UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q 

			ý			Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 For the quarterly period ended September 30, 2023

OR

			☐			Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _____ to _____.     

 Commission File Number:  001-35543

 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

385 East Colorado Boulevard,

Pasadena, California 91101

(Address of Registrant’s principal executive offices)

 

(626) 844-9400

(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

ý

Non-accelerated filer

o

Smaller reporting company

ý

Emerging growth company

o

 

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 November 8, 2023 there were 6,049,559 shares, par value $0.01, of the registrant’s common stock outstanding.

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TABLE OF CONTENTS

 

						Page
			PART I — FINANCIAL INFORMATION
ITEM 1.			Financial Statements			2
ITEM 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			48
ITEM 3.			Quantitative and Qualitative Disclosures about Market Risk			86
ITEM 4.			Controls and Procedures			92
			PART II — OTHER INFORMATION			93
ITEM 1.			Legal Proceedings			93
ITEM 1A.			Risk Factors			93
ITEM 2.			Unregistered Sales of Equity Securities and Use of Proceeds			95
ITEM 3.			Defaults Upon Senior Securities			95
ITEM 4.			Mine Safety Disclosures			95
ITEM 5.			Other Information			95
ITEM 6.			Exhibits			96
Signatures						99

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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)

			September 30, 2023						December 31, 2022
Assets:
Cash and cash equivalents			$	24,608					$	18,011
Restricted cash			—						248
Agency mortgage-backed securities, at fair value ($297 and $249 pledged as collateral, at fair value, respectively)			895						767
Non-Agency mortgage-backed securities, at fair value ($69,164 and $100,115 pledged as collateral, at fair value, respectively)			87,327						109,122
Other securities, at fair value ($15,645 and $27,262 pledged as collateral, at fair value, respectively)			16,867						27,262
Residential Whole Loans, at fair value ($986,978 and $1,089,914 pledged as collateral, at fair value, respectively)			986,978						1,091,145
Residential Bridge Loans, at fair value ($2,782 and none pledged as collateral, at fair value, respectively)			2,782						2,849
Securitized Commercial Loan, at fair value			1,012,650						1,085,103
Commercial Loans, at fair value ($66,202 and $66,864 pledged as collateral, at fair value, respectively)			78,701						90,002
Investment related receivable			8,648						5,960
Interest receivable			10,913						11,330
Due from counterparties			1,262						6,574
Derivative assets, at fair value			—						1
Other assets			4,145						4,860
Total Assets (1)			$	2,235,776					$	2,453,234
Liabilities and Equity:
Liabilities:
Repurchase agreements, net			$	169,910					$	193,117
Convertible senior unsecured notes, net			84,750						83,522
Securitized debt, net ($1,582,278 and $1,719,865 at fair value and $110,081 and $128,217 held by affiliates, respectively)			1,884,375						2,058,684
Interest payable (includes $615 and $655 on securitized debt held by affiliates, respectively)			8,638						12,794
Due to counterparties			103						300
Derivative liability, at fair value			845						61
Accounts payable and accrued expenses			6,021						3,201
Payable to affiliate			1,002						4,028
Dividend payable			2,117						2,415
Other liabilities			25						300
Total Liabilities(2)			2,157,786						2,358,422
Commitments and contingencies (Note 15)
Stockholders’ Equity:
Common stock, $0.01 par value, 50,000,000 shares authorized, 6,049,559 and 6,038,012 outstanding, respectively			60						60
Preferred stock, $0.01 par value, 10,000,000 shares authorized and no shares outstanding			—						—
Treasury stock, at cost, 57,981 and 57,981 shares held, respectively			(1,665)						(1,665)
Additional paid-in capital			919,646						919,238
Retained earnings (accumulated deficit)			(840,055)						(822,829)
Total Stockholders’ Equity			77,986						94,804
Non-controlling interest			4						8
Total Equity			77,990						94,812
Total Liabilities and Equity			$	2,235,776					$	2,453,234

 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)

			September 30, 2023						December 31, 2022
(1) Assets of consolidated VIEs included in the total assets above:
Restricted cash			$	—					$	248
Residential Whole Loans, at fair value ($986,978 and $1,089,914 pledged as collateral, at fair value, respectively)			986,978						1,091,145
Residential Bridge Loans, at fair value ($2,782 and none pledged as collateral, at fair value, respectively)			2,782						2,849
Securitized Commercial Loan, at fair value			1,012,650						1,085,103
Commercial Loans, at fair value			12,499						14,362
Investment related receivable			8,602						5,914
Interest receivable			9,731						10,182
Other assets			—						509
Total assets of consolidated VIEs			$	2,033,242					$	2,210,312
(2) Liabilities of consolidated VIEs included in the total liabilities above:
Securitized debt, net ($1,582,278 and $1,719,865 at fair value and $110,081 and $128,217 held by affiliates, respectively)			$	1,884,375					$	2,058,684
Interest payable (includes $615 and $655 on securitized debt held by affiliates, respectively)			7,887						8,303
Accounts payable and accrued expenses			21						43
Other liabilities			—						248
Total liabilities of consolidated VIEs			$	1,892,283					$	2,067,278

See notes to unaudited consolidated financial statements.

2

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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 September 30, 2023						For the three months ended September 30, 2022						For the nine months ended September 30, 2023						For the nine months ended September 30, 2022
Net Interest Income
Interest income			$	40,138					$	41,406					$	121,217					$	116,625
Interest expense (includes $3,265, $3,493, $9,848, and $10,412 on securitized debt held by affiliates, respectively)			36,976						35,707						109,690						100,408
Net Interest Income			3,162						5,699						11,527						16,217
Other Income (Loss)
Realized loss, net			(29)						(35)						(83,946)						(33,551)
Unrealized gain (loss), net			(7,362)						(43,582)						76,100						(66,300)
Gain on derivative instruments, net			1,157						4,882						1,221						16,599
Merger termination reimbursement			3,000						—						3,000						—
Other, net			181						(61)						424						(252)
Other Income			(3,053)						(38,796)						(3,201)						(83,504)
Expenses
Management fee to affiliate			974						850						2,908						2,952
Other operating expenses			353						343						932						901
Transaction costs			3,034						2,635						5,666						5,590
General and administrative expenses:
Compensation expense			607						515						1,622						1,143
Professional fees			344						1,626						3,309						4,434
Merger termination expense			3,000						—						3,000						—
Other general and administrative expenses			504						676						1,658						2,049
Total general and administrative expenses			4,455						2,817						9,589						7,626
Total Expenses			8,816						6,645						19,095						17,069
Loss before income taxes			(8,707)						(39,742)						(10,769)						(84,356)
Income tax provision			—						266						—						276
Net loss			(8,707)						(40,008)						(10,769)						(84,632)
Net income (loss) attributable to non-controlling interest			(2)						2						2						3,618
Net loss attributable to common stockholders and participating securities			$	(8,705)					$	(40,010)					$	(10,771)					$	(88,250)
Net loss per Common Share — Basic			$	(1.45)					$	(6.63)					$	(1.80)					$	(14.63)
Net loss per Common Share — Diluted			$	(1.45)					$	(6.63)					$	(1.80)					$	(14.63)

See notes to unaudited consolidated financial statements.

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Western Asset Mortgage Capital Corporation and Subsidiaries

Consolidated Statements of Changes in Equity

(in thousands—except shares and share data)

(Unaudited)

 

			Three Months Ended September 30, 2023
			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 June 30, 2023			6,038,012						$	60					$	919,511					$	(829,193)					$	(1,665)					$	88,713					$	8					$	88,721
Exchange of phantom stock to common stock			11,547						—						—						—						—						—						—						—
Vesting of restricted stock			—						—						100						—						—						100						—						100
Net loss			—						—						—						(8,705)						—						(8,705)						(2)						(8,707)
Dividends declared on non-controlling interest			—						—						—						—						—						—						(2)						(2)
Dividends declared on common stock			—						—						35						(2,157)						—						(2,122)						—						(2,122)
Balance at September 30, 2023			6,049,559						$	60					$	919,646					$	(840,055)					$	(1,665)					$	77,986					$	4					$	77,990

			Three Months Ended September 30, 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 June 30, 2022			6,038,012						$	60					$	918,974					$	(777,095)					$	(1,665)					$	140,274					$	64					$	140,338
Equity distribution			—						—						—						—						—						—						(49)						(49)
Vesting of restricted stock			—						—						100						—						—						100						—						100
Net income (loss)			—						—						—						(40,010)						—						(40,010)						2						(40,008)
Dividends declared on non-controlling interest			—						—						—						—						—						—						(2)						(2)
Dividends declared on common stock									—						32						(2,448)						—						(2,416)						—						(2,416)
Balance at September 30, 2022			6,038,012						60						$	919,106					$	(819,553)					$	(1,665)					$	97,948					$	15					$	97,963

See notes to unaudited consolidated financial statements.

4

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			Nine Months Ended September 30, 2023
			Common Stock Outstanding												Additional  Paid-In Capital						Retained  Earnings  (Accumulated Deficit)						Treasury Stock						Total Stockholders' Equity						Non-Controlling Interest
			Shares						Par																																				Total Equity
Balance at December 31, 2022			6,038,012						$	60					$	919,238					$	(822,829)					$	(1,665)					$	94,804					$	8					$	94,812
Exchange of phantom stock to common stock			11,547						—						—						—						—						—						—						—
Vesting of restricted stock			—						—						301						—						—						301						—						301
Net income (loss)			—						—						—						(10,771)						—						(10,771)						2						(10,769)
Dividends declared on non-controlling interest			—						—						—						—						—						—						(6)						(6)
Dividends declared on common stock			—						—						107						(6,455)						—						(6,348)						—						(6,348)
Balance at September 30, 2023			6,049,559						$	60					$	919,646					$	(840,055)					$	(1,665)					$	77,986					$	4					$	77,990

			Nine Months Ended September 30, 2022
			Common Stock Outstanding												Additional  Paid-In Capital						Retained  Earnings  (Accumulated Deficit)						Treasury Stock						Total Stockholders' Equity						Non-Controlling Interest
			Shares						Par																																				Total Equity
Balance at December 31, 2021			6,038,012						$	60					$	918,695					$	(723,981)					$	(1,665)					$	193,109					$	11,220					$	204,329
Equity distribution			—						—						—						—						—						—						(14,817)						(14,817)
Vesting of restricted stock			—						—						335						—						—						335						—						335
Net income (loss)			—						—						—						(88,250)						—						(88,250)						3,618						(84,632)
Dividends declared on non-controlling interest			—						—						—						—						—						—						(6)						(6)
Dividends declared on common stock			—						—						76						(7,322)						—						(7,246)						—						(7,246)
Balance at September 30, 2022			6,038,012						$	60					$	919,106					$	(819,553)					$	(1,665)					$	97,948					$	15					$	97,963

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Western Asset Mortgage Capital Corporation and Subsidiaries

Consolidated Statements of Cash Flows (in thousands)

(Unaudited)

			For the nine months ended September 30, 2023						For the nine months ended September 30, 2022
Cash flows from operating activities:
Net loss			$	(10,769)					$	(84,632)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Premium amortization and (discount accretion), net			1,253						2,492
Interest income earned added to principal of investments			(129)						(79)
Amortization of deferred financing costs			1,842						1,938
Amortization of discount on convertible senior unsecured notes			515						648
Restricted stock amortization			301						335
Premium on purchase of Residential Whole Loans			—						(6,619)
Unrealized (gain) loss, net			(76,100)						66,300
Realized loss on extinguishment of convertible senior notes			—						134
Realized gain on sale of real estate owned ("REO")			—						(12,198)
Unrealized loss (gain) on derivative instruments, net			650						(3,793)
Realized loss on investments, net			83,918						45,615
Loss on derivatives, net			—						1,762
Loss on foreign currency transactions, net			—						1
Changes in operating assets and liabilities:
Interest receivable			417						499
Other assets			715						—
Interest payable			(4,156)						188
Accounts payable and accrued expenses			2,820						(953)
Payable to affiliate			(3,026)						1,428
Other liabilities			(29)						7
Net cash (used in) provided by operating activities			(1,778)						13,073
Cash flows from investing activities:
Purchase of securities			(15,714)						(39,952)
Proceeds from sale of securities			15,324						42,287
Proceeds from sale of REO			—						54,681
Principal repayments and basis recovered on securities			21,121						6,704
Purchase of Residential Whole Loans			—						(405,298)
Proceeds from sale of Residential Whole Loans			—						11,735
Principal repayments on Residential Whole Loans			83,413						206,660
Proceeds from sale of Commercial Loans			8,776						—
Principal repayments on Commercial Loans			1,962						20,593
Principal repayments on Residential Bridge Loans			1,369						366
Premium for credit default swaps, net			—						(347)
Net settlements of TBAs			—						2,051
Proceeds from sale of interest rate swaptions, net			—						312
Due from counterparties			—						460
Premium for interest rate swaptions, net			—						(473)
Net cash provided by (used in) investing activities			116,251						(100,221)
Cash flows from financing activities:
Payment of offering costs			—						(2)
Payments on extinguishment of convertible senior unsecured notes			—						(11,690)
Proceeds from repurchase agreement borrowings			1,287,837						3,164,451
Repayments of repurchase agreement borrowings			(1,310,136)						(3,562,699)
Proceeds from securitized debt			—						742,432
Repayments of securitized debt			(83,042)						(207,799)

