (3,623) | (3,649) | |||||||||
| Net cash provided by (used in) financing activities | 5,329 | (207,376) | |||||||||
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Western Asset Mortgage Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows (Continued) (in thousands)
(Unaudited)
| For the three months ended March 31, 2022 | For the three months ended March 31, 2021 | ||||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | 2,653 | (58,255) | |||||||||
| Cash, cash equivalents and restricted cash, beginning of period | 40,453 | 107,745 | |||||||||
| Cash, cash equivalents and restricted cash, end of period | $ | 43,106 | $ | 49,490 | |||||||
| Supplemental disclosure of operating cash flow information: | |||||||||||
| Interest paid | $ | 26,657 | $ | 32,294 | |||||||
| Supplemental disclosure of non-cash financing/investing activities: | |||||||||||
| Dividends and distributions declared, not paid | $ | 2,415 | $ | 3,649 | |||||||
| Dividends to non-controlling interest, not paid | $ | 2 | $ | 2 | |||||||
| Principal payments of Residential Whole Loans, not settled | $ | 20,731 | $ | 31,239 | |||||||
| Principal payments of Residential Bridge Loans, not settled | $ | 151 | $ | — | |||||||
| Other assets - Transfer of Bridge Loans to REO | $ | — | $ | 684 | |||||||
| Reconciliation of cash, cash equivalents and restricted cash reported in the Consolidated Balance Sheets: | |||||||||||
| Cash and cash equivalents | $ | 42,849 | $ | 25,159 | |||||||
| Restricted cash | 257 | 24,331 | |||||||||
| Total cash, cash equivalents and restricted cash shown in the Consolidated Statements of Cash Flows | $ | 43,106 | $ | 49,490 | |||||||
See notes to unaudited consolidated financial statements.
6
Western Asset Mortgage Capital Corporation and Subsidiaries
Notes to Consolidated Financial Statements (Unaudited)
(in thousands- except share and per share data)
The following defines certain of the commonly used terms in these Notes to Consolidated Financial Statements: “Agency” or “Agencies” refer to a federally chartered corporation, such as the Federal National Mortgage Association (“Fannie Mae” or “FNMA”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “FHLMC”), or an agency of the U.S. Government, such as the Government National Mortgage Association (“Ginnie Mae” or “GNMA”); references to “MBS” refer to mortgage backed securities, including residential mortgage-backed securities or “RMBS,” commercial mortgage-backed securities or “CMBS,” and “Interest-Only Strips” (as defined herein); “Agency MBS” refer to RMBS, CMBS and Interest-Only Strips issued or guaranteed by the Agencies while “Non-Agency MBS” refer to RMBS, CMBS and Interest-Only Strips that are not issued or guaranteed by the Agencies; references to “ARMs” refers to adjustable rate mortgages; references to “Interest-Only Strips” refer to interest-only (“IO”) and inverse interest-only (“IIO”) securities issued as part of or collateralized with MBS; references to “TBA” refer to To-Be-Announced Securities; and references to “Residential Whole Loans,” “Residential Bridge Loans” and “Commercial Loans” (collectively “Whole Loans”) refer to individual mortgage loans secured by single family, multifamily and commercial properties.
Note 1 — Organization
Western Asset Mortgage Capital Corporation, a Delaware corporation, and its subsidiaries (the “Company”), commenced operations in May 2012. The Company invests in, finances and manages a portfolio of real estate related securities, Whole Loans and other financial assets. The Company’s current portfolio is comprised of Non-Qualified ("Non-QM") Residential Whole Loans, Non-Agency RMBS, Commercial Loans, Non-Agency CMBS and to a lesser extent Agency RMBS, GSE Risk Transfer Securities, Residential Bridge Loans, and asset-backed securities (“ABS”) secured by a portfolio of private student loans. The Company’s investment strategy is based on Western Asset Management Company, LLC’s (the “Manager”) perspective of which mix of portfolio assets it believes provides the Company with the best risk-reward opportunities at any given time. The Company's current investment strategy will focus on residential real estate related investments, including but not limited to non-qualified mortgage loans, Non-Agency RMBS, and other related investments. The Manager will vary the allocation among these asset classes subject to maintaining the Company’s qualification as a REIT and maintaining its exemption from the Investment Company Act of 1940, as amended (the “1940 Act”). These restrictions limit the Company’s ability to invest in non-qualified MBS, non-real estate assets and/or assets which are not secured by real estate. Accordingly, the Company’s portfolio will continue to be principally invested in qualifying MBS, Whole Loans and other real estate related assets.
The Company is externally managed by the Manager, an investment advisor registered with the Securities and Exchange Commission (“SEC”). The Manager is a wholly-owned subsidiary of Franklin Resources, Inc. (“Franklin”). The Company operates and has elected to be taxed as a real estate investment trust or “REIT” commencing with its taxable year ended December 31, 2012.
Note 2 — Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The accompanying unaudited financial statements and related notes have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial reporting in accordance with Article 10 of Regulation S-X and the instructions to Form 10-Q. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary have been made to state fairly the Company’s financial position, results of operations and cash flows. The results of operations for the period ended March 31, 2022, are not necessarily indicative of the results to be expected for the full year or any future period. These consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on March 8, 2022.
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The consolidated financial statements include the accounts of the Company, its wholly-owned and majority-owned subsidiaries, and variable interest entities (“VIEs”) in which it is considered the primary beneficiary. All intercompany amounts between the Company and its subsidiaries and consolidated VIEs have been eliminated in consolidation.
Variable Interest Entities
VIEs are defined as entities that by design either lack sufficient equity for the entity to finance its activities without additional subordinated financial support or are unable to direct the entity’s activities or are not exposed to the entity’s losses or entitled to its residual returns. The Company evaluates all of its interests in VIEs for consolidation. When the interests are determined to be variable interests, the Company assesses whether it is deemed the primary beneficiary. The primary beneficiary of a VIE is determined to be the party that has both the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to the VIE.
To assess whether the Company has the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, it considers all facts and circumstances, including its role in establishing the VIE and its ongoing rights and responsibilities. This assessment includes: first, identifying the activities that most significantly impact the VIE’s economic performance; and second, identifying which party, if any, has power over those activities. In general, the parties that make the most significant decisions affecting the VIE or have the right to unilaterally remove those decision makers are deemed to have the power to direct the activities of a VIE.
To assess whether the Company has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE, it considers all of its economic interests. This assessment requires the Company to apply judgment in determining whether these interests, in the aggregate, are considered potentially significant to the VIE. Factors considered in assessing significance include: the design of the VIE, including its capitalization structure; subordination of interests; payment priority; relative share of interests held across various classes within the VIE’s capital structure; and the reasons why the interests are held by the Company.
In instances where the Company and its related parties have variable interests in a VIE, the Company considers whether there is a single party in the related party group that meets both the power and losses or benefits criteria on its own as though no related party relationship existed. If one party within the related party group meets both these criteria, such reporting entity is the primary beneficiary of the VIE and no further analysis is needed. If no party within the related party group on its own meets both the power and losses or benefits criteria, but the related party group as a whole meets these two criteria, the determination of primary beneficiary within the related party group requires significant judgment. The analysis is based upon qualitative as well as quantitative factors, such as the relationship of the VIE to each of the members of the related-party group, as well as the significance of the VIE's activities to those members, with the objective of determining which party is most closely associated with the VIE.
Ongoing assessments of whether an enterprise is the primary beneficiary of a VIE are required.
Use of Estimates
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Impact of the COVID-19 Pandemic
The global impact of the COVID-19 pandemic continues to evolve rapidly. Beginning with the quarter ended March 31, 2020, the COVID-19 pandemic, created extensive disruptions to the global economy and the lives of individuals throughout the world. Governments and businesses took unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including vaccination efforts, face covering mandates, quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. With the roll out of the vaccines and the decline in COVID-19 cases many of these restrictions were lifted in 2021. While the overall economy is
8
showing signs of recovery from the impacts of COVID-19, workforce shortages, global supply chain bottlenecks and shortages, inflation, as well as the emergence of new COVID-19 variants, are impacting the pace of recovery. The extent of the future effects of COVID-19 on our business, results of operations, cash flows, and growth prospects is still highly uncertain and will ultimately depend on future COVID-19 developments, none of which can be predicted with any certainty.
Significant Accounting Policies
There have been no significant changes to our accounting policies included in Note 2 to the consolidated financial statements of our Annual Report on Form 10-K for the year ended December 31, 2021.
Recently adopted accounting pronouncements
| Description | Adoption Date | Effect on Financial Statements | ||||||||||||
In August 2020, the FASB issued ASU 2020-06, “Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40).” The amendments in this Update affect entities that issue convertible instruments and/or contracts in an entity’s own equity. For convertible instruments, the instruments primarily affected are those issued with beneficial conversion features or cash conversion features because the accounting models for those specific features are removed. | January 1, 2022 | The adoption of this standard did not have a material impact on the Company's consolidated financial statements due to the limited nature of such transactions. | ||||||||||||
Recently issued accounting pronouncements
| Description | Effective Date | Effect on Financial Statements | ||||||||||||
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” The amendments in this update provided optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in this Update apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. In January 2021, the FASB issued ASU 2021-01, "Reference Rate Reform (Topic 848)." The amendments in this Update clarify that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. | March 12, 2020 through December 31, 2022 | The Company may elect to adopt the amendments in ASU 2020-04 and ASU 2021-1 at any time after March 12, 2020 but not later than December 31, 2022. Currently, the Company's contracts that are referenced to LIBOR have not been affected by the amendments in these updates. The Company is in the process of evaluating the guidance and the other optional expedients, and the effect on the Company's financial statements has not yet been determined | ||||||||||||
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Note 3 — Fair Value of Financial Instruments
The following tables present the Company’s financial instruments carried at fair value as of March 31, 2022 and December 31, 2021, based upon the valuation hierarchy (dollars in thousands):
| March 31, 2022 | |||||||||||||||||||||||
| Fair Value | |||||||||||||||||||||||
| Level I | Level II | Level III | Total | ||||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Agency RMBS Interest-Only Strips | $ | — | $ | — | $ | 62 | $ | 62 | |||||||||||||||
Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS | — | — | 878 | 878 | |||||||||||||||||||
| Subtotal Agency MBS | — | — | 940 | 940 | |||||||||||||||||||
| Non-Agency CMBS | — | 99,808 | 5,478 | 105,286 | |||||||||||||||||||
| Non-Agency RMBS | — | 63,030 | — | 63,030 | |||||||||||||||||||
Non-Agency RMBS Interest-Only Strips | — | — | 1,181 | 1,181 | |||||||||||||||||||
| Subtotal Non-Agency MBS | — | 162,838 | 6,659 | 169,497 | |||||||||||||||||||
| Other securities | — | 49,040 | — | 49,040 | |||||||||||||||||||
| Total mortgage-backed securities and other securities | — | 211,878 | 7,599 | 219,477 | |||||||||||||||||||
| Residential Whole Loans | — | — | 1,002,710 | 1,002,710 | |||||||||||||||||||
| Residential Bridge Loans | — | — | 5,350 | 5,350 | |||||||||||||||||||
| Securitized commercial loans | — | — | 1,288,943 | 1,288,943 | |||||||||||||||||||
| Commercial Loans | — | — | 128,495 | 128,495 | |||||||||||||||||||
| Derivative assets | — | 3,602 | — | 3,602 | |||||||||||||||||||
| Total Assets | $ | — | $ | 215,480 | $ | 2,433,097 | $ | 2,648,577 | |||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Derivative liabilities | $ | — | $ | 2,335 | $ | — | $ | 2,335 | |||||||||||||||
| Securitized debt | — | 1,639,414 | 14,919 | 1,654,333 | |||||||||||||||||||
| Total Liabilities | $ | — | $ | 1,641,749 | $ | 14,919 | $ | 1,656,668 | |||||||||||||||
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| December 31, 2021 | |||||||||||||||||||||||
| Fair Value | |||||||||||||||||||||||
| Level I | Level II | Level III | Total | ||||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Agency RMBS Interest-Only Strips | $ | — | $ | — | $ | 114 | $ | 114 | |||||||||||||||
| Agency RMBS Interest-Only Strips accounted for as derivatives, included in MBS | — | — | 1,058 | 1,058 | |||||||||||||||||||
| Subtotal Agency MBS | — | — | 1,172 | 1,172 | |||||||||||||||||||
| Non-Agency CMBS | — | 99,630 | 5,728 | 105,358 | |||||||||||||||||||
| Non-Agency RMBS | — | 25,652 | — | 25,652 | |||||||||||||||||||
| Non-Agency RMBS Interest-Only Strips | — | — | 2,117 | 2,117 | |||||||||||||||||||
| Subtotal Non-Agency MBS | — | 125,282 | 7,845 | 133,127 | |||||||||||||||||||
| Other securities | — | 51,648 | — | 51,648 | |||||||||||||||||||
| Total mortgage-backed securities and other securities | — | 176,930 | 9,017 | 185,947 | |||||||||||||||||||
| Residential Whole Loans | — | — | 1,023,502 | 1,023,502 | |||||||||||||||||||
| Residential Bridge Loans | — | — | 5,428 | 5,428 | |||||||||||||||||||
| Securitized commercial loan | — | — | 1,355,808 | 1,355,808 | |||||||||||||||||||
| Commercial Loans | — | — | 130,572 | 130,572 | |||||||||||||||||||
| Derivative assets | — | 105 | — | 105 | |||||||||||||||||||
| Total Assets | $ | — | $ | 177,035 | $ | 2,524,327 | $ | 2,701,362 | |||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Derivative liabilities | $ | — | $ | 602 | $ | — | $ | 602 | |||||||||||||||
| Securitized debt | — | 1,329,451 | 14,919 | 1,344,370 | |||||||||||||||||||
| Total Liabilities | $ | — | $ | 1,330,053 | $ | 14,919 | $ | 1,344,972 | |||||||||||||||
When available, the Company uses quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, the Company will use independent pricing services, and if the independent pricing service cannot price a particular asset or liability, the Company will obtain third party broker quotes. The Manager’s pricing group, which functions independently from its portfolio management personnel, reviews the third party broker quotes by comparing the broker quotes for reasonableness to alternate sources when available. If independent pricing services or third party broker quotes are not available, the Company determines the fair value of the securities using valuation techniques that use, when possible, current market-based or independently sourced market parameters, such as interest rates and when applicable, estimates of prepayments and credit losses.
In instances when the Company is required to consolidate a VIE that is determined to be a qualifying collateralized financing entity ("CFE"), under GAAP and if the Company has elected the fair value option for the securitized debt, the Company will measure both the financial assets and financial liabilities of the VIE using the fair value of either the VIE’s financial assets or financial liabilities, whichever is more observable.
Mortgage-backed securities and other securities
In determining the proper fair value hierarchy or level, the Company considers the amount of available observable market data for each security. For Agency IOs, Non-Agency RMBS, CMBS and other securities, to determine whether a security should be a Level II, the securities are grouped by security type and the Manager reviews the internal trade history, for the quarter, for each security type. If there is sufficient trade data above a predetermined threshold of a security type, the
11
Manager determines it has sufficient observable market data and the security will be categorized as a Level II; otherwise, the security is classified as a Level III.
Values for the Company’s securities are based upon prices obtained from independent third party pricing services. The valuation methodology of the third party pricing services incorporates market information and commonly used market pricing methods, which include actual trades and quoted prices for similar or identical instruments, and are designed to produce a pricing process that is responsive to market conditions. Depending on the type of asset and the underlying collateral, the primary inputs to the model include yields for TBAs, Agency RMBS, the U.S. Treasury market and floating rate indices such as LIBOR, the Constant Maturity Treasury rate and the prime rate as a benchmark yield. In addition, the model may incorporate the current weighted average maturity and additional pool level information such as prepayment speeds, default frequencies and default severities, if applicable. When the third party pricing service cannot adequately price a particular security, the Company utilizes a broker’s quote which is reviewed for reasonableness by the Manager’s pricing group.
Residential Whole Loans and Residential Bridge Loans
Values for the Company's Residential Whole Loans and Bridge Loans are based upon prices obtained from an independent third party pricing service that specializes in loan valuation, utilizing a discounted cash flow valuation model that is calibrated to recent loan trade execution. Their valuation methodology incorporates commonly used market pricing methods, which include the inputs considered most significant to the determination of fair value of the Company's Residential Whole Loans and Residential Bridge Loans. The key loan inputs include loan balance, interest rate, loan to value, delinquencies and fair value of the collateral for collateral dependent loans. The assumptions made by the independent third-party pricing service includes the market discount rate, default assumptions and loss severity. Other inputs and assumptions relevant to the pricing of Residential Whole Loans include FICO scores and prepayment speeds.
The independent third party pricing service used a combination of recent loan trades and recent Residential Whole Loans securitization transactions adjusted for deal cost and liquidity premium, to form their opinion on the appropriate discount rate.
The Company reviews the analysis provided by pricing service as well as the key assumptions made available to the Company. Due to the inherent uncertainty of such valuation, the fair values established for residential loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's loans are classified as Level III.
Commercial Loans
Values for the Company's Commercial Loans are based upon prices obtained from an independent third party pricing service that specializes in loan valuation, utilizing a valuation model that is calibrated to recent loan trade execution. Their valuation methodology incorporates commonly used market pricing methods, which include the inputs considered most significant to the determination of fair value of the Company's Commercial Loans. The assumptions made by the independent third party pricing vendor include a market discount rate, default assumption, loss severity, cash flows and probability weighted loss scenarios. The Company reviews the analysis provided by the pricing service as well as the key assumptions. Due to the inherent uncertainty of such valuation, the fair values established for Commercial Loans held by the Company may differ from the fair values that would have been established if a readily available market existed for these loans. Accordingly, the Company's Commercial Loans are classified as a Level III.
Securitized commercial loans
Values for the Company’s securitized commercial loans are based on the collateralized financing entity ("CFE") valuation methodology. Since there is an extremely limited market for the securitized commercial loans, the Company determined the securitized debt is more actively traded and therefore was more observable. Due to the inherent uncertainty of the securitized commercial loans' valuation, the Company classifies its securitized commercial loans as Level III.
Securitized debt
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Values for the Company's securitized debt that the Company elected the fair value option are based upon prices obtained from independent third party pricing services. The valuation methodology of the third-party pricing services incorporates market information and commonly used market pricing methods, which include actual trades and quoted prices for similar or identical instruments. In determining the proper fair value hierarchy or level, the Company considers the amount of available observable market data for each security. Since the securitized debt represents traded debt securities, the Manager's pricing team reviews the trade activity during the quarter for each security to determine the appropriate level within the fair value hierarchy. If there is sufficient trade data above a predetermined volume threshold, the Manager determines it has sufficient observable market data and the debt security will be categorized as a Level II. If there is not sufficient observable market data the debt security will be categorized as a Level III.
Derivatives
Values for the Company's derivatives are based upon prices from third party pricing services, whose pricing is subject to review by the Manager’s pricing committee. In valuing its over-the-counter interest rate derivatives, such as swaps and swaptions, its currency derivatives, such as swaps and forwards and credit derivatives such as total return swaps, the Company considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both the Company and its counterparties. No credit valuation adjustment was made in determining the fair value of interest rate derivatives and/or futures contracts for the periods ended March 31, 2022 and December 31, 2021.
Third Party Pricing Data Review
The Company performs quarterly reviews of the independent third party pricing data. These reviews may include a review of the valuation methodology used by third party valuation specialists and review of the daily change in the prices provided by the independent pricing vendor which exceed established tolerances or comparisons to executed transaction prices, utilizing the Manager’s pricing group. The Manager’s pricing group, which functions independently from its portfolio management personnel, reviews the price differences or changes in price by comparing the vendor price to alternate sources including other independent pricing services or broker quotations. If the price change or difference cannot be corroborated, the Manager’s pricing group consults with the portfolio management team for market color in reviewing such pricing data as warranted. To the extent that the Manager has information, typically in the form of broker quotations that would indicate that a price received from the independent pricing service is outside of a tolerance range, the Manager generally challenges the independent pricing service price.
The following tables present a summary of the available quantitative information about the significant unobservable inputs used in the fair value measurement of financial instruments for which the Company has utilized Level III inputs to determine fair value as of March 31, 2022 and December 31, 2021 (dollars in thousands):
| Fair Value at | Range | |||||||||||||||||||||||||||||||||||||
| March 31, 2022 | Valuation Technique | Unobservable Input | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||||||
| Residential Whole Loans | $ | 1,002,710 | Discounted Cash Flow | Market Discount Rate | 4.6 | % | 7.5 | % | 5.2 | % | ||||||||||||||||||||||||||||
| Weighted Average Life | 1.8 | 10.2 | 4.1 | |||||||||||||||||||||||||||||||||||
| Residential Bridge Loans | $ | 5,350 | Discounted Cash Flow | Market Discount Rate | 13.1 | % | 20.1 | % | (1) | 15.2 | % | |||||||||||||||||||||||||||
| Weighted Average Life | 0.3 | 3.8 | 2.7 | |||||||||||||||||||||||||||||||||||
| Commercial Loans | $ | 128,495 | Discounted Cash Flow | Market Discount Rate | 5.6 | % | 24.8 | % | 10.5 | % | ||||||||||||||||||||||||||||
| Weighted Average Life | 0.3 | 4.1 | 1.2 | |||||||||||||||||||||||||||||||||||
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| Fair Value at | Range | |||||||||||||||||||||||||||||||||||||
| December 31, 2021 | Valuation Technique | Unobservable Input | Minimum | Maximum | Weighted Average | |||||||||||||||||||||||||||||||||
| Residential Whole Loans | $ | 1,023,502 | Discounted Cash Flow | Market Discount Rate | 2.6 | % | 7.5 | % | 3.5 | % | ||||||||||||||||||||||||||||
| Weighted Average Life | 1.4 | 8.9 | 3.1 | |||||||||||||||||||||||||||||||||||
| Residential Bridge Loans | $ | 5,428 | Discounted Cash Flow | Market Discount Rate | 9.8 | % | 23.1 | % | (1) | 17.2 | % | |||||||||||||||||||||||||||
| Weighted Average Life | 0.3 | 3.6 | 2.4 | |||||||||||||||||||||||||||||||||||
| Commercial Loans | $ | 130,572 | Discounted Cash Flow | Market Discount Rate | 4.5 | % | 21.7 | % | 9.3 | % | ||||||||||||||||||||||||||||
| Weighted Average Life | 0.5 | 2.8 | 1.2 | |||||||||||||||||||||||||||||||||||
(1) Yield to maturity is the total return on the loan expressed as an annual rate. Delinquent Bridge Loans that are nearing maturity and with fair value that is significantly less than the principal amount have a higher discount rate or yield to maturity.
The following tables present additional information about the Company’s financial instruments which are measured at fair value on a recurring basis for which the Company has utilized Level III inputs to determine fair value:
| Three months ended March 31, 2022 | |||||||||||||||||||||||||||||||||||||||||
| $ in thousands | Agency MBS | Non-Agency MBS | Residential Whole Loans | Residential Bridge Loans | Commercial Loans | Securitized commercial loans | Securitized debt | ||||||||||||||||||||||||||||||||||
| Beginning balance | $ | 1,172 | $ | 7,845 | $ | 1,023,502 | $ | 5,428 | $ | 130,572 | $ | 1,355,808 | $ | 14,919 | |||||||||||||||||||||||||||
| Transfers into Level III from Level II | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Transfers from Level III into Level II | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Purchases | — | — | 118,738 | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Loan modifications / capitalized interest | — | — | 64 | — | — | — | — | ||||||||||||||||||||||||||||||||||
| Principal repayments | — | — | (95,224) | (105) | (4) | — | — | ||||||||||||||||||||||||||||||||||
Total net gains / losses included in net income | |||||||||||||||||||||||||||||||||||||||||
Unrealized gains/(losses), net on assets(1) | (157) | (1,104) | (42,327) | 27 | (2,073) | (73,564) | — | ||||||||||||||||||||||||||||||||||
Unrealized (gains)/losses, net on liabilities(2) | — | — | — | — | — | — | 811 | ||||||||||||||||||||||||||||||||||
Premium and discount amortization, net | (75) | (82) | (2,043) | — | — | 6,699 | (811) | ||||||||||||||||||||||||||||||||||
| Ending balance | $ | 940 | $ | 6,659 | $ | 1,002,710 | $ | 5,350 | $ | 128,495 | $ | 1,288,943 | $ | 14,919 | |||||||||||||||||||||||||||
Unrealized gains/(losses), net on assets held at the end of the period(1) | $ | (157) | $ | (1,104) | $ | (40,637) | $ | 25 | $ | (2,073) | $ | (73,564) | $ | — | |||||||||||||||||||||||||||
Unrealized gains/(losses), net on liabilities held at the end of the period(2) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (811) | |||||||||||||||||||||||||||
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| Three months ended March 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| $ in thousands | Agency MBS | Non-Agency MBS | Other Securities | Residential Whole Loans | Residential Bridge Loans | Commercial Loans | Securitized commercial loan | Securitized debt | |||||||||||||||||||||||||||||||||||||||
| Beginning balance | $ | 1,708 | $ | 34,369 | $ | 8,593 | $ | 1,008,782 | $ | 12,813 | $ | 310,523 | $ | 1,605,335 | $ | 15,418 | |||||||||||||||||||||||||||||||
| Transfers into Level III from Level II | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Transfers from Level III into Level II | — | — | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Transfers to REO | — | — | — | — | (684) | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Loan modifications / capitalized interest | — | — | — | 174 | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Principal repayments | — | (119) | — | (95,015) | (1,082) | (148) | (51,168) | — | |||||||||||||||||||||||||||||||||||||||
Total net gains / losses included in net income | 0 | ||||||||||||||||||||||||||||||||||||||||||||||
| Realized gains/(losses), net on assets | — | — | — | — | (36) | — | — | — | |||||||||||||||||||||||||||||||||||||||
Unrealized gains/(losses), net on assets(1) | 25 | 1,302 | 426 | 16,805 | 203 | 1,622 | 75,810 | — | |||||||||||||||||||||||||||||||||||||||
Unrealized (gains)/losses, net on liabilities(2) | — | — | — | — | — | — | — | 776 | |||||||||||||||||||||||||||||||||||||||
Premium and discount amortization, net | (104) | 66 | 37 | (1,531) | (2) | 64 | 6,150 | (1,248) | |||||||||||||||||||||||||||||||||||||||
| Ending balance | $ | 1,629 | $ | 35,618 | $ | 9,056 | $ | 929,215 | $ | 11,212 | $ | 312,061 | $ | 1,636,127 | $ | 14,946 | |||||||||||||||||||||||||||||||
Unrealized gains/(losses), net on assets held at the end of the period(1) | $ | 25 | $ | 1,302 | $ | 426 | $ | 17,525 | $ | 58 | $ | 1,622 | $ | 75,810 | $ | — | |||||||||||||||||||||||||||||||
Unrealized gains/(losses), net on liabilities held at the end of the period(2) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (776) | |||||||||||||||||||||||||||||||
(1)Gains and losses are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.
(2)Gains and losses on securitized debt are included in "Unrealized gain (loss), net" in the Consolidated Statements of Operations.
The Company did not have transfers between either Level I and Level II or Level I and Level III for the three months ended March 31, 2022 and March 31, 2021.
Other Fair Value Disclosures
The Company's repurchase agreement borrowings, convertible senior unsecured notes and securitized debt are not carried at fair value in the consolidated financial statements.
Borrowings under repurchase agreements
The fair values of the Company's repurchase agreements approximates the carrying value due to the floating interest rates that are based on an index plus a spread, which is typically consistent with those demanded in the market and the short-term maturities of generally one year or less. The Company's repurchase agreements are classified as Level II.
The following table presents the carrying value and estimated fair value of the Company’s convertible senior unsecured notes and securitized debt that are not carried at fair value as of March 31, 2022 and December 31, 2021 in the consolidated financial statements (dollars in thousands):
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| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||
| Carrying Value | Estimated Fair Value | Carrying Value | Estimated Fair Value | ||||||||||||||||||||
| Liabilities | |||||||||||||||||||||||
Convertible senior unsecured notes | 116,347 | 114,846 | 119,168 | 122,133 | |||||||||||||||||||
Securitized debt(1) | 443,339 | 434,066 | 524,649 | 528,046 | |||||||||||||||||||
| Total | $ | 559,686 | $ | 548,912 | $ | 643,817 | $ | 650,179 | |||||||||||||||
(1) Carrying value excludes $5.2 million and $5.5 million of deferred financing costs as of March 31, 2022 and December 31, 2021, respectively.
"Due from counterparties" and "Due to counterparties" in the Company’s Consolidated Balance Sheets are reflected at cost which approximates fair value.
Convertible senior unsecured notes
The fair value of the convertible senior unsecured notes is based on quoted market prices. Accordingly, the Company's convertible senior unsecured notes are classified as Level I.