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Western Asset Mortgage Capital Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Continued) (in thousands)

(Unaudited)

			For the nine months ended September 30, 2023						For the nine months ended September 30, 2022
Payments made for deferred financing costs			(1,000)						—
Due from counterparties, net			5,312						890
Due to counterparties, net			(197)						—
Decrease in other liabilities			(248)						(9)
Equity distributions to non-controlling interest			—						(14,817)
Dividends paid on common stock			(6,646)						(8,454)
Dividends paid to non-controlling interest			(4)						(4)
Net cash (used in) provided by financing activities			(108,124)						102,299
Effect of exchange rate changes on cash and cash equivalents			—						(1)
Net increase in cash, cash equivalents and restricted cash			6,349						15,150
Cash, cash equivalents and restricted cash, beginning of period			18,259						40,453
Cash, cash equivalents and restricted cash, end of period			$	24,608					$	55,603
Supplemental disclosure of operating cash flow information:
Interest paid			$	90,765					$	79,700
Income taxes paid			$	24					$	50
Supplemental disclosure of non-cash financing/investing activities:
Dividends and distributions declared, not paid			$	2,117					$	2,415
Dividends to non-controlling interest, not paid			$	2					$	2
Principal payments of Residential Whole Loans, not settled			$	8,602					$	8,674
Principal payments of Residential Bridge Loans, not settled			$	—					$	46
Reconciliation of cash, cash equivalents and restricted cash reported in the Consolidated Balance Sheets:
Cash and cash equivalents			$	24,608					$	55,352
Restricted cash			—						251
Total cash, cash equivalents and restricted cash shown in the Consolidated Statements of Cash Flows			$	24,608					$	55,603

See notes to unaudited consolidated financial statements.

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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.

On June 28, 2023, the Company announced that Terra Property Trust, Inc. (“TPT”), an externally managed real estate investment trust (“REIT”) that originates, invests in, and manages loans and assets secured by commercial real estate (“CRE”), and the Company entered into a definitive merger agreement (the “TPT Merger Agreement”) under which TPT and WMC agreed to combine.

On August 8, 2023, the Company terminated the TPT Merger Agreement, and concurrently entered into an Agreement and Plan of Merger (the “MITT Merger Agreement”), dated August 8, 2023, by and among AG Mortgage Investment Trust, Inc., a Maryland corporation (“MITT”), AGMIT Merger Sub, LLC, a Delaware limited liability company (“Merger Sub”), the Company, and, solely for the purposes of Section 3.3(a), Section 3.3(i), Article V, Section 6.13, Section 7.2, Section 7.3 and Article IX therein, AG REIT Management, LLC, a Delaware limited liability company (“MITT Manager”), pursuant to which the Company will merge with and into Merger Sub, with Merger Sub surviving as a wholly owned subsidiary of MITT (the “Merger”).

Due to the termination of the TPT Merger Agreement, the Company was obligated to pay or cause to be paid to TPT a termination fee of $3 million. Concurrently with the execution of the MITT Merger Agreement, MITT paid the $3 million termination fee directly to TPT on behalf of the Company on August 8, 2023.

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Pursuant to, and subject to the terms and conditions set forth in, the MITT Merger Agreement, each outstanding share of the Company’s common stock would be converted into the right to receive (i) 1.498 shares of MITT common stock and (ii) the per share portion of a cash payment from the MITT Manager equal to the lesser of $7 million or approximately 9.9% of the aggregate per share merger consideration (any difference between $7 million and such lower amount would be used to benefit the combined company post closing by offsetting reimbursable expenses that would otherwise be payable to the MITT Manager). Additionally, the MITT Manager, which would be the manager of the combined company, would waive $2.4 million of management fees in the first year post-closing. Cash will be paid in lieu of fractional shares of MITT common stock that would have been received as a result of the Merger.

On November 7, 2023, the Company adjourned its special meeting of stockholders until December 5, 2023, at 9:00 a.m. Pacific Time, due to a lack of quorum and to allow further solicitation of proxies from the Company’s common stockholders for the approval of the merger at the special meeting.

At a special meeting of MITT stockholders held on November 7, 2023, MITT stockholders approved the issuance of

MITT’s common stock to be issued in connection with the proposed Merger.

The transaction has been approved by the Board of Directors of the Company and is subject to customary closing conditions. The transaction is expected to close during the fourth quarter of 2023.

 

Note 2 — Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation and Consolidation

 

The accompanying unaudited consolidated financial statements and related notes have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. For all periods presented, all per share amounts and common shares outstanding have been adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split, which was effected on July 11, 2022. The results of operations for the period ended September 30, 2023 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, 2022, filed with the SEC on March 13, 2023.

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.

Reverse Stock Split

Our amended and restated certificate of incorporation as of June 30, 2022, authorized the Company to issue a total of 600,000,000 shares of capital stock, consisting of 500,000,000 shares of common stock, par value $0.01 per share, and 100,000,000 shares of preferred stock, par value $0.01 per share.

Following approval by the Company’s stockholders of a reverse stock split between a range of one-for-five and one-for-ten of currently outstanding shares of the Company’s common stock, on June 30, 2022, the Company's Board of Directors selected a one-for-ten reverse stock split ratio. The one-for-ten reverse stock split was effected on July 11, 2022, which reduced the total number of authorized shares of common stock from 500,000,000 to 50,000,000 and also reduced the total number of authorized shares of preferred stock from 100,000,000 to 10,000,000. The total number of issued and outstanding shares from 60,380,105 to 6,038,012. The par value per share of our common stock remained unchanged at $0.01. All per share amounts and common shares outstanding have been adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split.

Our stockholders' equity, in the aggregate, remained unchanged. Per share net income or loss increased because there are fewer shares of common stock outstanding. The common stock held in treasury was reduced in proportion to the reverse stock split ratio. There were no other accounting consequences, including changes to the amount of stock-based compensation expense to be recognized in any period, that arose as a result of the reverse stock split. No fractional shares were issued in

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connection with the reverse stock split. Instead, each stockholder holding fractional shares was entitled to receive, in lieu of such fractional shares, cash in an amount determined based on the closing price of the Company's common stock the business day prior to the effective date. The reverse stock split applied to all of the Company's outstanding shares of common stock and did not affect any stockholder’s ownership percentage of shares of the Company's common stock, except for immaterial changes resulting from the payment of cash for fractional shares.

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.

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, 2022.

 

Recently Issued Accounting Pronouncements

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Description

Effective 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, 2024

The Company evaluated the impact this standard may have on its consolidated financial statements and does not believe it will have a material impact on its financial statements and disclosures due to the limited nature of such transactions.

In March 2021, the FCA announced that the intended cessation date of the overnight 1-, 3-, 6-, and 12-month tenors of USD LIBOR would be June 30, 2023, which is beyond the current sunset date of Topic 848. Accordingly, during December 2022, the FASB issued ASU 2022-06 to defer the sunset date of ASC Topic 848, Reference Rate Reform, which provides temporary optional relief in accounting for the impact of reference rate reform from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of rate reform.

December 31, 2024

With additional time granted to apply the relief in Topic 848 extended through December 31, 2024, Management monitored if any legacy LIBOR reference rate contracts remained outstanding as of September 30, 2023 in the investment portfolio, as either they they terminated prior to the June 30, 2023 LIBOR cessation date, or the Company elected to use the practical expedients per Topic 848 to account for modifications to contracts prospectively within the scope of Topics 310, Receivables, and 470, Debt, as a continuation of the existing contracts. The Company adjusted the effective interest rate of all contracts, hedging relationships, and other transactions that reference LIBOR to revised reference rates and spreads as they occured. The variable-rate and floating-rate note sectors have primarily transitioned away from LIBOR as the market has already adapted to the secured overnight financing rate (SOFR), as the primary index used by issuers. As of September 30, 2023, the Company has fully transitioned away from any contracts, hedging relationships, or other transactions that reference LIBOR, which did not have a material impact on its financial statements and disclosures.

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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 September 30, 2023 and December 31, 2022, based upon the valuation hierarchy (dollars in thousands):

 

			September 30, 2023
			Fair Value
			Level I						Level II						Level III						Total
Assets
Agency RMBS Interest-only strips			$	—					$	—					$	61					$	61
Agency RMBS Interest-only strips accounted for as derivatives, included in MBS			—						—						834						834
Subtotal Agency MBS			—						—						895						895
Non-Agency CMBS			—						54,206						—						54,206
Non-Agency RMBS			—						31,872						—						31,872
Non-Agency RMBS Interest-only strips			—						—						1,249						1,249
Subtotal Non-Agency MBS			—						86,078						1,249						87,327
Other securities			—						16,867						—						16,867
Total mortgage-backed securities and other securities			—						102,945						2,144						105,089
Residential Whole Loans			—						—						986,978						986,978
Residential Bridge Loans			—						—						2,782						2,782
Securitized Commercial Loans			—						—						1,012,650						1,012,650
Commercial Loans			—						—						78,701						78,701
Total Assets			$	—					$	102,945					$	2,083,255					$	2,186,200
Liabilities
Derivative liabilities			$	—					$	845					$	—					$	845
Securitized debt			—						1,576,499						5,779						1,582,278
Total Liabilities			$	—					$	1,577,344					$	5,779					$	1,583,123

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			December 31, 2022
			Fair Value
			Level I						Level II						Level III						Total
Assets
Agency RMBS Interest-only strips			$	—					$	—					$	53					$	53
Agency RMBS Interest-only strips accounted for as derivatives, included in MBS			—						—						714						714
Subtotal Agency MBS			—						—						767						767
Non-Agency CMBS			—						85,435						—						85,435
Non-Agency RMBS			—						22,483						—						22,483
Non-Agency RMBS Interest-only strips			—						—						1,204						1,204
Subtotal Non-Agency MBS			—						107,918						1,204						109,122
Other securities			—						27,262						—						27,262
Total mortgage-backed securities and other securities			—						135,180						1,971						137,151
Residential Whole Loans			—						—						1,091,145						1,091,145
Residential Bridge Loans			—						—						2,849						2,849
Securitized Commercial Loan			—						—						1,085,103						1,085,103
Commercial Loans			—						—						90,002						90,002
Derivative assets			—						1						—						1
Total Assets			$	—					$	135,181					$	2,271,070					$	2,406,251
Liabilities
Derivative liabilities			$	—					$	61					$	—					$	61
Securitized debt			—						1,710,938						8,927						1,719,865
Total Liabilities			$	—					$	1,710,999					$	8,927					$	1,719,926

 

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 the 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

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the quarter, for each security type. If there is sufficient trade data above a predetermined threshold of a security type, the 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 and SOFR, 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 Residential 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 and Residential Bridge 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 the 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 Whole Loans and Residential Bridge 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. In addition, the fair values for the Company's Non-QM Residential Whole Loans held in Arroyo Trust 2022-1 and Arroyo Trust 2022-2 are measured using the fair value of the securitized debt based on the CFE valuation methodology. See Note 5, "Residential Whole Loans and Residential Bridge Loans" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional details. Accordingly, the Company classifies its Residential Whole Loans and Residential Bridge Loans 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 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.

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Securitized Debt

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, 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 September 30, 2023 and December 31, 2022. See Note 8, "Derivative Instruments" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.