Securitized debt
Values for the Company's securitized debt, related to the securitization of a portion of its Residential Whole Loans, are based upon prices obtained from independent third party pricing services. The valuation methodology of the third party pricing services incorporates market information and commonly used market pricing methods, which include actual trades and quoted prices for similar or identical instruments. In determining the proper fair value hierarchy or level, the Company considers the amount of available observable market data for each security. Since the securitized debt represents traded debt securities, the Manager's pricing team reviews the trade activity during the quarter for each security to determine the appropriate level within the fair value hierarchy. If there is sufficient trade data above a predetermined threshold, the Manager determines it has sufficient observable market data and the debt security will be categorized as a Level II. If there is not sufficient observable market data the debt security will be categorized as a Level III. At March 31, 2022, there was $1.6 billion of securitized debt classified as a Level II, while $14.9 million was classified as a Level III because there was not sufficient market data for the debt to be classified as Level II.
Note 4 – Mortgage-Backed Securities and other securities
The following tables present certain information about the Company’s investment portfolio at March 31, 2022 and December 31, 2021 (dollars in thousands):
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| March 31, 2022 | ||||||||||||||||||||||||||||||||||||||||||||
| Principal Balance | Unamortized Premium (Discount), net | Amortized Cost | Unrealized Gain | Unrealized Loss | Estimated Fair Value | Net Weighted Average Coupon | ||||||||||||||||||||||||||||||||||||||
Agency RMBS Interest-Only Strips (1)(2) | N/A | N/A | $ | 55 | $ | 7 | $ | — | $ | 62 | 1.1 | % | ||||||||||||||||||||||||||||||||
Agency RMBS Interest-Only Strips, accounted for as derivatives (1) (2) | N/A | N/A | N/A | N/A | N/A | 878 | 1.8 | % | ||||||||||||||||||||||||||||||||||||
| Total Agency MBS | — | — | 55 | 7 | — | 940 | 1.7 | % | ||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS | 76,855 | (14,718) | 62,137 | 2,648 | (1,755) | 63,030 | 4.1 | % | ||||||||||||||||||||||||||||||||||||
Non-Agency RMBS Interest- Only Strips (1) | N/A | N/A | 5,492 | — | (4,311) | 1,181 | 0.3 | % | ||||||||||||||||||||||||||||||||||||
| Subtotal Non-Agency RMBS | 76,855 | (14,718) | 67,629 | 2,648 | (6,066) | 64,211 | 1.4 | % | ||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS | 178,974 | (13,489) | 165,485 | 1,184 | (61,383) | 105,286 | 5.4 | % | ||||||||||||||||||||||||||||||||||||
| Total Non-Agency MBS | 255,829 | (28,207) | 233,114 | 3,832 | (67,449) | 169,497 | 3.2 | % | ||||||||||||||||||||||||||||||||||||
Other securities (3) | 51,130 | (8,426) | 47,402 | 3,921 | (2,283) | 49,040 | 5.5 | % | ||||||||||||||||||||||||||||||||||||
| Total | $ | 306,959 | $ | (36,633) | $ | 280,571 | $ | 7,760 | $ | (69,732) | $ | 219,477 | 3.4 | % | ||||||||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||
| Principal Balance | Unamortized Premium (Discount), net | Amortized Cost | Unrealized Gain | Unrealized Loss | Estimated Fair Value | Net Weighted Average Coupon(4) | ||||||||||||||||||||||||||||||||||||||
Agency RMBS Interest-Only Strips (1) | N/A | N/A | $ | 59 | $ | 55 | $ | — | $ | 114 | 1.3 | % | ||||||||||||||||||||||||||||||||
Agency RMBS Interest-Only Strips, accounted for as derivatives (1) (2) | N/A | N/A | N/A | N/A | N/A | 1,058 | 1.3 | % | ||||||||||||||||||||||||||||||||||||
| Total Agency MBS | — | — | 59 | 55 | — | 1,172 | 1.3 | % | ||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS | 36,147 | (13,936) | 22,211 | 3,476 | (35) | 25,652 | 4.3 | % | ||||||||||||||||||||||||||||||||||||
Non-Agency RMBS Interest- Only Strips (1) | N/A | N/A | 5,608 | — | (3,491) | 2,117 | 0.3 | % | ||||||||||||||||||||||||||||||||||||
| Subtotal Non-Agency RMBS | 36,147 | (13,936) | 27,819 | 3,476 | (3,526) | 27,769 | 1.0 | % | ||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS | 179,619 | (13,088) | 166,531 | 1,543 | (62,716) | 105,358 | 5.4 | % | ||||||||||||||||||||||||||||||||||||
| Total Non-Agency MBS | 215,766 | (27,024) | 194,350 | 5,019 | (66,242) | 133,127 | 3.0 | % | ||||||||||||||||||||||||||||||||||||
Other securities (3) | 51,159 | (8,229) | 47,652 | 4,209 | (213) | 51,648 | 5.6 | % | ||||||||||||||||||||||||||||||||||||
| Total | $ | 266,925 | $ | (35,253) | $ | 242,061 | $ | 9,283 | $ | (66,455) | $ | 185,947 | 3.2 | % | ||||||||||||||||||||||||||||||
(1) IOs and IIOs have no principal balances and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on interest-only class of securities. At March 31, 2022, the notional balance for Agency RMBS IOs and IIOs, Non-Agency RMBS IOs and IIO and Agency RMBS IOs and IIOs, accounted for as derivatives was $2.7 million, $165.3 million and $15.7 million, respectively. At December 31, 2021, the notional balance for Agency RMBS IOs and IIOs, Non-Agency RMBS IOs and IIOs and Agency RMBS IOs and IIOs, accounted for as derivatives was $2.9 million, $181.0 million and $16.8 million, respectively.
(2) Interest on these securities is reported as a component of "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations.
(3) Other securities include residual interests in ABS which have no principal balance and an amortized cost of approximately $4.7 million and $4.7 million, as of March 31, 2022 and December 31, 2021, respectively.
(4) The calculation of the weighted average coupon rate includes the weighted average coupon rates of IOs and IIOs accounted for as derivatives using their notional amounts.
As of March 31, 2022 and December 31, 2021 the weighted average expected remaining term of the MBS and other securities investment portfolio was 8.4 years and 5.9 years, respectively.
17
The following tables present the fair value and contractual maturities of the Company’s investment securities at March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | |||||||||||||||||||||||||||||
| < or equal to 10 years | > 10 years and < or equal to 20 years | > 20 years and < or equal to 30 years | > 30 years | Total | |||||||||||||||||||||||||
| Agency RMBS Interest-Only Strips | $ | — | $ | — | $ | 62 | $ | — | $ | 62 | |||||||||||||||||||
Agency RMBS Interest-Only Strips accounted for as derivatives | — | 878 | — | — | 878 | ||||||||||||||||||||||||
| Subtotal Agency | — | 878 | 62 | — | 940 | ||||||||||||||||||||||||
| Non-Agency CMBS | 66,687 | 16,749 | 21,814 | 36 | 105,286 | ||||||||||||||||||||||||
| Non-Agency RMBS | — | 12,583 | 17,389 | 33,058 | 63,030 | ||||||||||||||||||||||||
| Non-Agency RMBS Interest- Only Strips | — | — | 73 | 1,108 | 1,181 | ||||||||||||||||||||||||
| Subtotal Non-Agency | 66,687 | 29,332 | 39,276 | 34,202 | 169,497 | ||||||||||||||||||||||||
| Other securities | 8,729 | 3,955 | 24,177 | 12,179 | 49,040 | ||||||||||||||||||||||||
| Total | $ | 75,416 | $ | 34,165 | $ | 63,515 | $ | 46,381 | $ | 219,477 | |||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
| < or equal to 10 years | > 10 years and < or equal to 20 years | > 20 years and < or equal to 30 years | > 30 years | Total | |||||||||||||||||||||||||
| Agency RMBS Interest-Only Strips | $ | — | $ | — | $ | 114 | $ | — | $ | 114 | |||||||||||||||||||
Agency RMBS Interest-Only Strips accounted for as derivatives | — | 1,058 | — | — | 1,058 | ||||||||||||||||||||||||
| Subtotal Agency | — | 1,058 | 114 | — | 1,172 | ||||||||||||||||||||||||
| Non-Agency CMBS | 66,384 | 17,644 | 21,171 | 159 | 105,358 | ||||||||||||||||||||||||
| Non-Agency RMBS | — | — | 10,282 | 15,370 | 25,652 | ||||||||||||||||||||||||
| Non-Agency RMBS Interest- Only Strips | — | — | 106 | 2,011 | 2,117 | ||||||||||||||||||||||||
| Subtotal Non-Agency | 66,384 | 17,644 | 31,559 | 17,540 | 133,127 | ||||||||||||||||||||||||
| Other securities | 9,255 | 4,266 | 25,653 | 12,474 | 51,648 | ||||||||||||||||||||||||
| Total | $ | 75,639 | $ | 22,968 | $ | 57,326 | $ | 30,014 | $ | 185,947 | |||||||||||||||||||
18
The following tables present the gross unrealized losses and estimated fair value of the Company’s MBS and other securities by length of time that such securities have been in a continuous unrealized loss position at March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | |||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS | $ | — | $ | — | — | $ | 96,209 | $ | (61,383) | 16 | $ | 96,209 | $ | (61,383) | 16 | ||||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS | 46,043 | (1,702) | 8 | 178 | (53) | 1 | 46,221 | (1,755) | 9 | ||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS Interest-Only Strips | — | — | — | 1,180 | (4,311) | 4 | 1,180 | (4,311) | 4 | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal Non-Agency | 46,043 | (1,702) | 8 | 97,567 | (65,747) | 21 | 143,610 | (67,449) | 29 | ||||||||||||||||||||||||||||||||||||||||||||
| Other securities | 20,238 | (1,464) | 3 | 8,423 | (819) | 4 | 28,661 | (2,283) | 7 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 66,281 | $ | (3,166) | 11 | $ | 105,990 | $ | (66,566) | 25 | $ | 172,271 | $ | (69,732) | 36 | ||||||||||||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | Fair Value | Unrealized Losses | Number of Securities | |||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS | $ | — | $ | — | — | $ | 96,080 | $ | (62,716) | 16 | $ | 96,080 | $ | (62,716) | 16 | ||||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS | — | — | — | 201 | (35) | 1 | 201 | (35) | 1 | ||||||||||||||||||||||||||||||||||||||||||||
| Non-Agency RMBS Interest-Only Strips | — | — | — | 2,117 | (3,491) | 4 | 2,117 | (3,491) | 4 | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal Non-Agency | — | — | — | 98,398 | (66,242) | 21 | 98,398 | (66,242) | 21 | ||||||||||||||||||||||||||||||||||||||||||||
| Other securities | — | — | — | 9,022 | (213) | 4 | 9,022 | (213) | 4 | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | — | $ | — | — | $ | 107,420 | $ | (66,455) | 25 | $ | 107,420 | $ | (66,455) | 25 | ||||||||||||||||||||||||||||||||||||||
The following table presents components of interest income on the Company’s MBS and other securities for the three months ended March 31, 2022 and March 31, 2021, respectively (dollars in thousands):
| Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||
| Coupon Interest | Net (Premium Amortization/Amortization Basis) Discount Accretion | Interest Income | Coupon Interest | Net (Premium Amortization/Amortization Basis) Discount Accretion | Interest Income | ||||||||||||||||||||||||||||||
| Agency RMBS | $ | 8 | $ | (4) | $ | 4 | $ | 15 | $ | (11) | $ | 4 | |||||||||||||||||||||||
| Non-Agency CMBS | 2,972 | (402) | 2,570 | 2,337 | 2,430 | 4,767 | |||||||||||||||||||||||||||||
| Non-Agency RMBS | 545 | (15) | 530 | 413 | (58) | 355 | |||||||||||||||||||||||||||||
| Other securities | 888 | (234) | 654 | 1,591 | (769) | 822 | |||||||||||||||||||||||||||||
| Total | $ | 4,413 | $ | (655) | $ | 3,758 | $ | 4,356 | $ | 1,592 | $ | 5,948 | |||||||||||||||||||||||
The following table presents the sales and realized gain (loss) of the Company’s MBS and other securities for the three months ended March 31, 2022 and March 31, 2021, respectively (dollars in thousands):
19
| Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| Proceeds | Gross Gains | Gross Losses | Net Gain (Loss) | Proceeds | Gross Gains | Gross Losses | Net Gain (Loss) | ||||||||||||||||||||||||||||||||||||||||
Non-Agency CMBS(1) | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (5,929) | $ | (5,929) | |||||||||||||||||||||||||||||||
| Total | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (5,929) | $ | (5,929) | |||||||||||||||||||||||||||||||
(1) There were no sales of Non-Agency CMBS in the three months ended March 31, 2022. The realized loss for the three months ended March 31, 2021 was attributable to a legacy Non-Agency CMBS bond that factored down to zero from a cash shortfall in the securitization.
Unconsolidated CMBS VIEs
The Company’s economic interests held in unconsolidated CMBS VIEs are limited in nature to those of a passive holder of CMBS issued by securitization trusts; the Company was not involved in the design or creation of the securitization trusts. The Company evaluates its CMBS holdings, for potential consolidation of the securitized trust, in which it owns the most subordinate tranche or a portion of the controlling class. As of both March 31, 2022 and December 31, 2021, the Company held five variable interests in unconsolidated CMBS VIEs, respectively, in which it either owned the most subordinate class or a portion of the controlling class. The Company determined it was not the primary beneficiary and accordingly, the CMBS VIEs were not consolidated in the Company’s consolidated financial statements. As of March 31, 2022 and December 31, 2021, the Company’s maximum exposure to loss from these variable interests did not exceed the carrying value of these investments of $27.7 million and $26.5 million, respectively. These investments are classified in "Non-Agency mortgage-backed securities, at fair value" in the Company’s Consolidated Balance Sheets. Further, as of March 31, 2022 and December 31, 2021, the Company did not guarantee any obligations of unconsolidated entities or enter into any commitment or intent to provide funding to any such entities.
Note 5 — Residential Whole Loans and Bridge Loans
Residential Whole-Loan Trusts
Revolving Mortgage Investment Trust 2015-1QR2
Revolving Mortgage Investment Trust 2015-1QR2 ("RMI 2015 Trust") was formed to acquire Non-QM Residential Whole Loans. RMI 2015 Trust issued a trust certificate that is wholly-owned by the Company and represents the entire beneficial interest in pools of Non-QM Residential Whole Loans held by the trust. The Company consolidates the trust since it met the definition of a VIE and the Company determined that it was the primary beneficiary. The Company classifies the underlying Non-QM Residential Whole Loans owned by the trust in "Residential Whole Loans, at fair value" in the Consolidated Balance Sheets and has eliminated the intercompany trust certificate in consolidation.
As of March 31, 2022 and December 31, 2021, the RMI 2015 Trust owns 356 and 770 Non-QM Residential Whole Loans with a fair value of $120.2 million and $451.7 million, respectively. The loans are financed under the Company's Residential Whole Loan Facility, and the Company holds the financing liability outside the RMI 2015 Trust. Refer to Note 7 - Financings for details.
Arroyo Mortgage Trust 2019-2
In May 2019, the Company formed Arroyo Mortgage Trust 2019-2 ("Arroyo Trust 2019"), a wholly-owned subsidiary of the Company, to complete its first residential mortgage-backed securitization comprised of $945.5 million of Non-QM Residential Whole Loans, to a wholly-owned subsidiary of the Company, Arroyo Mortgage Trust 2019-2 (the "Arroyo Trust 2019"). The Arroyo Trust 2019 issued $919.0 million of mortgage-backed notes and retained all the subordinate and residual debt securities ("Owner Certificates"), which includes the required 5% eligible risk retention. Refer to Note 7 - "Financings" for details. The Company consolidates the trust since it met the definition of a VIE and the Company determined that it was the primary beneficiary. The Company classifies the underlying Non-QM Residential Whole Loans in "Residential Whole Loans, at fair value" in the Consolidated Balance Sheets and eliminated the intercompany Owner Certificates in consolidation.
20
As of March 31, 2022 and December 31, 2021, the Arroyo Trust 2019 owns 926 and 1,042 Non-QM Residential Whole Loans with a fair value of $310.6 million and $374.3 million, respectively.
Arroyo Mortgage Trust 2020-1
In June 2020, the Company formed Arroyo Mortgage Trust 2020-1 ("Arroyo Trust 2020"), a wholly-owned subsidiary of the Company, to complete its second residential mortgage-backed securitization comprised of $355.8 million of Non-QM Residential Whole Loans. The Arroyo Trust 2020 issued $341.7 million of mortgage-backed notes and retained all the subordinate and residual debt securities, which includes the required 5% eligible risk retention. Refer to Note 7 - "Financings" for details. The Company consolidates the trust since it met the definition of a VIE and the Company determined that it was the primary beneficiary. The Company classifies the underlying Non-QM Residential Whole Loans in "Residential Whole Loans, at fair value" in the Consolidated Balance Sheets and eliminated the intercompany Owner Certificates.
As of March 31, 2022, and December 31, 2021, the Arroyo Trust 2020 owns 489 and 543 Non-QM Residential Whole Loans with a fair value of $162.3 million and $195.7 million, respectively.
Arroyo Mortgage Trust 2022-1
In February 2022, the Company formed Arroyo Mortgage Trust 2022-1 ("Arroyo Trust 2022"), a wholly-owned subsidiary of the Company, to complete its third residential mortgage-backed securitization comprised of $432.0 million of Non-QM Residential Whole Loans. The Arroyo Trust 2022 issued $398.9 million of mortgage-backed notes and retained all the subordinate and residual debt securities, which includes the required 5% eligible risk retention. Refer to Note 7 - "Financings" for details. The Company consolidates the trust since it met the definition of a VIE and the Company determined that it was the primary beneficiary. The Company classifies the underlying Non-QM Residential Whole Loans in "Residential Whole Loans, at fair value" in the Consolidated Balance Sheets and eliminated the intercompany Owners Certificates.
As of March 31, 2022, the Arroyo Trust 2022 owns 734 Non-QM Residential Whole Loans with a fair value of $408.0 million. The Company has elected the fair value option for the securitized debt. The fair values for the Company’s Non-QM loans held in the Arroyo Trust 2022 are measured using the fair value of the securitized debt based on the CFE valuation methodology. The Company determined that the securitized debt is more actively traded and, therefore, more observable.
Residential Bridge Loan Trust
In February 2017, the Company formed Revolving Mortgage Investment Trust 2017-BRQ1 ("RMI 2017 Trust") to acquire Residential Bridge Loans. RMI 2017 Trust issued a trust certificate that is wholly-owned by the Company and represents the entire beneficial interest in pools of Residential Bridge Loans and certain Residential Whole Loans held by the trust. Residential Bridge Loans are mortgage loans secured by residences, typically short-term. The Company consolidates the trust since it met the definition of a VIE and the Company determined that it was the primary beneficiary. The Company has eliminated the intercompany trust certificate in consolidation.
The Company is no longer allocating capital to Residential Bridge Loans. As of March 31, 2022, and December 31, 2021, there were seven and eight remaining Residential Bridge Loans in the RMI 2017 Trust with a fair value of $5.1 million and $5.2 million, respectively. As of March 31, 2022, and December 31, 2021, the trust also owned six investor fixed rate residential mortgages with a fair value of $1.6 million and $1.7 million, respectively.
Consolidated Residential Whole Loan and Residential Bridge Loan Trusts
The following table presents a summary of the assets and liabilities of the consolidated residential whole loan trusts and residential bridge loan trust included in the Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021 (dollars in thousands):
21
| March 31, 2022 | December 31, 2021 | ||||||||||
| Cash and cash equivalents | $ | — | $ | 266 | |||||||
Residential Whole Loans, at fair value ($1,002,710 and $1,023,502 pledged as collateral, at fair value, respectively) | 1,002,710 | 1,023,502 | |||||||||
Residential Bridge Loans, at fair value ($5,129 and $5,207 pledged as collateral, at fair value, respectively) | 5,129 | 5,207 | |||||||||
| Investment related receivable | 20,836 | 22,087 | |||||||||
| Interest receivable | 4,249 | 5,282 | |||||||||
| Total assets | $ | 1,032,924 | $ | 1,056,344 | |||||||
| Securitized debt, net | $ | 814,571 | $ | 519,118 | |||||||
| Interest payable | 2,058 | 1,316 | |||||||||
| Accounts payable and accrued expenses | 66 | 69 | |||||||||
| Total liabilities | $ | 816,695 | $ | 520,503 | |||||||
The Residential Whole Loans held by the consolidated Arroyo Trust 2019, Arroyo Trust 2020 and Arroyo Trust 2022 are held solely to satisfy the liabilities of each respective trust, and has no recourse to the general credit of the Company. The Company is not contractually required and has not provided any additional financial support to the trusts for the periods ended March 31, 2022 and December 31, 2021.
The following table presents the components of the carrying value of Residential Whole Loans and Residential Bridge Loans as of March 31, 2022 and December 31, 2021 (dollars in thousands):
| Residential Whole Loans, at Fair Value | Residential Bridge Loans, at Fair Value | ||||||||||||||||||||||
| March 31, 2022 | December 31, 2021 | March 31, 2022 | December 31, 2021 | ||||||||||||||||||||
| Principal balance | $ | 1,010,687 | $ | 989,143 | $ | 5,729 | $ | 5,834 | |||||||||||||||
| Unamortized premium | 30,560 | 31,070 | — | — | |||||||||||||||||||
| Unamortized discount | (1,322) | (1,337) | — | — | |||||||||||||||||||
| Amortized cost | 1,039,925 | 1,018,876 | 5,729 | 5,834 | |||||||||||||||||||
| Gross unrealized gains | 3,105 | 14,190 | 87 | 78 | |||||||||||||||||||
| Gross unrealized losses | (40,320) | (9,564) | (466) | (484) | |||||||||||||||||||
| Fair value | $ | 1,002,710 | $ | 1,023,502 | $ | 5,350 | $ | 5,428 | |||||||||||||||
Residential Whole Loans
The Residential Whole Loans have low LTV's and are comprised of 2,505 Non-QM adjustable rate mortgages and six investor fixed rate residential mortgages. The following tables present certain information about the Company’s Residential Whole Loan investment portfolio at March 31, 2022 and December 31, 2021 (dollars in thousands):
22
| March 31, 2022 | |||||||||||||||||||||||||||||||||||||||||
| Weighted Average | |||||||||||||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Original FICO Score(1) | Expected Life (years) | Contractual Maturity (years) | Coupon Rate | ||||||||||||||||||||||||||||||||||
2.01% – 3.00% | 40 | $ | 20,896 | 54.2 | % | 751 | 6.5 | 29.0 | 2.9 | % | |||||||||||||||||||||||||||||||
3.01% – 4.00% | 543 | 266,264 | 61.1 | % | 744 | 4.4 | 27.9 | 3.7 | % | ||||||||||||||||||||||||||||||||
4.01% – 5.00% | 1,232 | 453,466 | 55.1 | % | 752 | 4.1 | 27.2 | 4.6 | % | ||||||||||||||||||||||||||||||||
5.01% – 6.00% | 668 | 260,311 | 63.8 | % | 741 | 3.7 | 26.7 | 5.4 | % | ||||||||||||||||||||||||||||||||
6.01% – 7.00% | 26 | 9,320 | 67.8 | % | 725 | 3.8 | 25.6 | 6.3 | % | ||||||||||||||||||||||||||||||||
7.01% - 8.00% | 2 | 430 | 73.7 | % | 748 | 3.2 | 26.5 | 7.1 | % | ||||||||||||||||||||||||||||||||
| Total | 2,511 | $ | 1,010,687 | 59.0 | % | 747 | 4.1 | 27.3 | 4.5 | % | |||||||||||||||||||||||||||||||
(1)The original FICO score is not available for 249 loans with a principal balance of approximately $83.2 million at March 31, 2022. The Company has excluded these loans from the weighted average computations.
| December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||
| Weighted Average | |||||||||||||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Original FICO Score(1) | Expected Life (years)(2) | Contractual Maturity (years) | Coupon Rate | ||||||||||||||||||||||||||||||||||
2.01% – 3.00% | 27 | $ | 15,640 | 65.1 | % | 757 | 5.3 | 28.8 | 2.8 | % | |||||||||||||||||||||||||||||||
3.01% – 4.00% | 496 | 244,022 | 63.7 | % | 756 | 3.3 | 28.0 | 3.7 | % | ||||||||||||||||||||||||||||||||
4.01% – 5.00% | 1,051 | 413,451 | 65.1 | % | 747 | 2.9 | 28.2 | 4.7 | % | ||||||||||||||||||||||||||||||||
5.01% – 6.00% | 757 | 305,344 | 64.9 | % | 738 | 3.0 | 26.8 | 5.4 | % | ||||||||||||||||||||||||||||||||
6.01% – 7.00% | 28 | 10,181 | 67.9 | % | 721 | 3.1 | 25.8 | 6.3 | % | ||||||||||||||||||||||||||||||||
7.01% - 8.00% | 2 | 505 | 73.2 | % | 753 | 4.5 | 26.8 | 7.1 | % | ||||||||||||||||||||||||||||||||
| Total | 2,361 | $ | 989,143 | 64.8 | % | 746 | 3.1 | 27.7 | 4.6 | % | |||||||||||||||||||||||||||||||
(1)The original FICO score is not available for 230 loans with a principal balance of approximately $74.3 million at December 31, 2021. The Company has excluded these loans from the weighted average computations.
The following table presents the various states across the United States in which the collateral securing the Company’s Residential Whole Loans at March 31, 2022 and December 31, 2021, based on principal balance, is located (dollars in thousands):
| March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||
| State | State Concentration | Principal Balance | State | State Concentration | Principal Balance | |||||||||||||||||||||
| California | 69.6 | % | $ | 703,135 | California | 73.9 | % | $ | 730,771 | |||||||||||||||||
| New York | 12.6 | % | 127,581 | New York | 11.6 | % | 114,625 | |||||||||||||||||||
| Georgia | 3.3 | % | 33,024 | Florida | 2.7 | % | 26,293 | |||||||||||||||||||
| Texas | 2.9 | % | 29,139 | Georgia | 2.5 | % | 25,106 | |||||||||||||||||||
| Florida | 2.7 | % | 27,221 | Texas | 1.9 | % | 19,062 | |||||||||||||||||||
| Other | 8.9 | % | 90,587 | Other | 7.4 | % | 73,286 | |||||||||||||||||||
| Total | 100.0 | % | $ | 1,010,687 | Total | 100.0 | % | $ | 989,143 | |||||||||||||||||
Residential Bridge Loans
The Company is no longer allocating capital to Residential Bridge Loans. The following tables present certain information about the remaining Residential Bridge Loans which are non-performing in the Company's investment portfolio at March 31, 2022 and December 31, 2021 (dollars in thousands):
23
| March 31, 2022 | ||||||||||||||||||||||||||||||||
| c | Weighted Average | |||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Contractual Maturity (months)(1) | Coupon Rate | |||||||||||||||||||||||||||
7.01% – 9.00% | 3 | $ | 2,946 | 70.4 | % | 0.0 | 8.8 | % | ||||||||||||||||||||||||
9.01% – 11.00% | 3 | 2,288 | 77.0 | % | 0.0 | 10.5 | % | |||||||||||||||||||||||||
11.01% – 13.00% | 2 | 495 | 69.7 | % | 0.0 | 11.4 | % | |||||||||||||||||||||||||
| Total | 8 | $ | 5,729 | 73.0 | % | 0.0 | 9.7 | % | ||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||
| Weighted Average | ||||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Contractual Maturity (months)(1) | Coupon Rate | |||||||||||||||||||||||||||
7.01% – 9.00% | 3 | $ | 2,946 | 70.4 | % | 0.0 | 8.8 | % | ||||||||||||||||||||||||
9.01% – 11.00% | 4 | 2,393 | 76.7 | % | 0.0 | 10.4 | % | |||||||||||||||||||||||||
11.01% – 13.00% | 2 | 495 | 69.7 | % | 0.0 | 11.4 | % | |||||||||||||||||||||||||
| Total | 9 | $ | 5,834 | 72.9 | % | 0.0 | 9.7 | % | ||||||||||||||||||||||||
(1) Non-performing loans that are past their maturity date are excluded from the calculation of the weighted average contractual maturity. The weighted average contractual maturity for these loans is zero.
The following table presents the various states across the United States in which the collateral securing the Company’s Residential Bridge Loans at March 31, 2022 and December 31, 2021, based on principal balance, is located (dollars in thousands):
| March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||
| State | Concentration | Principal Balance | State | Concentration | Principal Balance | |||||||||||||||||||||
| New York | 45.9 | % | $ | 2,631 | New York | 45.1 | % | $ | 2,631 | |||||||||||||||||
| California | 30.6 | % | 1,754 | California | 30.1 | % | 1,754 | |||||||||||||||||||
| Florida | 19.6 | % | 1,125 | Florida | 19.3 | % | 1,125 | |||||||||||||||||||
| New Jersey | 3.9 | % | 219 | New Jersey | 3.7 | % | 219 | |||||||||||||||||||
| Total | 100.0 | % | 5,729 | Pennsylvania | 1.8 | % | 105 | |||||||||||||||||||
| Total | 100.0 | % | $ | 5,834 | ||||||||||||||||||||||
Non-performing Loans
The following table presents the aging of the Residential Whole Loans and Bridge Loans as of March 31, 2022 (dollars in thousands):
Residential Whole Loans(1) | Bridge Loans | |||||||||||||||||||||||||||||||||||||
| No of Loans | Principal | Fair Value | No of Loans | Principal | Fair Value | |||||||||||||||||||||||||||||||||
Current(1) | 2,479 | $ | 994,489 | $ | 986,712 | 1 | $ | 849 | $ | 859 | ||||||||||||||||||||||||||||
| 1-30 days | 16 | 7,247 | 7,250 | 1 | 75 | 75 | ||||||||||||||||||||||||||||||||
| 31-60 days | 2 | 824 | 766 | — | — | — | ||||||||||||||||||||||||||||||||
| 61-90 days | 1 | 536 | 509 | — | — | — | ||||||||||||||||||||||||||||||||
| 90+ days | 13 | 7,591 | 7,473 | 6 | 4,805 | 4,416 | ||||||||||||||||||||||||||||||||
| Total | 2,511 | $ | 1,010,687 | $ | 1,002,710 | 8 | $ | 5,729 | $ | 5,350 | ||||||||||||||||||||||||||||
(1) As of March 31, 2022, there was one loan in forbearance.
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Residential Whole Loans
As of March 31, 2022, there were 13 Residential Whole Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $7.6 million and a fair value of $7.5 million. These nonperforming loans represent approximately 0.8% of the total outstanding principal balance. These loans are collateral dependent with a weighted average original LTV of 61.0%.
As of December 31, 2021, there were 20 Residential Whole Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $12.2 million and a fair value of approximately $12.0 million. These nonperforming loans represent approximately 1.2% of the total outstanding principal balance. These loans are collateral dependent with a weighted average original LTV of 60.0%.
These loans are carried at fair value, and accordingly no allowance for credit losses or credit loss expense was recorded, since the adjustment for credit losses, if any, would be reflected in the fair value of these loans as a component of "Unrealized gain (loss), net" in the Consolidated Statements of Operations. The Company stopped accruing interest income for these loans when they became contractually 90 days delinquent.
Residential Bridge Loans
As of March 31, 2022, the Company had eight remaining Residential Bridge Loans in the portfolio. Of these, six were in non-accrual status with an unpaid principal balance of approximately $4.8 million and a fair value of $4.4 million. These nonperforming loans had an outstanding principal balance of $4.8 million. These loans are collateral dependent.
As of December 31, 2021, the Company had nine remaining Residential Bridge Loans in the portfolio. Of these, six were in non-accrual status with an unpaid principal balance of $4.8 million and a fair value of $4.4 million. These nonperforming loans had an outstanding principal balance of $5.8 million. These loans are collateral dependent.
The remaining Residential Bridge Loans were carried at fair value. No allowance for credit losses was recorded because the valuation adjustments as of March 31, 2022 and December 31, 2021, if any, would be reflected in the fair value of these loans. The Company stopped accruing interest income for these loans when they became contractually 90 days delinquent.
Residential Real Estate Owned
As of March 31, 2022 and December 31, 2021, the Company had four residential REO properties with an aggregate carrying value of $1.1 million, related to foreclosed Bridge Loans. The residential REO properties are held for sale and accordingly carried at the lower of cost or fair value less cost to sell. The residential REO properties are classified in "Other assets" in the Consolidated Balance Sheets.
Note 6 — Commercial Loans
Commercial Loans
In January 2019, WMC CRE LLC ("CRE LLC"), a wholly-owned subsidiary of the Company was formed for the purpose of acquiring Commercial Loans. The Commercial Loans owned by CRE LLC are financed under the Commercial Whole Loan Facility. Refer to Note 7 - Financings for details.
The following table presents information about the Commercial Loans owned by CRE LLC as of March 31, 2022 (dollars in thousands):
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| Loan | Acquisition Date | Loan Type | Principal Balance | Fair Value | Original LTV | Interest Rate | Maturity Date | Extension Option | Collateral | ||||||||||||||||||||
| CRE 3 | August 2019 | Interest-Only Mezzanine loan | $ | 90,000 | $ | 27,060 | 58% | 1-Month LIBOR plus 9.25% | 6/29/2021 | None(1) | Entertainment and Retail | ||||||||||||||||||
| CRE 4 | September 2019 | Interest-Only First Mortgage | 38,367 | 38,229 | 63% | 1-Month LIBOR plus 3.02% | 8/6/2022 | -Year Extension | Retail | ||||||||||||||||||||
| CRE 5 | December 2019 | Interest-Only First Mortgage | 24,535 | 24,242 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two -Year Extensions | Hotel | ||||||||||||||||||||
| CRE 6 | December 2019 | Interest-Only First Mortgage | 13,207 | 13,049 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two -Year Extensions | Hotel | ||||||||||||||||||||
| CRE 7 | December 2019 | Interest-Only First Mortgage | 7,259 | 7,172 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two -Year Extensions | Hotel | ||||||||||||||||||||
| CRE 8 | December 2019 | Interest-Only First Mortgage | 4,425 | 4,381 | 79% | 1-Month LIBOR plus 4.85% | 12/6/2022 | None | Assisted Living Facilities | ||||||||||||||||||||
| $ | 177,793 | $ | 114,133 | ||||||||||||||||||||||||||
(1) CRE 3 is in default and not eligible for extension.
Commercial Loan Trust
In March 2018, the Company formed the Revolving Small Balance Commercial Trust 2018-1 ("RSBC Trust") to acquire commercial real estate mortgage loans. The Company consolidates the trust because it determined that the wholly-owned RSBC Trust was a VIE and that the Company was the primary beneficiary. As of March 31, 2022, there is one loan remaining in the trust and it is financed under one of the Company's short-term repurchase agreements. The Company holds the financing liability outside the RSBC Trust. Refer to Note 7 - "Financings" for details.
The following table presents information on the commercial real estate mortgage loan held by RSBC Trust as of March 31, 2022 (dollars in thousands):
| Loan | Acquisition Date | Loan Type | Principal Balance | Fair Value | LTV | Interest Rate | Maturity Date | Extension Option | Collateral | ||||||||||||||||||||
| SBC 3 | January 2019 | Interest-Only First Mortgage | $ | 14,362 | $ | 14,362 | 49% | 1-Month LIBOR plus 4.10% | 7/6/2022 | None | Nursing Facilities | ||||||||||||||||||
| $ | 14,362 | $ | 14,362 | ||||||||||||||||||||||||||
Securitized Commercial Loans
Securitized commercial loans are comprised of commercial loans from consolidated third party sponsored CMBS VIE's. At March 31, 2022, the Company had a variable interest in one third party sponsored CMBS VIE, CSMC Trust 2014-USA, that it determined it was the primary beneficiary and was required to consolidate. The commercial loans that serve as collateral for the securitized debt issued by this VIE can only be used to settle the securitized debt. Refer to Note 7 - "Financings" for details on the associated securitized debt. The Company assesses modifications to VIEs on an ongoing basis to determine if a significant reconsideration event has occurred that would change the Company’s initial consolidation assessment.
RETL 2019-RVP
RETL 2018 was refinanced with a new securitization RETL 2019-RVP ("RETL 2019 Trust") in March 2019. The Company acquired a $65.3 million interest in the trust certificates issued by the RETL 2019 Trust, including $45.3 million which represents the 5% eligible risk retention certificate. The Company determined that RETL 2019 Trust was a VIE and that the Company was also the primary beneficiary because the Manager was involved in certain aspects of the design of the trust and the Company together with other related party entities own more than 50% of the controlling class. As the primary beneficiary, the Company consolidated RETL 2019 Trust and its investment in the trust certificates (HRR class and a portion of the C class) of RETL 2019 Trust was eliminated in consolidation. The RETL 2019 Trust held a commercial loan collateralized by first mortgages, deeds of trusts and interests in commercial real estate.
26
On September 15, 2021, the commercial loan was paid in full by the borrower and the RETL HRR bond with an outstanding principal amount of $45.3 million held in WMC RETL LLC, a wholly-owned subsidiary of the Company, was paid off. Accordingly, the RETL 2019 Trust is no longer consolidated.
CSMC Trust 2014-USA
The Company together with other related party entities own more than 50% of the controlling class of CSMC Trust 2014-USA ("CSMC USA"). As of March 31, 2022, the Company held an 8.8% interest in the trust certificates issued by CSMC USA (F Class) with an outstanding principal balance of $14.9 million. The Company performs ongoing reassessment of its CMBS VIE holdings for potential consolidation of the securitized trust in which it owns a portion of the controlling class. Since the ownership of the controlling financial interest is held within a related party group, the Company must determine whether it is the primary beneficiary under the related party tie-breaker rule. As a result of the Company's evaluation, it was determined that the Company is the primary beneficiary of CSMC USA, and effective on August 1, 2020, consolidated CSMC USA. The Company’s investment in the trust certificate of CSMC USA (F Class) was eliminated in the consolidation. The CSMC USA holds a commercial loan secured by a first mortgage lien on the borrowers’ fee and leasehold interests in a portion of a super-regional mall. The outstanding principal balance on this commercial loan is $1.4 billion as of March 31, 2022. The loan has a stated maturity date of September 11, 2025 and bears a fixed interest rate of 4.38%. The Company elected the fair value option for the commercial loan as well as the associated securitized debt.
In December 2020, the commercial loan held by CSMC USA was amended to an interest only payment through maturity. As part of the modification, a Cash Management Forbearance Agreement was entered into by the special servicer and the borrower, which required both increased reporting requirements and monthly net cash remittance.
Consolidated Securitized Commercial Loan Trusts and Commercial Loan Trust
The two commercial consolidated trusts, CSMC USA and RSBC Trust, collectively held two Commercial Loans as of March 31, 2022. The following table presents a summary of the assets and liabilities of the two consolidated trusts included in the Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||
| Restricted cash | $ | 257 | $ | 260 | |||||||
| Securitized commercial loans, at fair value | 1,288,943 | 1,355,808 | |||||||||
| Commercial Loans, at fair value | 14,362 | 14,362 | |||||||||
| Interest receivable | 5,290 | 5,290 | |||||||||
| Total assets | $ | 1,308,852 | $ | 1,375,720 | |||||||
| Securitized debt, at fair value | $ | 1,277,911 | $ | 1,344,370 | |||||||
| Interest payable | 5,164 | 5,164 | |||||||||
| Accounts payable and accrued expenses | 9 | 9 | |||||||||
| Other liabilities | 257 | 260 | |||||||||
| Total liabilities | $ | 1,283,341 | $ | 1,349,803 | |||||||
The Company’s risk with respect to its investment in the securitized commercial loan trust is limited to its direct ownership in the trust. The commercial loan held by the consolidated securitized commercial loan trust is held solely to satisfy the liabilities of the trust, and creditors of the trust have no recourse to the general credit of the Company. The securitized commercial loan of the trust can only be used to satisfy the obligations of that trust. The Company is not contractually required to provide, and has not provided any additional financial support to the securitized commercial loan trust for the three months ended March 31, 2022 and March 31, 2021.
The following table presents the components of the carrying value of the securitized commercial loans and commercial loans as of March 31, 2022 and December 31, 2021 (dollars in thousands):
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| CSMC USA Trust Securitized Commercial Loan, at Fair Value | RSBC Trust Commercial Loans, at Fair Value | Commercial Loans, at Fair Value | ||||||||||||||||||||||||||||||||||||
| March 31, 2022 | December 31, 2021 | March 31, 2022 | December 31, 2021 | March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||||||||||
| Principal balance | $ | 1,385,591 | $ | 1,385,591 | $ | 14,362 | $ | 14,362 | $ | 177,793 | $ | 177,797 | ||||||||||||||||||||||||||
| Unamortized premium | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||
| Unamortized discount | (104,071) | (110,770) | — | — | — | — | ||||||||||||||||||||||||||||||||
| Amortized cost | 1,281,520 | 1,274,821 | 14,362 | 14,362 | 177,793 | 177,797 | ||||||||||||||||||||||||||||||||
| Gross unrealized gains | 7,423 | 80,987 | — | — | — | — | ||||||||||||||||||||||||||||||||
| Gross unrealized losses | — | — | — | — | (63,660) | (61,587) | ||||||||||||||||||||||||||||||||
| Fair value | $ | 1,288,943 | $ | 1,355,808 | $ | 14,362 | $ | 14,362 | $ | 114,133 | $ | 116,210 | ||||||||||||||||||||||||||
Non-Performing Commercial Loans
The following table presents the aging of the Commercial Loans as of March 31, 2022 (dollars in thousands):
| Commercial Loans | ||||||||||||||||||||
| No of Loans | Principal | Fair Value | ||||||||||||||||||
| Current | 6 | $ | 102,155 | $ | 101,435 | |||||||||||||||
| 1-30 days | — | — | — | |||||||||||||||||
| 31-60 days | — | — | — | |||||||||||||||||
| 61-90 days | — | — | — | |||||||||||||||||
| 90+ days | 1 | 90,000 | 27,060 | |||||||||||||||||
| Total | 7 | $ | 192,155 | $ | 128,495 | |||||||||||||||
The COVID-19 pandemic has adversely impacted a broad range of industries in which the commercial loan borrowers operate and could impair their ability to fulfill their financial obligations to the Company, most significantly hospitality and retail assets. The low average original LTV of the Company's commercial loan portfolio of 59.7%, reflecting significant equity value that the sponsors are motivated to protect, is a mitigating factor of these risks. However, there is no guarantee that losses will not occur.
CRE 3 Loan
As of March 31, 2022, the CRE 3 junior mezzanine loan which has an outstanding principal balance of $90.0 million secured by a class A retail and entertainment complex located in the North East U.S. (the “Property”) was in default. The Property, which was originally scheduled to open in March 2020, was severely impacted by COVID-19 related shutdowns and restrictions and continues to face the challenging conditions impacting large portions of the retail sector. The Company was receiving interest payments on this loan from a reserve that was exhausted in May 2021 and the loan became non-performing.
Additionally, on May 10, 2021, the administrative agent for the senior mortgage loan on the Property (the “Administrative Agent”) notified us, as administrative agent for the junior mezzanine loan, of the Administrative Agent’s intent to accept an assignment in lieu of foreclosure with respect to the Property if the junior mezzanine lenders did not elect to purchase the senior mortgage loan within 30 days pursuant to the terms set forth in an intercreditor agreement among the Administrative Agent, the Company and the senior mezzanine lender. The senior mezzanine lender was provided with a similar notice on May 10, 2021. Since the original notice provided by the Administrative Agent on May 10, 2021, the Administrative Agent has extended the deadline for the junior mezzanine lenders and the senior mezzanine lender to exercise their purchase right with respect to the senior mortgage loan a total of three times, with the most recent extension expired on July 14, 2021, and neither the junior mezzanine lenders nor the senior mezzanine lender offered to purchase the senior mortgage loan.
28
The Company is currently in discussions with the borrower and certain other lenders regarding alternatives to address the situation which might include modifications of loan terms, deferral of payments and the funding of new advances. There can be no assurance that these discussions will result in an outcome in which the Company would be repaid any amount of the loan and the Company may suffer further declines in fair value with respect to this mezzanine investment. The Company could experience a total loss of its investment under various scenarios, which at current levels would result in a $27.1 million reduction in the Company’s book value.
Commercial Real Estate Owned
Hotel REO
In February 2022, the Company and the other investors sold the unencumbered hotel property which was foreclosed on in the third quarter of 2021 for $55.9 million . The Company and the other investors fully recovered their aggregate initial investment of $42.0 million. The Company recognized a gain on sale of approximately $12.2 million of which $8.7 million was the Company's share of the gain.
Note 7— Financings
Repurchase Agreements
The Company has primarily financed its investment acquisitions with repurchase agreements. The repurchase agreements bear interest at a contractually agreed-upon rate and historically had terms ranging from one month to 12 months. The Company’s repurchase agreement borrowings are accounted for as secured borrowings when the Company maintains effective control of the financed assets. Under these repurchase agreements, the respective counterparties retain the right to determine the fair value of the underlying collateral. A reduction in the value of pledged assets normally requires the Company to post additional securities as collateral, pay down borrowings or establish cash margin accounts with the counterparties in order to re-establish the agreed-upon collateral requirements, and is referred to as a margin call. The inability of the Company to post adequate collateral for a margin call by a counterparty, in a time frame as short as the close of the same business day, could result in a condition of default under the Company’s repurchase agreements, thereby enabling the counterparty to liquidate the collateral pledged by the Company, which may have a material adverse effect on the Company’s financial position, results of operations and cash flows.
In order to manage the severe market conditions and the resulting large margin demands from lenders and pressure on the Company’s liquidity, the Company entered into three longer term financing arrangements to reduce its exposure to short-term financings with daily mark-to-market exposure. Below is a summary of each of these financing arrangements.
Residential Whole Loan Facility
On November 5, 2021, the Company entered into an amendment of its Residential Whole Loan Facility. The amended facility has a stated capacity of $500.0 million. and bears an interest rate of LIBOR plus 2.00%, with a LIBOR floor of 0.25%. The facility is available to finance five types of residential mortgages: Non-Agency mortgage loans, Non-QM loans, investor loans, re-performing and non-performing loans. The advance rates may differ by type of loan, but for performing Non-QM loans the advance rate is 90%. The facility matures on November 4, 2022. The facility is a mark-to-market margin facility; however, the margin requirement is only triggered if the fair value of the collateral declines to below the aggregate outstanding principal amount of the collateral.
The Company finances its Non-QM Residential Whole Loans held in RMI 2015 Trust under this facility. As of March 31, 2022, the Company had outstanding borrowings of $109.1 million. The borrowing is secured by Non-QM Residential Whole Loans with a fair value of $120.2 million as of March 31, 2022.
Non-Agency CMBS and Non-Agency RMBS Facility
29
On May 5, 2021, the Company amended its Non-Agency CMBS and Non-Agency RMBS financing facility to, among other things, extend the facility for an additional 12 months and reduce the interest rate. The amended facility has improved advance rates and bears interest at a rate of three-month LIBOR plus 2.00%. As of March 31, 2022, the outstanding balance under this facility was $100.4 million. The borrowing is secured by investments with a fair market value of $173.7 million as of March 31, 2022.
Commercial Whole Loan Facility
On May 5, 2021, the Company amended its Commercial Whole Loan Facility to, among other things, convert the term to a 12-month facility with a stated capacity of up to $100 million. The facility has a 12-month extension option, subject to the lender's consent.
As of March 31, 2022, the Company had approximately $63.7 million in borrowings, with a weighted average interest rate of 2.27% under its Commercial Whole Loan Facility. The borrowing is secured by the performing commercial loans that are held in CRE LLC with an estimated fair market value of $87.1 million as of March 31, 2022.
Financial Metrics
Certain of the Company’s financing arrangements provide the counterparty with the right to terminate the agreement and accelerate amounts due under the associated agreement if the Company does not maintain financial metrics. Although specific to each financing arrangement, typical financial metrics include minimum equity and liquidity requirements, leverage ratios, and performance triggers. In addition, some of the financing arrangements contain cross-default features, whereby default under an agreement with one lender simultaneously causes default under agreements with other lenders. The Company complied with the terms of such financial metrics as of March 31, 2022.
As of March 31, 2022, the Company had borrowings under six of its master repurchase agreements. The following table summarizes certain characteristics of the Company’s repurchase agreements at March 31, 2022 and December 31, 2021 (dollars in thousands):
30
| March 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||||||||||||||
| Securities Pledged | Repurchase Agreement Borrowings | Weighted Average Interest Rate on Borrowings Outstanding at end of period | Weighted Average Remaining Maturity (days) | Repurchase Agreement Borrowings | Weighted Average Interest Rate on Borrowings Outstanding at end of period | Weighted Average Remaining Maturity (days) | ||||||||||||||||||||||||||||||||
| Short-Term Borrowings: | ||||||||||||||||||||||||||||||||||||||
| Agency RMBS | $ | 354 | 1.13 | % | 32 | $ | 976 | 1.02 | % | 58 | ||||||||||||||||||||||||||||
Non-Agency RMBS (1) | 54,388 | 2.33 | % | 11 | 38,354 | 2.94 | % | 4 | ||||||||||||||||||||||||||||||
Residential Whole Loans (2) | 1,322 | 2.95 | % | 28 | 1,439 | 2.57 | % | 5 | ||||||||||||||||||||||||||||||
Residential Bridge Loans (2) | 4,231 | 2.95 | % | 28 | 4,368 | 2.61 | % | 5 | ||||||||||||||||||||||||||||||
Commercial Loans (2) | 6,463 | 3.56 | % | 28 | 6,463 | 3.20 | % | 5 | ||||||||||||||||||||||||||||||
| Other Securities | 2,410 | 3.49 | % | 18 | 2,457 | 3.50 | % | 18 | ||||||||||||||||||||||||||||||
| Total short-term borrowings | 69,168 | 2.53 | % | 15 | 54,057 | 2.92 | % | 6 | ||||||||||||||||||||||||||||||
| Long-Term Borrowings: | ||||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS and Non-Agency RMBS Facility | ||||||||||||||||||||||||||||||||||||||
Non-Agency CMBS (1) | 56,486 | 2.14 | % | 35 | 59,802 | 2.14 | % | 125 | ||||||||||||||||||||||||||||||
| Non-Agency RMBS | 16,451 | 2.15 | % | 35 | 15,632 | 2.14 | % | 125 | ||||||||||||||||||||||||||||||
| Other Securities | 27,506 | 2.22 | % | 35 | 27,506 | 2.22 | % | 125 | ||||||||||||||||||||||||||||||
| Subtotal | 100,443 | 2.17 | % | 35 | 102,940 | 2.16 | % | 125 | ||||||||||||||||||||||||||||||
| Residential Whole Loan Facility | ||||||||||||||||||||||||||||||||||||||
Residential Whole Loans (2) | 109,111 | 2.25 | % | 218 | 396,531 | 2.25 | % | 308 | ||||||||||||||||||||||||||||||
| Commercial Whole Loan Facility | ||||||||||||||||||||||||||||||||||||||
| Commercial Loans | 63,658 | 2.27 | % | 178 | 63,661 | 2.27 | % | 268 | ||||||||||||||||||||||||||||||
| Total long-term borrowings | 273,212 | 2.22 | % | 141 | 563,132 | 2.24 | % | 270 | ||||||||||||||||||||||||||||||
| Repurchase Agreements Borrowings | $ | 342,380 | 2.29 | % | 116 | $ | 617,189 | 2.30 | % | 247 | ||||||||||||||||||||||||||||
| Less Unamortized Debt Issuance Costs | — | N/A | N/A | — | N/A | N/A | ||||||||||||||||||||||||||||||||
| Repurchase Agreements Borrowings, net | $ | 342,380 | 2.29 | % | 116 | $ | 617,189 | 2.30 | % | 247 | ||||||||||||||||||||||||||||
(1)Includes repurchase agreement borrowings on securities eliminated upon VIE consolidation.
(2)Repurchase agreement borrowings on loans owned are through trust certificates. The trust certificates are eliminated in consolidation.
At March 31, 2022 and December 31, 2021, repurchase agreements collateralized by investments had the following remaining maturities:
| (dollars in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
| 1 to 29 days | $ | 68,815 | $ | 53,081 | |||||||
| 30 to 59 days | 100,796 | 370 | |||||||||
| 60 to 89 days | — | 606 | |||||||||
| Greater than or equal to 90 days | 172,769 | 563,132 | |||||||||
| Total | $ | 342,380 | $ | 617,189 | |||||||
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At March 31, 2022, the following table reflects amounts of collateral at risk under its repurchase agreements greater than 10% of the Company's equity with any counterparty (dollars in thousands):
| March 31, 2022 | ||||||||||||||||||||
| Counterparty | Amount of Collateral at Risk, at fair value | Weighted Average Remaining Maturity (days) | Percentage of Stockholders’ Equity | |||||||||||||||||
| Citigroup Global Markets Inc. | $ | 73,741 | 35 | 44.7 | % | |||||||||||||||
| Credit Suisse AG, Cayman Islands Branch | 36,296 | 170 | 22.0 | % | ||||||||||||||||
Collateral for Borrowings under Repurchase Agreements
The following table summarizes the Company’s collateral positions, with respect to its borrowings under repurchase agreements at March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||
| Assets Pledged | Accrued Interest | Assets Pledged and Accrued Interest | Assets Pledged | Accrued Interest | Assets Pledged and Accrued Interest | ||||||||||||||||||||||||||||||
| Assets pledged for borrowings under repurchase agreements: | |||||||||||||||||||||||||||||||||||
| Agency RMBS, at fair value | $ | 300 | $ | 8 | $ | 308 | $ | 1,172 | $ | 19 | $ | 1,191 | |||||||||||||||||||||||
Non-Agency CMBS, at fair value(1) | 106,380 | 505 | 106,885 | 107,624 | 504 | 108,128 | |||||||||||||||||||||||||||||
| Non-Agency RMBS, at fair value | 81,898 | 427 | 82,325 | 66,555 | 343 | 66,898 | |||||||||||||||||||||||||||||
Residential Whole Loans, at fair value(2) | 121,794 | 521 | 122,315 | 453,447 | 2,674 | 456,121 | |||||||||||||||||||||||||||||
Residential Bridge Loans(2) | 5,129 | 80 | 5,209 | 5,207 | 91 | 5,298 | |||||||||||||||||||||||||||||
Commercial Loans, at fair value(2) | 101,435 | 360 | 101,795 | 101,459 | 360 | 101,819 | |||||||||||||||||||||||||||||
| Other securities, at fair value | 49,040 | 100 | 49,140 | 51,648 | 100 | 51,748 | |||||||||||||||||||||||||||||
Cash(3) | 1,766 | — | 1,766 | 3,151 | — | 3,151 | |||||||||||||||||||||||||||||
| Total | $ | 467,742 | $ | 2,001 | $ | 469,743 | $ | 790,263 | $ | 4,091 | $ | 794,354 | |||||||||||||||||||||||
(1)Includes securities eliminated upon VIE consolidation.
(2)Loans owned through trust certificates are pledged as collateral. The trust certificates are eliminated upon consolidation.
(3)Cash posted as collateral is included in "Due from counterparties" in the Company’s Consolidated Balance Sheets.
A reduction in the value of pledged assets typically results in the repurchase agreement counterparties initiating a margin call. At March 31, 2022 and December 31, 2021, investments held by counterparties as security for repurchase agreements totaled approximately $466.0 million and $787.1 million, respectively. Cash collateral held by counterparties at March 31, 2022 and December 31, 2021 was approximately $1.8 million and $3.2 million, respectively. There was no cash posted by repurchase agreement counterparties at both March 31, 2022 and December 31, 2021.
Convertible Senior Unsecured Notes
6.75% Convertible Senior Unsecured Notes due 2024 (the "2024 Notes")
In September 2021, the Company issued $86.3 million aggregate principal amount of the 2024 Notes for net proceeds of $83.3 million. Interest on the 2024 Notes is paid semiannually. The 2024 Notes are convertible into, at the Company's election, cash, shares of the Company's common stock or a combination of both, subject to the satisfaction of certain conditions and during specified periods. The conversion rate is subject to adjustment upon the occurrence of certain specified events and the holders may require the Company to repurchase all or any portion of their notes for cash equal to 100% of the principal amount of the 2024 Notes, plus accrued and unpaid interest, if the Company undergoes a fundamental change as specified in the supplemental indenture for the 2024 Notes. The initial conversion rate was 337.9520 shares of common stock per $1,000 principal amount of notes and represented a conversion price of $2.96 per share of common stock. The 2024 Notes mature on
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September 15, 2024, unless earlier converted, redeemed or repurchased by the holders pursuant to their terms, and are not redeemable by the Company except during the final three months prior to maturity.
6.75% Convertible Senior Unsecured Notes due 2022 (the "2022 Notes")
At March 31, 2022 and December 31, 2021, the Company had $34.3 million and $37.7 million aggregate principal amount, respectively, of the 2022 Notes outstanding. Interest on the 2022 Notes is paid semiannually. The 2022 Notes are convertible into, at the Company's election, cash, shares of the Company's common stock or a combination of both, subject to the satisfaction of certain conditions and during specified periods. The conversion rate is subject to adjustment upon the occurrence of certain specified events and the holders may require the Company to repurchase all or any portion of their notes for cash equal to 100% of the principal amount of the 2022 Notes, plus accrued and unpaid interest, if the Company undergoes a fundamental change as specified in the supplemental indenture for the 2022 Notes. The initial and current conversion rate was 83.1947 shares of common stock per $1,000 principal amount of notes and represented a conversion price of $12.02 per share of common stock. The 2022 Notes mature on October 1, 2022, unless earlier converted, redeemed or repurchased by the holders pursuant to their terms, and are not redeemable by the Company except during the final three months prior to maturity.