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 September 30, 2023 and December 31, 2022 (dollars in thousands):

						Fair Value at																		Range
						September 30, 2023						Valuation Technique						Unobservable Input						Minimum						Maximum						Weighted Average
Residential Whole Loans						$	986,978					Discounted Cash Flow						Market Discount Rate						6.4		%				8.4		%				6.8		%
																		Weighted Average Life						1.4						10.5						6.4
Residential Bridge Loans						$	2,782					Discounted Cash Flow						Market Discount Rate						12.2		%				20.0		%				15.1		%
																		Weighted Average Life						1.3						5.2						3.4
Securitized Commercial Loan						$	1,012,650					Market Comparables, Vendor Pricing						Weighted Average Life						2						2						2
Commercial Loans						$	78,701					Discounted Cash Flow						Market Discount Rate						9.2		%				11.5		%				10.5		%
																		Weighted Average Life						0						1.6						1.37

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						Fair Value at																		Range
						December 31, 2022						Valuation Technique						Unobservable Input						Minimum						Maximum						Weighted Average
Residential Whole Loans						$	1,091,145					Discounted Cash Flow						Market Discount Rate						6.0		%				8.4		%				6.8		%
																		Weighted Average Life						1.4						10.4						5.4
Residential Bridge Loans						$	2,849					Discounted Cash Flow						Market Discount Rate						12.9		%				35.7		%	(1)			22.4		%
																		Weighted Average Life						0.4						4.1						2.0
Securitized Commercial Loan						$	1,085,103					Market Comparables, Vendor Pricing						Weighted Average Life						2.7						2.7						2.7
Commercial Loans						$	90,002					Discounted Cash Flow						Market Discount Rate						8.4		%				9.6		%				9.2		%
																		Weighted Average Life						0.3						2.4						1.2

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 September 30, 2023
$ in thousands			Agency MBS						Non-Agency MBS												Residential  Whole Loans						Residential Bridge Loans						Commercial Loans						Securitized  Commercial  Loan						Securitized debt
Beginning balance			$	838					$	1,608											$	1,037,381					$	2,782					$	78,806					$	1,025,321					$	6,932
Transfers into Level III from Level II			—						—												—						—						—						—						—
Transfers from Level III into Level II			—						—												—						—						—						—						—
Loan modifications / capitalized interest			—						—												87						—						—						—						—
Principal repayments			—						—												(28,604)						—						(281)						—						—
Total net gains / losses included in net income
Realized gains/(losses), net on assets			—						—												(29)						—						—						—						—
Unrealized gains/(losses), net on assets(1)			67						(251)												(21,131)						—						143						(19,735)						—
Unrealized (gains)/losses, net on liabilities(2)			—						—												—						—						—						—						66
Premium and discount amortization, net			(10)						(108)												(726)						—						33						7,064						(1,219)
Ending balance			$	895					$	1,249											$	986,978					$	2,782					$	78,701					$	1,012,650					$	5,779
Unrealized gains/(losses), net on assets held at the end of the period(1)			$	67					$	(251)											$	(22,085)					$	—					$	143					$	(19,735)					$	—
Unrealized gains/(losses), net on liabilities held at the end of the period(2)			$	—					$	—											$	—					$	—					$	—					$	—					$	(66)

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			Three months ended September 30, 2022
$ in thousands			Agency MBS						Non-Agency MBS												Residential  Whole Loans						Residential Bridge Loans						Commercial Loans						Securitized  Commercial  Loan						Securitized debt
Beginning balance			$	785					$	1,181											$	1,195,853					$	5,095					$	128,421					$	1,243,371					$	14,919
Transfers into Level III from Level II			—						—												—						—						—						—						—
Transfers from Level III into Level II			—						—												—						—						—						—						—
Sales and settlements			—						—												(11,735)						—						—						—						—
Loan modifications / capitalized interest			—						—												4						—						—						—						—
Principal repayments			—						—												(37,036)						—						(20,588)						—						—
Total net gains / losses included in net income
Realized gains/(losses), net on assets			—						—												(33)						—						—						—						—
Unrealized gains/(losses), net on assets(1)			(63)						88												(46,545)						25						(17,730)						(78,046)						—
Unrealized (gains)/losses, net on liabilities(2)			—						—												—						—						—						—						(3,863)
Premium and discount amortization, net			(2)						(96)												(883)						—						—						6,589						(1,170)
Ending balance			$	720					$	1,173											$	1,099,625					$	5,120					$	90,103					$	1,171,914					$	9,886
Unrealized gains/(losses), net on assets held at the end of the period(1)			$	(63)					$	88											$	(35,855)					$	25					$	(17,730)					$	(78,046)					$	—
Unrealized gains/(losses), net on liabilities held at the end of the period(2)			$	—					$	—											$	—					$	—					$	—					$	—					$	3,863

			Nine months ended September 30, 2023
$ in thousands			Agency MBS						Non-Agency MBS												Residential  Whole Loans						Residential Bridge Loans						Commercial Loans						Securitized  commercial  loan						Securitized debt
Beginning balance			$	767					$	1,204											$	1,091,145					$	2,849					$	90,002					$	1,085,103					$	8,927
Transfers into Level III from Level II			—						—												—						—						—						—						—
Transfers from Level III into Level II			—						—												—						—						—						—						—
Sales and settlements			—						—												—						—						(8,776)						—						—
Loan modifications / capitalized interest			—						—												129						—						—						—						—
Principal repayments			—						—												(87,397)						(74)						(1,961)						—						—
Total net gains / losses included in net income
Realized gains/(losses), net on assets			—						—												(29)						—						(81,223)						—						—
Unrealized gains/(losses), net on assets(1)			134						361												(14,593)						7						80,560						(93,785)						—
Unrealized (gains)/losses, net on liabilities(2)			—						—												—						—						—						—						(35)
Premium and discount amortization, net			(6)						(316)												(2,277)						—						99						21,332						(3,113)
Ending balance			$	895					$	1,249											$	986,978					$	2,782					$	78,701					$	1,012,650					$	5,779
Unrealized gains/(losses), net on assets held at the end of the period(1)			$	134					$	361											$	(18,171)					$	—					$	(662)					$	(93,785)					$	—
Unrealized gains/(losses), net on liabilities held at the end of the period(2)			$	—					$	—											$	—					$	—					$	—					$	—					$	35

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			Nine months ended September 30, 2022
$ in thousands			Agency MBS						Non-Agency MBS												Residential  Whole Loans						Residential Bridge Loans						Commercial Loans						Securitized  commercial  loan						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			—						(5,437)												—						—						—						—						—
Purchases			—						—												402,650						—						—						—						—
Sales and settlements			—						—												(11,362)						—						—						—						—
Loan modifications / capitalized interest			—						—												79						—						—						—						—
Principal repayments			—						—												(184,683)						(250)						(20,593)						—						—
Total net gains / losses included in net income
Realized gains/(losses), net on assets			—						—												(32)						—						—						—						—
Unrealized gains/(losses), net on assets(1)			(329)						(998)												(125,943)						(58)						(19,876)						(203,828)						—
Unrealized (gains)/losses, net on liabilities(2)			—						—												—						—						—						—						(2,064)
Premium and discount amortization, net			(123)						(237)												(4,586)						—						—						19,934						(2,969)
Ending balance			$	720					$	1,173											$	1,099,625					$	5,120					$	90,103					$	1,171,914					$	9,886
Unrealized gains/(losses), net on assets held at the end of the period(1)			$	(329)					$	(644)											$	(107,944)					$	17					$	(19,884)					$	(203,828)					$	—
Unrealized gains/(losses), net on liabilities held at the end of the period(2)			$	—					$	—											$	—					$	—					$	—					$	—					$	2,064

(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.

Transfers into the Level III category of the fair value hierarchy occur due to the above segmented classes of investments exhibiting indications of reduced levels of market transparency, including changes in observable transactions or executable quotes involving these investments or similar classes of investments. Changes in these indications could impact price transparency, and thereby cause a change in level designations. The Company did not have transfers between either Level I and Level II or Level I and Level III for the three and nine months ended September 30, 2023 and September 30, 2022.

 

Other Fair Value Disclosures

 

The Company's repurchase agreement borrowings, convertible senior unsecured notes, and securitized debt from the Arroyo 2019-2 and Arroyo 2020-1 trusts 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.

Convertible Senior Unsecured Notes

The fair values of the convertible senior unsecured notes are based on quoted market prices. Accordingly, the Company's convertible senior unsecured notes were classified as Level I.

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 September 30, 2023 and December 31, 2022 in the consolidated financial statements (dollars in thousands):

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			September 30, 2023												December 31, 2022
			Carrying Value						Estimated Fair Value						Carrying Value						Estimated Fair Value
Convertible senior unsecured notes			$	84,750					$	83,367					$	83,522					$	74,712
Securitized debt(1)			305,205						273,799						342,965						309,474
Total			$	389,955					$	357,166					$	426,487					$	384,186

(1) Carrying value excludes $3.1 million and $4.1 million of deferred financing costs as of September 30, 2023 and December 31, 2022, respectively.

"Due from counterparties" and "Due to counterparties" in the Company’s Consolidated Balance Sheets are reflected at cost which approximates fair value.

Note 4 – Mortgage-Backed Securities and Other Securities

 

The following tables present certain information about the Company’s investment portfolio at September 30, 2023 and December 31, 2022 (dollars in thousands):

			September 30, 2023
			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												$	68					$	—					$	(7)					$	61					—		%
Agency RMBS Interest-Only Strips, accounted for as derivatives(1)(2)			N/A						N/A												N/A						N/A						N/A						834						1.3		%
Total Agency MBS			—						—												68						—						(7)						895						1.1		%
Non-Agency RMBS			50,507						(14,670)												35,837						572						(4,537)						31,872						4.9		%
Non-Agency RMBS Interest- Only Strips(1)			N/A						N/A												4,888						—						(3,639)						1,249						0.3		%
Subtotal Non-Agency RMBS			50,507						(14,670)												40,725						572						(8,176)						33,121						1.6		%
Non-Agency CMBS			88,559						(1,746)												86,813						65						(32,672)						54,206						8.0		%
Total Non-Agency MBS			139,066						(16,416)												127,538						637						(40,848)						87,327						3.7		%
Other securities(3)			25,613						(7,941)												18,740						813						(2,686)						16,867						7.1		%
Total			$	164,679					$	(24,357)											$	146,346					$	1,450					$	(43,541)					$	105,089					3.8		%

			December 31, 2022
			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												$	58					$	—					$	(5)					$	53					—		%
Agency RMBS Interest-Only Strips, accounted for as derivatives(1)(2)			N/A						N/A												N/A						N/A						N/A						714						0.1		%
Total Agency MBS			—						—												58						—						(5)						767						0.1		%
Non-Agency RMBS			39,873						(14,423)												25,450						928						(3,895)						22,483						4.2		%
Non-Agency RMBS Interest-Only Strips(1)			N/A						N/A												5,204						—						(4,000)						1,204						0.3		%
Subtotal Non-Agency RMBS			39,873						(14,423)												30,654						928						(7,895)						23,687						1.1		%
Non-Agency CMBS			109,266						(2,763)												106,503						636						(21,704)						85,435						8.1		%
Total Non-Agency MBS			149,139						(17,186)												137,157						1,564						(29,599)						109,122						3.8		%
Other securities(3)			34,691						(8,581)												31,112						543						(4,393)						27,262						7.2		%
Total			$	183,830					$	(25,767)											$	168,327					$	2,107					$	(33,997)					$	137,151					3.9		%

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(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 September 30, 2023, 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 $2.2 million, $132.0 million, and $12.2 million, respectively. At December 31, 2022, 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 $2.4 million, $143.2 million, and $13.1 million, respectively.

(2)     Interest on these securities is reported as a component of "Gain 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 $1.1 million and $5.0 million, as of September 30, 2023 and December 31, 2022, 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 September 30, 2023 and December 31, 2022, the weighted average expected remaining term of the MBS and other securities investment portfolio was 7.8 years and 6.7 years, respectively.