The 2022 Notes Exchanges and Repurchases
During the quarter ended March 31, 2022, the Company repurchased $3.4 million aggregate principal amount of the 2022 Notes at an approximate 0.8% premium to par value, plus accrued and unpaid interest.
Securitized Debt
Residential Mortgage-Backed Notes
Arroyo Trust 2019
In May 2019, the Company completed a residential mortgage-backed securitization comprised of $945.5 million of Non-QM Residential Whole Loans, issuing $919.0 million of mortgage-backed notes. The Company did not elect the fair value option for these notes and accordingly they are recorded at their principal balance less unamortized deferred financing cost and classified in "Securitized debt, net" in the Consolidated Balance Sheets. The following table summarizes the issued Arroyo Trust 2019's residential mortgage pass-through certificates at March 31, 2022 (dollars in thousands):
| Classes | Principal Balance | Coupon | Carrying Value | Contractual Maturity | ||||||||||
| Offered Notes: | ||||||||||||||
| Class A-1 | $ | 234,900 | 3.3% | $ | 234,900 | 4/25/2049 | ||||||||
| Class A-2 | 12,598 | 3.5% | 12,598 | 4/25/2049 | ||||||||||
| Class A-3 | 19,959 | 3.8% | 19,959 | 4/25/2049 | ||||||||||
| Class M-1 | 25,055 | 4.8% | 25,055 | 4/25/2049 | ||||||||||
| Subtotal | $ | 292,512 | $ | 292,512 | ||||||||||
| Less: Unamortized Deferred Financing Costs | N/A | 3,280 | ||||||||||||
| Total | $ | 292,512 | $ | 289,232 | ||||||||||
The Company retained the non-offered securities in the securitization, which include the class B, Class A-IO-S and Class XS certificates. These non-offered securities were eliminated in consolidation. The securitized debt of the Arroyo Trust 2019 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At March 31, 2022, Residential Whole Loans, with an outstanding principal balance of approximately $308.2 million, serve as collateral for the Arroyo Trust 2019's securitized debt. The Company may redeem the offered notes on or after the earlier of (i) the three-year anniversary of the closing date or (ii) the date on which the aggregate collateral balance is 20% of the original principal balance. The notes are redeemable at their face value plus accrued interest.
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Arroyo Trust 2020
In June 2020, the Company completed a residential mortgage-backed securitization comprised of $355.8 million of Non-QM Residential Whole Loans, issuing $341.7 million of mortgage-backed notes. The Company did not elect the fair value option for these notes and accordingly they are recorded at their principal balance less unamortized deferred financing cost and classified in "Securitized debt, net" in the Consolidated Balance Sheets. The following table summarizes the issued Arroyo Trust 2020's residential mortgage pass-through certificates at March 31, 2022 (dollars in thousands):
| Classes | Principal Balance | Coupon | Carrying Value | Contractual Maturity | ||||||||||
| Offered Notes: | ||||||||||||||
| Class A-1A | $ | 96,193 | 1.7% | $ | 96,193 | 3/25/2055 | ||||||||
| Class A-1B | 11,414 | 2.1% | 11,414 | 3/25/2055 | ||||||||||
| Class A-2 | 13,518 | 2.9% | 13,518 | 3/25/2055 | ||||||||||
| Class A-3 | 17,963 | 3.3% | 17,963 | 3/25/2055 | ||||||||||
| Class M-1 | 11,739 | 4.3% | 11,739 | 3/25/2055 | ||||||||||
| Subtotal | $ | 150,827 | $ | 150,827 | ||||||||||
| Less: Unamortized Deferred Financing Costs | N/A | 1,910 | ||||||||||||
| Total | $ | 150,827 | $ | 148,917 | ||||||||||
The Company retained the non-offered securities in the securitization, which include the Class B, Class A-IO-S and Class XS certificates. These non-offered securities were eliminated in consolidation. The securitized debt of the Arroyo Trust 2020 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At March 31, 2022, Residential Whole Loans with an outstanding principal balance of approximately $162.2 million serve as collateral for the Arroyo Trust 2020's securitized debt. The Company may redeem the offered notes on or after the earlier of (i) the three-year anniversary of the closing date or (ii) the date on which the aggregate collateral balance is equal to or less than 30% of the original principal balance. The notes are redeemable at their face value plus accrued interest.
Arroyo Trust 2022
In February 2022, the Company completed a residential-mortgage backed securitization comprised of $432.0 million of Non-QM Residential Whole Loans, issuing $398.9 million of mortgage-backed notes. The Company has chosen to make the fair value election pursuant to ASC 825 for the debt and accordingly the bonds are recorded at fair value in the Consolidated Balance Sheets with the periodic changes in fair value are recorded in current period earnings in the Consolidated Statements of Operations as a component of "Unrealized gain (loss), net."
The following table summarizes the issued Arroyo Trust 2022's residential mortgage pass-through certificates at March 31, 2022 (dollars in thousands):
| Classes | Principal Balance | Coupon | Fair Value | Contractual Maturity | ||||||||||
| Offered Notes: | ||||||||||||||
| Class A-1A | $ | 238,419 | 2.5% | $ | 232,676 | 12/25/2056 | ||||||||
| Class A-1B | 82,942 | 3.3% | 79,703 | 12/25/2056 | ||||||||||
| Class A-2 | 21,168 | 3.6% | 20,381 | 12/25/2056 | ||||||||||
| Class A-3 | 28,079 | 3.7% | 26,918 | 12/25/2056 | ||||||||||
| Class M-1 | 17,928 | 3.7% | 16,744 | 12/25/2056 | ||||||||||
| Total | $ | 388,536 | $ | 376,422 | ||||||||||
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The Company retained the non-offered securities in the securitization, which include the Class B, Class A-IO-S and Class XS certificates. These non-offered securities were eliminated in consolidation. The securitized debt of the Arroyo Trust 2022 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At March 31, 2022, Residential Whole Loans with an outstanding principal balance of approximately $415.2 million serve as collateral for the Arroyo Trust 2022's securitized debt. The Company may redeem the offered notes on or after the earlier of (i) the three-year anniversary of the closing date or (ii) the date on which the aggregate collateral balance is equal to or less than 30% of the original principal balance. The notes are redeemable at their fair value plus accrued interest.
Commercial Mortgage-Backed Notes
CSMC 2014 USA
The following table summarizes CSMC 2014 USA's commercial mortgage pass-through certificates at March 31, 2022 (dollars in thousands):
| Classes | Principal Balance | Coupon | Fair Value | Contractual Maturity | ||||||||||
| Class A-1 | $ | 120,391 | 3.3 | % | $ | 117,768 | 9/11/2025 | |||||||
| Class A-2 | 531,700 | 4.0 | % | 523,078 | 9/11/2025 | |||||||||
| Class B | 136,400 | 4.2 | % | 126,957 | 9/11/2025 | |||||||||
| Class C | 94,500 | 4.3 | % | 86,707 | 9/11/2025 | |||||||||
| Class D | 153,950 | 4.4 | % | 142,388 | 9/11/2025 | |||||||||
| Class E | 180,150 | 4.4 | % | 152,369 | 9/11/2025 | |||||||||
| Class F | 153,600 | 4.4 | % | 113,725 | 9/11/2025 | |||||||||
Class X-1(1) | N/A | 0.7 | % | 12,347 | 9/11/2025 | |||||||||
Class X-2(1) | N/A | 0.2 | % | 2,572 | 9/11/2025 | |||||||||
| $ | 1,370,691 | $ | 1,277,911 | |||||||||||
(1) Class X-1 and X-2 are interest-only classes with notional balances of $652.1 million and $733.5 million as of March 31, 2022, respectively.
At March 31, 2022, the Company owned a portion of the class F certificates with an outstanding principal balance of $14.9 million, which is eliminated in consolidation. The remaining CSMC USA debt that we elected the fair value option had a fair value of $1.3 billion at March 31, 2022, and is recorded in "Securitized debt, net" in the Consolidated Balance Sheets. Of the remaining outstanding principal balance of $1.4 billion, $198.3 million is owned by related parties and $1.2 billion is owned by third parties. The securitized debt of the CSMC USA can only be settled with the commercial loan with an outstanding principal balance of approximately $1.4 billion at March 31, 2022, that serves as collateral for the securitized debt and is non-recourse to the Company. The Company has chosen to make the fair value election pursuant to ASC 825 for the debt and accordingly the periodic changes in fair value are recorded in current period earnings in the Consolidated Statements of Operations as a component of "Unrealized gain (loss), net."
Note 8 — Derivative Instruments
The Company’s derivatives may include interest rate swaps, swaptions, options, futures contracts, TBAs, Agency and Non-Agency Interest-Only Strips that are classified as derivatives, credit default swaps and total return swaps.
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The following table summarizes the Company’s derivative instruments at March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||
| Derivative Instrument | Accounting Designation | Consolidated Balance Sheets Location | Notional Amount | Fair Value | Notional Amount | Fair Value | |||||||||||||||||||||||||||||||||||
| Credit default swaps, asset | Non-Hedge | Derivative assets, at fair value | 4,140 | $ | 3,602 | 2,030 | $ | 105 | |||||||||||||||||||||||||||||||||
| Total derivative instruments, assets | 3,602 | 105 | |||||||||||||||||||||||||||||||||||||||
| Interest rate swaps, liability | Non-Hedge | Derivative liability, at fair value | 252,000 | (487) | 22,000 | (38) | |||||||||||||||||||||||||||||||||||
| Credit default swaps, liability | Non-Hedge | Derivative liability, at fair value | 2,030 | (1,848) | 4,140 | (564) | |||||||||||||||||||||||||||||||||||
| Total derivative instruments, liabilities | (2,335) | (602) | |||||||||||||||||||||||||||||||||||||||
| Total derivative instruments, net | $ | 1,267 | $ | (497) | |||||||||||||||||||||||||||||||||||||
The following table summarizes the effects of the Company’s derivative positions, including Interest-Only Strips characterized as derivatives and TBAs, which are reported in "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations for the three months ended March 31, 2022 and March 31, 2021 (dollars in thousands):
| Realized Gain (Loss), net | ||||||||||||||||||||||||||||||||||||||
| Description | Other Settlements / Expirations | Variation Margin Settlement | Return (Recovery) of Basis | Mark-to-Market | Contractual interest income (expense), net(1) | Total | ||||||||||||||||||||||||||||||||
| Three months ended March 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | — | $ | 5,540 | $ | — | $ | (449) | $ | (291) | $ | 4,800 | ||||||||||||||||||||||||||
Interest-Only Strips— accounted for as derivatives | — | — | (72) | (109) | 89 | (92) | ||||||||||||||||||||||||||||||||
| Credit default swaps | 15 | — | — | 2,213 | — | 2,228 | ||||||||||||||||||||||||||||||||
| Total | $ | 15 | $ | 5,540 | $ | (72) | $ | 1,655 | $ | (202) | $ | 6,936 | ||||||||||||||||||||||||||
| Three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||
Interest-Only Strips— accounted for as derivatives | $ | — | $ | — | $ | (94) | $ | — | $ | 121 | $ | 27 | ||||||||||||||||||||||||||
| Credit default swap | 16 | — | — | (17) | — | (1) | ||||||||||||||||||||||||||||||||
| Total | $ | 16 | $ | — | $ | (94) | $ | (17) | $ | 121 | $ | 26 | ||||||||||||||||||||||||||
At March 31, 2022 and December 31, 2021, the Company had cash pledged as collateral for derivatives of approximately $7.1 million and $1.4 million, respectively, which is reported in "Due from counterparties" in the Consolidated Balance Sheets.
Interest rate swaps
The Company uses interest rate swaps to mitigate its exposure to higher short-term interest rates in connection with its repurchase agreements. Interest rate swaps generally involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. Notwithstanding the foregoing, in order to manage its hedge position with regard to its liabilities, the Company on occasion will enter into interest rate swaps which involve the receipt of fixed-rate amounts from a counterparty in exchange for the Company making variable-rate payments over the life of the interest rate swap without exchange of the underlying notional amount. The Company also enters into forward starting swaps to help mitigate the effects of changes in interest rates on a portion of its borrowings under repurchase agreements. The Company generally enters into MAC (Market Agreed Coupon) interest rate swaps in which it may receive or make a payment at the time of entering such interest rate swap to
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compensate for the out of the market nature of such interest rate swap. Similar to all other interest rate swaps, these interest rate swaps are also subject to margin requirements.
The Company has not elected to account for its interest rate swaps as “hedges” under GAAP, accordingly the change in fair value of the interest rate swaps not designated in hedging relationships are recorded together with periodic net interest settlement amounts in "Gain (loss) on derivatives instruments, net" in the Consolidated Statements of Operations.
The following tables provide additional information on the Company's fixed-pay interest rate swaps as of March 31, 2022 and December 31, 2021 (dollars in thousands):
| March 31, 2022 | ||||||||||||||||||||||||||||||||
| Fixed Pay Interest Rate Swap Remaining Term | Notional Amount | Average Fixed Pay Rate | Average Variable Receive Rate | Average Maturity (Years) | Forward Starting | |||||||||||||||||||||||||||
| Greater than 1 year and less than 3 years | $ | 60,000 | 1.4 | % | 0.2 | % | 2.0 | — | % | |||||||||||||||||||||||
| Greater than 3 years and less than 5 years | 70,000 | 1.4 | % | 0.1 | % | 4.8 | — | % | ||||||||||||||||||||||||
| Greater than 5 years | 122,000 | 2.3 | % | 0.1 | % | 6.0 | 82.0 | % | ||||||||||||||||||||||||
| Total | $ | 252,000 | 1.8 | % | 0.1 | % | 4.7 | 39.7 | % | |||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||
| Fixed Pay Interest Rate Swap Remaining Term | Notional Amount | Average Fixed Pay Rate | Average Variable Receive Rate | Average Maturity (Years) | Forward Starting | |||||||||||||||||||||||||||
| Greater than 5 years | $ | 22,000 | 1.2 | % | 0.1 | % | 9.8 | — | % | |||||||||||||||||||||||
| Total | $ | 22,000 | 1.2 | % | 0.1 | % | 9.8 | — | % | |||||||||||||||||||||||
Interest-Only Strips
The Company also invests in Interest-Only Strips. In determining the classification of its holdings of Interest-Only Strips, the Company evaluates the securities to determine if the nature of the cash flows has been altered from that of the underlying mortgage collateral. Generally, Interest-Only Strips for which the security represents a strip off of a mortgage pass through security will be considered a hybrid instrument classified as an MBS investment in the Consolidated Balance Sheets utilizing the fair value option. Alternatively, those Interest-Only Strips, for which the underlying mortgage collateral has been included into a structured security that alters the cash flows from the underlying mortgage collateral, are accounted for as derivatives at fair value with changes recognized in "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations, along with any interest received. The carrying value of these Interest-Only Strips is included in "Agency mortgage-backed securities, at fair value" in the Consolidated Balance Sheets.
Credit Default Swaps
The Company currently has outstanding credit default swaps and, in the future, may continue to enter into these types of credit derivatives. Under these instruments, the buyer makes a monthly premium payment over the term of the contract in exchange for the seller making a payment for losses of the reference securities, upon the occurrence of a specified credit event.
Note 9 — Offsetting Assets and Liabilities
The following tables present information about certain assets and liabilities that are subject to master netting agreements (or similar agreements) and can potentially be offset in the Company’s Consolidated Balance Sheets at March 31, 2022 and December 31, 2021 (dollars in thousands):
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| March 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Gross Amounts | Gross Amounts Offset in the Consolidated Balance Sheets | Net Amounts of Assets presented in the Consolidated Balance Sheets | Gross Amounts Not Offset in the Consolidated Balance Sheets | Net Amount | ||||||||||||||||||||||||||||||||||
Description | Financial Instruments(1) | Cash Collateral (1) | ||||||||||||||||||||||||||||||||||||
| Derivative Assets | ||||||||||||||||||||||||||||||||||||||
Agency and Non-Agency Interest-Only Strips, accounted for as derivatives included in MBS | $ | 878 | $ | — | $ | 878 | $ | (239) | $ | — | $ | 639 | ||||||||||||||||||||||||||
Derivative asset, at fair value (2) | 3,602 | — | 3,602 | (1,848) | — | 1,754 | ||||||||||||||||||||||||||||||||
| Total assets | $ | 4,480 | $ | — | $ | 4,480 | $ | (2,087) | $ | — | $ | 2,393 | ||||||||||||||||||||||||||
| Derivative Liabilities and Repurchase Agreements | ||||||||||||||||||||||||||||||||||||||
Derivative liability, at fair value(2)(3) | $ | 2,335 | $ | — | $ | 2,335 | $ | (1,848) | $ | (487) | $ | — | ||||||||||||||||||||||||||
Repurchase Agreements(4) | 342,380 | — | 342,380 | (342,327) | (53) | — | ||||||||||||||||||||||||||||||||
| Total liability | $ | 344,715 | $ | — | $ | 344,715 | $ | (344,175) | $ | (540) | $ | — | ||||||||||||||||||||||||||
(1)Amounts disclosed in the Financial Instruments column of the tables above represent securities, Whole Loans and securitized commercial loan collateral pledged and derivative assets that are available to be offset against liability balances associated with repurchase agreement and derivative liabilities. Amounts disclosed in the Cash Collateral column of the tables above represents amounts pledged or received as collateral against derivative transactions.
(2)Derivative asset, at fair value and Derivative liability, at fair value includes interest rate swaps and credit default swaps.
(3)Cash collateral pledged against the Company’s derivative counterparties was approximately $7.1 million as of March 31, 2022.
(4)The carrying value of investments pledged against the Company’s repurchase agreements was approximately $466.0 million as of March 31, 2022.
| December 31, 2021 | ||||||||||||||||||||||||||||||||||||||
| Gross Amounts | Gross Amounts Offset in the Consolidated Balance Sheets | Net Amounts of Assets presented in the Consolidated Balance Sheets | Gross Amounts Not Offset in the Consolidated Balance Sheets | Net Amount | ||||||||||||||||||||||||||||||||||
Financial Instruments(1) | Cash Collateral (1) | |||||||||||||||||||||||||||||||||||||
Derivative Assets | ||||||||||||||||||||||||||||||||||||||
Agency and Non-Agency Interest-Only Strips, accounted for as derivatives included in MBS | $ | 1,058 | $ | — | $ | 1,058 | $ | (1,058) | $ | — | $ | — | ||||||||||||||||||||||||||
Derivative asset, at fair value(2) | 105 | — | 105 | (105) | — | — | ||||||||||||||||||||||||||||||||
| Total derivative assets | $ | 1,163 | $ | — | $ | 1,163 | $ | (1,163) | $ | — | $ | — | ||||||||||||||||||||||||||
| Derivative Liabilities and Repurchase Agreements | ||||||||||||||||||||||||||||||||||||||
Derivative liability, at fair value(2)(3) | $ | 602 | $ | — | $ | 602 | $ | (105) | $ | (497) | $ | — | ||||||||||||||||||||||||||
Repurchase Agreements(4) | 617,189 | — | 617,189 | (617,189) | — | — | ||||||||||||||||||||||||||||||||
| Total derivative liability | $ | 617,791 | $ | — | $ | 617,791 | $ | (617,294) | $ | (497) | $ | — | ||||||||||||||||||||||||||
(1)Amounts disclosed in the Financial Instruments column of the tables above represent securities, Whole Loans and securitized commercial loan collateral pledged and derivative assets that are available to be offset against liability balances associated with repurchase agreement and derivative liabilities. Amounts disclosed in the Cash Collateral column of the tables above represents amounts pledged or received as collateral against derivative transactions.
(2)Derivative asset, at fair value and Derivative liability, at fair value includes interest rate swaps and credit default swaps.
(3)Cash collateral pledged against the Company’s derivative counterparties was approximately $1.4 million as of December 31, 2021.
(4)The carrying value of investments pledged against the Company’s repurchase agreements was approximately $787.1 million as of December 31, 2021.
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Certain of the Company’s repurchase agreement and derivative transactions are governed by underlying agreements that generally provide for a right of set-off in the event of default or in the event of a bankruptcy of either party to the transaction.
Note 10 — Related Party Transactions
Management Agreement
In connection with the Company’s initial public offering ("IPO") in May 2012, the Company entered into a management agreement (the “Management Agreement”) with the Manager, which describes the services to be provided by the Manager and compensation for such services. The Manager is responsible for managing the Company’s operations, including: (i) performing all of its day-to-day functions; (ii) determining investment criteria in conjunction with the Board of Directors; (iii) sourcing, analyzing and executing investments, asset sales and financings; (iv) performing asset management duties; and (v) performing financial and accounting management, subject to the direction and oversight of the Company’s Board of Directors. Pursuant to the terms of the Management Agreement, the Manager is paid a management fee equal to 1.50% per annum of the Company’s stockholders’ equity (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears. For purposes of calculating the management fee, “stockholders’ equity” means the sum of the net proceeds from any issuances of the Company’s equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus retained earnings, calculated in accordance with GAAP, at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods), less any amount paid for repurchases of the Company’s shares of common stock, excluding any unrealized gains or losses on our investments and derivatives and other non-cash items (excluding other than temporary impairment) that have impacted stockholders' equity as reported in the Company’s consolidated financial statements prepared in accordance with GAAP, regardless of whether such items are included in other comprehensive income or loss, or in net income, and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Manager and the Company’s independent directors and after approval by a majority of the Company’s independent directors. However, if the Company’s stockholders’ equity for any given quarter is negative based on the calculation described above, the Manager will not be entitled to receive any management fee for that quarter.
In addition, the Company may be required to reimburse the Manager for certain expenses as described below, and shall reimburse the Manager for the compensation paid to the Company’s chief financial officer, controller and their staff. Expense reimbursements to the Manager are made in cash on a regular basis. The Company’s reimbursement obligation is not subject to any dollar limitation. Because the Manager’s personnel perform certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, the Manager may be paid or reimbursed for the documented cost of performing such tasks, provided that such costs and reimbursements are in amounts which are no greater than those which would be payable to outside professionals or consultants engaged to perform such services pursuant to agreements negotiated on an arm’s-length basis.
The Management Agreement may be amended, supplemented or modified by agreement between the Company and the Manager. The Management Agreement expires on May 16, 2023. It is automatically renewed for one-year terms on each May 15th unless previously terminated as described below. The Company’s independent directors review the Manager’s performance and any fees payable to the Manager annually and, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds (2/3) of the Company’s independent directors, based upon: (i) the Manager’s unsatisfactory performance that is materially detrimental to the Company; or (ii) the Company’s determination that any fees payable to the Manager are not fair, subject to the Manager’s right to prevent such termination due to unfair fees by accepting a reduction of management fees agreed to by at least two-thirds (2/3) of the Company’s independent directors. The Company will provide the Manager 180 days prior notice of any such termination. Unless terminated for cause, the Company will pay the Manager a termination fee equal to three times the average annual management fee earned by the Manager during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.
The Company may also terminate the Management Agreement at any time, without the payment of any termination fee, with 30 days prior written notice from the Company’s Board of Directors for cause, which will be determined by at least two-thirds (2/3) of the Company’s independent directors, which is defined as: (i) the Manager’s continued material breach of any provision of the Management Agreement (including the Manager’s failure to comply with the Company’s investment
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guidelines); (ii) the Manager’s fraud, misappropriation of funds, or embezzlement against the Company; (iii) the Manager’s gross negligence in the performance of its duties under the Management Agreement; (iv) the occurrence of certain events with respect to the bankruptcy or insolvency of the Manager, including an order for relief in an involuntary bankruptcy case or the Manager authorizing or filing a voluntary bankruptcy petition; (v) the Manager is convicted (including a plea of nolo contendere) of a felony; or (vi) the dissolution of the Manager.
In December 2021, the Manager agreed to voluntarily waive 25% of its management fee solely for the duration of calendar year 2022 in order to support the earnings potential of the Company and its transition to a residential focused investment portfolio. Future waivers, if any, will be at the Manager's discretion.
For the three months ended March 31, 2022 and March 31, 2021, the Company incurred approximately $1.1 million and approximately $1.5 million in management fees, respectively.
In addition to the management fee, the Company is also responsible for reimbursing the Manager for certain expenses paid by the Manager on behalf of the Company as defined in the Management Agreement. For the three months ended March 31, 2022 and March 31, 2021, the Company recorded expenses included in general and administrative expenses totaling approximately $151 thousand and approximately $219 thousand, respectively, related to reimbursable employee costs. Any such expenses incurred by the Manager and reimbursed by the Company, including the employee compensation expense, are typically included in the Company’s general and administrative expense in the Consolidated Statements of Operations. At March 31, 2022 and December 31, 2021, approximately $2.6 million and approximately $1.5 million, respectively, for management fees incurred but not yet paid was included in "Payable to affiliate" in the Consolidated Balance Sheets. In addition, at March 31, 2022 and December 31, 2021, approximately $122 thousand and approximately $457 thousand, respectively, of reimbursable costs incurred but not yet paid was included in "Payable to affiliate" in the Consolidated Balance Sheets.
Note 11 — Share-Based Payments
In conjunction with the Company's IPO and concurrent private placement, the Company's Board of Directors approved the Western Asset Mortgage Capital Corporation Equity Plan (the "Equity Plan") and the Western Asset Manager Equity Plan (the "Manager Equity Plan" and collectively the "Equity Incentive Plans"). The Equity Incentive Plans include provisions for grants of restricted common stock and other equity-based awards, including restricted stock units, to the Manager, its employees and employees of its affiliates and to the Company's directors, officers and employees. The Company can issue up to 3.0% of the total number of issued and outstanding shares of its common stock (on a fully diluted basis) at the time of each award (other than any shares previously issued or subject to awards made pursuant to one of the Company's Equity Incentive Plans) under these Equity Incentive Plans. The number of shares of common stock available under the Equity Incentive Plans increased to 1,804,258. Approximately 1,153,789 shares have been issued under the Equity Plans with 650,469 shares available for issuance, as of March 31, 2022.
On June 25, 2021, the Company granted a total of 81,160 shares (20,290 each) of restricted stock units under the Equity Plan to the Company’s four independent directors. These restricted stock units will vest in full on June 25, 2022, the first anniversary of the grant date. Each of the independent directors has elected to defer the issuance of the shares granted under the Director Deferred Fee Plan.
During the three months ended March 31, 2022 and March 31, 2021, 36,000 and 36,000 restricted stock units vested, respectively, including shares whose issuance has been deferred under the Director Deferred Fee Plan. The Company recognized stock-based compensation expense of approximately $165 thousand and approximately $182 thousand for the three months ended March 31, 2022 and March 31, 2021, respectively. In addition, the Company had unamortized compensation expense of $47 thousand and $211 thousand for equity awards at March 31, 2022 and December 31, 2021, respectively.
Holders of restricted stock units are entitled to receive dividends (or dividend equivalent payments) and distributions that become payable on the restricted stock units during the restricted period. Dividend equivalent payments allocable to restricted stock units are deemed to purchase additional phantom shares of the Company's common stock that are credited to each participant's deferral account. The award agreements include restrictions whereby the restricted stock units cannot be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of prior to the lapse of restrictions under the respective award agreement. The restrictions lapse on the unvested restricted stock units awarded when vested, subject to the grantee's
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continuing to provide services to the Company as of the vesting date. Unvested restricted stock units and rights to dividends thereon are forfeited upon termination of the grantee.
The following is a summary of restricted common stock vesting dates as of March 31, 2022 and December 31, 2021, including shares whose issuance has been deferred under the Director Deferred Fee Plan:
| March 31, 2022 | December 31, 2021 | ||||||||||
| Vesting Date | Shares Vesting | Shares Vesting | |||||||||
| March 2022 | — | 36,000 | |||||||||
| June 2022 | 81,160 | 81,160 | |||||||||
| Total | 81,160 | 117,160 | |||||||||
The following table presents information with respect to shares issued under the Company’s Equity Incentive Plans for the three months ended March 31, 2022 and March 31, 2021, respectively, including shares whose issuance has been deferred under the Director Deferred Fee Plan:
| March 31, 2022 | March 31, 2021 | ||||||||||||||||||||||
| Restricted Stock Units | Weighted Average Grant Date Fair Value (1) | Restricted Stock Units | Weighted Average Grant Date Fair Value (1) | ||||||||||||||||||||
| Outstanding at beginning of period | 1,148,225 | $ | 13.19 | 1,025,542 | $ | 14.10 | |||||||||||||||||
Granted (2) | 5,564 | 3.19 | 2,450 | 3.19 | |||||||||||||||||||
| Cancelled/forfeited | — | — | — | — | |||||||||||||||||||
| Outstanding at end of period | 1,153,789 | 13.14 | 1,027,992 | 14.13 | |||||||||||||||||||
| Unvested at end of period | 81,160 | $ | 3.45 | 168,815 | $ | 4.40 | |||||||||||||||||
(1)The grant date fair value of the awards is based on the closing market price of the Company’s common stock at the grant date.