The following tables present the fair value and contractual maturities of the Company’s investment securities at September 30, 2023 and December 31, 2022 (dollars in thousands):

 

			September 30, 2023
			< 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			$	—					$	61					$	—					$	—					$	61
Agency RMBS Interest-Only Strips accounted for as derivatives			—						834						—						—						834
Subtotal Agency			—						895						—						—						895
Non-Agency CMBS			37,134						7,418						9,654						—						54,206
Non-Agency RMBS			—						—						7,912						23,960						31,872
Non-Agency RMBS Interest-Only Strips			—						—						188						1,061						1,249
Subtotal Non-Agency			37,134						7,418						17,754						25,021						87,327
Other securities			3,006						—						7,117						6,744						16,867
Total			$	40,140					$	8,313					$	24,871					$	31,765					$	105,089

			December 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			$	—					$	53					$	—					$	—					$	53
Agency RMBS Interest-Only Strips accounted for as derivatives			—						714						—						—						714
Subtotal Agency			—						767						—						—						767
Non-Agency CMBS			64,484						10,469						10,482						—						85,435
Non-Agency RMBS			—						—						8,667						13,816						22,483
Non-Agency RMBS Interest-Only Strips			—						—						230						974						1,204
Subtotal Non-Agency			64,484						10,469						19,379						14,790						109,122
Other securities			6,735						—						13,020						7,507						27,262
Total			$	71,219					$	11,236					$	32,399					$	22,297					$	137,151

 

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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 September 30, 2023 and December 31, 2022 (dollars in thousands):

			September 30, 2023
			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
Agency RMBS Interest-Only Strips			$	61					$	(7)					1						$	—					$	—					—						$	61					$	(7)					1
Subtotal Agency			61						(7)						1						—						—						—						61						(7)						1
Non-Agency CMBS			7,188						(1,898)						1						46,953						(30,774)						9						54,141						(32,672)						10
Non-Agency RMBS			15,661						(519)						2						9,706						(4,018)						6						25,367						(4,537)						8
Non-Agency RMBS Interest-Only Strips			—						—						—						1,249						(3,639)						4						1,249						(3,639)						4
Subtotal Non-Agency			22,849						(2,417)						3						57,908						(38,431)						19						80,757						(40,848)						22
Other securities			—						—						—						5,521						(2,686)						1						5,521						(2,686)						1
Total			$	22,910					$	(2,424)					4						$	63,429					$	(41,117)					20						$	86,339					$	(43,541)					24

 

			December 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
Agency RMBS Interest-Only Strips			$	52					$	(5)					1						$	—					$	—					—						$	52					$	(5)					1
Subtotal Agency			52						(5)						1						—						—						—						52						(5)						1
Non-Agency CMBS			—						—						—						76,365						(21,704)						11						76,365						(21,704)						11
Non-Agency RMBS			19,054						(2,794)						5						1,557						(1,101)						2						20,611						(3,895)						7
Non-Agency RMBS Interest-Only Strips			—						—						—						1,203						(4,000)						4						1,203						(4,000)						4
Subtotal Non-Agency			19,054						(2,794)						5						79,125						(26,805)						17						98,179						(29,599)						22
Other securities			12,483						(2,425)						3						9,468						(1,968)						2						21,951						(4,393)						5
Total			$	31,589					$	(5,224)					9						$	88,593					$	(28,773)					19						$	120,182					$	(33,997)					28

 

The following tables present components of interest income on the Company’s MBS and other securities for the three and nine months ended September 30, 2023 and September 30, 2022, respectively (dollars in thousands):

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			Three months ended September 30, 2023																		Three months ended September 30, 2022
			Coupon Interest						Net (Premium Amortization/Amortization Basis) Discount Accretion						Interest Income						Coupon Interest						Net (Premium Amortization/Amortization Basis) Discount Accretion						Interest Income
Agency RMBS			$	—					$	4					$	4					$	—					$	2					$	2
Non-Agency CMBS			1,657						351						2,008						1,949						387						2,336
Non-Agency RMBS			756						(306)						450						446						26						472
Other securities			583						(144)						439						860						185						1,045
Total			$	2,996					$	(95)					$	2,901					$	3,255					$	600					$	3,855

			Nine months ended September 30, 2023																		Nine months ended September 30, 2022
			Coupon Interest						Net (Premium Amortization/Amortization Basis) Discount Accretion						Interest Income						Coupon Interest						Net (Premium Amortization/Amortization Basis) Discount Accretion						Interest Income
Agency RMBS			$	—					$	10					$	10					$	13					$	(4)					$	9
Non-Agency CMBS			5,234						1,006						6,240						7,050						386						7,436
Non-Agency RMBS			1,960						(651)						1,309						1,804						(141)						1,663
Other securities			2,079						(345)						1,734						2,515						223						2,738
Total			$	9,273					$	20					$	9,293					$	11,382					$	464					$	11,846

There were no sales nor realized gain (loss) related to the Company's MBS and Other Securities for the three months ended September 30, 2023 and September 30, 2022. The following table presents the sales and realized gain (loss) of the Company’s MBS and other securities for the nine months ended September 30, 2023 and September 30, 2022, respectively (dollars in thousands):

			Nine months ended September 30, 2023																								Nine months ended September 30, 2022
			Proceeds						Gross Gains						Gross Losses						Net Gain  (Loss)						Proceeds						Gross Gains						Gross Losses						Net Gain (Loss)
Non-Agency CMBS			$	—					$	—					$	(1,239)					$	(1,239)					$	10,152					$	—					$	(43,934)					$	(43,934)
Non-Agency RMBS			—						—						(48)						(48)						27,729						255						(1,425)						(1,170)
Other securities			15,324						649						(2,028)						(1,379)						4,406						—						(478)						(478)
Total			$	15,324					$	649					$	(3,315)					$	(2,666)					$	42,287					$	255					$	(45,837)					$	(45,582)

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 September 30, 2023 and December 31, 2022, the Company held two and two 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 September 30, 2023 and December 31, 2022, the Company’s maximum exposure to loss from these variable interests did not exceed the carrying value of these investments of $15.1 million and $15.5 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 September 30, 2023 and December 31, 2022, the Company did not guarantee any obligations of unconsolidated entities or enter into any commitment or intent to provide funding to any such entities.

 

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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. The RMI 2015 Trust issued a trust certificate which 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.

During the three months ended September 30, 2023, all loans formerly held at Revolving Mortgage Investment Trust 2017-BRQ1 ("RMI 2017 Trust") were transferred to the RMI 2015 Trust in order to consolidate costs.

As of September 30, 2023, the RMI 2015 Trust owned nine Non-QM Residential Whole Loans with a fair value of $4.3 million, three of which are investor fixed rate residential mortgages previously held by RMI 2017 Trust with a fair value of $991.7 thousand. As of December 31, 2022, RMI 2015 Trust owned six Non-QM Residential Whole Loans with a fair value of $3.2 million, and RMI 2017 Trust owned three investor fixed rate mortgages with a fair value of $1.2 million. The loans are financed under the Company's residential whole loan facility, and the Company holds the financing liability outside the RMI 2015 Trust. See Note 7, "Financings" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional details.

As of September 30, 2023, the RMI 2015 Trust owned four Residential Bridge Loans with a fair value of $2.8 million. As of December 31, 2022, the RMI 2017 Trust owned five Residential Bridge Loans with a fair value of $2.8 million. The Company is no longer allocating capital to Residential Bridge Loans.

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. 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.

As of September 30, 2023 and December 31, 2022, the Arroyo Trust 2019 owned 684 and 766 Non-QM Residential Whole Loans with a fair value of $214.0 million and $237.6 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. See Note 7, "Financings" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional 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 September 30, 2023 and December 31, 2022, the Arroyo Trust 2020 owned 406 and 432 Non-QM Residential Whole Loans with a fair value of $127.7 million and $135.1 million, respectively.

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Arroyo Mortgage Trust 2022-1

In February 2022, the Company formed Arroyo Mortgage Trust 2022-1 ("Arroyo Trust 2022-1"), 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 2022-1 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. See Note 7, "Financings" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional 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 September 30, 2023 and December 31, 2022, the Arroyo Trust 2022-1 owned 682 and 705 Non-QM Residential Whole Loans with a fair value of $324.6 million and $350.7 million, respectively. 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 2022-1 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.

Arroyo Mortgage Trust 2022-2

In July 2022, the Company formed Arroyo Mortgage Trust 2022-2 ("Arroyo Trust 2022-2"), a wholly-owned subsidiary of the Company, to complete its fourth residential mortgage-backed securitization comprised of $402.2 million of Non-QM Residential Whole Loans. The Arroyo Trust 2022-2 issued $351.9 million of mortgage-backed notes and retained all the subordinate and residual debt securities, which includes the required 5% eligible risk retention. See Note 7, "Financings" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional 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 September 30, 2023 and December 31, 2022, the Arroyo Trust 2022-2 owned 980 and 1,029 Non-QM Residential Whole Loans with a fair value of $316.3 million and $363.3 million, respectively. 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 2022-2 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.

During the three months ended September 30, 2023, the four remaining Residential Bridge Loans with a fair value of $2.8 million in the RMI 2017 Trust were transferred to the RMI 2015 Trust to consolidate costs. The Company is no longer allocating capital to Residential Bridge Loans.

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 September 30, 2023 and December 31, 2022 (dollars in thousands):

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			September 30, 2023						December 31, 2022
Residential Whole Loans, at fair value ($986,978 and $1,089,914 pledged as collateral, at fair value, respectively)			$	986,978					$	1,091,145
Residential Bridge Loans, at fair value ($2,782 and none pledged as collateral, at fair value, respectively)			2,782						2,849
Investment related receivable			8,602						5,914
Interest receivable			4,580						4,871
Other assets			—						509
Total assets			$	1,002,942					$	1,105,288
Securitized debt, net			$	877,745					$	981,073
Interest payable			2,892						3,139
Accounts payable and accrued expenses			12						34
Total liabilities			$	880,649					$	984,246

The Residential Whole Loans held by the consolidated Arroyo Trust 2019, Arroyo Trust 2020, Arroyo Trust 2022-1, and Arroyo Trust 2022-2 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 September 30, 2023 and December 31, 2022.

The following table presents the components of the fair value of Residential Whole Loans and Residential Bridge Loans as of September 30, 2023 and December 31, 2022 (dollars in thousands):

 

			Residential Whole Loans, at Fair Value												Residential Bridge Loans, at Fair Value
			September 30, 2023						December 31, 2022						September 30, 2023						December 31, 2022
Principal balance			$	1,078,005					$	1,165,301					$	3,091					$	3,166
Unamortized premium			28,530						30,961						—						—
Unamortized discount			(1,394)						(1,536)						—						—
Amortized cost			1,105,141						1,194,726						3,091						3,166
Gross unrealized gains			5,371						2,038						—						—
Gross unrealized losses			(123,534)						(105,619)						(309)						(317)
Fair value			$	986,978					$	1,091,145					$	2,782					$	2,849

Residential Whole Loans

The Residential Whole Loans have low LTV's and are comprised of 2,761 adjustable and fixed rate Non-QM and investor mortgages. The following tables present certain information about the Company’s residential whole loan investment portfolio at September 30, 2023 and December 31, 2022 (dollars in thousands):

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September 30, 2023
															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%			39						$	21,880					66.3		%				758						9.1						27.6						2.9		%
3.01% – 4.00%			361						196,884						67.0		%				760						8.2						28.0						3.7		%
4.01% – 5.00%			1,134						384,437						64.8		%				750						6.8						25.5						4.5		%
5.01% – 6.00%			813						322,376						66.0		%				743						6.1						26.2						5.5		%
6.01% – 7.00%			321						120,933						67.2		%				743						4.8						26.9						6.5		%
7.01% - 8.00%			69						23,865						60.6		%				734						4.1						23.1						7.4		%
8.01% - 9.00%			24						7,630						55.5		%				744						4.3						24.0						8.6		%
Total			2,761						$	1,078,005					65.7		%				749						6.6						26.3						4.9		%

(1)The original FICO score is not available for 210 loans with a principal balance of approximately $64.6 million at September 30, 2023. The Company has excluded these loans from the weighted average computations.

 

December 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%			39						$	22,277					66.3		%				758						8.9						28.3						2.9		%
3.01% – 4.00%			402						214,402						66.3		%				759						7.3						28.5						3.7		%
4.01% – 5.00%			1,337						453,811						64.1		%				749						5.5						26.0						4.6		%
5.01% – 6.00%			901						363,197						65.6		%				742						4.7						26.7						5.4		%
6.01% – 7.00%			249						105,933						69.9		%				742						3.6						28.4						6.4		%
7.01% - 8.00%			15						5,681						75.2		%				730						3.0						29.2						7.4		%
Total			2,943						$	1,165,301					65.6		%				748						5.5						27.0						4.8		%

(1)The original FICO score is not available for 231 loans with a principal balance of approximately $76.6 million at December 31, 2022. The Company has excluded these loans from the weighted average computations.

The following table presents geographic concentrations by U.S. state in which the collateral securing the Company’s Residential Whole Loans are located as of September 30, 2023 and December 31, 2022 (dollars in thousands):

September 30, 2023															December 31, 2022
State			State Concentration						Principal Balance						State			State Concentration						Principal Balance
California			67.8		%				$	731,058					California			66.8		%				$	778,732
New York			9.0		%				96,757						New York			9.3		%				108,108
Texas			4.8		%				51,407						Texas			4.8		%				56,126
Florida			3.9		%				42,157						Florida			4.1		%				47,681
Georgia			3.3		%				35,297						Georgia			3.5		%				40,845
Other			11.2		%				121,329						Other			11.5		%				133,809
Total			100.0		%				$	1,078,005					Total			100.0		%				$	1,165,301

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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 September 30, 2023 and December 31, 2022 (dollars in thousands):

 

September 30, 2023
																		Weighted Average
Current Coupon Rate						Number of Loans						Principal Balance						Original LTV						Contractual Maturity  (months)(1)						Coupon Rate
7.01% – 9.00%						2						$	1,822					67.5		%				0.0						8.7		%
9.01% – 11.00%						1						849						90.5		%				0.0						10.0		%
11.01% – 13.00%						1						420						70.0		%				0.0						11.3		%
Total						4						$	3,091					74.2		%				0.0						9.4		%

December 31, 2022
																		Weighted Average
Current Coupon Rate						Number of Loans						Principal Balance						Original LTV						Contractual Maturity  (months)(1)						Coupon Rate
7.01% – 9.00%						2						$	1,822					67.5		%				0.0						8.7		%
9.01% – 11.00%						1						849						90.5		%				0.0						10.0		%
11.01% – 13.00%						2						495						69.7		%				0.0						11.4		%
Total						5						$	3,166					74.0		%				0.0						9.5		%

(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 geographic concentrations by U.S. state in which the collateral securing the Company’s Residential Bridge Loans are located as of September 30, 2023 and December 31, 2022 (dollars in thousands):

  

September 30, 2023															December 31, 2022
State			Concentration						Principal Balance						State			Concentration						Principal Balance
California			56.7		%				$	1,754					California			55.4		%				$	1,754
New York			43.3		%				1,337						New York			42.2		%				1,337
Total			100.0		%				$	3,091					New Jersey			2.4		%				75
															Total			100.0		%				$	3,166

Loan Aging

The following table presents the aging of the Residential Whole Loans and Residential Bridge Loans as of September 30, 2023 (dollars in thousands):

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						Residential Whole Loans (1)																		Residential Bridge Loans (1)
						No of Loans						Principal						Fair Value						No of Loans						Principal						Fair Value
Current						2,707						$	1,048,261					$	959,343					—						$	—					$	—
1-30 days						23						10,407						9,617						—						—						—
31-60 days						—						—						—						—						—						—
61-90 days						11						8,155						7,696						—						—						—
90+ days						20						11,182						10,322						4						3,091						2,782
Total						2,761						$	1,078,005					$	986,978					4						$	3,091					$	2,782

(1) As of September 30, 2023, there were no loans in forbearance.

Residential Whole Loans

    

As of September 30, 2023, there were 20 Residential Whole Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $11.2 million and a fair value of $10.3 million. These non-performing loans represent approximately 1.0% of the total outstanding principal balance. These loans are collateral dependent with a weighted average original LTV of 61.6%.

As of December 31, 2022, there were 13 Residential Whole Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $8.7 million and a fair value of approximately $8.0 million. These non-performing loans represent approximately 0.8% 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 contained in this Quarterly Report on Form 10-Q. The Company stopped accruing interest income for these loans when they became contractually 90 days delinquent.

Residential Bridge Loans

    As of September 30, 2023, the Company had four remaining Residential Bridge Loans in the portfolio. Of these, four were in non-accrual status with an unpaid principal balance of approximately $3.1 million and a fair value of $2.8 million.

As of December 31, 2022, the Company had five remaining Residential Bridge Loans in the portfolio. Of these, five were in non-accrual status with an unpaid principal balance of approximately $3.2 million and a fair value of $2.8 million. These loans are collateral dependent.

The Residential Bridge Loans were carried at fair value. No allowance for credit losses was recorded because the valuation adjustments as of September 30, 2023 and December 31, 2022, 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 September 30, 2023 and December 31, 2022, the Company had one residential REO property with a carrying value of $2.3 million, respectively, related to a foreclosed Residential Whole Loan. The REO property held by the Company as of September 30, 2023 and December 31, 2022 was transferred to REO in December 2022. 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 contained in this Quarterly Report on Form 10-Q.

Note 6 — Commercial Loans

Commercial Loans

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    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. See Note 7, "Financing" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.

The following table presents information about the Commercial Loans owned by CRE LLC as of September 30, 2023 (dollars in thousands):

    

Loan

Acquisition Date

Loan Type

Principal Balance

Fair Value

Original LTV

Interest Rate

Maturity Date

Extension Option

Collateral

CRE 4

September 2019

Interest-Only First Mortgage

$

22,204

$

22,071

63%

1-Month SOFR plus 3.38%

8/6/2025(1)

None

Retail

CRE 5

December 2019

Interest-Only First Mortgage

24,535

24,061

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

CRE 6

December 2019

Interest-Only First Mortgage

13,207

12,952

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

CRE 7

December 2019

Interest-Only First Mortgage

7,259

7,118

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

$

67,205

$

66,202

(1) In August 2022, CRE 4 was extended three-years through August 6, 2025, with a principal paydown of $16.2 million.

(2) In November 2023, CRE 5, 6, and 7 were each extended through May 6, 2025.

Commercial Loan Sale

On February 3, 2023, the CRE 3 loan was sold to an unaffiliated third party for its recorded fair value as of December 31, 2022 of $8.8 million. At the time of sale, the Company recognized a realized loss of $81.2 million and a related reversal of unrealized loss of the same amount.

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 September 30, 2023, there was one loan remaining in the trust.

The following table presents information on the commercial real estate mortgage loan held by RSBC Trust as of September 30, 2023 (dollars in thousands):

Loan

Acquisition Date

Loan Type

Principal Balance

Fair Value

LTV

Interest Rate(1)

Maturity Date(1)

Extension Option

Collateral

SBC 3

January 2019

Interest-Only First Mortgage

$

12,500

$

12,499

49%

1-Month SOFR plus 5.50%

10/4/2023

None

Nursing Facilities

$

12,500

$

12,499

(1) In January 2023, the SBC 3 loan was partially paid down by $862 thousand to bring the unpaid principal balance to $13.5 million, the maturity date was extended through May 5, 2023 for a 50 bps extension fee and the margin was increased from 4.47% to 5.00%. In May 2023, the SBC 3 loan was partially paid down by $750 thousand to bring the unpaid principal to $12.8 million, the maturity date was extended through August 4, 2023, and the margin was increased from 5.00% to 5.50%. In July 2023, the SBC 3 loan was partially paid down by $250 thousand to bring the unpaid principal balance to $12.5 million, and the maturity date was extended to October 4, 2023 for a 25 bps extension fee. In October 2023, the SBC 3 loan was partially paid down by $250 thousand to bring the unpaid principal to $12.3 million and the maturity date was extended to December 31, 2023 for a 25 bps extension fee.

Securitized Commercial Loans

    

    Securitized Commercial Loans are comprised of Commercial Loans from consolidated third party sponsored CMBS VIE's. At September 30, 2023, 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 Loan that serves as collateral for the securitized debt issued by this VIE can only be used to settle the securitized debt. See Note 7, "Financings"

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to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q 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.

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 September 30, 2023, 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 September 30, 2023. 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 Trust and Commercial Loan Trust

 

The two commercial consolidated trusts, CSMC USA and RSBC Trust, collectively held two Commercial Loans as of September 30, 2023. The following table presents a summary of the assets and liabilities of the two consolidated trusts included in the Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022 (dollars in thousands):

 

			September 30, 2023						December 31, 2022
Restricted cash			$	—					$	248
Securitized Commercial Loan, at fair value			1,012,650						1,085,103
Commercial Loans, at fair value			12,499						14,362
Interest receivable			5,151						5,311
Total assets			$	1,030,300					$	1,105,024
Securitized debt, at fair value			$	1,006,630					$	1,077,611
Interest payable			4,995						5,164
Accounts payable and accrued expenses			9						9
Other liabilities			—						248
Total liabilities			$	1,011,634					$	1,083,032

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 the 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 and nine months ended September 30, 2023 and September 30, 2022. 

The following table presents the components of the fair value of the Securitized Commercial Loan and Commercial Loans as of September 30, 2023 and December 31, 2022 (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
																											September 30, 2023						December 31, 2022						September 30, 2023						December 31, 2022						September 30, 2023						December 31, 2022
Principal balance																											$	1,385,591					$	1,385,591					$	12,500					$	14,362					$	67,205					$	157,205
Unamortized discount																											(62,799)						(84,132)						—						—						—						—
Amortized cost																											1,322,792						1,301,459						12,500						14,362						67,205						157,205
Gross unrealized gains																											—						—						—						—						—						—
Gross unrealized losses																											(310,142)						(216,356)						(1)						—						(1,003)						(81,565)
Fair value																											$	1,012,650					$	1,085,103					$	12,499					$	14,362					$	66,202					$	75,640

Non-Performing Commercial Loans

As of September 30, 2023, there are no Commercial Loans that are non-performing.

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, which 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. 

Residential Whole Loan Facility

The facility was extended on October 12, 2023 and matures on March 29, 2024. It bears interest at a rate of 1-Month Term SOFR plus 2.25%, with a floor of 0.25%.

The Company finances its non-securitized Non-QM residential whole loans under this facility. As of September 30, 2023, the Company had outstanding borrowings of $4.2 million under the facility. The borrowing is secured by Non-QM residential whole loans with a fair value of $4.3 million, Residential Bridge Loans with a fair value of $2.8 million and one REO property with a carrying value of $2.3 million as of September 30, 2023.

Non-Agency CMBS and Non-Agency RMBS facility

The facility was paid off in full in May 2023 and replaced with a facility from a different counterparty which matures in May 2024. It bears a current weighted average interest rate of 1-Month Term SOFR plus 2.50%. As of September 30, 2023, the outstanding balance under this facility was $54.9 million. The borrowing is secured by investments with a fair market value of $90.8 million as of September 30, 2023.

Commercial Whole Loan Facility

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The facility was extended on October 12, 2023 and matures on March 29, 2024. It bears interest at a rate of 1-Month Term SOFR plus 2.25%. As of September 30, 2023, the outstanding balance under this facility was $48.0 million. The borrowing is secured by the performing commercial loans with an estimated fair market value of $66.2 million as of September 30, 2023.

Fixed Rate Term Financing Facility

On July 25th, the Company replaced an existing short-term repurchase financing facility with Credit Suisse AG (UBS) with a new two-year term, $65 million fixed rate, non-mark-to-market, syndicated repurchase agreement, in a securitized form. As a result, the Company no longer has any financing arrangements with Credit Suisse AG (UBS) as a counterparty. As of September 30, 2023, the outstanding balance under this facility was $62.4 million, net of deferred financing costs, and is collateralized by our retained Arroyo bonds with an estimated fair market value of $134.7 million which are eliminated in consolidation as of September 30, 2023.

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, 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 was in compliance with the terms of such financial tests as of September 30, 2023.

As of September 30, 2023, the Company had borrowings under four of its master repurchase agreements. The following table summarizes certain characteristics of the Company’s repurchase agreements at September 30, 2023 and December 31, 2022 (dollars in thousands):

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						September 30, 2023																		December 31, 2022
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						$	351					5.98		%				2						$	293					4.78		%				32
Non-Agency RMBS(1)						—						—		%				0						48,237						7.50		%				26
Other securities						—						—		%				0						1,776						7.09		%				17
Total short-term borrowings						351						5.98		%				2						50,306						7.47		%				26
Long-term borrowings:
Non-Agency CMBS and Non-Agency RMBS Facility
Non-Agency CMBS(1)						31,621						7.79		%				215						55,154						6.30		%				122
Non-Agency RMBS						77,751						10.80		%				585						19,129						6.30		%				122
Other securities						8,860						8.09		%				215						16,863						6.30		%				122
Subtotal						118,232						9.79		%				458						91,146						6.30		%				122
Residential Whole Loan Facility
Residential Whole Loans(2)						2,562						7.56		%				25						3,633						6.66		%				298
Residential Bridge Loans(2)						1,641						7.56		%				25						—						—		%				0
Commercial Whole Loan Facility
Commercial Loans						48,032						7.56		%				34						48,032						6.13		%				307
Total long-term borrowings						170,467						9.11		%				328						142,811						6.25		%				189
Repurchase agreements borrowings						$	170,818					9.10		%				327						$	193,117					6.57		%				146
Less unamortized debt issuance costs						908						N/A						N/A						—						N/A						N/A
Repurchase agreements borrowings, net						$	169,910					9.10		%				327						$	193,117					6.57		%				146

(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 September 30, 2023 and December 31, 2022, repurchase agreements collateralized by investments had the following remaining maturities:

 

(dollars in thousands)			September 30, 2023						December 31, 2022
1 to 29 days			$	4,554					$	50,013
30 to 59 days			48,032						293
60 to 89 days			—						—
Greater than or equal to 90 days			118,232						142,811
Total			$	170,818					$	193,117

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At September 30, 2023, 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):

						September 30, 2023
Counterparty						Amount of  Collateral at Risk, at fair value						Weighted Average Remaining Maturity (days)						Percentage of  Stockholders’  Equity
Goldman Sachs Bank USA						$	36,387					214						46.7		%
Atlas Securitized Products Investments 2, L.P.						18,461						34						23.7		%

Collateral For Borrowings Under Repurchase Agreements

The following table summarizes the Company’s collateral positions, with respect to its borrowings under repurchase agreements at September 30, 2023 and December 31, 2022 (dollars in thousands):

 

			September 30, 2023																		December 31, 2022
			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			$	297					$	3					$	300					$	249					$	—					$	249
Non-Agency CMBS, at fair value(1)			53,038						386						53,424						83,925						483						84,408
Non-Agency RMBS, at fair value			83,029						456						83,485						104,487						533						105,020
Residential Whole Loans, at fair value(2)			4,343						11						4,354						3,229						3						3,232
Residential Bridge Loans(2)			2,782						32						2,814						—						—						—
Commercial Loans, at fair value(2)			66,202						424						66,626						66,864						362						67,226
REO, at carrying value			2,255						—						2,255						2,255						—						2,255
Other securities, at fair value			15,645						67						15,712						27,262						78						27,340
Cash(3)			241						—						241						3,410						—						3,410
Total			$	227,832					$	1,379					$	229,211					$	291,681					$	1,459					$	293,140

(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 September 30, 2023 and December 31, 2022, investments held by counterparties as security for repurchase agreements totaled approximately $227.6 million and $288.3 million, respectively. Cash collateral held by counterparties at September 30, 2023 and December 31, 2022 was approximately $241 thousand and $3.4 million, respectively. Cash posted by repurchase agreement counterparties at both September 30, 2023 and December 31, 2022 was $103 thousand and $300 thousand, respectively.