(2)Includes 5,564 and 2,450 shares attributed to dividends on restricted stock under the Director Deferred Fee Plan for the three months ended March 31, 2022 and March 31, 2021, respectively.
Note 12 — Stockholders’ Equity
At-The-Market Program
In March 2017, the Company entered into an equity distribution agreement with JMP Securities LLC, which was amended on June 5, 2020, under which the Company may offer and sell up to $100.0 million shares of common stock in an At-The-Market equity offering. During the three months ended March 31, 2022, the Company did not sell any shares under the amended agreement.
Stock Repurchase Program
In December 2021, the Company extended its stock repurchase program as authorized by its Board of Directors. Under the extended program, the Company is permitted to repurchase up to 3,000,000 shares of its common stock through December 31, 2023. The previous authorization expired December 31, 2021. Any purchases made pursuant to the program will be made in the open market, in privately negotiated transactions, or pursuant to any trading plan that may be adopted in accordance with Rules 10b5-1 and 10b-18 of the Securities and Exchange Commission Act of 1934, as amended. The authorization does not obligate the Company to acquire any particular amount of common shares, or any shares at all, and the program may be suspended or discontinued at the Company's discretion without prior notice.
During the three months ended March 31, 2022, the Company did not repurchase any shares under the stock repurchase program.
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Dividends
The following table presents cash dividends declared and paid by the Company on its common stock:
| Declaration Date | Record Date | Payment Date | Amount per Share | Tax Characterization | ||||||||||||||||||||||
| 2022 | ||||||||||||||||||||||||||
| March 23, 2022 | April 4, 2022 | April 26, 2022 | $ | 0.04 | Not yet determined | |||||||||||||||||||||
| 2021 | ||||||||||||||||||||||||||
| December 21, 2021 | December 31, 2021 | January 26, 2022 | $ | 0.06 | Not yet determined(1) | |||||||||||||||||||||
| September 23, 2021 | October 4, 2021 | October 26, 2021 | $ | 0.06 | Return of capital | |||||||||||||||||||||
| June 22, 2021 | July 2, 2021 | July 26, 2021 | $ | 0.06 | Return of capital | |||||||||||||||||||||
| March 23, 2021 | April 2, 2021 | April 26, 2021 | $ | 0.06 | Return of capital | |||||||||||||||||||||
(1)The cash distributions made on January 26, 2022, with a record date of December 31, 2021, are treated as received by stockholders on January 26, 2022 and taxable in calendar year 2022. The tax characterization of these distributions will be determined in January 2023.
Note 13 — Net Income (loss) per Common Share
The table below presents basic and diluted net income (loss) per share of common stock using the two-class method for the three months ended March 31, 2022 and March 31, 2021 (dollars, other than shares and per share amounts, in thousands):
| For the three months ended March 31, 2022 | For the three months ended March 31, 2021 | |||||||||||||
Numerator: | ||||||||||||||
Net income (loss) attributable to common stockholders and participating securities for basic and diluted earnings per share | $ | (25,853) | $ | 7,953 | ||||||||||
| Less: | ||||||||||||||
Dividends and undistributed earnings allocated to participating securities | 15 | 48 | ||||||||||||
Net income (loss) allocable to common stockholders — basic and diluted | $ | (25,868) | $ | 7,905 | ||||||||||
Denominator: | ||||||||||||||
Weighted average common shares outstanding for basic earnings per share | 60,345,705 | 60,742,301 | ||||||||||||
Weighted average common shares outstanding for diluted earnings per share | 60,345,705 | 60,740,701 | ||||||||||||
| Basic earnings (loss) per common share | $ | (0.43) | $ | 0.13 | ||||||||||
| Diluted earnings (loss) per common share | $ | (0.43) | $ | 0.13 | ||||||||||
For the three months ended March 31, 2022 and March 31, 2021, the Company excluded the effects of the convertible senior unsecured notes from the computation of diluted earnings per share since the average market value per share of the Company’s common stock was below the exercise price of the convertible senior unsecured notes.
Note 14 — Income Taxes
As a REIT, the Company is not subject to federal income tax to the extent that it makes qualifying distributions to its stockholders and satisfies on a continuing basis, through actual investment and operating results, the REIT requirements including certain asset, income and stock ownership tests.
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Based on the Company’s analysis of any potential uncertain income tax positions, the Company concluded that it does not have any uncertain tax positions that meet the recognition or measurement criteria as of March 31, 2022. The Company files U.S. federal and state income tax returns. As of March 31, 2022, U.S. federal tax returns filed by the Company for 2020, 2019 and 2018 and state tax returns filed for 2020, 2019, 2018, 2017 and 2016 are open for examination pursuant to relevant statutes of limitation. In the event that the Company incurs income tax related interest and penalties, the Company’s policy is to classify them as a component of its provision for income taxes.
Income Tax Provision
Subject to the limitation under the REIT asset test rules, the Company is permitted to own up to 100% of the stock of one or more taxable REIT subsidiaries ("TRS"). Currently, the Company owns one TRS that is taxable as a corporation and is subject to federal, state and local income tax on its net income at the applicable corporate rates. The TRS, which was formed in Delaware on July 28, 2014, is a limited liability company and a wholly-owned subsidiary of the Company. During the three months ended March 31, 2022 and March 31, 2021, the Company recorded a federal and state tax provision of $56 thousand and tax provision of $98 thousand, respectively, which is recorded in "Income tax provision (benefit)" in the Consolidated Statements of Operations.
Deferred Tax Asset
As of March 31, 2022 and December 31, 2021, the Company recorded a deferred tax asset of approximately $13.2 million and $13.0 million, respectively, relating to capital loss carryforward and temporary differences as a result of the timing of income recognition of certain investments held in the TRS. The capital loss carryforwards may only be recognized to the extent of capital gains. There is uncertainty as to the TRS ability to recognize capital gains in the future. As a result, the Company has concluded it is more likely than not the deferred tax asset will not be realized and has recorded a full valuation allowance.
In addition, the REIT generated net operating losses ("NOLs") during the three months ended March 31, 2022 related to ordinary losses on its MBS portfolio and it generated NOLs for the years ended December 31, 2020 and December 31, 2017, related to its interest rate swap terminations, and for its California return a portion of the NOLs is apportioned to the TRS. The Company recorded a deferred tax asset relating to the NOLs of $18.6 million and $18.6 million in the REIT and $2.0 million and $2.0 million in the TRS as of March 31, 2022 and December 31, 2021, respectively. The TRS can carryback the NOLs generated during the years ended December 31, 2020 and December 31, 2017 to each of the two preceding years to request a refund for taxes paid. As of March 31, 2022 and December 31, 2021, the Company has concluded it is more likely than not the deferred tax asset relating to the NOLs will not be realized, with the exception of the TRS carryback to 2015, and it has recorded a combined valuation allowance of $20.6 million and $20.6 million, respectively.
Effective Tax Rate
The Company's effective tax rate differs from its combined federal and state income tax rate primarily due to its valuation allowance and the deduction of dividends distributions to be paid under Code Section 857(a).
Note 15 — Contingencies
From time to time, the Company may become involved in various claims and legal actions arising in the ordinary course of business. Management is not aware of any material contingencies at March 31, 2022.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
FORWARD-LOOKING INFORMATION
The Company makes forward-looking statements herein and will make forward-looking statements in future filings with the Securities and Exchange Commission (the “SEC”), press releases or other written or oral communications within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). For these statements, the Company claims the protections of the safe harbor for forward-looking statements contained in such sections. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond the Company’s control. In particular, it is difficult to fully assess the ongoing impact of the COVID-19 pandemic on the United States economy, the mortgage finance markets and the broader financial markets. There is still uncertainty around the severity and duration of the pandemic domestically and internationally, as well as uncertainty around the efficacy of Federal, State and local governments' efforts to contain the spread of COVID-19 and respond to its direct and indirect impacts on many aspects of Americans' lives and economic activity.
These forward-looking statements include information about possible or assumed future results of the Company’s business, financial condition, liquidity, results of operations, plans and objectives. When the Company uses the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, the Company intends to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in the Company’s industry, interest rates, real estate values, the debt securities markets, the U.S. housing and the U.S. and foreign commercial real estate markets or the general economy or the market for residential and/or commercial mortgage loans; the Company’s business and investment strategy; the Company’s projected operating results; changes in interest rates and the market value of the Company’s target assets; credit risks; servicing-related risks, including those associated with foreclosure and liquidation; the state of the U.S. and to a lesser extent, international economy generally or in specific geographic regions; economic trends and economic recoveries; the Company’s ability to obtain and maintain financing arrangements, including under the Company’s repurchase agreements, a form of secured financing, and securitizations; the current potential return dynamics available in residential mortgage-backed securities (“RMBS”), and commercial mortgage-backed securities (“CMBS” and collectively with RMBS, “MBS”); the level of government involvement in the U.S. mortgage market; the anticipated default rates on CMBS and Commercial Loans; the loss severity on Non-Agency MBS; the general volatility of the securities markets in which the Company participates; changes in the value of the Company’s assets; the Company’s expected portfolio of assets; the Company’s expected investment and underwriting process; interest rate mismatches between the Company’s target assets and any borrowings used to fund such assets; changes in prepayment rates on the Company’s target assets; effects of hedging instruments on the Company’s target assets; rates of default or decreased recovery rates on the Company’s target assets; the degree to which the Company’s hedging strategies may or may not protect the Company from interest rate volatility; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; the Company’s ability to maintain the Company’s qualification as a real estate investment trust for U.S. federal income tax purposes; the Company’s ability to maintain its exemption from registration under the Investment Company Act of 1940, as amended (the “1940 Act”); the availability of opportunities to acquire Agency RMBS, Non-Agency RMBS, CMBS, Residential and Commercial Whole Loans, Residential and Commercial Bridge Loans and other mortgage assets; the availability of qualified personnel; estimates relating to the Company’s ability to make distributions to its stockholders in the future; the Company’s understanding of its competition; the uncertainty and economic impact of pandemics, epidemics or other public health emergencies, such as the ongoing outbreak of COVID-19; and the Manager's expectations regarding COVID-19 recovery.
The forward-looking statements are based on the Company’s beliefs, assumptions and expectations of its future performance, taking into account all information currently available to it. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to the Company. Some of these factors, are described in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” herein and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, filed with the SEC on March 8, 2022. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that the Company files with the SEC, could cause its actual results to differ materially from those included in any forward-looking statements the Company makes. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect the Company. Except as required by law, the Company is not obligated to, and does not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
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Overview
Western Asset Mortgage Capital Corporation, a Delaware corporation, and its subsidiaries (the “Company” unless otherwise indicated or except where the context otherwise requires “we,” “us” or “our”) commenced operations in May 2012, focused on investing in, financing and managing a portfolio of real estate related securities, Whole Loans and other financial assets, which we collectively refer to as our target assets. We are externally managed by Western Asset Management Company, LLC (our “Manager”) pursuant to the terms of a management agreement. We conduct our operations to qualify and be taxed as a real estate investment trust, or REIT, for U.S. federal income tax purposes. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income that we distribute currently to our stockholders as long as we maintain our intended qualification as a REIT. However, certain activities that we may perform may cause us to earn income which will not be qualifying income for REIT purposes. We have designated a subsidiary as a taxable REIT subsidiary, or TRS, to engage in such activities. We also intend to operate our business in a manner that permits us to maintain our exemption from registration under the 1940 Act. Our common stock is traded on the New York Stock Exchange, or the NYSE, under the symbol "WMC."
Our objective is to provide attractive risk adjusted returns to our stockholders primarily through an attractive dividend, which we intend to support with sustainable distributable earnings (which we previously referred to as core earnings), as well as the potential for higher returns through capital appreciation. Our investment strategy is based on our Manager's perspective of which mix of our target assets it believes provides us with the best risk-reward opportunities at any given time. We also deploy leverage as part of our investment strategy to increase potential returns.
Our Investment Strategy
Our Manager’s investment philosophy, which developed from a singular focus in fixed-income asset management over a variety of credit cycles and conditions, is to provide clients with a long-term value-oriented portfolio. We benefit from the breadth and depth of our Manager’s overall investment philosophy, which focuses on a macroeconomic analysis as well as an in-depth analysis of individual assets and their relative value. In making investment decisions on our behalf, our Manager seeks to identify assets across the broad mortgage universe with attractive risk adjusted returns, which incorporates its view on the outlook for the mortgage markets, including relative valuation, supply and demand trends, the level of interest rates, the shape of the yield curve, prepayment rates, financing and liquidity, residential real estate prices, delinquencies, default rates, recovery of various segments of the economy and vintage of collateral, subject to maintaining our REIT qualification and our exemption from registration under the 1940 Act.
In December 2021, we announced that our investment strategy will focus on residential real estate-related investments, including but not limited to non-qualified mortgage loans, Non-Agency RMBS, and other related investments. We believe this focus will allow us to address attractive market opportunities while maintaining alignment with our Manager’s core competencies. The portfolio transition is expected to be accomplished over the next 15 months. We plan to transition out of the commercial investments in our portfolio, though we may from time to time make commercial investments on an opportunistic basis.
Our Target Assets
Residential Whole Loans. — Residential Whole Loans are mortgages secured by single family residences held directly by us or through consolidated trusts with us holding the beneficial interest in the trusts. Our Residential Whole Loans are mainly adjustable rate mortgages that do not qualify for the Consumer Finance Protection Bureau’s (or CFPB) safe harbor provision for “qualified mortgages” ("Non-QM mortgages"). Our Manager’s review, relating to Non-QM mortgages, includes an analysis of the loan originator’s procedures and documentation for compliance with Ability to Repay requirements. As discussed in Note 7 "Financing," we have and may continue to securitize Whole Loan interests, selling more senior interests in the pool of loans and retaining residual portions. The characteristics of our Residential Whole Loans may vary going forward.
Non-Agency RMBS. — RMBS that are not guaranteed by a U.S. Government agency or U.S. Government-sponsored entity. The mortgage loan collateral for Non-Agency RMBS consists of residential mortgage loans that do not generally conform to underwriting guidelines issued by a U.S. Government agency or U.S. Government-sponsored entity due to certain factors, including mortgage balances in excess of Agency underwriting guidelines, borrower characteristics, loan characteristics and/or level of documentation, and therefore are not issued or guaranteed by a U.S. Government agency or U.S. Government-
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sponsored entity. The mortgage loan collateral may be classified as subprime, Alternative-A or prime depending on the borrower’s credit rating and the underlying level of documentation. Non-Agency RMBS collateral may also include reperforming loans, which are conventional mortgage loans that were current at the time of the securitization, but had been delinquent in the past. Non-Agency RMBS may be secured by fixed-rate mortgages, adjustable-rate mortgages or hybrid adjustable-rate mortgages.
Agency RMBS. — Agency RMBS, which are RMBS for which the principal and interest payments are guaranteed by a U.S. Government agency, such as the Government National Mortgage Association (“GNMA” or “Ginnie Mae”), or a U.S. Government-sponsored entity ("GSE"), such as the Federal National Mortgage Association (“FNMA” or “Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”). The Agency RMBS we acquire can be secured by fixed-rate mortgages, adjustable-rate mortgages or hybrid adjustable-rate mortgages. Fixed-rate mortgages have interest rates that are fixed for the term of the loan and do not adjust. The interest rates on adjustable-rate mortgages generally adjust annually (although some may adjust more frequently) to an increment over a specified interest rate index. Hybrid adjustable-rate mortgages have interest rates that are fixed for a specified period of time (typically three, five, seven or ten years) and, thereafter, adjust to an increment over a specified interest rate index. Adjustable-rate mortgages and hybrid adjustable-rate mortgages generally have periodic and lifetime constraints on the amount by which the loan interest rate can change on any predetermined interest rate reset date. These investments can be in the form of pools, TBA and CMO (including interest only, principal only or other structures).
GSE Risk Sharing Securities Issued by Fannie Mae and Freddie Mac. — From time to time we have and may in the future continue to invest in risk sharing securities issued by Fannie Mae and Freddie Mac. Principal and interest payments on these securities are based on the performance of a specified pool of Agency residential mortgages. The payments due on these securities, however, are not secured by the referenced mortgages. The payments due are full faith and credit obligations of Fannie Mae or Freddie Mac respectively, but neither agency guarantees full payment of the underlying mortgages. Investments in these securities generally are not qualifying assets for purposes of the 75% real estate asset test applicable to REITs and generally do not generate qualifying income for purposes of the 75% real estate income test applicable to REITs. As a result, we may be limited in our ability to invest in such assets.
Other investments. — In addition to Residential Whole Loans and Non-Agency RMBS, our current target investments, we may also make investments in Commercial Loans and Non-Agency CMBS and other securities on an opportunistic basis, which our Manager believes will assist us in meeting our investment objective and are consistent with our overall investment policies. These investments will normally be limited by the REIT requirements that 75% our assets be real estate assets and that 75% of our income be generated from real estate, thereby limiting our ability to invest in such assets.
Our Investment Portfolio
Our investment strategy will focus on residential real estate related investments, including but not limited to non-qualified mortgage loans, Non-Agency RMBS and other related investments. The portfolio transition is expected to be accomplished over 15 months.
Our investment portfolio composition at March 31, 2022.
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Our Financing Strategy
During 2020, the uncertainties created by the COVID-19 pandemic made it challenging to obtain financing arrangements on favorable terms. In the latter part of 2020 and the beginning of 2021, terms for financing arrangements have improved significantly. As a result, we diversified our financing sources to provide an alternative to short-term repurchase agreements with daily margin requirements. We expect to continue to seek financing arrangements without daily margin requirements or with margin requirements that apply only after a significant reduction in the valuation of the assets financed, including but not limited to repurchase agreements, term financing, securitization and convertible senior unsecured notes, as the market permits. We believe the amount of leverage we use is consistent with our intention of keeping total borrowings within a prudent range, as determined by our Manager, taking into account a variety of factors such as general economic, political and financial market conditions, the anticipated liquidity and price volatility of our assets, the availability and cost of financing the assets, the creditworthiness of financing counterparties and the health of the U.S. residential and commercial mortgage markets. We expect to maintain a debt-to-equity ratio of two to four and a half times the amount of our stockholders' equity, depending on our investment composition. We seek to enhance equity returns by effectively utilizing leverage and seeking to limit our exposure to interest rate volatility and daily margin calls. The following table presents our debt-to-equity ratio on March 31, 2022 and December 31, 2021:
| (dollars in thousands) | March 31, 2022 | December 31, 2021 | |||||||||
Total debt(1) | $ | 458,727 | $ | 736,357 | |||||||
| Total equity | $ | 165,006 | $ | 193,109 | |||||||
| Debt-to-equity ratio | 2.8 | 3.8 | |||||||||
(1) Total debt excludes the securitized debt which is non-recourse to us.
Our Hedging and Risk Management Strategy
Our overall portfolio strategy is designed to generate attractive returns to our investors through various economic cycles. In connection with our risk management activities, we may enter into a variety of derivative and non-derivative instruments. When purchased, our primary objective for acquiring these derivatives and non-derivative instruments is to mitigate our exposure to future events that are outside our control. Our derivative instruments are designed to mitigate the
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effects of market risk and cash flow volatility associated with interest rate risk, including prepayment risk. As part of our hedging strategy, we may enter into interest rate swaps, including forward starting swaps, interest rate swaptions, U.S. Treasury options, future contracts, TBAs, credit default swaps, forwards and other similar instruments. There can be no assurance that appropriate hedging strategies will be available or that if implemented they will be successful.
Critical Accounting Policies
The consolidated financial statements include our accounts, those of our wholly-owned subsidiaries and certain VIEs in which we are the primary beneficiary. All intercompany amounts have been eliminated in consolidation. In accordance with GAAP, our consolidated financial statements require the use of estimates and assumptions that involve the exercise of judgment and use of assumptions as to future uncertainties. Our most critical accounting policies will involve decisions and assessments that could affect our reported assets and liabilities, as well as our reported revenues and expenses. We believe that all of the decisions and assessments upon which our consolidated financial statements have been based were reasonable at the time made and based upon information available to us at that time. There have been no significant changes to our critical accounting policies that are disclosed in our most recent Annual Report on Form 10-K for the year ended December 31, 2021.
2022 Activity
Investment Activity
We continually evaluate potential investments and our investment selection is based on supply and demand of our target assets, costs of financing, and the expected future interest rate volatility costs of hedging. During the three months ended March 31, 2022, we acquired $119.1 million of Residential Whole Loans and $40.0 million of Non-Agency RMBS. Also,we along with the other investors sold a Commercial REO for total proceeds of $54.7 million.
The following table presents our investing activity for the three months ended March 31, 2022 (dollars in thousands):
| Balance at | Loan Modification/Capitalized Interest | Principal Payments and Basis Recovery | Proceeds from Sales | Transfers to REO | Realized Gain/(Loss) | Unrealized Gain/(loss) | Premium and discount amortization, net | Balance at | ||||||||||||||||||||||||
| Investment Type | December 31, 2021 | Purchases | March 31, 2022 | |||||||||||||||||||||||||||||
| Agency RMBS and Agency RMBS IOs | $ | 1,172 | $ | — | N/A | $ | (76) | $ | — | N/A | $ | — | $ | (156) | $ | — | $ | 940 | ||||||||||||||
| Non-Agency RMBS | 27,769 | 39,952 | N/A | (187) | — | N/A | — | (3,425) | 102 | 64,211 | ||||||||||||||||||||||
| Non-Agency CMBS | 105,358 | — | N/A | (644) | — | N/A | — | 974 | (402) | 105,286 | ||||||||||||||||||||||
Other securities(1) | 51,648 | — | N/A | — | — | N/A | — | (2,374) | (234) | 49,040 | ||||||||||||||||||||||
| Total MBS and other securities | 185,947 | 39,952 | N/A | (907) | — | N/A | — | (4,981) | (534) | 219,477 | ||||||||||||||||||||||
| Residential Whole Loans | 1,023,502 | 119,093 | 64 | (95,569) | — | — | — | (41,843) | (2,537) | 1,002,710 | ||||||||||||||||||||||
| Residential Bridge Loans | 5,428 | — | — | (105) | — | — | — | 27 | — | 5,350 | ||||||||||||||||||||||
| Commercial Loans | 130,572 | — | — | (4) | — | — | — | (2,073) | — | 128,495 | ||||||||||||||||||||||
| Securitized commercial loans | 1,355,808 | — | — | — | — | — | — | (73,564) | 6,699 | 1,288,943 | ||||||||||||||||||||||
| REO | 43,607 | — | N/A | — | (54,681) | — | 12,198 | — | N/A | 1,124 | ||||||||||||||||||||||
| Total Investments | $ | 2,744,864 | $ | 159,045 | $ | 64 | $ | (96,585) | $ | (54,681) | $ | — | $ | 12,198 | $ | (122,434) | $ | 3,628 | $ | 2,646,099 | ||||||||||||
(1) Other securities include $42.4 million of GSE CRTs and $6.7 million of ABS at March 31, 2022.
Portfolio Characteristics
Residential Real Estate Investments
Residential Whole Loans
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The Residential Whole Loans have low LTV's and are comprised of 2,505 Non-QM adjustable rate mortgages and six investor fixed rate mortgages. The following table presents certain information about our Residential Whole Loans investment portfolio at March 31, 2022 (dollars in thousands):
| Weighted Average | ||||||||||||||||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Original FICO Score(1) | Expected Life (years) | Contractual Maturity (years) | Coupon Rate | |||||||||||||||||||||||||||||||||||||
2.01% – 3.00% | 40 | $ | 20,896 | 54.2 | % | 751 | 6.5 | 29.0 | 2.9 | % | ||||||||||||||||||||||||||||||||||
3.01% – 4.00% | 543 | 266,264 | 61.1 | % | 744 | 4.4 | 27.9 | 3.7 | % | |||||||||||||||||||||||||||||||||||
4.01% – 5.00% | 1,232 | 453,466 | 55.1 | % | 752 | 4.1 | 27.2 | 4.6 | % | |||||||||||||||||||||||||||||||||||
5.01% – 6.00% | 668 | 260,311 | 63.8 | % | 741 | 3.7 | 26.7 | 5.4 | % | |||||||||||||||||||||||||||||||||||
6.01% – 7.00% | 26 | 9,320 | 67.8 | % | 725 | 3.8 | 25.6 | 6.3 | % | |||||||||||||||||||||||||||||||||||
7.01% - 8.00% | 2 | 430 | 73.7 | % | 748 | 3.2 | 26.5 | 7.1 | % | |||||||||||||||||||||||||||||||||||
| Total | 2,511 | $ | 1,010,687 | 59.0 | % | 747 | 4.1 | 27.3 | 4.5 | % | ||||||||||||||||||||||||||||||||||
(1)The original FICO score is not available for 249 loans with a principal balance of approximately $83.2 million at March 31, 2022. We have excluded these loans from the weighted average computations.
Residential Bridge Loans
We are no longer allocating capital to Residential Bridge Loans. The following table presents certain information about the remaining eight Residential Bridge Loans left in the portfolio at March 31, 2022 (dollars in thousands):
| Weighted Average | ||||||||||||||||||||||||||||||||
| Current Coupon Rate | Number of Loans | Principal Balance | Original LTV | Contractual Maturity (months)(1) | Coupon Rate | |||||||||||||||||||||||||||
7.01% – 9.00% | 3 | $ | 2,946 | 70.4 | % | 0.0 | 8.8 | % | ||||||||||||||||||||||||
9.01% – 11.00% | 3 | 2,288 | 77.0 | % | 0.0 | 10.5 | % | |||||||||||||||||||||||||
11.01% – 13.00% | 2 | 495 | 69.7 | % | 0.0 | 11.4 | % | |||||||||||||||||||||||||
| Total | 8 | $ | 5,729 | 73.0 | % | 0.0 | 9.7 | % | ||||||||||||||||||||||||
(1) Non-performing loans that are past their maturity date are excluded from the calculation of the weighted average contractual maturity. The weighted average contractual maturity for these loans is zero.
Non-performing Residential Loans
The following table presents the aging of the Residential Whole Loans and Bridge Loans as of March 31, 2022 (dollars in thousands):
| Residential Whole Loans | Bridge Loans | |||||||||||||||||||||||||||||||||||||
| No of Loans | Principal | Fair Value | No of Loans | Principal | Fair Value | |||||||||||||||||||||||||||||||||
| Current | 2,479 | $ | 994,489 | $ | 986,712 | 1 | $ | 849 | $ | 859 | ||||||||||||||||||||||||||||
| 1-30 days | 16 | 7,247 | 7,250 | 1 | 75 | 75 | ||||||||||||||||||||||||||||||||
| 31-60 days | 2 | 824 | 766 | — | — | — | ||||||||||||||||||||||||||||||||
| 61-90 days | 1 | 536 | 509 | — | — | — | ||||||||||||||||||||||||||||||||
| 90+ days | 13 | 7,591 | 7,473 | 6 | 4,805 | 4,416 | ||||||||||||||||||||||||||||||||
| Total | 2,511 | $ | 1,010,687 | $ | 1,002,710 | 8 | $ | 5,729 | $ | 5,350 | ||||||||||||||||||||||||||||
Residential Whole Loans in Non-Accrual Status
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As of March 31, 2022, there were 13 Non-QM loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $7.6 million and a fair value of $7.5 million. These nonperforming loans represent approximately 0.8% of the total outstanding principal balance. No allowance or provision for credit losses was recorded as of and for the three months ended March 31, 2022 since the valuation adjustment, if any, would be reflected in the fair value of these loans. We stopped accruing interest income for these loans when they became contractually 90 days delinquent.
As of March 31, 2022, there were six Residential Bridge Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $4.8 million and a fair value of $4.4 million. No allowance and provision for credit losses was recorded for loans carried at fair value as of and for the three months ended March 31, 2022 since valuation adjustments, if any, would be reflected in the fair value of these loans. We stopped accruing interest income for these loans when they became contractually 90 days delinquent.
As of March 31, 2022, we had four real estate owned ("REO") properties with an aggregate carrying value of $1.1 million related to foreclosed Bridge Loans. The REO properties are held for sale and accordingly carried at the lower of cost or fair value less cost to sell. The REO properties are classified in "Other assets" in the Consolidated Balance Sheet.