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 post reverse stock split conversion rate is 33.7952 shares of common stock per

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$1,000 principal amount of notes and represented a conversion price of $29.59 per share of common stock. 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 the Company except during the final three months prior to maturity.

Securitized Debt

Arroyo Trust 2019-2

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, so 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 2019-2's residential mortgage pass-through certificates at September 30, 2023 (dollars in thousands):

 

Classes			Principal Balance			Coupon			Carrying Value			Contractual Maturity
Offered Notes:
Class A-1			$	142,973		3.3%			$	142,973		4/25/2049
Class A-2			7,668			3.5%			7,668			4/25/2049
Class A-3			12,148			3.8%			12,148			4/25/2049
Class M-1			25,055			4.8%			25,055			4/25/2049
Subtotal			$	187,844					$	187,844
Less: Unamortized Deferred Financing Costs			N/A						1,932
Total			$	187,844					$	185,912

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 2019-2 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At September 30, 2023, Residential Whole Loans, with an outstanding principal balance of approximately $212.3 million, serve as collateral for the Arroyo Trust 2019-2'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.

Arroyo Trust 2020-1

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, so 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 2020-1's residential mortgage pass-through certificates at September 30, 2023 (dollars in thousands):

 

Classes			Principal Balance			Coupon			Carrying Value			Contractual Maturity
Offered Notes:
Class A-1A			$	66,276		1.7%			$	66,276		3/25/2055
Class A-1B			7,865			2.1%			7,865			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			$	117,361					$	117,361
Less: Unamortized Deferred Financing Costs			N/A						1,176
Total			$	117,361					$	116,185

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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 2020-1 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At September 30, 2023, Residential Whole Loans with an outstanding principal balance of approximately $130.4 million serve as collateral for the Arroyo Trust 2020-1'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 2022-1

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 2022-1's residential mortgage pass-through certificates at September 30, 2023 (dollars in thousands):

Classes			Principal Balance			Coupon			Fair Value			Contractual Maturity
Offered Notes:
Class A-1A			$	196,149		2.5%			$	174,066		12/25/2056
Class A-1B			82,942			3.3%			68,578			12/25/2056
Class A-2			21,168			3.6%			15,527			12/25/2056
Class A-3			28,079			3.7%			19,864			12/25/2056
Class M-1			17,928			3.7%			11,374			12/25/2056
Total			$	346,266					$	289,409

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 2022-1 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At September 30, 2023, Residential Whole Loans with an outstanding principal balance of approximately $378.0 million serve as collateral for the Arroyo Trust 2022-1'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.

Arroyo Trust 2022-2

In July 2022, the Company completed a residential-mortgage backed securitization comprised of $402.2 million of Non-QM Residential Whole Loans, issuing $351.9 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 2022-2's residential mortgage pass-through certificates at September 30, 2023 (dollars in thousands):

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Classes			Principal Balance			Coupon			Fair Value			Contractual Maturity
Offered Notes:
Class A-1			$	243,033		5.0%			$	230,646		7/25/2057
Class A-2			20,687			5.0%			19,097			7/25/2057
Class A-3			25,208			5.0%			23,219			7/25/2057
Class M-1			17,694			5.0%			13,277			7/25/2057
Total			$	306,622					$	286,239

The Company retained the non-offered securities in the securitization, which include the Class B-1, Class B-2, Class B-3, Class A-IO-S, and Class XS certificates. These non-offered securities were eliminated in consolidation. The securitized debt of the Arroyo Trust 2022-2 can only be settled with the residential loans that serve as collateral for the securitized debt and is non-recourse to the Company. At September 30, 2023, Residential Whole Loans with an outstanding principal balance of approximately $353.1 million serve as collateral for the Arroyo Trust 2022-2'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 September 30, 2023 (dollars in thousands):

 

Classes			Principal Balance			Coupon			Fair Value			Contractual Maturity
Class A-1			$	120,391		3.3		%	$	100,388		9/11/2025
Class A-2			531,700			4.0		%	453,714			9/11/2025
Class B			136,400			4.2		%	107,723			9/11/2025
Class C			94,500			4.3		%	71,132			9/11/2025
Class D			153,950			4.4		%	109,772			9/11/2025
Class E			180,150			4.4		%	96,059			9/11/2025
Class F			153,600			4.4		%	62,063			9/11/2025
Class X-1(1)			n/a			0.5		%	4,785			9/11/2025
Class X-2(1)			n/a			—		%	994			9/11/2025
			$	1,370,691					$	1,006,630

(1) Class X-1 and X-2 are interest-only classes with notional balances of $652.1 million and $733.5 million as of September 30, 2023, respectively.

At September 30, 2023, 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 $1.0 billion at September 30, 2023, and is recorded in "Securitized debt, net" in the Consolidated Balance Sheets. Of the remaining outstanding principal balance of $1.4 billion, $174.7 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 September 30, 2023, 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, 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 September 30, 2023 and December 31, 2022 (dollars in thousands):

																		September 30, 2023												December 31, 2022
Derivative Instrument						Accounting Designation						Consolidated Balance Sheets Location						Notional Amount						Fair Value												Notional Amount						Fair Value
Interest rate swaps, asset						Non-Hedge						Derivative assets, at fair value						$	—					$	—											$	60,000					$	1
Total derivative instruments, assets																								—																		1
Interest rate swaps, liability						Non-Hedge						Derivative liability, at fair value						82,000						(845)												98,000						(61)
Total derivative instruments, liabilities																								(845)																		(61)
Total derivative instruments, net																								$	(845)																	$	(60)

    

The following tables summarize the effects of the Company’s derivative positions, including Interest-Only Strips characterized as derivatives and TBAs, which are reported in "Gain on derivative instruments, net" in the Consolidated Statements of Operations for the three and nine months ended September 30, 2023 and September 30, 2022 (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 September 30, 2023
Interest rate swaps						$	—					$	1,008					$	—					$	(777)					$	846					$	1,077
Interest-Only Strips— accounted for as derivatives						—						—						(14)						70						24						80
Total						$	—					$	1,008					$	(14)					$	(707)					$	870					$	1,157
Three months ended September 30, 2022
Interest rate swaps						$	(3,371)					$	3,423					$	—					$	4,790					$	298					$	5,140
Interest rate swaptions						$	(161)					$	—					$	—					$	—					$	—					$	(161)
Interest-Only Strips— accounted for as derivatives						—						—						(5)						(54)						16						(43)
Credit default swaps						(273)						—						—						283						—						10
TBAs						1,319						—						—						(1,383)						—						(64)
Total						$	(2,486)					$	3,423					$	(5)					$	3,636					$	314					$	4,882

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						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
Nine months ended September 30, 2023
Interest rate swaps						$	—					$	(992)					$	—					$	(785)					$	2,832					$	1,055
Interest-Only Strips— accounted for as derivatives						—						—						(16)						135						47						166
Total						$	—					$	(992)					$	(16)					$	(650)					$	2,879					$	1,221
Nine months ended September 30, 2022
Interest rate swaps						$	(3,371)					$	14,744					$	—					$	3,670					$	(255)					$	14,788
Interest rate swaptions						(161)						—						—						—						—						(161)
Interest-Only Strips— accounted for as derivatives						—						—						(120)						(270)						160						(230)
Credit default swaps						(242)						—						—						393						—						151
TBAs						2,051						—						—						—						—						2,051
Total						$	(1,723)					$	14,744					$	(120)					$	3,793					$	(95)					$	16,599

At September 30, 2023 and December 31, 2022, the Company had cash pledged as collateral for derivatives of approximately $1.0 million and $3.2 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 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 on derivatives instruments, net" in the Consolidated Statements of Operations.

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The following tables provide additional information on the Company's fixed-pay interest rate swaps as of September 30, 2023 and December 31, 2022 (dollars in thousands):

						September 30, 2023
Fixed Pay Interest Rate Swap Remaining Term						Notional Amount						Average  Fixed Pay Rate						Average Variable Receive Rate						Average Maturity (Years)
1 year or less						$	60,000					1.4		%				5.1		%				0.5
Greater than 5 years						22,000						1.2		%				5.3		%				8.0
Total						$	82,000					1.3		%				5.2		%				2.5

						December 31, 2022
Fixed Pay Interest Rate Swap Remaining Term						Notional Amount						Average  Fixed Pay Rate						Average Variable Receive Rate						Average Maturity (Years)
Greater than 1 year and less than 3 years						$	60,000					1.4		%				2.0		%				1.3
Greater than 3 years and less than 5 years						70,000						1.4		%				1.8		%				4.1
Greater than 5 years						$	28,000					1.7		%				3.6		%				9.0
Total						$	158,000					1.4		%				2.2		%				3.9

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 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 no outstanding credit default swaps. 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 September 30, 2023 and December 31, 2022 (dollars in thousands):

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						September 30, 2023
						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						$	834					$	—					$	834					$	(236)					$	—					$	598
Total assets						$	834					$	—					$	834					$	(236)					$	—					$	598
Derivative Liabilities and Repurchase Agreements
Derivative liability, at fair value(2)(3)						$	845					$	—					$	845					$	—					$	(845)					$	—
Repurchase Agreements(4)						169,910						—						169,910						(167,509)						—						2,401
Total liability						$	170,755					$	—					$	170,755					$	(167,509)					$	(845)					$	2,401

(1)Amounts disclosed in the financial instruments column of the tables above represent securities, whole loans, 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, includes interest rate swaps.

(3)Cash collateral pledged against the Company’s derivative counterparties was approximately $1.0 million as of September 30, 2023.

(4)The carrying value of investments pledged against the Company’s repurchase agreements was approximately $227.6 million as of September 30, 2023.

 

						December 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						$	714					$	—					$	714					$	(196)					$	—					$	518
Derivative asset, at fair value(2)						1						—						1						(1)						—						—
Total assets						$	715					$	—					$	715					$	(197)					$	—					$	518
Derivative Liabilities and Repurchase Agreements
Derivative liability, at fair value(2)(3)						$	61					$	—					$	61					$	(1)					$	(60)					$	—
Repurchase Agreements(4)						193,117						—						193,117						(193,073)						(44)						—
Total liability						$	193,178					$	—					$	193,178					$	(193,074)					$	(104)					$	—

(1)Amounts disclosed in the financial instruments column of the tables above represent securities, whole loans, 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 $3.2 million as of December 31, 2022.

(4)The carrying value of investments pledged against the Company’s repurchase agreements was approximately $288.3 million as of December 31, 2022.

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.

 

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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 controller. 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 15, 2024. 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 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

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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 September 30, 2023 and September 30, 2022, the Company incurred approximately $974 thousand and approximately $850 thousand in management fees, respectively. For the nine months ended September 30, 2023 and September 30, 2022, the Company incurred approximately $2.9 million and approximately $3.0 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 September 30, 2023 and September 30, 2022, the Company recorded expenses included in general and administrative expenses totaling approximately $67 thousand and approximately $64 thousand, respectively, related to reimbursable employee costs. For the nine months ended September 30, 2023 and September 30, 2022, the Company recorded expenses included in general and administrative expenses totaling approximately $217 thousand and approximately $511 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 September 30, 2023 and December 31, 2022, approximately $1.0 million and approximately $3.9 million, respectively, for management fees incurred but not yet paid was included in "Payable to affiliate" in the Consolidated Balance Sheets. In addition, at September 30, 2023 and December 31, 2022, approximately $49 thousand and approximately $86 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

 

The Company's ability to grant equity-based awards under the Company's previous equity incentive plans expired on May 9, 2022. At the Annual Meeting of Stockholders held on June 24, 2022, the Company's stockholders approved the Western Asset Mortgage Capital Corporation 2022 Omnibus Incentive Plan and the Western Asset Mortgage Capital Corporation 2022 Manager Omnibus Incentive Plan (collectively, the “2022 Plans”). The 2022 Plans provide for the issuance of options (including non-statutory stock options and incentive stock options), stock appreciation rights (referred to as SARs), restricted stock, restricted stock units (referred to as RSUs), stock bonuses, other stock based awards and cash awards.

The aggregate maximum number of shares of our common stock available for future issuances under the 2022 Plans is 1,000,000 shares, which was reduced to 100,000 shares following the completion of the reverse stock split. The Manager and the officers, employees, non-employee directors, independent contractors, and consultants of the Company or any affiliate of the Company, including any individuals who are employees of the Manager or one of the Manager’s affiliates, are eligible to participate in the 2022 Plans, provided that they have been selected by the Plan Administrator.

On June 23, 2023, the Company granted a total of 31,184 restricted stock units (7,796 per each independent director), to each of the Company's four independent directors. These restricted stock units will vest in full on June 23, 2024, the first anniversary of the grant date, and will be settled in shares of the Company’s common stock upon each of the independent director’s separation from service with the Company.

On June 24, 2022, the Company granted 21,704 restricted stock units (5,426 per each independent director) on a post reverse stock split basis, to each of the Company's 4 independent directors. These restricted stock units and associated dividend equivalent units vested in full on June 24, 2023, the one year anniversary of the grant date, and will be settled in shares of the Company's common stock upon each of the independent director's separation from service with the Company.

On June 30, 2022, the Company granted 20,000 restricted stock units on a post reverse-stock-split basis under the Western Asset Mortgage Capital Corporation 2022 Omnibus Incentive Plan to the Company’s Chief Financial Officer. These restricted stock units and associated dividend equivalent units vest in equal installments on the first and second anniversary of the grant date. On June 30, 2023, 10,000 restricted stock units and 1,547 dividend equivalent units vested which were settled by the issuance of 11,547 shares of the Company's common stock during Q3 2023.

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During the nine months ended September 30, 2023 and September 30, 2022, 31,704 and 11,716 restricted stock units vested, respectively. The Company recognized stock-based compensation expense of approximately $101 thousand and approximately $100 thousand for the three months ended September 30, 2023 and September 30, 2022, respectively. The Company recognized stock-based compensation expense of approximately $301 thousand and approximately $335 thousand for the nine months ended September 30, 2023 and September 30, 2022, respectively. In addition, the Company had unamortized compensation expense of $277 thousand and $298 thousand for equity awards at September 30, 2023 and December 31, 2022, respectively.

 

Holders of restricted stock units are entitled to receive dividends (or dividend equivalent units) and distributions that become payable on the restricted stock units during the restricted period. Dividend equivalent units 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 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 equity awards vesting dates as of September 30, 2023 and December 31, 2022: 

			September 30, 2023						December 31, 2022
Vesting Date			Shares Vesting						Shares Vesting
June 2023			—						31,704
June 2024			43,151						10,000
Total			43,151						41,704

The following table presents information with respect to shares issued under the Company’s Equity Incentive Plans for the nine months ended September 30, 2023 and September 30, 2022:

 

			September 30, 2023												September 30, 2022
			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			81,914						$	31.21					114,825						$	131.85
Granted(2)			41,559						9.15						45,954						12.75
Issuance of common shares			(11,547)						11.89						—						—
Outstanding at end of period			111,926						25.01						160,779						97.81
Unvested at end of period			43,151						$	9.58					41,704						$	12.52

(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 10,375 and 4,250 shares attributed to dividends on restricted stock under the Director Deferred Fee Plan for the nine months ended September 30, 2023 and September 30, 2022, respectively.

Note 12 — Stockholders’ Equity

Reverse Stock Split

On June 30, 2022, the Company announced that its Board of Directors approved a one-for-ten reverse stock split of the Company's outstanding shares of common stock. The one-for-ten reverse stock split was effected on July 11, 2022, which reduced the total number of authorized shares of common stock from 500,000,000 to 50,000,000 and also reduced the total number of authorized shares of preferred stock from 100,000,000 to 10,000,000. The number of common shares outstanding reducing from 60,380,105 to 6,038,012. The par value per share of our common stock remained unchanged at $0.01. All per

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share amounts and common shares outstanding have been adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split.

The Company's stockholders' equity, in the aggregate, remains unchanged. Per share net income or loss increased because there are fewer shares of common stock outstanding. The common stock held in treasury was reduced in proportion to the Reverse Stock Split Ratio. There were no other accounting consequences, including changes to the amount of stock-based compensation expense to be recognized in any period, that arose as a result of the reverse stock split. No fractional shares were issued in connection with the reverse stock split. Instead, each stockholder holding fractional shares was entitled to receive, in lieu of such fractional shares, cash in an amount determined based on the closing price of the Company's common stock the business day prior to the Effective Date. The reverse stock split applied to all of the Company's outstanding shares of common stock and did not affect any stockholder’s ownership percentage of shares of the Company's common stock, except for immaterial changes resulting from the payment of cash for fractional shares.

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 million worth of shares of common stock in an At-The-Market equity offering. During the nine months ended September 30, 2023, 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 300,000 shares of its common stock, adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split, 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 nine months ended September 30, 2023, the Company did not repurchase any shares under the stock repurchase program.

Dividends

 

The following table presents cash dividends declared and paid by the Company on its common stock, not adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split to align with 1099-DIV per share amounts as reported.

 

Declaration Date

Record Date

Payment Date

Amount per Share

Tax Characterization

2023

September 21, 2023

October 2, 2023

October 26, 2023

$

0.35

Not yet determined

June 21, 2023

July 3, 2023

July 26, 2023

$

0.35

Not yet determined

March 22, 2023

April 3, 2023

April 26, 2023

$

0.35

Not yet determined

2022

December 21, 2022

January 3, 2023

January 26, 2023

$

0.40

Not yet determined(1)

September 22, 2022

October 3, 2022

October 26, 2022

$

0.40

Ordinary income

June 21, 2022

July 1, 2022

July 25, 2022

$

0.04

Ordinary income

March 23, 2022

April 4, 2022

April 26, 2022

$

0.04

Ordinary income

(1)The cash distributions made on January 26, 2023, with a record date of January 3, 2023, are treated as received by stockholders on January 26, 2023 and taxable in calendar year 2023.

Note 13 — Net Loss per Common Share

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The table below presents basic and diluted net loss per share of common stock using the two-class method for the three and nine months ended September 30, 2023 and September 30, 2022 (dollars, other than shares and per share amounts, in thousands), adjusted on a retroactive basis to reflect the Company's one-for-ten reverse stock split.

 

			For the three months ended September 30, 2023						For the three months ended September 30, 2022						For the nine months ended September 30, 2023						For the nine months ended September 30, 2022
Numerator:
Net loss attributable to common stockholders and participating securities for basic and diluted earnings per share			$	(8,705)					$	(40,010)					$	(10,771)					$	(88,250)
Less:
Dividends and undistributed earnings allocated to participating securities			39						32						101						62
Net loss allocable to common stockholders — basic and diluted			$	(8,744)					$	(40,042)					$	(10,872)					$	(88,312)
Denominator:
Weighted average common shares outstanding for basic earnings per share			6,049,559						6,038,012						6,041,946						6,036,876
Weighted average common shares outstanding for diluted earnings per share			6,049,559						6,038,012						6,041,946						6,036,876
Basic loss per common share			$	(1.45)					$	(6.63)					$	(1.80)					$	(14.63)
Diluted loss per common share			$	(1.45)					$	(6.63)					$	(1.80)					$	(14.63)

 

For the three and nine months ended September 30, 2023 and September 30, 2022, 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.

 

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 September 30, 2023. The Company files U.S. federal and state income tax returns.  As of September 30, 2023, U.S. federal tax returns filed by the Company for 2021, 2020, and 2019 and state tax returns filed for 2021, 2020, 2019, 2018 and 2017 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 September 30, 2023 and September 30, 2022, the Company recorded a federal and state tax benefit of zero and a tax provision of $266 thousand, respectively, which is recorded in "Income tax provision" in the Consolidated Statements of Operations. During the nine months ended September 30, 2023 and September 30, 2022, the Company recorded a federal and state tax provision of zero and a tax provision of $276 thousand respectively.

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Deferred Tax Asset

As of September 30, 2023 and December 31, 2022, the Company recorded a deferred tax asset of approximately $13.8 million and $13.5 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 year ended December 31, 2021 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 $14.6 million and $14.5 million in the REIT and $1.7 million and $1.6 million in the TRS as of September 30, 2023 and December 31, 2022, 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 September 30, 2023 and December 31, 2022, the Company has concluded it is more likely than not the deferred tax asset relating to the NOLs will not be realized and it has recorded a combined valuation allowance of $16.3 million and $16.1 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 — Commitments and 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 commitments nor contingencies at September 30, 2023.

 

Note 16 — Subsequent Events

On October 26, 2023, the Company announced that its Board of Directors declared an interim fourth quarter dividend of $0.14 per share of the Company’s common stock. The dividend is payable on November 8, 2023 to stockholders of record as of November 3, 2023. The interim fourth quarter dividend was made pursuant to the terms of the MITT Merger Agreement.

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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.

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, 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 result of Company's recently announced definitive merger agreement where MITT and the Company have agreed to combine and form a REIT; and the uncertainty and economic impact of pandemics, epidemics, or other public health emergencies, such as the lingering effects of the COVID-19 pandemic.

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 Item 1A - “Risk Factors” and Item 7 - “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, 2022, filed with the SEC on March 13, 2023. 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 allows us to address attractive market opportunities while maintaining alignment with our Manager’s core competencies. We are continuing 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" to the financial statements contained in this Quarterly Report on Form 10-Q, 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 — Non-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-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 re-

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performing 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. We are continuing to transition out of our commercial loan investments.

Our investment portfolio composition at September 30, 2023 is as follows:    

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Our Financing Strategy

 

The Company has worked to diversify our financing sources to provide an alternative to short-term repurchase agreements. We expect to continue to seek financing arrangements with longer terms and less onerous margin requirements, including but not limited to longer-term repurchase agreements, term financing, securitizations, 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 September 30, 2023 and December 31, 2022:

(dollars in thousands)			September 30, 2023						December 31, 2022
Total debt(1)			$	254,660					$	276,639
Total equity			$	77,986					$	94,804
Debt-to-equity ratio			3.3						2.9

(1) Total debt excludes the securitized debt which is non-recourse to the Company.

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 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

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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, 2022.

2023 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 nine months ended September 30, 2023, we sold the CRE 3 loan to an unaffiliated third party for its recorded fair value as of December 31, 2022 of $8.8 million.

The following table presents our investing activity for the nine months ended September 30, 2023 (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, 2022			Purchases																											September 30, 2023
Agency RMBS and Agency RMBS IOs			$	767		$	—		N/A			$	(6)		$	—		N/A			$	—		$	134		$	—								$	895
Non-Agency RMBS			23,687			11,000			N/A			(431)			—			N/A			(48)			(750)			(337)									33,121
Non-Agency CMBS			85,435			—			N/A			(20,684)			—			N/A			(1,239)			(10,314)			1,008									54,206
Other securities(1)			27,262			4,714			N/A			—			(15,324)			N/A			(1,379)			1,939			(345)									16,867
Total MBS and other securities			137,151			15,714			N/A			(21,121)			(15,324)			N/A			(2,666)			(8,991)			326									105,089
Residential Whole Loans			1,091,145			—			129			(87,397)			—			—			(29)			(14,582)			(2,288)									986,978
Residential Bridge Loans			2,849			—			—			(74)			—			—			—			7			—									2,782
Commercial Loans			90,002			—			—			(1,961)			(8,776)			—			(81,223)			80,560			99									78,701
Securitized Commercial Loans			1,085,103			—			—			—			—			—			—			(93,785)			21,332									1,012,650
REO			2,255			—			N/A			—			28			—			(28)			—			N/A									2,255
Total Investments			$	2,408,505		$	15,714		$	129		$	(110,553)		$	(24,072)		$	—		$	(83,946)		$	(36,791)		$	19,469								$	2,188,455

(1) Other securities include $15.6 million of GSE CRTs and $1.2 million of ABS at September 30, 2023.