Non-Agency RMBS
The following table presents the fair value and weighted average purchase price for each of our Non-Agency RMBS categories, including IOs accounted for as derivatives, together with certain of their respective underlying loan collateral attributes and current performance metrics as of March 31, 2022 (fair value dollars in thousands):
| Weighted Average | ||||||||||||||||||||||||||||||||||||||||||||
| Category | Fair Value | Purchase Price | Life (Years) | Original LTV | Original FICO | 60+ Day Delinquent | CPR | |||||||||||||||||||||||||||||||||||||
| Prime | $ | 44,095 | $ | 91.87 | 9.6 | 46.4 | % | 535 | 0.9 | % | 15.5 | % | ||||||||||||||||||||||||||||||||
| Alt-A | 20,116 | 65.31 | 19.1 | 69.9 | % | 641 | 14.4 | % | 13.3 | % | ||||||||||||||||||||||||||||||||||
| Total | $ | 64,211 | $ | 83.55 | 12.6 | 53.7 | % | 568 | 5.1 | % | 14.8 | % | ||||||||||||||||||||||||||||||||
Agency RMBS Portfolio
The following table summarizes our Agency portfolio by investment category as of March 31, 2022 (dollars in thousands):
| Principal Balance | Amortized Cost | Fair Value | Net Weighted Average Coupon | ||||||||||||||||||||
Agency RMBS IOs and IIOs (1) | N/A | $ | 55 | $ | 62 | 1.1 | % | ||||||||||||||||
Agency RMBS IOs and IIOs accounted for as derivatives (1) | N/A | N/A | 878 | 1.8 | % | ||||||||||||||||||
| Total Agency RMBS | — | 55 | 940 | 1.7 | % | ||||||||||||||||||
| Total | $ | — | $ | 55 | $ | 940 | 1.7 | % | |||||||||||||||
(1)IOs and IIOs have no principal balances and bear interest based on a notional balance. The notional balance is used solely to determine interest distributions on the interest-only class of securities.
Commercial Real Estate Investments
With the new focus on residential real estate related investments, we plan to transition out of commercial real estate investments over the next 15 months.
Non-Agency CMBS
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The following table presents certain characteristics of our Non-Agency CMBS portfolio as of March 31, 2022 (dollars in thousands):
| Principal | Weighted Average | |||||||||||||||||||||||||||||||
| Type | Vintage | Balance | Fair Value | Life (Years) | Original LTV | |||||||||||||||||||||||||||
| Conduit: | ||||||||||||||||||||||||||||||||
| 2006-2009 | $ | 164 | $ | 159 | 1.9 | 83.7 | % | |||||||||||||||||||||||||
| 2010-2020 | 78,776 | 21,691 | 4.4 | 62.8 | % | |||||||||||||||||||||||||||
| 78,940 | 21,850 | 4.4 | 62.9 | % | ||||||||||||||||||||||||||||
| Single Asset: | ||||||||||||||||||||||||||||||||
| 2010-2020 | 100,034 | 83,436 | 1.7 | 65.3 | % | |||||||||||||||||||||||||||
| Total | $ | 178,974 | $ | 105,286 | 2.2 | 64.8 | % | |||||||||||||||||||||||||
Commercial Real Estate Investments
The following table presents our commercial loan investments as of March 31, 2022 (dollars in thousands):
| Loan | Loan Type | Principal Balance | Fair Value | Original LTV | Interest Rate | Maturity Date | Extension Option | Collateral | Geographic Location | ||||||||||||||||||||
| CRE 3 | Interest-Only Mezzanine loan | $ | 90,000 | $ | 27,060 | 58% | 1-Month LIBOR plus 9.25% | 6/29/2021 | None(1) | Entertainment and Retail | NJ | ||||||||||||||||||
| CRE 4 | Interest-Only First Mortgage | 38,367 | 38,229 | 63% | 1-Month LIBOR plus 3.02% | 8/6/2022 | A One-Year Extensions | Retail | CT | ||||||||||||||||||||
| CRE 5 | Interest-Only First Mortgage | 24,535 | 24,242 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two One-Year Extensions | Hotel | NY | ||||||||||||||||||||
| CRE 6 | Interest-Only First Mortgage | 13,207 | 13,049 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two One-Year Extensions | Hotel | CA | ||||||||||||||||||||
| CRE 7 | Interest-Only First Mortgage | 7,259 | 7,172 | 62% | 1-Month LIBOR plus 3.75% | 11/6/2022 | Two One-Year Extensions | Hotel | IL, FL | ||||||||||||||||||||
| CRE 8 | Interest-Only First Mortgage | 4,425 | 4,381 | 79% | 1-Month LIBOR plus 4.85% | 12/6/2022 | None | Assisted Living Facilities | FL | ||||||||||||||||||||
| SBC 3 | Interest-Only First Mortgage | 14,362 | 14,362 | 49% | 1-Month LIBOR plus 4.10% | 7/6/2022 | None | Nursing Facilities | CT | ||||||||||||||||||||
| $ | 192,155 | $ | 128,495 | ||||||||||||||||||||||||||
(1) CRE 3 is in default and not eligible for extension.
Non-Performing Commercial Loans
The COVID-19 pandemic has adversely impacted a broad range of industries in which our commercial loan borrowers operate and could impair their ability to fulfill their financial obligations to us, most significantly retail and hospitality asset. All but the one loan discussed below remain current.
CRE 3 Loan
As of March 31, 2022, the CRE 3 junior mezzanine loan with an outstanding principal balance of $90.0 million secured by a retail facility was non-performing and past its maturity date of June 29, 2021. We were receiving interest payments on this loan from a reserve that was exhausted in May 2021. We are currently in discussions with the borrower and
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certain other lenders regarding alternatives to address the situation which might include modifications of loan terms, deferral of payments and the funding of new advances. There can be no assurance that these discussions will result in an outcome in which we would be repaid any amount of the loan and we may suffer further declines in fair value with respect to the mezzanine investment. We could experience a total loss of our investment under various scenarios, which at current levels would result in a $27.1 million reduction in the Company’s book value. Refer to Note 6 - "Commercial Loans" for details.
The following table presents the aging of the Commercial Loans as of March 31, 2022 (dollars in thousands):
| Commercial Loans | ||||||||||||||||||||
| No of Loans | Principal | Fair Value | ||||||||||||||||||
| Current | 6 | $ | 102,155 | $ | 101,435 | |||||||||||||||
| 1-30 days | — | — | — | |||||||||||||||||
| 31-60 days | — | — | — | |||||||||||||||||
| 61-90 days | — | — | — | |||||||||||||||||
| 90+ days | 1 | 90,000 | 27,060 | |||||||||||||||||
| Total | 7 | $ | 192,155 | $ | 128,495 | |||||||||||||||
Commercial Real Estate Owned
In February 2022, we and the other investors sold the unencumbered hotel property for $55.9 million which was foreclosed on in the third quarter of 2021. We and the other investors fully recovered our aggregate initial investment of $42.0 million. We recognized a gain on sale of approximately $12.2 million.
Geographic Concentration
The mortgages underlying our Non-Agency RMBS and Non-Agency CMBS are located in various states across the United States and other countries. The following table presents the five largest concentrations by location for the mortgages collateralizing our Non-Agency RMBS and Non-Agency CMBS as of March 31, 2022, based on fair value (dollars in thousands):
| Non-Agency RMBS | Non-Agency CMBS | |||||||||||||||||||||||||
| Concentration | Fair Value | Concentration | Fair Value | |||||||||||||||||||||||
| California | 37.2 | % | $ | 23,890 | California | 36.4 | % | $ | 38,343 | |||||||||||||||||
| Florida | 14.6 | % | 9,402 | Nevada | 18.5 | % | 19,468 | |||||||||||||||||||
| New York | 7.2 | % | 4,628 | Bahamas | 13.7 | % | 14,420 | |||||||||||||||||||
| New Jersey | 3.8 | % | 2,425 | Delaware | 5.2 | % | 5,474 | |||||||||||||||||||
| Texas | 3.7 | % | 2,363 | Texas | 4.1 | % | 4,298 | |||||||||||||||||||
The following table presents the various states across the United States in which the collateral securing our Residential Whole Loans and Residential Bridge Loans at March 31, 2022, based on principal balance, is located (dollars in thousands):
| Residential Whole Loans | Residential Bridge Loans | |||||||||||||||||||||||||
| State Concentration | Principal Balance | State Concentration | Principal Balance | |||||||||||||||||||||||
| California | 69.6 | % | $ | 703,135 | New York | 45.9 | % | $ | 2,631 | |||||||||||||||||
| New York | 12.6 | % | 127,581 | California | 30.6 | % | 1,754 | |||||||||||||||||||
| Georgia | 3.3 | % | 33,024 | Florida | 19.6 | % | 1,125 | |||||||||||||||||||
| Texas | 2.9 | % | 29,139 | New Jersey | 3.9 | % | 219 | |||||||||||||||||||
| Florida | 2.7 | % | 27,221 | Total | 100.0 | % | 5,729 | |||||||||||||||||||
| Other | 8.9 | % | 90,587 | |||||||||||||||||||||||
| Total | 100.0 | % | $ | 1,010,687 | ||||||||||||||||||||||
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Financing Activity
We will look to continue to expand and diversify our financing sources, especially those sources that provide an alternative to short-term repurchase agreements with daily margin requirements.
Repurchase Agreements
Our repurchase agreements bear interest at a contractually agreed-upon rate and have terms ranging from one month to 12 months. Our counterparties generally require collateral in excess of the loan amount, or haircuts. As of March 31, 2022, the contractual haircuts required under repurchase agreements on our investments were as follows:
| Minimum | Maximum | |||||||||||||
| Short-Term Borrowings | ||||||||||||||
| Agency RMBS IOs | 33% | 37% | ||||||||||||
| Non-Agency RMBS | 13% | 61% | ||||||||||||
| Residential Whole Loans | 21% | 21% | ||||||||||||
| Residential Bridge Loans | 18% | 18% | ||||||||||||
| Commercial Loans | 55% | 55% | ||||||||||||
| Other Securities | 63% | 65% | ||||||||||||
| Long-Term Borrowings | ||||||||||||||
| Non-Agency CMBS and Non-Agency RMBS Facility | ||||||||||||||
| Non-Agency RMBS | 25% | 25% | ||||||||||||
| Non-Agency CMBS | 30% | 30% | ||||||||||||
| Other Securities | 25% | 30% | ||||||||||||
| Residential Whole Loan Facility | ||||||||||||||
Residential Whole Loans(1) | 10% | 10% | ||||||||||||
| Commercial Whole Loan Facility | ||||||||||||||
Commercial Loans(2) | 22% | 31% | ||||||||||||
(1) The haircut is based on 10% of the outstanding principal amount of the Residential Whole Loans.
(2) Each Commercial Loan is financed separately under this facility and the haircuts are dependent on the type of collateral.
Convertible Senior Unsecured Notes
During the quarter ended March 31, 2022, we repurchased $3.4 million aggregate principal amount of the 2022 Notes at an approximate 0.8% premium to par value, plus accrued and unpaid interest.
Securitized Debt
In February 2022, we completed a residential mortgage-backed securitization. The Arroyo Trust 2022 issued $398.9 million of mortgage-backed notes and we retained the subordinate non-offered securities in the securitization, which include the Class B, Class A-IO-S and Class XS certificates. These non-offered securities were eliminated in the consolidation. As of March 31, 2022, Residential Whole Loans, with an outstanding principal balance of approximately $415.2 million, serve as collateral for the Arroyo Trust 2022's securitized debt.
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Outstanding Borrowings
Repurchase Agreements
At March 31, 2022, we had outstanding borrowings under six of our repurchase agreements. The following table summarizes certain characteristics of our repurchase agreements at March 31, 2022 (dollars in thousands):
| Securities Pledged | Repurchase Agreement Borrowings | Weighted Average Interest Rate on Borrowings Outstanding at end of period | Weighted Average Remaining Maturity (days) | |||||||||||||||||
| Short-Term Borrowings: | ||||||||||||||||||||
| Agency RMBS | $ | 354 | 1.13 | % | 32 | |||||||||||||||
Non-Agency RMBS(1) | 54,388 | 2.33 | % | 11 | ||||||||||||||||
Residential Whole Loans (2) | 1,322 | 2.95 | % | 28 | ||||||||||||||||
Residential Bridge Loans (2) | 4,231 | 2.95 | % | 28 | ||||||||||||||||
Commercial Loans (2) | 6,463 | 3.56 | % | 28 | ||||||||||||||||
| Other Securities | 2,410 | 3.49 | % | 18 | ||||||||||||||||
| Total short term borrowings | 69,168 | 2.53 | % | 15 | ||||||||||||||||
| Long Term Borrowings: | ||||||||||||||||||||
| Non-Agency CMBS and Non-Agency RMBS Facility | ||||||||||||||||||||
Non-Agency CMBS (1) | 56,486 | 2.14 | % | 35 | ||||||||||||||||
| Non-Agency RMBS | 16,451 | 2.15 | % | 35 | ||||||||||||||||
| Other Securities | 27,506 | 2.22 | % | 35 | ||||||||||||||||
| Subtotal | 100,443 | 2.17 | % | 35 | ||||||||||||||||
| Residential Whole Loan Facility | ||||||||||||||||||||
Residential Whole Loans (2) | 109,111 | 2.25 | % | 218 | ||||||||||||||||
| Commercial Whole Loan Facility | ||||||||||||||||||||
| Commercial Loans | 63,658 | 2.27 | % | 178 | ||||||||||||||||
| Total long term borrowings | 273,212 | 2.22 | % | 141 | ||||||||||||||||
| Repurchase agreements borrowings | $ | 342,380 | 2.29 | % | 116 | |||||||||||||||
| Less unamortized debt issuance costs | — | N/A | N/A | |||||||||||||||||
| Repurchase agreement borrowings, net | $ | 342,380 | 2.29 | % | 116 | |||||||||||||||
(1)Includes repurchase agreement borrowings on securities eliminated upon VIE consolidation.
(2)Repurchase agreement borrowings on loans owned are through trust certificates. The trust certificates are eliminated in consolidation.
At March 31, 2022, we had outstanding repurchase agreement borrowings with the following counterparties:
| (dollars in thousands) Repurchase Agreement Counterparties | Amount Outstanding | Percent of Total Amount Outstanding | Company Investments Held as Collateral | Counterparty Rating(1) | ||||||||||||||||||||||
Credit Suisse AG, Cayman Islands Branch (2) | $ | 207,753 | 60.7 | % | $ | 241,846 | A+ | |||||||||||||||||||
| Citigroup Global Markets Inc. | 100,443 | 29.3 | % | 173,733 | A+ | |||||||||||||||||||||
| RBC Capital Markets LLC | 19,405 | 5.7 | % | 22,349 | AA- | |||||||||||||||||||||
Nomura Securities International, Inc. (3) | 12,016 | 3.5 | % | 21,092 | Unrated (3) | |||||||||||||||||||||
All other counterparties (4) | 2,763 | 0.8 | % | 6,956 | ||||||||||||||||||||||
| Total | $ | 342,380 | 100.0 | % | $ | 465,976 | ||||||||||||||||||||
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(1)The counterparty ratings presented above are the long-term issuer credit ratings as rated at March 31, 2022 by S&P.
(2)Includes master repurchase agreements in which the buyer includes Alpine Securitization LTD., a Credit Suisse sponsored asset-backed commercial paper conduit.
(3) Nomura Holdings, Inc., the parent company of Nomura Securities International, Inc., is rated BBB+ by S&P at March 31, 2022.
(4) Represents amount outstanding with two counterparties, which each holds collateral valued less than 5% of our stockholders’ equity as security for our obligations under the applicable repurchase agreements as of March 31, 2022.
The following table presents our average repurchase agreement borrowings, excluding unamortized debt issuance costs, by type of collateral pledged for the three months ended March 31, 2022 (dollars in thousands):
| Collateral | Three Months Ended March 31, 2022 | ||||||||||
| Agency RMBS | $ | 850 | |||||||||
Non-Agency RMBS(1) | 56,798 | ||||||||||
Non-Agency CMBS(1) | 71,803 | ||||||||||
| Residential Whole Loans | 201,228 | ||||||||||
Commercial loans | 65,272 | ||||||||||
Residential Bridge Loans | 5,625 | ||||||||||
| Other securities | 36,343 | ||||||||||
| Total | $ | 437,919 | |||||||||
Maximum borrowings during the period(2) | $ | 613,518 | |||||||||
(1)Includes repurchase agreement borrowings on securities eliminated upon VIE consolidation.
(2)Amount represents the maximum borrowings at month-end during each of the respective periods.
Repurchase Agreements Financial Metrics
Certain of our financing agreements provide the counterparty with the right to terminate the agreement and accelerate amounts due under the associated agreement if we do not maintain certain financial metrics. Although specific to each financing arrangement, typical financial metrics include minimum equity and liquidity requirements, leverage ratios, and performance triggers. In addition, some of the financing arrangements contain cross-default features, whereby default under an agreement with one lender simultaneously causes default under agreements with other lenders. with borrowings outstanding as of March 31, 2022. We complied with the terms of such financial metrics as of March 31, 2022.
Securitized Debt
Residential Mortgage-Backed Notes
Arroyo Trust 2019
The following table summarizes the consolidated Arroyo Trust 2019's issued mortgage-backed notes at March 31, 2022 which is classified in "Securitized debt, net" in the Consolidated Balance Sheets (dollars in thousands):
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| Classes | Principal Balance | Coupon | Carrying Value | Contractual Maturity | ||||||||||
| Issued Mortgage-Backed Notes | ||||||||||||||
| Class A-1 | $ | 234,900 | 3.3% | $ | 234,900 | 4/25/2049 | ||||||||
| Class A-2 | 12,598 | 3.5% | 12,598 | 4/25/2049 | ||||||||||
| Class A-3 | 19,959 | 3.8% | 19,959 | 4/25/2049 | ||||||||||
| Class M-1 | 25,055 | 4.8% | 25,055 | 4/25/2049 | ||||||||||
| Subtotal | $ | 292,512 | $ | 292,512 | ||||||||||
| Less: Unamortized deferred financing costs | N/A | 3,280 | ||||||||||||
| Total | $ | 292,512 | $ | 289,232 | ||||||||||
Arroyo Trust 2020
The following table summarizes the consolidated Arroyo Trust 2020's issued mortgage-backed notes at March 31, 2022 which is classified in "Securitized debt, net" in the Consolidated Balance Sheets (dollars in thousands):
| Classes | Principal Balance | Coupon | Carrying Value | Contractual Maturity | ||||||||||
| Issued Mortgage-Backed Notes | ||||||||||||||
| Class A-1A | $ | 96,193 | 1.7% | $ | 96,193 | 3/25/2055 | ||||||||
| Class A-1B | 11,414 | 2.1% | 11,414 | 3/25/2055 | ||||||||||
| Class A-2 | 13,518 | 2.9% | 13,518 | 3/25/2055 | ||||||||||
| Class A-3 | 17,963 | 3.3% | 17,963 | 3/25/2055 | ||||||||||
| Class M-1 | 11,739 | 4.3% | 11,739 | 3/25/2055 | ||||||||||
| Subtotal | $ | 150,827 | $ | 150,827 | ||||||||||
| Less: Unamortized deferred financing costs | N/A | 1,910 | ||||||||||||
| Total | $ | 150,827 | $ | 148,917 | ||||||||||
Arroyo Trust 2022
The following table summarizes the consolidated Arroyo Trust 2022's issued mortgage-backed notes at March 31, 2022 which is classified as "Securitized debt, net" on the Consolidated Balance Sheets (dollars in thousands):
| Classes | Principal Balance | Coupon | Fair Value | Contractual Maturity | ||||||||||
| Issued Mortgage-Backed Notes | ||||||||||||||
| Class A-1A | $ | 238,419 | 2.5% | $ | 232,676 | 12/25/2056 | ||||||||
| Class A-1B | 82,942 | 3.3% | 79,703 | 12/25/2056 | ||||||||||
| Class A-2 | 21,168 | 3.6% | 20,381 | 12/25/2056 | ||||||||||
| Class A-3 | 28,079 | 3.7% | 26,918 | 12/25/2056 | ||||||||||
| Class M-1 | 17,928 | 3.7% | 16,744 | 12/25/2056 | ||||||||||
| Total | $ | 388,536 | $ | 376,422 | ||||||||||
Commercial Mortgage-Backed Notes
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We hold a controlling financial variable interest in CSMC USA and were required to consolidate the CMBS VIE. Refer to Note 7 - "Financings" for details. The following table summarizes the consolidated 2014 CSMC USA's commercial mortgage pass-through certificates at March 31, 2022 which is classified in "Securitized debt, net" in the Consolidated Balance Sheets (dollars in thousands):
| Classes | Principal Balance | Coupon | Fair Value | Contractual Maturity | ||||||||||
| Class A-1 | $ | 120,391 | 3.3 | % | $ | 117,768 | 9/11/2025 | |||||||
| Class A-2 | 531,700 | 4.0 | % | 523,078 | 9/11/2025 | |||||||||
| Class B | 136,400 | 4.2 | % | 126,957 | 9/11/2025 | |||||||||
| Class C | 94,500 | 4.3 | % | 86,707 | 9/11/2025 | |||||||||
| Class D | 153,950 | 4.4 | % | 142,388 | 9/11/2025 | |||||||||
| Class E | 180,150 | 4.4 | % | 152,369 | 9/11/2025 | |||||||||
| Class F | 153,600 | 4.4 | % | 113,725 | 9/11/2025 | |||||||||
Class X-1(1) | N/A | 0.7 | % | 12,347 | 9/11/2025 | |||||||||
Class X-2(1) | N/A | 0.2 | % | 2,572 | 9/11/2025 | |||||||||
| $ | 1,370,691 | $ | 1,277,911 | |||||||||||
(1) Class X-1 and X-2 are interest-only classes with notional balances of $652.1 million and $733.5 million as of March 31, 2022, respectively.
The above table does not reflect the portion of the class F bond held by us because the bond is eliminated in consolidation. Our ownership interest in the F bonds represents a controlling financial interest, which resulted in consolidation of the trust. The bond had a fair market value of $11.0 million at March 31, 2022, and our exposure to loss is limited to our ownership interest in this bond.
Convertible Senior Unsecured Notes
2022 Notes
As of March 31, 2022, we had $34.3 million of the 2022 Notes outstanding. The 2022 Notes mature on October 1, 2022, unless earlier converted, redeemed or repurchased by the holders pursuant to their terms, and are not redeemable by us except during the final three months prior to maturity.
2024 Notes
As of March 31, 2022, we had $86.3 million aggregate principal amount of the 2024 Notes outstanding. The 2024 notes mature on September 15, 2024, unless earlier converted, redeemed or repurchased by the holders pursuant to their terms, and are not redeemable by us except during the final three months prior to maturity.
Recourse and Non-Recourse Financing
We utilize both recourse and non-recourse debt to finance our portfolio. Our recourse debt included our short and long-term repurchase agreement financings and our convertible senior unsecured notes. At March 31, 2022, our total non-recourse financing is comprised of $814.6 million of securitized debt issued in connection with our three Residential Whole Loan securitizations and $1.3 billion of securitized debt from owning a Non-Agency CMBS bond with a fair value of $14.9 million that was deemed to be a controlling financial variable interest in CSMC USA which required us to consolidate the CMBS VIE.
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| (dollars in thousands) | March 31, 2022 | December 31, 2021 | ||||||||||||
| Recourse and non-recourse financing | $ | 2,551,209 | $ | 2,599,845 | ||||||||||
| Non-recourse financing | ||||||||||||||
| Arroyo 2019-2 | 289,232 | 337,571 | ||||||||||||
| Arroyo 2020-1 | 148,917 | 181,547 | ||||||||||||
| Arroyo 2022-1 | 376,422 | — | ||||||||||||
| CMSC USA | 1,277,911 | 1,344,370 | ||||||||||||
| Total recourse financing | $ | 458,727 | $458,727 | $ | 736,357 | |||||||||
| Stockholders' equity | $ | 165,006 | $ | 193,109 | ||||||||||
| Recourse leverage | 2.8x | 3.8x | ||||||||||||
Hedging Activity
The following tables summarize the hedging activity during the three months ended March 31, 2022 (dollars in thousands):
| Notional Amount at | Settlements, Terminations or Expirations | Notional Amount at | |||||||||||||||||||||
| Derivative Instrument | December 31, 2021 | Acquisitions | March 31, 2022 | ||||||||||||||||||||
| Fixed pay interest rate swaps | $ | 22,000 | $ | 265,000 | $ | (35,000) | $ | 252,000 | |||||||||||||||
| Credit default swaps | 6,170 | — | — | 6,170 | |||||||||||||||||||
| Total derivative instruments | $ | 28,170 | $ | 265,000 | $ | (35,000) | $ | 258,170 | |||||||||||||||
| Fair Value at | Acquisitions | Settlements, Terminations or Expirations | Realized Gains / Losses | Mark-to-market | Fair Value at | ||||||||||||||||||||||||||||||
| Derivative Instrument | December 31, 2021 | March 31, 2022 | |||||||||||||||||||||||||||||||||
| Fixed pay interest rate swaps | $ | (38) | $ | — | $ | (5,540) | $ | 5,540 | $ | (449) | $ | (487) | |||||||||||||||||||||||
| Credit default swaps | (459) | — | — | — | 2,213 | 1,754 | |||||||||||||||||||||||||||||
| Total derivative instruments | $ | (497) | $ | — | $ | (5,540) | $ | 5,540 | $ | 1,764 | $ | 1,267 | |||||||||||||||||||||||
Dividends
During the three months ended March 31, 2022, we declared a $0.04 dividend per share generating a dividend yield of approximately 9.4% based on the stock closing price of $1.71 on March 31, 2022.
Book Value
The following chart reflects our book value per common share basic and diluted over five consecutive quarters:
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We continue to implement measures to improve our balance sheet by increasing liquidity, reducing leverage, and seek alternative financing arrangements to preserve long-term shareholder value. The decrease in book value from $3.20 as of December 31, 2021, to $2.73 as of March 31, 2022, was primarily due to a decline in fair value in our investment portfolio, mainly the Residential Whole Loan investments attributable to spread widening. Also, contributing were lower net interest income from accelerated premium amortization associated prepayments in our Residential Whole Loan portfolio.
Results of Operations
Comparison of the three months ended March 31, 2022 to the three months ended March 31, 2021.
General
Due to the continued uncertainty still surrounding the ongoing COVID-19 pandemic, our results of operations for the three months ended March 31, 2022 and March 31, 2021 may not be comparable. During the first quarter of 2022, we continued to make progress towards strengthening our balance sheet, improving liquidity and the transition of our portfolio to residential investments.
During the three months ended March 31, 2022, we completed our third securitization, continued to repurchase our 2022 Notes, and sold the hotel REO, realizing a gain on sale. However, due to spread widening we experienced a significant decline in the fair value of Residential Whole Loan investments. This decline in fair value of $41.8 million was a key contributor to the generation of a net loss of $25.9 million, or $0.43 per basic and diluted weighted common share for the three months ended March 31, 2022
In contrast, for the three months ended March 31, 2021, the improved residential credit markets resulted in a significant increase in our Residential Whole Loan investments, which was a key contributor to the generation of net income of $8.0 million, or $0.13 per basic and diluted weighted common share.
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Net Interest Income
The following tables set forth certain information regarding our net interest income on our investment portfolio for the three months ended March 31, 2022 and March 31, 2021 (dollars in thousands):
| Three Months Ended March 31, 2022 | Average Amortized Cost of Assets | Total Interest Income | Yield on Average Assets | |||||||||||||||||
| Investments | ||||||||||||||||||||
| Agency RMBS | $ | 59 | $ | 4 | 27.50 | % | ||||||||||||||
| Non-Agency CMBS | 166,171 | 2,570 | 6.27 | % | ||||||||||||||||
| Non-Agency RMBS | 40,422 | 530 | 5.32 | % | ||||||||||||||||
| Residential Whole Loans | 1,052,261 | 8,746 | 3.37 | % | ||||||||||||||||
| Residential Bridge Loans | 5,798 | 20 | 1.40 | % | ||||||||||||||||
| Commercial loans | 192,156 | 1,246 | 2.63 | % | ||||||||||||||||
| Securitized commercial loans | 1,274,896 | 21,872 | 6.96 | % | ||||||||||||||||
| Other securities | 47,641 | 654 | 5.57 | % | ||||||||||||||||
| Total investments | $ | 2,779,404 | $ | 35,642 | 5.20 | % | ||||||||||||||
| Average Carrying Value | Total Interest Expense | Average Cost of Funds(1) | ||||||||||||||||||
| Borrowings | ||||||||||||||||||||
| Repurchase agreements | $ | 437,919 | $ | 2,442 | 2.26 | % | ||||||||||||||
| Convertible senior unsecured notes, net | 118,308 | 2,597 | 8.90 | % | ||||||||||||||||
| Securitized debt | 1,991,512 | 26,320 | 5.36 | % | ||||||||||||||||
| Total borrowings | $ | 2,547,739 | $ | 31,359 | 4.99 | % | ||||||||||||||
Net interest income and net interest margin(2) | $ | 4,283 | 0.62 | % | ||||||||||||||||
| Three Months Ended March 31, 2021 | Average Amortized Cost of Assets | Total Interest Income | Yield on Average Assets | |||||||||||||||||
| Investments | ||||||||||||||||||||
| Agency RMBS | $ | 89 | $ | 4 | 18.23 | % | ||||||||||||||
| Non-Agency CMBS | 208,870 | 4,767 | 9.26 | % | ||||||||||||||||
| Non-Agency RMBS | 29,554 | 355 | 4.87 | % | ||||||||||||||||
| Residential Whole Loans | 970,642 | 10,058 | 4.20 | % | ||||||||||||||||
| Residential Bridge Loans | 14,141 | 230 | 6.60 | % | ||||||||||||||||
| Commercial Loans | 325,227 | 5,217 | 6.51 | % | ||||||||||||||||
| Securitized commercial loan | 1,568,571 | 24,564 | 6.35 | % | ||||||||||||||||
| Other securities | 49,396 | 822 | 6.75 | % | ||||||||||||||||
| Total investments | $ | 3,166,490 | $ | 46,017 | 5.89 | % | ||||||||||||||
| Average Carrying Value | Total Interest Expense | Average Cost of Funds(1) | ||||||||||||||||||
| Borrowings | ||||||||||||||||||||
| Repurchase agreements | $ | 348,541 | $ | 3,604 | 4.19 | % | ||||||||||||||
| Convertible senior unsecured notes, net | 169,010 | 3,540 | 8.49 | % | ||||||||||||||||
| Securitized debt | 2,336,479 | 29,625 | 5.14 | % | ||||||||||||||||
| Total borrowings | $ | 2,854,030 | $ | 36,769 | 5.22 | % | ||||||||||||||
Net interest income and net interest margin(2) | $ | 9,248 | 1.18 | % | ||||||||||||||||
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(1) Average cost of funds does not include the interest expense related to our derivatives. In accordance with GAAP, such costs are included in "Gain (loss) on derivative instruments, net" in the Consolidated Statements of Operations.
(2) Since we do not apply hedge accounting, our net interest margin in this table does not reflect the benefit / cost of our interest rate swaps. See "Non-GAAP Financial Measures" for net investment income table that includes the benefit / cost from our interest rate swaps.
Interest Income
For the three months ended March 31, 2022, and March 31, 2021, we earned interest income on our investments of approximately $35.6 million and $46.0 million, respectively. The decrease of approximately $10.4 million was mainly due to a smaller investment portfolio from principal payments and payoffs of $421.4 million of commercial investments and $416.0 million of residential investments. Also, interest income was further reduced by our $90.0 million commercial mezzanine loan becoming non-performing in May 2021, and certain Non-Agency CMBS positions were placed on non-accrual status. The decrease was partially offset by acquisitions of $587.0 million of residential investments.
Interest Expense
Interest expense decreased from $36.8 million for the three months ended March 31, 2021 to $31.4 million for the three months ended March 31, 2022. The decrease in interest expense was a result of a smaller investment portfolio, improved cost of financing from the improved terms on our amended residential and securities financing facilities and Residential Whole Loan facility and a decrease in our convertible senior unsecured notes outstanding as a result of the repurchases.
Other income (loss), net
Realized gain (loss), net
Realized gain (loss) represents the net gain (loss) on sales or settlements from our investment portfolio and debt. The following table presents the realized gains (losses) of our investments and debt for each of the three months ended March 31, 2022 and March 31, 2021 (dollars in thousands):
| For the three months ended March 31, 2022 | For the three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||||
| Proceeds (Payments) | Gross Gains | Gross Losses | Net Gain (Loss) | Proceeds (Payments) | Gross Gains | Gross Losses | Net Gain (Loss) | ||||||||||||||||||||||||||||||||||||||||
| Non-Agency CMBS | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | (5,929) | $ | (5,929) | |||||||||||||||||||||||||||||||
Loans transferred to REO(1) | — | — | — | — | 684 | — | (36) | (36) | |||||||||||||||||||||||||||||||||||||||
Disposition of REO(2) | 54,681 | 12,198 | — | 12,198 | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Convertible senior unsecured notes(3) | (3,408) | (53) | — | (53) | (6,315) | 240 | — | 240 | |||||||||||||||||||||||||||||||||||||||
| Total | $ | 51,273 | $ | 12,145 | $ | — | $ | 12,145 | $ | (5,631) | $ | 240 | $ | (5,965) | $ | (5,725) | |||||||||||||||||||||||||||||||
(1)Realized gains/losses recognized on the transfer of Residential Bridge Loans to REO. Proceeds represent the fair value less estimated selling costs of the real estate on the date of transfer.
(2)Realized gains/losses recognized in connection with the sale of the hotel REO.
(3)Realized gains/losses recognized on the extinguishment of the 2022 Notes. See Note 7 - Financings for details.
Unrealized gain (loss), net
Our investments, and securitized debt, for which we have elected the fair value option are recorded at fair value with the periodic changes in fair value being recorded in earnings. The change in unrealized gain (loss) is directly attributable to changes in market pricing on the underlying investments and securitized debt during the period.
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The following table presents the net unrealized gains (losses) we recorded on our investments and securitized debt (dollars in thousands):
| Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||
| Agency RMBS | $ | (48) | $ | 26 | |||||||
| Non-Agency CMBS | 974 | (13,972) | |||||||||
| Non-Agency RMBS | (3,424) | 1,454 | |||||||||
| Residential Whole Loans | (41,843) | 17,321 | |||||||||
| Residential Bridge Loans | 27 | 203 | |||||||||
| Commercial loans | (2,073) | 1,622 | |||||||||
| Securitized commercial loans | (73,564) | 75,810 | |||||||||
| Other securities | (2,374) | 681 | |||||||||
| Securitized debt | 83,422 | (74,095) | |||||||||
| Total | $ | (38,903) | $ | 9,050 | |||||||
Gain (loss) on derivatives, net
As of March 31, 2022, we had interest rate swaps and forward starting swaps with a notional amount of $252.0 million, including $100.0 million of forward starting swaps. Our hedging strategy is designed to mitigate our exposure to interest rate volatility.
The following table presents the components of gain (loss) on derivatives for the three months ended March 31, 2022 and March 31, 2021 (dollars in thousands):
| Realized Gain (Loss), net | ||||||||||||||||||||||||||||||||||||||
| Description | Other Settlements / Expirations | Variation Margin Settlement | Return (Recovery) of Basis | Mark-to-Market | Contractual interest income (expense), net(1) | Total | ||||||||||||||||||||||||||||||||
| Three months ended March 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | — | $ | 5,540 | $ | — | $ | (449) | $ | (291) | $ | 4,800 | ||||||||||||||||||||||||||
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives | — | — | (72) | (109) | 89 | (92) | ||||||||||||||||||||||||||||||||
| Credit default swaps | 15 | — | — | 2,213 | — | 2,228 | ||||||||||||||||||||||||||||||||
| Total | $ | 15 | $ | 5,540 | $ | (72) | $ | 1,655 | $ | (202) | $ | 6,936 | ||||||||||||||||||||||||||
| Three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||||||
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives | $ | — | $ | — | $ | (94) | $ | — | $ | 121 | $ | 27 | ||||||||||||||||||||||||||
| Credit default swaps | 16 | — | — | (17) | — | (1) | ||||||||||||||||||||||||||||||||
| Total | $ | 16 | $ | — | $ | (94) | $ | (17) | $ | 121 | $ | 26 | ||||||||||||||||||||||||||
(1)Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.
Other, net
For the three months ended March 31, 2022 and March 31, 2021, "Other, net" was a loss of $145 thousand and a loss of $28 thousand, respectively. The balance is mainly comprised of income on cash balances, miscellaneous net interest income (expense) on cash collateral for our repurchase agreements and derivatives, and miscellaneous fees and expenses on residential mortgage loans.
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Expenses
Management Fee
We incurred management fee expense of approximately $1.1 million and $1.5 million for the three months ended March 31, 2022 and March 31, 2021, respectively. The decline in management fees was a result of our Manager voluntarily waiving 25% of its management fee solely for the duration of calendar year 2022 in order to support our earnings potential and our transition to a residential focused investment portfolio. Future waivers, if any, will be at the Manager's discretion.
The management fees, expense reimbursements and the relationship between our Manager and us are discussed further in Note 10, “Related Party Transactions” to the financial statements contained in this Quarterly Report on Form 10-Q.
Other Operating Expenses
We incurred other operating expenses of approximately $296 thousand and $392 thousand for the three months ended March 31, 2022, and March 31, 2021, respectively. Other operating costs comprise bank fees, trustee fees and asset management/loan servicing fees for loans acquired serving released. Formerly, transaction and financing costs were included in this expense category.
Transaction costs
We incurred transaction costs of $2.6 million for the three months ended March 31, 2022, and there were no similar costs for the three months ended March 31, 2021. The transaction costs are associated with the Arroyo Trust 2022-1 securitization that was completed in February 2022. We elected the fair value option for the securitized debt. Under generally accepted accounting principles, we were required to expense the associated finance costs.
General and Administrative Expenses
General and administrative expenses for the three months ended March 31, 2022 compared to the three months ended March 31, 2021 was relatively flat quarter over quarter.
Non-GAAP Financial Measures
We believe that our non-GAAP measures (described below), when considered with GAAP, provide supplemental information useful to investors in evaluating the results of our operations. Our presentations of such non-GAAP measures may not be comparable to similarly-titled measures of other companies, who may use different calculations. As a result, such non-GAAP measures should not be considered as substitutes for our GAAP net income, as measures of our financial performance or any measure of our liquidity under GAAP.
Distributable Earnings (formerly referred to as Core Earnings) is a non-GAAP financial measure that is used by us to approximate cash yield or income associated with our portfolio and is defined as GAAP net income (loss) as adjusted, excluding: (i) net realized gain (loss) on investments and termination of derivative contracts; (ii) net unrealized gain (loss) on investments and debt; (iii) net unrealized gain (loss) resulting from mark-to-market adjustments on derivative contracts; (iv) provision for income taxes; (v) non-cash stock-based compensation expense; (vi) non-cash amortization of the convertible senior unsecured notes discount; (vii) one-time charges such as acquisition costs and impairment on loans; and (viii) one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between us, our Manager and our independent directors and after approval by a majority of our independent directors.
We utilize Distributable Earnings as a key metric to evaluate the effective yield of the portfolio. Distributable Earnings allows us to reflect the net investment income of our portfolio as adjusted to reflect the net interest rate swap interest expense. Distributable Earnings allows us to isolate the interest expense associated with our interest rate swaps in order to monitor and project our borrowing costs and interest rate spread. It is one metric of several used in determining the appropriate distributions to our shareholders.
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The table below reconciles Net Income to Distributable Earnings for the three months ended March 31, 2022 and March 31, 2021:
| (dollars in thousands) | Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||||
| Net income (loss) attributable to common stockholders and participating securities | $ | (25,853) | $ | 7,953 | ||||||||||
| Income tax provision (benefit) | 56 | 98 | ||||||||||||
| Net income (loss) before income taxes | (25,797) | 8,051 | ||||||||||||
| Adjustments: | ||||||||||||||
| Investments: | ||||||||||||||
| Unrealized (gain) loss on investments, securitized debt and other liabilities | 38,903 | (9,050) | ||||||||||||
| Realized (gain) loss on investments | (8,713) | 5,965 | ||||||||||||
| One-time transaction costs | 2,740 | (4) | ||||||||||||
| Derivative Instruments: | ||||||||||||||
| Net realized gain on derivatives | (5,540) | — | ||||||||||||
| Net unrealized (gain) loss on derivatives | (1,655) | 17 | ||||||||||||
| Other: | ||||||||||||||
| Realized (gain) loss on extinguishment of convertible senior unsecured notes | 53 | (240) | ||||||||||||
| Amortization of discount on convertible senior unsecured notes | 223 | 245 | ||||||||||||
| Other non-cash adjustments | — | 977 | ||||||||||||
| Non-cash stock-based compensation expense | 165 | 182 | ||||||||||||
| Total adjustments | 26,176 | (1,908) | ||||||||||||
| Distributable Earnings | $ | 379 | $ | 6,143 | ||||||||||
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Alternatively, our Distributable Earnings can also be derived as presented in the table below by starting with Adjusted net interest income, which includes interest income on Interest-Only Strips accounted for as derivatives and other derivatives, and net interest expense incurred on interest rate swaps and foreign currency swaps and forwards (a Non-GAAP financial measure) subtracting Total expenses, adding Non-cash stock based compensation, adding one-time transaction costs, adding amortization of discount on convertible senior notes and adding interest income on cash balances and other income (loss), net:
| (dollars in thousands) | Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||||
Net interest income | $ | 4,283 | $ | 9,248 | ||||||||||
| Interest income from IOs and IIOs accounted for as derivatives | 17 | 27 | ||||||||||||
| Net interest income (expense) from interest rate swaps | (291) | — | ||||||||||||
Adjusted net interest income | 4,009 | 9,275 | ||||||||||||
| Total expenses | (6,497) | (4,518) | ||||||||||||
| Other non-cash adjustments | — | 977 | ||||||||||||
| Non-cash stock-based compensation | 165 | 182 | ||||||||||||
| One-time transaction costs | 2,740 | (4) | ||||||||||||
| Amortization of discount on convertible unsecured senior notes | 223 | 245 | ||||||||||||
Interest income on cash balances and other income (loss), net | (130) | (12) | ||||||||||||
| Income attributable to non-controlling interest | (131) | (2) | ||||||||||||
| Distributable Earnings | $ | 379 | $ | 6,143 | ||||||||||
Reconciliation of GAAP Book Value to Non-GAAP Economic Book Value
"Economic book value" is a non-GAAP financial measure of our financial position on an unconsolidated basis. We own certain securities that represent a controlling variable interest, which under GAAP requires consolidation; however, our economic exposure to these variable interests is limited to the fair value of the individual investments. Economic book value is calculated by taking the GAAP book value and 1) adding the fair value of the retained interest or acquired security of the VIEs held by us and 2) removing the asset and liabilities associated with each of consolidated trusts (CSMC USA, Arroyo 2019-2, Arroyo 2020-1 and Arroyo 2022-1). Management considers that Economic book value provides investors with a useful supplemental measure to evaluate our financial position as it reflects the actual financial interest of these investments irrespective of the variable interest consolidation model applied for GAAP reporting purposes. Economic book value does not represent and should not be considered as a substitute for Stockholders' Equity, as determined in accordance with GAAP, and our calculation of this measure may not be comparable to similarly titled measures reported by other companies.
The table below is a reconciliation of the GAAP Book Value to Non-GAAP Economic Book Value (dollars in thousands - except per share data):
| $ Amount | Per Share | |||||||||||||
| GAAP Book Value at March 31, 2022 | $ | 165,006 | $ | 2.73 | ||||||||||
| Adjustments to deconsolidate VIEs and reflect the Company's interest in the securities owned | ||||||||||||||
| Deconsolidation of VIEs assets | (2,197,379) | (36.39) | ||||||||||||
| Deconsolidation of VIEs liabilities | 2,099,721 | 34.78 | ||||||||||||
| Interest in securities of VIEs owned, at fair value | 102,031 | 1.69 | ||||||||||||
| Economic Book Value at March 31, 2022 | $ | 169,379 | $ | 2.81 | ||||||||||
Net Interest Income and Net Interest Margin
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The following tables set forth certain information regarding our Non-GAAP net investment income and net interest margin which includes interest income on Agency and Non-Agency Interest-Only Strips classified as derivatives and excludes the interest expense for third-party consolidated VIEs for the three months ended March 31, 2022 and March 31, 2021 (dollars in thousands):
| Three Months Ended March 31, 2022 | Average Amortized Cost of Assets(1) | Total Interest Income(2) | Yield on Average Assets | |||||||||||||||||
| Investments | ||||||||||||||||||||
| Agency RMBS | $ | 1,022 | $ | 21 | 8.33 | % | ||||||||||||||
| Non-Agency CMBS | 166,171 | 2,570 | 6.27 | % | ||||||||||||||||
| Non-Agency RMBS | 40,422 | 530 | 5.32 | % | ||||||||||||||||
| Residential Whole Loans | 1,052,261 | 8,746 | 3.37 | % | ||||||||||||||||
| Residential Bridge Loans | 5,798 | 20 | 1.40 | % | ||||||||||||||||
| Commercial loans | 192,156 | 1,246 | 2.63 | % | ||||||||||||||||
| Securitized commercial loans | 1,274,896 | 21,872 | 6.96 | % | ||||||||||||||||
| Other securities | 47,641 | 654 | 5.57 | % | ||||||||||||||||
| Total investments | 2,780,367 | 35,659 | 5.20 | % | ||||||||||||||||
| Adjustments: | ||||||||||||||||||||
| Securitized commercial loans from consolidated VIEs | (1,274,896) | (21,872) | 6.96 | % | ||||||||||||||||
| Investments in consolidated VIEs eliminated in consolidation | 13,966 | 219 | 6.36 | % | ||||||||||||||||
| Adjusted total investments | $ | 1,519,437 | $ | 14,006 | 3.74 | % | ||||||||||||||
| Average Carrying Value | Total Interest Expense | Average Effective Cost of Funds | ||||||||||||||||||
| Borrowings | ||||||||||||||||||||
| Repurchase agreements | $ | 437,919 | $ | 2,442 | 2.26 | % | ||||||||||||||
| Convertible senior unsecured notes, net | 118,308 | 2,597 | 8.90 | % | ||||||||||||||||
| Securitized debt | 1,991,512 | 26,320 | 5.36 | % | ||||||||||||||||
| Interest rate swaps | n/a | 291 | 0.05 | % | ||||||||||||||||
| Total borrowings | 2,547,739 | 31,650 | 5.04 | % | ||||||||||||||||
| Adjustments: | ||||||||||||||||||||
Securitized debt from consolidated VIEs(3) | (1,259,147) | (20,829) | 6.71 | % | ||||||||||||||||
| Adjusted total borrowings | $ | 1,288,592 | $ | 10,821 | 3.41 | % | ||||||||||||||
| Adjusted net interest income and net interest margin | $ | 3,185 | 0.85 | % | ||||||||||||||||
(1)Includes Agency and Non-Agency Interest-Only Strips accounted for as derivatives.
(2)Refer to below table for components of interest income.
(3)Includes only the third-party sponsored securitized debt from CSMC USA.
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| Three Months Ended March 31, 2021 | Average Amortized Cost of Assets(1) | Total Interest Income(2) | Yield on Average Assets | |||||||||||||||||
| Investments | ||||||||||||||||||||
| Agency RMBS | $ | 1,352 | $ | 31 | 9.30 | % | ||||||||||||||
| Non-Agency CMBS | 208,870 | 4,767 | 9.26 | % | ||||||||||||||||
| Non-Agency RMBS | 29,554 | 355 | 4.87 | % | ||||||||||||||||
| Residential Whole-Loans | 970,642 | 10,058 | 4.20 | % | ||||||||||||||||
| Residential Bridge Loans | 14,141 | 230 | 6.60 | % | ||||||||||||||||
| Commercial loans | 325,227 | 5,217 | 6.51 | % | ||||||||||||||||
| Securitized commercial loan | 1,568,571 | 24,564 | 6.35 | % | ||||||||||||||||
| Other securities | 49,396 | 822 | 6.75 | % | ||||||||||||||||
| Total investments | 3,167,753 | 46,044 | 5.89 | % | ||||||||||||||||
| Adjustments: | ||||||||||||||||||||
| Securitized commercial loans from consolidated VIEs | (1,568,571) | (24,564) | 6.35 | % | ||||||||||||||||
| Investments in consolidated VIEs eliminated in consolidation | 59,051 | 1,193 | 8.19 | % | ||||||||||||||||
| Adjusted total investments | $ | 1,658,233 | $ | 22,673 | 5.55 | % | ||||||||||||||
| Average Carrying Value | Total Interest Expense | Average Effective Cost of Funds | ||||||||||||||||||
| Borrowings | ||||||||||||||||||||
| Repurchase agreements | $ | 348,541 | $ | 3,604 | 4.19 | % | ||||||||||||||
| Convertible senior unsecured notes, net | $ | 169,010 | $ | 3,540 | 8.49 | % | ||||||||||||||
| Securitized debt | 2,336,479 | 29,625 | 5.14 | % | ||||||||||||||||
| Total borrowings | 2,854,030 | 36,769 | 5.22 | % | ||||||||||||||||
| Adjustments: | ||||||||||||||||||||
Securitized debt from consolidated VIEs(3) | (1,495,410) | (23,035) | 6.25 | % | ||||||||||||||||
| Adjusted total borrowings | $ | 1,358,620 | $ | 13,734 | 4.10 | % | ||||||||||||||
| Adjusted net interest income and net interest margin | $ | 8,939 | 2.19 | % | ||||||||||||||||
(1)Includes Agency and Non-Agency Interest-Only Strips accounted for as derivatives.
(2)Refer to below table for components of interest income.
(3)Includes only the third-party sponsored securitized debt from RETL Trust and CSMC USA.
The following table reconciles total interest income to adjusted interest income, which includes interest income on Agency and Non-Agency Interest-Only Strips classified as derivatives (Non-GAAP financial measure) for the three months ended March 31, 2022 and March 31, 2021:
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| (dollars in thousands) | Three months ended March 31, 2022 | Three months ended March 31, 2021 | ||||||||||||
| Coupon interest income: | ||||||||||||||
| Agency RMBS | $ | 8 | $ | 15 | ||||||||||
| Non-Agency CMBS | 2,972 | 2,337 | ||||||||||||
| Non-Agency RMBS | 545 | 413 | ||||||||||||
| Residential Whole Loans | 11,283 | 12,105 | ||||||||||||
| Residential Bridge Loans | 20 | 232 | ||||||||||||
| Commercial loans | 1,246 | 5,153 | ||||||||||||
| Securitized commercial loans | 15,173 | 18,414 | ||||||||||||
| Other Securities | 888 | 1,591 | ||||||||||||
| Subtotal coupon interest | 32,135 | 40,260 | ||||||||||||
| Premium accretion, discount amortization and amortization of basis, net: | ||||||||||||||
| Agency RMBS | (4) | (11) | ||||||||||||
| Non-Agency CMBS | (402) | 2,430 | ||||||||||||
| Non-Agency RMBS | (15) | (58) | ||||||||||||
| Residential Whole Loans | (2,537) | (2,047) | ||||||||||||
| Residential Bridge Loans | — | (2) | ||||||||||||
| Commercial loans | — | 64 | ||||||||||||
| Securitized commercial loans | 6,699 | 6,150 | ||||||||||||
| Other Securities | (234) | (769) | ||||||||||||
| Subtotal accretion and amortization | 3,507 | 5,757 | ||||||||||||
| Interest income | $ | 35,642 | $ | 46,017 | ||||||||||
Contractual interest income, net of amortization of basis on Agency and Non-Agency Interest-Only Strips, classified as derivatives(1): | ||||||||||||||
| Coupon interest income | $ | 89 | $ | 121 | ||||||||||
| Amortization of basis | (72) | (94) | ||||||||||||
| Subtotal | 17 | 27 | ||||||||||||
Total adjusted interest income | $ | 35,659 | $ | 46,044 | ||||||||||
(1)Reported in "Gain (loss) on derivative instruments, net" in our Consolidated Statements of Operations.
Effective Cost of Funds
Effective Cost of Funds includes the net interest component related to our interest rate swaps, as well as the impact of our foreign currency swaps and forwards. While we have not elected hedge accounting for these instruments, such derivative instruments are viewed by us as an economic hedge against increases in future market interest rates on our liabilities and changes in foreign currency exchange rates on our assets and liabilities and are characterized as hedges for purposes of satisfying the REIT requirements and therefore the Effective Cost of Funds reflects interest expense adjusted to include the realized gain/loss (i.e., the interest income/expense component) for all of our interest rate swaps and the impact of our foreign currency swaps and forwards.
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The following table reconciles the Effective Cost of Funds (Non-GAAP financial measure) with interest expense for the three months ended March 31, 2022 and March 31, 2021:
| Three months ended March 31, 2022 | Three months ended March 31, 2021 | |||||||||||||||||||||||||
| (dollars in thousands) | Reconciliation | Cost of Funds/ Effective Borrowing Costs | Reconciliation | Cost of Funds/ Effective Borrowing Costs | ||||||||||||||||||||||
| Interest expense | $ | 31,359 | 4.99 | % | $ | 36,769 | 5.22 | % | ||||||||||||||||||
Adjustments: | ||||||||||||||||||||||||||
Interest expense on Securitized debt from consolidated VIEs | (20,829) | (6.71) | % | (23,035) | (6.25) | % | ||||||||||||||||||||
| Net interest paid - interest rate swaps | 291 | 0.05 | % | — | — | % | ||||||||||||||||||||
| Effective Cost of Funds | $ | 10,821 | 3.41 | % | $ | 13,734 | 4.10 | % | ||||||||||||||||||
Weighted average borrowings | $ | 1,288,592 | $ | 1,358,620 | ||||||||||||||||||||||
Liquidity and Capital Resources
General
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders, and other general business needs. To maintain our REIT qualifications under the Internal Revenue Code, we must distribute annually at least 90% of our taxable income, excluding capital gains and, such distributions requirements limit our ability to retain earnings and increase capital for operations. Our principal sources of funds generally consist of borrowings under repurchase agreements, Residential Whole Loan securitizations, payments of principal and interest we receive on our investment portfolio, cash generated from investment sales and, to the extent such transactions are entered into, proceeds from capital market and unsecured convertible note transactions.
We will continue to closely monitor developments related to COVID-19 as it relates to our liquidity position and financial obligations. We currently believe we have sufficient liquidity and capital resources available, for at least the next 12 months, to fund our operations, meet our financial obligations, purchase our target assets, and make dividend payments to maintain our REIT qualifications. As of March 31, 2022, we had $42.8 million in cash and cash equivalents. Also our other sources of liquidity were unencumbered investments, and unused borrowing capacity in certain borrowing facilities since the amount borrowed is less than the maximum advance rate.
Sources of Liquidity
Our primary sources of liquidity are as follows:
Cash Generated from Operations
For the three months ended March 31, 2022, net cash provided by operating activities was approximately $1.6 million. This was primarily attributable to the net interest income on our investments, less operating expenses, and general and administrative expenses. For the three months ended March 31, 2021, net cash provided by operating activities was approximately $3.9 million. This was primarily attributable to margin settlements of interest rate swaps, operating expenses, and general and administrative expenses, which were offset by the interest income we earned on our investments.
Cash Provided by and Used in Investing Activities
For the three months ended March 31, 2022, net cash used in investing activities was approximately $4.3 million. This was primarily attributable to purchases of Non-Agency RMBS and Residential Whole Loans during the quarter, which was partially offset by receipts of principal payments and payoffs on our investments and the sale of an REO hotel. For the three months ended March 31, 2021, net cash provided by investing activities was approximately $145.2 million. This was primarily
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attributable to proceeds from sales to meet the margin calls and receipts of principal payments and payoffs on our investments, which were partially offset by our investment acquisitions.
Cash Provided by and Used in Financing Activities
For the three months ended March 31, 2022, net cash provided by financing activities was approximately $5.3 million. This was attributable the Arroyo Trust 2022 securitization, which was partially offset by a net decrease in repurchase agreement borrowings, paydowns in our securitized debt, and extinguishment of convertible senior unsecured notes. For the three months ended March 31, 2021, net cash used in financing activities was approximately $207.4 million. This was attributable to net repayments of our repurchase agreement borrowings to reduce our exposure to short term financings and repayment of securitized debt related to consolidated VIEs which was offset net proceeds from the Arroyo 2020-1 that closed during the quarter ended June 30, 2020.
Repurchase Agreements
As of March 31, 2022, we had borrowings under six of our master repurchase agreements of approximately $342.4 million. The following tables present our repurchase agreement borrowings by type of collateral pledged, as of March 31, 2022 and March 31, 2021, and the respective effective cost of funds (Non-GAAP financial measure) for the three months ended March 31, 2022 and March 31, 2021, respectively (dollars in thousands). See “Non-GAAP Financial Measures” for more information:
| March 31, 2022 | Three months ended March 31, 2022 | ||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Outstanding | Value of Collateral Pledged | Weighted Average Interest Rate end of period | Weighted Average Cost of Funds | Weighted Average Effective Cost of Funds (Non-GAAP)(1) | Weighted Average Haircut end of period | |||||||||||||||||||||||||||||
| Agency RMBS, at fair value | $ | 354 | $ | 300 | 1.13 | % | 0.95 | % | 0.95 | % | 25.00 | % | |||||||||||||||||||||||
Non-Agency CMBS, at fair value(2) | 56,486 | 106,380 | 2.14 | % | 1.75 | % | 1.75 | % | 40.00 | % | |||||||||||||||||||||||||
| Non-Agency RMBS, at fair value | 70,839 | 81,898 | 2.29 | % | 2.51 | % | 2.51 | % | 31.87 | % | |||||||||||||||||||||||||
Residential Whole Loans, at fair value(3) | 110,433 | 121,794 | 2.26 | % | 2.33 | % | 2.33 | % | 10.00 | % | |||||||||||||||||||||||||
Residential Bridge Loans(3) | 4,231 | 5,129 | 2.95 | % | 2.67 | % | 2.67 | % | 20.00 | % | |||||||||||||||||||||||||
Commercial loans, at fair value(3) | 70,121 | 101,435 | 2.39 | % | 2.55 | % | 2.55 | % | 29.73 | % | |||||||||||||||||||||||||
| Other securities, at fair value | 29,916 | 49,040 | 2.32 | % | 1.94 | % | 1.94 | % | 37.01 | % | |||||||||||||||||||||||||
| Interest rate swaps | n/a | n/a | n/a | n/a | 0.27 | % | n/a | ||||||||||||||||||||||||||||
| Total | $ | 342,380 | $ | 465,976 | 2.29 | % | 2.26 | % | 2.53 | % | 26.05 | % | |||||||||||||||||||||||
(1)The effective cost of funds for the period presented is calculated on an annualized basis and includes interest expense for the period and net periodic interest payments on interest rate swaps of approximately $291 thousand for the three months ended March 31, 2022. While interest rate swaps are not accounted for using hedge accounting, such instruments are viewed by us as an economic hedge against increases in interest rates on our liabilities and are treated as hedges for purposes of satisfying the REIT requirements. See “Non-GAAP Financial Measures.”
(2)Includes repurchase agreement borrowings on securities eliminated upon VIE consolidation.
(3)Repurchase agreement borrowings collateralized by Whole Loans, Bridge Loans and commercial loans owned through trust certificates. The trust certificates are eliminated upon consolidation.
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| March 31, 2021 | Three months ended March 31, 2021 | ||||||||||||||||||||||||||||||||||
| Collateral | Borrowings Outstanding | Fair Value of Collateral Pledged(3) | Weighted Average Interest Rate end of period | Weighted Average Cost of Funds | Weighted Average Effective Cost of Funds (Non-GAAP) | Weighted Average Haircut end of period | |||||||||||||||||||||||||||||
| Agency RMBS, at fair value | $ | 1,242 | $ | 1,629 | 1.13 | % | 1.18 | % | 1.18 | % | 25.00 | % | |||||||||||||||||||||||
Non-Agency CMBS, at fair value(1) | 76,226 | 144,346 | 4.76 | % | 4.86 | % | 4.86 | % | 40.21 | % | |||||||||||||||||||||||||
| Non-Agency RMBS, at fair value | 14,456 | 26,659 | 5.20 | % | 5.25 | % | 5.25 | % | 33.33 | % | |||||||||||||||||||||||||
Residential Whole Loans, at fair value(2) | 57,296 | 92,497 | 3.09 | % | 8.04 | % | 8.04 | % | 35.99 | % | |||||||||||||||||||||||||
Residential Bridge Loans(2) | 10,097 | 12,044 | 2.70 | % | 2.76 | % | 2.76 | % | 20.00 | % | |||||||||||||||||||||||||
Commercial loans, at fair value(2) | 153,542 | 312,061 | 2.36 | % | 2.43 | % | 2.43 | % | 34.86 | % | |||||||||||||||||||||||||
Membership interest(3) | 19,551 | 34,439 | 2.86 | % | 3.05 | % | 3.05 | % | 35.00 | % | |||||||||||||||||||||||||
| Other securities, at fair value | 15,969 | 48,666 | 5.08 | % | 5.17 | % | 5.17 | % | 36.75 | % | |||||||||||||||||||||||||
| Total | $ | 348,379 | $ | 672,341 | 3.28 | % | 4.19 | % | 4.19 | % | 35.71 | % | |||||||||||||||||||||||
(1)Includes repurchase agreement borrowings on securities eliminated upon VIE consolidation.
(2)Repurchase agreement borrowings collateralized by Whole Loans, Bridge Loans and commercial loan owned through trust certificates. The trust certificates are eliminated upon consolidation.
(3)The pledged amount relates to our non-controlling membership interest in our wholly-owned subsidiary, WMC RETL LLC, which was financed under a repurchase agreement. The membership interest is eliminated in consolidation.
Contractual Obligations and Commitments
Our contractual obligations as of March 31, 2022 are as follows (dollars in thousands):
| Less than 1 year | 1 to 3 years | 3 to 5 years | More than 5 years | Total | |||||||||||||||||||||||||
| Borrowings under repurchase agreements | $ | 342,380 | $ | — | $ | — | $ | — | $ | 342,380 | |||||||||||||||||||
| Contractual interest on repurchase agreements | 3,257 | — | — | — | 3,257 | ||||||||||||||||||||||||
| Convertible senior unsecured notes | 34,287 | 86,250 | — | — | 120,537 | ||||||||||||||||||||||||
| Contractual interest on convertible senior unsecured notes | 6,979 | 8,733 | — | — | 15,712 | ||||||||||||||||||||||||
Securitized debt(2) | — | — | 1,370,691 | 831,875 | 2,202,566 | ||||||||||||||||||||||||
| Contractual interest on securitized debt | 80,823 | 161,647 | 77,453 | 650,210 | 970,133 | ||||||||||||||||||||||||
| Total | $ | 467,726 | $ | 256,630 | $ | 1,448,144 | $ | 1,482,085 | $ | 3,654,585 | |||||||||||||||||||
(1)The table above does not include amounts due under the Management Agreement (as defined herein) with our Manager, as those obligations do not have fixed and determinable payments.
(2)The securitized debt is non-recourse to us and can only be settled with the loans that serve as collateral. The collateral for the securitized debt has a principal balance of $2.3 billion. Assumes entire outstanding principal balance at March 31, 2022 is paid at maturity.
Management Agreement
On May 9, 2012, we entered into a management agreement (the “Management Agreement”) with our Manager which describes the services to be provided by our Manager and compensation for such services. Our Manager is responsible for managing our operations, including: (i) performing all of our day-to-day functions; (ii) determining investment criteria in conjunction with our Board of Directors; (iii) sourcing, analyzing and executing investments, asset sales and financings; (iv) performing asset management duties; and (v) performing financial and accounting management, subject to the direction and oversight of our Board of Directors. Pursuant to the terms of the Management Agreement, our Manager is paid a management fee equal to 1.50% per annum of our stockholders’ equity, (as defined in the Management Agreement), calculated and payable (in cash) quarterly in arrears.
In December 2021, the Manager agreed to voluntarily waive 25% of its management fee solely for the duration of calendar year 2022 in order to support the earnings potential of the Company and its transition to a residential focused investment portfolio. Future waivers, if any, will be at the Manager's discretion.
Off-Balance Sheet Arrangements
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We do not have any relationships with any entities or financial partnerships, such as entities often referred to as structured investment vehicles, or special purpose or variable interest entities, established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes.
Further, other than guaranteeing certain obligations of our wholly-owned taxable REIT subsidiary or TRS and the obligations of our wholly-owned subsidiary, WMC CRE LLC, we have not guaranteed any obligations of any entities or entered into any commitment to provide additional funding to any such entities.
Dividends
To maintain our qualification as a REIT, U.S. federal income tax law generally requires that we distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding capital gains. We must pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our taxable income.
We evaluate each quarter to determine our ability to pay dividends to our stockholders based on our net taxable income if and to the extent authorized by our Board of Directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service payments. If our cash available for distribution is less than our net taxable income, we could be required to sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution.
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ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.
We seek to manage the risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market values while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns from our assets through ownership of our common stock. While we do not seek to avoid risk completely, our Manager seeks to actively manage risk for us, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.
Credit Risk
We are subject to varying degrees of credit risk in connection with our assets. Although we do not expect to encounter credit risk in our Agency CMBS and Agency RMBS, we are exposed to the risk of potential credit losses from general credit spread widening related to Non-Agency RMBS, Non-Agency CMBS, Residential Whole Loans, Residential Bridge Loans, Commercial Loans and other portfolio investments in addition to unexpected increase in borrower defaults on these investments. Investment decisions are made following a bottom-up credit analysis and specific relevant risk assumptions. As part of the risk management process, our Manager uses detailed proprietary models, applicable to evaluate, depending on the asset class, house price appreciation and depreciation by region, prepayment speeds and foreclosure/default frequency, cost and timing. If our Manager determines that the proposed investment can meet the appropriate risk and return criteria as well as complement our existing asset portfolio, the investment will undergo a more thorough analysis.
As of March 31, 2022, four of the counterparties with which we had outstanding repurchase agreement borrowings held collateral which we posted as security for such borrowings in excess of 5% of our stockholders’ equity. Prior to entering into a repurchase agreement with any particular institution, our Manager does a thorough review of such potential counterparty. Such review, however, does not assure the creditworthiness of such counterparty nor that the financial wherewithal of the counterparty will not deteriorate in the future.
Interest Rate Risk
Interest rates are highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and political considerations, as well as other factors beyond our control. We are subject to interest rate risk in connection with our assets and our related financing obligations. In general, we expect to finance the acquisition of our assets through financings in the form of repurchase agreements, warehouse facilities, securitizations, bank credit facilities (including term loans and revolving facilities) and public and private equity and debt issuances in addition to transaction or asset specific funding arrangements. Subject to maintaining our qualification as a REIT for U.S. federal income tax purposes, we may utilize derivative financial instruments to hedge the interest rate risk associated with our borrowings. These hedging activities may not be effective. We also may engage in a variety of interest rate management techniques that seek to mitigate changes in interest rates or other potential influences on the values of our assets.
Interest Rate Effect on Net Interest Income
Our operating results will depend in large part on differences between the income earned on our assets and our borrowing costs. The cost of our borrowings is generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase and the yields earned on our leveraged fixed-rate mortgage assets will remain static. Further, the cost of such financing could increase at a faster pace than the yields earned on our leveraged ARM and hybrid ARM assets. This could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could adversely affect our liquidity and results of operations.
Interest Rate Cap Risk
To the extent we invest in adjustable-rate RMBS and Whole-Loans, such instruments may be subject to interest rate caps, which potentially could cause such instruments to acquire many of the characteristics of fixed-rate securities if interest rates were to rise above the cap levels. This issue is magnified to the extent we acquire ARM and hybrid ARM assets that are not based on mortgages which are fully indexed. In addition, ARM and hybrid ARM assets may be subject to periodic payment
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caps that result in some portion of the interest being deferred and added to the principal outstanding or a portion of the incremental interest rate increase being deferred. To the extent we invest in such ARM and/or hybrid ARM assets, we could potentially receive less cash income on such assets than we would need to pay the interest cost on our related borrowings. To mitigate interest rate mismatches, we may utilize the hedging strategies discussed above under “Interest Rate Risk.”
Interest Rate Effects on Fair value
Another component of interest rate risk is the effect that changes in interest rates will have on the market value of the assets that we acquire. We face the risk that the market value of our assets will increase or decrease at different rates than those of our liabilities, including our hedging instruments. See “Market Risk” below.
The impact of changing interest rates on fair value can change significantly when interest rates change materially. Therefore, the volatility in the fair value of our assets could increase significantly in the event interest rates change materially. In addition, other factors impact the fair value of our interest rate-sensitive investments and hedging instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, changes in actual interest rates may have a material adverse effect on us.
Market Risk
Our MBS and other assets are reflected at their fair value with unrealized gains and losses included in earnings. The fair value of our investments fluctuates primarily due to changes in interest rates and other factors. Generally, in a rising interest rate environment, the fair value of these assets would be expected to decrease; conversely, in a decreasing interest rate environment, the fair value of these securities would be expected to increase.
The sensitivity analysis table presented below shows the estimated impact of an instantaneous parallel shift in the yield curve, up and down 50 and 100 basis points, on the market value of our interest rate-sensitive investments, including interest rate swaps, Interest-Only Strips, and net interest income at March 31, 2022, assuming a static portfolio of assets. When evaluating the impact of changes in interest rates, prepayment assumptions and principal reinvestment rates are adjusted based on our Manager’s expectations. The analysis presented utilizes our Manager’s assumptions, models and estimates, which are based on our Manager’s judgment and experience.
| Change in Interest Rates | Percentage Change in Projected Net Interest Income | Percentage Change in Projected Portfolio Value | ||||||||||||
| +1.00% | (9.97) | % | (0.77) | % | ||||||||||
| +0.50% | (4.86) | % | (0.39) | % | ||||||||||
| -0.50% | 17.42 | % | 0.38 | % | ||||||||||
| -1.00% | 37.50 | % | 0.73 | % | ||||||||||
While the table above reflects the estimated immediate impact of interest rate increases and decreases on a static portfolio, we may rebalance our portfolio from time to time either to seek to take advantage of or reduce the impact of changes in interest rates. It is important to note that the impact of changing interest rates on market value and net interest income can change significantly when interest rates change beyond 100 basis points from current levels. Therefore, the volatility in the market value of our assets could increase significantly when interest rates change beyond amounts shown in the table above. In addition, other factors impact the market value of and net interest income from our interest rate-sensitive investments and derivative instruments, such as the shape of the yield curve, market expectations as to future interest rate changes and other market conditions. Accordingly, interest income would likely differ from that shown above and such difference might be material and adverse to our stockholders.
Certain assumptions have been made in connection with the calculation of the information set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. The base interest rate scenario assumes interest rates at March 31, 2022. The analysis presented utilizes assumptions and estimates based on our Manager’s judgment and experience. Furthermore, while we generally expect to retain such assets and the associated interest rate risk, future purchases and sales of assets could materially change our interest rate risk profile.
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Prepayment Risk
The value of our Agency and Non-Agency RMBS and our Residential Whole Loans may be affected by prepayment rates on the underlying residential mortgage. We acquire RMBS and Residential Whole Loans and anticipate that the underlying residential mortgages will prepay at a projected rate generating an expected yield. If we purchase assets at a premium to par value, when borrowers prepay their residential mortgage loans faster than expected, the corresponding prepayments may reduce the expected yield on our residential mortgage assets because we will have to amortize the related premium on an accelerated basis and, in the case of Agency RMBS, other than interest-only strips, and certain other investment grade rated securities, we are required to make a retrospective adjustment to historical amortization. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their residential mortgage loans slower than expected, such decrease may reduce the expected yield on such assets because we will not be able to accrete the related discount as quickly as originally anticipated and, in the case of Agency RMBS, other than interest-only strips, and certain other investment grade rated securities, we will be required to make a retrospective adjustment to historical amortization.
The value of our Agency and Non-Agency CMBS, as well as Commercial Whole Loans, will also be affected by prepayment rates; however, commercial mortgages frequently limit the ability of the borrower to prepay, thereby providing a certain level of prepayment protection. Common restrictions include yield maintenance and prepayment penalties, the proceeds of which are generally at least partially allocable to these securities, as well as defeasance.
Likewise, the value of our ABS and other structured securities will also be affected by prepayment rates. The collateral underlying such securities may, similar to most residential mortgages, allow the borrower to prepay at any time or, similar to commercial mortgages, limit the ability of the borrower to prepay by imposing lock-out provisions, prepayment penalties and/or make whole provisions.
Extension Risk
Most residential mortgage loans do not prohibit the partial or full prepayment of principal outstanding. Accordingly, while the stated maturity of a residential mortgage loan may be 30 years, or in some cases even longer, historically the vast majority of residential mortgage loans are satisfied prior to their maturity date. In periods of rising interest rates, borrowers have less incentive to refinance their existing mortgages and mortgage financing may not be as readily available. This generally results in a slower rate of prepayments and a corresponding longer weighted average life for RMBS and Residential Whole Loans. The increase, or extension, in weighted average life is commonly referred to as “Extension Risk” which can negatively impact our portfolio. To the extent we receive smaller pre-payments of principal, we will have less capital to invest in new assets. This is extremely detrimental in periods of rising interest rates as we will be unable to invest in new higher coupon investments and a larger portion of our portfolio will remain invested in lower coupon investments. Further, our borrowing costs are generally short-term and, even if hedged, are likely to increase in a rising interest rate environment, thereby reducing our net interest margin. Finally, to the extent we acquired securities at a discount to par, a portion of the overall return on such investments is based on the recovery of this discount. Slower principal prepayments will result in a longer recovery period and a lower overall return on our investment.
Prepayment rates on Agency and Non-Agency CMBS, as well as Commercial Whole Loans, are generally less volatile than residential mortgage assets as commercial mortgages usually limit the ability of the borrower to prepay the mortgage prior to maturity or a period shortly before maturity. Accordingly, extension risk for Agency and Non-Agency CMBS and Commercial Whole Loans is generally less than RMBS and Residential Whole Loans as it presumed that other than defaults (i.e., involuntary prepayments), most commercial mortgages will remain outstanding for the contractual term of the mortgage.
Prepayment rates on ABS and our other structured securities will be determined by the underlying collateral. The extension risk of such securities will generally be less than residential mortgages, but greater than commercial mortgages.
Real Estate Risk
Residential and commercial property values are subject to volatility and may be adversely affected by a number of factors, including, but not limited to: national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as the supply of housing stock); changes or continued weakness in specific industry segments; construction quality, age and design; demographic factors; and retroactive changes to
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building or similar codes. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause us to suffer losses. The COVID 19 pandemic could have a significant impact on real estate values generally or as certain sectors more affected by health related shut downs or reductions in activity.
Counterparty Risk
The following discussion on counterparty risk reflects how these transactions are structured, rather than how they are presented for financial reporting purposes.
When we engage in repurchase transactions, we generally sell securities to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same securities back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the securities to the lender is less than the value of those securities (this difference is the haircut), if the lender defaults on its obligation to resell the same securities back to us, we could incur a loss on the transaction up to the amount of the haircut (assuming there was no change in the value of the securities).
If a counterparty to a bi-lateral interest rate swap cannot perform under the terms of the interest rate swap, we may not receive payments due under that agreement, and thus, we may lose any unrealized gain associated with the interest rate swap. We may also risk the loss of any collateral we have pledged to secure our obligations under an interest rate swap if the counterparty becomes insolvent or files for bankruptcy. In the case of a cleared swap, if our clearing broker were to default, become insolvent or file for bankruptcy, we may also risk the loss of any collateral we have posted to the clearing broker unless we were able to transfer or “port” our positions and held collateral to another clearing broker. In addition, the interest rate swap would no longer mitigate the impact of changes in interest rates as intended. Most of our interest swaps are currently cleared through a central clearing house which reduces but does not eliminate the aforementioned risks. Also see “Liquidity Risk” below.
Prior to entering into a trading agreement or transaction with any particular institution where we take on counterparty risk, our Manager does a thorough review of such potential counterparty. Such review, however, does not assure the creditworthiness of such counterparty nor that the financial wherewithal of the counterparty will not deteriorate in the future.
Funding Risk
We have financed a substantial majority of our assets with repurchase agreement financing. Over time, as market conditions change, in addition to these financings, we may use other forms of leverage. Changes in the regulatory environment, as well as, weakness in the financial markets, the residential mortgage markets, the commercial mortgage markets, the asset-backed securitization markets and the economy generally could adversely affect one or more of our potential lenders and could cause one or more of our potential lenders to be unwilling or unable to provide us with financing or to increase the costs of that financing.
Liquidity Risk
Our liquidity risk is principally associated with the financing of long-maturity assets with short-term borrowings in the form of repurchase agreements. Although the interest rate adjustments of these assets and liabilities fall within the guidelines established by our operating policies, maturities are not required to be, nor are they, matched.
Should the value of our assets pledged as collateral suddenly decrease, margin calls relating to our repurchase agreements could increase, causing an adverse change in our liquidity position. Our inability to post adequate collateral for a margin call by the counterparty could result in a condition of default under our repurchase agreements, thereby enabling the counterparty to liquidate the collateral pledged by us, which may have a material adverse consequence on our business and results of operations.
In an instance of severe volatility, or where the additional stress on liquidity resulting from volatility is sustained over an extended period of time, we could be required to sell securities, possibly even at a loss to generate sufficient liquidity to
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satisfy collateral and margin requirements which could have a material adverse effect on our financial position, results of operations and cash flows.
Additionally, if one or more of our repurchase agreement counterparties chose not to provide on-going funding, our ability to finance would decline or exist at possibly less advantageous terms. Further, if we are unable to renew, replace or expand repurchase financing with other sources of financing on substantially similar terms, it may have a material adverse effect on our business, financial position, results of operations and cash flows, due to the long term nature of our investments and relatively short-term maturities of our repurchase agreements. As such, there is no assurance that we will always be able to roll over our repurchase agreements.
The costs associated with our borrowings are generally based on prevailing market interest rates. During a period of rising interest rates, our borrowing costs generally will increase while the yields earned on our existing portfolio of leveraged fixed-rate MBS and other fixed rate assets will remain static. Further, certain of our floating rate assets may contain annual or lifetime interest rate caps as well as limit the frequency or timing of changes to the underlying interest rate index. This could result in a decline in our net interest spread and net interest margin. The severity of any such decline would depend on our asset/liability composition at the time, as well as the magnitude and duration of the interest rate increase. Further, an increase in short-term interest rates could also have a negative impact on the market value of our assets. If any of these events happen, we could experience a decrease in net income or incur a net loss during these periods, which could have a material adverse effect on our liquidity and results of operations.
In addition, the assets that comprise our investment portfolio are not traded on a public exchange. A portion of these assets may be subject to legal and other restrictions on resale or will otherwise be less liquid than publicly-traded securities. The illiquidity of our assets may make it difficult for us to sell such assets if the need or desire arises, including in response to changes in economic and other conditions. Recent regulatory changes have imposed new capital requirements and other restrictions on banks and other market intermediaries’ ability and desire to hold assets on their balance sheets and otherwise make markets in fixed income securities and other assets resulting in reduced liquidity in many sectors of the market. This regulatory trend is expected to continue. As a result of these developments, it may become increasingly difficult for us to sell assets in the market, especially in credit oriented sectors such as Non-Agency RMBS and CMBS, ABS and Whole Loans.
We enter into interest rate swaps to manage our interest rate risk. We are required to pledge cash or securities as collateral as part of a margin arrangement, calculated daily, in connection with the interest rate swaps. The amount of margin that we are required to post will vary and generally reflects collateral required to be posted with respect to interest rate swaps that are in an unrealized loss position to us and is generally based on a percentage of the aggregate notional amount of interest rate swaps per counterparty. Margin calls could adversely affect our liquidity. Our inability to post adequate collateral for a margin call could result in a condition of default under our interest rate swap agreements, thereby resulting in liquidation of the collateral pledged by us, which may have a material adverse consequence on our business, financial position, results of operations and cash flows. Conversely, if our interest rate swaps are in an unrealized gain position, our counterparties to bilateral swaps are required to post collateral with us, under the same terms that we post collateral with them. We at times enter into a MAC interest rate swap in which we receive or make a payment at the time of entering such interest rate swap to compensate for the out of the market nature of such interest rate swap. Similar to all other interest rate swaps, MAC interest rate swaps are subject to the margin requirements previously described.
Inflation
Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily directly correlate with inflation rates or changes in inflation rates. Our consolidated financial statements are prepared in accordance with GAAP and our distributions will be determined by our Board of Directors consistent with our obligation to distribute to our stockholders at least 90% of our net taxable income on an annual basis, in accordance with the REIT regulations, in order to maintain our REIT qualification. In each case, our activities and consolidated balance sheets are measured with reference to historical cost and/or fair market value without considering inflation.
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Foreign Investment risk
We have invested in non U.S. CMBS transactions and, in the future, we may make other investments in non U.S. issuers and transactions. These investments present certain unique risks, including those resulting from future political, legal, and economic developments, which could include favorable or unfavorable changes in currency exchange rates, exchange control regulations (including currency blockage), expropriation, nationalization, or confiscatory taxation of assets, adverse changes in investment capital or exchange control regulations (which may include suspension of the ability to transfer currency from a country), political changes, diplomatic developments, difficulty in obtaining and enforcing judgments against non U.S. entities, the possible imposition of the applicable country’s governmental laws or restrictions, and the reduced availability of public information concerning issuers. In the event of a nationalization, expropriation, or other confiscation of assets, we could lose our entire investment in a security. Legal remedies available to investors in certain jurisdictions may be more limited than those available to investors in the United States. Issuers of non U.S. securities may not be subject to the same degree of regulation as U.S. issuers.
Furthermore, non U.S. issuers are not generally subject to uniform accounting, auditing, and financial reporting standards or other regulatory practices and requirements comparable to those applicable to U.S. issuers. There is generally less government supervision and regulation of non U.S. exchanges, brokers, and issuers than there is in the United States, and there is greater difficulty in taking appropriate legal action in non U.S. courts. There are also special tax considerations that apply to securities of non U.S. issuers and securities principally traded overseas.
To the extent that our investments are denominated in U.S. dollars, these investments are not affected directly by changes in currency exchange rates relative to the dollar and exchange control regulations. We are, however, subject to currency risk with respect to such investments to the extent that a decline in a non U.S. issuer’s or borrower’s own currency relative to the dollar may impair such issuer’s or borrower’s ability to make timely payments of principal and/or interest on a loan or other debt security. To the extent that our investments are in non-dollar denominated securities, the value of the investment and the net investment income available for distribution may be affected favorably or unfavorably by changes in currency exchange rates relative to the dollar and exchange control regulations.
Currency exchange rates can be volatile and affected by, among other factors, the general economics of a country, the actions of governments or central banks and the imposition of currency controls and speculation. In addition, a security may be denominated in a currency that is different from the currency where the issuer is domiciled.
Currency Risk
We have and may continue in the future to invest in assets which are denominated in a currency other than U.S. dollars and may finance such investments with repurchase financing or other forms of financing which may also be denominated in a currency other than U.S. dollars. To the extent we make such investments and/or enter into such financing arrangements, we may utilize foreign currency swaps, forwards or other derivative instruments to hedge our exposure to foreign currency risk. Despite being economic hedges, we have elected not to treat such derivative instruments as hedges for accounting purposes and therefore the changes in the value of such instruments, including actual and accrued payments, will be included in our Consolidated Statements of Operations. While such transactions are entered into in an effort to minimize our foreign currency risk, there can be no assurance that they will perform as expected. If actual prepayments of the foreign denominated asset are faster, or slower, than expected, the hedge instrument is unlikely to fully protect us from changes in the valuation of such foreign currency. Further, as with interest rate swaps, there is counterparty risk associated with the future creditworthiness of such counterparty.
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ITEM 4. Controls and Procedures
Disclosure Controls and Procedures: Our management is responsible for establishing and maintaining disclosure controls and procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that the required information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
We have evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures as of March 31, 2022. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
No change occurred in our internal control over financial reporting (as defined in Rule13a-15(f) and Rule 15d-15(f) of the Exchange Act) during the three months ended March 31, 2022 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II — OTHER INFORMATION
ITEM 1. Legal Proceedings
From time to time, the Company may be involved in various claims and legal actions arising in the ordinary course of business. During the three months ended March 31, 2022, the Company was not involved in any material legal proceedings.
ITEM 1A. Risk Factors
There were no material changes during the period covered by this report to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the SEC on March 8, 2022. Additional risks not presently known, or that we currently deem immaterial, also may have a material adverse effect on our business, financial condition and results of operations.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults Upon Senior Securities
None.
ITEM 4. Mine Safety Disclosures
Not Applicable.
ITEM 5. Other Information
None.
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ITEM 6. Exhibits
The following exhibits are filed as part of this report.
| Exhibit No. | Description | |||||||
| 3.1* | ||||||||
| 3.2* | ||||||||
| 3.3* | ||||||||
| 4.1* | ||||||||
| 4.2* | ||||||||
| 4.3* | ||||||||
| 4.4* | ||||||||
| 4.5* | Second Supplemental Indenture, dated as of September 14, 2021, between Western Asset Mortgage Capital Corporation and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 4.2 to the Current Report on Form 8-K, filed on October 3, 2017. | |||||||
| 4.6* | Form of 6.75% Convertible Senior Notes due 2024 (attached as Exhibit A to the Second Supplemental Indenture filed as Exhibit 4.5 hereto), incorporated by reference to Exhibit 4.3 to the Current Report on Form 8-K, filed on October 3, 2017. | |||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 101 | The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2022, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets as of March 31, 2022 and December 31, 2021; (ii) the Consolidated Statements of Operations for the three months ended March 31, 2022 and 2021; (iii) the Consolidated Statements of Changes in Equity for the three months ended March 31, 2022 and 2021; (iv) the Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021; and (v) the Notes to Consolidated Financial Statements. | |||||||
| 104 | Cover Page Interactive Data File (the cover page XBRL tags are embedded within the iXBRL document). | |||||||
__________________________________
*Fully or partly previously filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| By: | /s/ BONNIE M. WONGTRAKOOL | |||||||
| Bonnie M. Wongtrakool | ||||||||
| Chief Executive Officer and Director (Principal Executive Officer) | ||||||||
| May 6, 2022 | ||||||||
| By: | /s/ LISA MEYER | |||||||
| Lisa Meyer | ||||||||
| President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) | ||||||||
| May 6, 2022 | ||||||||
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