Portfolio Characteristics

Residential Whole Loans

 

The Residential Whole Loans have low LTV's and are comprised of 2,761 adjustable and fixed-rate Non-QM and investor mortgages. The following table presents certain information about our Residential Whole Loans investment portfolio at September 30, 2023 (dollars in thousands): 

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																		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%						39						$	21,880					66.3		%				758						9.1						27.6						2.9		%
3.01% – 4.00%						361						196,884						67.0		%				760						8.2						28.0						3.7		%
4.01% – 5.00%						1,134						384,437						64.8		%				750						6.8						25.5						4.5		%
5.01% – 6.00%						813						322,376						66.0		%				743						6.1						26.2						5.5		%
6.01% – 7.00%						321						120,933						67.2		%				743						4.8						26.9						6.5		%
7.01% - 8.00%						69						23,865						60.6		%				734						4.1						23.1						7.4		%
8.01% - 9.00%						24						7,630						55.5		%				744						4.3						24.0						8.6		%
Total						2,761						$	1,078,005					65.7		%				749						6.6						26.3						4.9		%

(1)The original FICO score is not available for 210 loans with a principal balance of approximately $64.6 million at September 30, 2023. 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 four Residential Bridge Loans left in the portfolio at September 30, 2023 (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%						2						$	1,822					67.5		%				0.0						8.7		%
9.01% – 11.00%						1						849						90.5		%				0.0						10.0		%
11.01% – 13.00%						1						420						70.0		%				0.0						11.3		%
Total						4						$	3,091					74.2		%				0.0						9.4		%

(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 September 30, 2023 (dollars in thousands):

						Residential Whole Loans																		Bridge Loans
						No of Loans						Principal						Fair Value						No of Loans						Principal						Fair Value
Current						2,707						$	1,048,261					$	959,343					—						$	—					$	—
1-30 days						23						10,407						9,617						—						—						—
31-60 days						—						—						—						—						—						—
61-90 days						11						8,155						7,696						—						—						—
90+ days						20						11,182						10,322						4						3,091						2,782
Total						2,761						$	1,078,005					$	986,978					4						$	3,091					$	2,782

Residential Whole Loans in Non-Accrual Status

As of September 30, 2023, there were twenty Non-QM loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $11.2 million and a fair value of $10.3 million. These non-performing loans represent approximately 1.0% of the total outstanding principal balance. No allowance or provision for credit losses was recorded as of and for the three and nine months ended September 30, 2023, since the valuation adjustment, if any, would be reflected in the

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fair value of these loans. We stopped accruing interest income for these loans when they became contractually 90 days delinquent.     

    As of September 30, 2023, there were four Residential Bridge Loans carried at fair value in non-accrual status with an unpaid principal balance of approximately $3.1 million and a fair value of $2.8 million. No allowance and provision for credit losses was recorded for loans carried at fair value as of and for the three and nine months ended September 30, 2023, 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 September 30, 2023, the Company had one real estate owned ("REO") property with an aggregate carrying value of $2.3 million related to a foreclosed Residential Whole Loan. 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 Sheets.

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 September 30, 2023 (fair value dollars in thousands):

 

												Weighted Average
Category						Fair Value						Purchase Price						Life (Years)						Original  LTV1						Original FICO1						60+ Day Delinquent						CPR
Prime						$	22,222					$	90.81					8.5						69.3		%				732						0.5		%				14.6		%
Alt-A						10,899						49.55						18.6						81.3		%				661						17.5		%				6.0		%
Total						$	33,121					$	77.23					11.8						73.3		%				708						6.1		%				11.8		%

(1) For any Non-Agency RMBS security for which the original LTV and original FICO score was not available, the minimum FICO score and maximum LTV allowed as disclosed per offering documents was substituted in the above calculation.

Agency RMBS Portfolio

 

The following table summarizes our Agency portfolio by investment category as of September 30, 2023 (dollars in thousands):

			Principal Balance						Amortized Cost						Fair Value						Net Weighted Average Coupon
Agency RMBS IOs and IIOs(1)			N/A						$	68					$	61					—		%
Agency RMBS IOs and IIOs accounted for as derivatives(1)			N/A						N/A						834						1.3		%
Total			$	—					$	68					$	895					1.1		%

(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.

Non-Agency CMBS

The following table presents certain characteristics of our Non-Agency CMBS portfolio as of September 30, 2023 (dollars in thousands):

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												Principal												Weighted Average
Type						Vintage						Balance						Fair Value						Life (Years)						Original LTV
Conduit:
						2006-2009						$	68					$	65					1.0						88.7		%
						2010-2020						14,982						9,589						4.9						62.4		%
												15,050						9,654						4.9						62.5		%
Single Asset:
						2010-2020						73,509						44,552						2.4						66.1		%
Total												$	88,559					$	54,206					2.9						65.4		%

Commercial Real Estate Investments

We are continuing to transition out of our commercial loan investments. The following table presents our commercial loan investments as of September 30, 2023 (dollars in thousands):

Loan

Loan Type

Principal Balance

Fair Value

Original LTV

Interest Rate

Maturity Date

Extension Option

Collateral

Geographic Location

CRE 4

Interest-Only First Mortgage

22,204

22,071

63%

1-Month SOFR plus 3.38%

8/6/2025(1)

None

Retail

CT

CRE 5

Interest-Only First Mortgage

24,535

24,061

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

NY

CRE 6

Interest-Only First Mortgage

13,207

12,952

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

CA

CRE 7

Interest-Only First Mortgage

7,259

7,118

62%

1-Month SOFR plus 4.20%

5/6/2025(2)

None

Hotel

IL, FL

SBC 3(3)

Interest-Only First Mortgage

12,500

12,499

49%

1-Month SOFR plus 5.50%

10/4/2023

None

Nursing Facilities

CT

$

79,705

$

78,701

(1) In August 2022, the CRE 4 loan was extended by three years through August 6, 2025, with a principal pay down of $16.2 million.

(2) In November 2023, the CRE 5, 6, and 7 loans were each extended through May 6, 2025.

(3) In January 2023, the SBC 3 loan was partially paid down by $862 thousand to bring the unpaid principal balance to $13.5 million, the maturity date was extended through May 5, 2023 for a 50-bps extension fee and the margin was increased from 4.47% to 5.00%. In May 2023, the SBC 3 loan was partially paid down by $750 thousand to bring the unpaid principal to $12.8 million, the maturity date was extended through August 4, 2023, and the margin was increased from 5.00% to 5.50%. In July 2023, the SBC 3 loan was partially paid down by $250 thousand to bring the unpaid principal balance to $12.5 million, and the maturity date was extended through October 4, 2023 for a 25 bps extension fee. In October 2023, the SBC 3 loan was partially paid down by $250 thousand to bring the unpaid principal to $12.3 millions and the maturity date was extended to December 31, 2023 for a 25 bps extension fee.

Non-Performing Commercial Loans

As of September 30, 2023, there are no Commercial Loans that are non-performing.

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 September 30, 2023, based on fair value (dollars in thousands):

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			Non-Agency RMBS															Non-Agency CMBS
			Concentration						Fair Value									Concentration						Fair Value
California			33.6		%				$	11,130					California			51.3		%				$	27,803
Florida			13.5		%				4,461						Bahamas			24.8		%				13,425
New York			5.8		%				1,907						Texas			5.1		%				2,782
New Jersey			3.3		%				1,104						Pennsylvania			2.7		%				1,474
Georgia			3.6		%				1,198						New York			2.6		%				1,411

 

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 September 30, 2023, based on principal balance, is located (dollars in thousands): 

			Residential Whole Loans															Residential Bridge Loans
			State Concentration						Principal Balance									State Concentration						Principal Balance
California			67.8		%				$	731,058					California			56.7		%				$	1,754
New York			9.0		%				96,757						New York			43.3		%				1,337
Texas			4.8		%				51,407						Total			100.0		%				$	3,091
Florida			3.9		%				42,157
Georgia			3.3		%				35,297
Other			11.2		%				121,329
Total			100.0		%				$	1,078,005

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Financing Activity

     The Company will continue to look to expand and diversify our financing sources, especially those sources that provide an alternative to short-term repurchase agreements with less onerous 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 September 30, 2023, the contractual haircuts required under repurchase agreements on our investments were as follows:

			Minimum						Maximum
Short-Term Borrowings
Agency RMBS IOs			25%						25%
Non-Agency RMBS			—%						—%
Long-Term Borrowings
Non-Agency CMBS and Non-Agency RMBS Facility
Non-Agency RMBS			25%						50%
Non-Agency CMBS			30%						60%
Other Securities			35%						48%
Residential Whole Loan Facility
Residential Whole Loans(1)			—%						—%
Commercial Whole Loan Facility
Commercial Loans(2)			22%						32%

(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.

Residential Whole Loan Facility

The facility was extended on October 12, 2023 and matures on March 29, 2024. It bears interest at a rate of 1-Month Term SOFR plus 2.25%, with a SOFR floor of 0.25%.

We finance our Non-QM residential whole loans under this facility. As of September 30, 2023, we had outstanding borrowings of $4.2 million. The borrowing is secured by Non-QM residential whole loans with a fair value of $4.3 million, Residential Bridge Loans with a fair value of $2.8 million and one REO property with a carrying value of $2.3 million as of September 30, 2023.

Non-Agency CMBS and Non-Agency RMBS facility

The facility was paid off in full in May 2023 and replaced with a facility from a different counterparty which matures in May 2024. It bears a current weighted average interest rate of 1-Month Term SOFR plus 2.50%. As of September 30, 2023, the outstanding balance under this facility was $54.9 million. The borrowing is secured by investments with an estimated fair market value of $90.8 million as of September 30, 2023.

Commercial Whole Loan Facility

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The facility was extended on October 12, 2023 and matures on March 29, 2024. It bears interest at a rate of 1-Month Term SOFR plus 2.25%. As of September 30, 2023, the outstanding balance under this facility was $48.0 million. The borrowing is secured by performing commercial loans, with an estimated fair market value of $66.2 million as of September 30, 2023.

Fixed Rate Term Financing Facility

On July 25th, the Company replaced an existing short-term repurchase financing facility with Credit Suisse AG (UBS) with a new two-year term, $65 million fixed rate, non-mark-to-market, syndicated repurchase agreement, in a securitized form. As a result, the Company no longer has any financing arrangements with Credit Suisse AG (UBS) as a counterparty. As of September 30, 2023, the outstanding balance under this facility was $62.4 million, net of deferred financing costs, and is collateralized by our retained Arroyo bonds with an estimated fair market value of $134.7 million which are eliminated in consolidation as of September 30, 2023.

Repurchase Agreements

 

At September 30, 2023, we had outstanding borrowings under four of our repurchase agreements. The following table summarizes certain characteristics of our repurchase agreements at September 30, 2023 (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						$	351					5.98		%				2
Total short term borrowings						351						5.98		%				2
Long Term Borrowings:
Non-Agency CMBS and Non-Agency RMBS Facility
Non-Agency CMBS (1)						31,621						7.79		%				215
Non-Agency RMBS						77,751						10.80		%				585
Other Securities						8,860						8.09		%				215
Subtotal						118,232						9.79		%				458
Residential Whole Loan Facility
Residential Whole Loans (2)						2,562						7.56		%				25
Residential Bridge Loans (2)						1,641						7.56		%				25
Commercial Whole Loan Facility
Commercial Loans						48,032						7.56		%				34
Total long term borrowings						170,467						9.11		%				328
Repurchase agreements borrowings						$	170,818					9.10		%				327
Less unamortized debt issuance costs						908						N/A						N/A
Repurchase agreement borrowings, net						$	169,910					9.10		%				327

(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 September 30, 2023, we had outstanding repurchase agreement borrowings with the following counterparties: 

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(dollars in thousands) Repurchase Agreement Counterparties						Amount Outstanding						Percent of Total Amount Outstanding						Company Investments Held as Collateral						Counterparty Rating(1)
WMC RR 2023-1 Trust						$	63,284					37.0		%				$	60,883					Unrated (2)
Goldman Sachs Bank USA						55,299						32.4		%				91,127						A+
Atlas Securitized Products Investments 2, L.P.						48,032						28.1		%				66,201						Unrated (3)
Atlas Securitized Products, L.P.						4,203						2.5		%				9,380						Unrated (3)
Total						$	170,818					100.0		%				$	227,591

(1)The counterparty ratings presented above are the long-term issuer credit ratings as rated at September 30, 2023 by S&P.

(2)WMC RR 2023-1 Trust was established during the three months ended September 30, 2023 and is a syndicated repurchase agreement, in a securitized form, collateralized by our retained Arroyo bonds. This Trust is currently unrated as it has not operated for a sufficient period of time to achieve a credit rating.

(3)    Affiliates of Apollo purchased a significant portion of the Securitized Products Group from Credit Suisse. A majority of the assets and professionals associated with the transaction are now part of or managed by ATLAS SP Partners, a new standalone credit firm focused on asset-backed financing and capital markets solutions. The firm needs more time operating to achieve a credit rating and, therefore, is currently unrated.

The following table presents our average repurchase agreement borrowings, excluding unamortized debt issuance costs, by type of collateral pledged for the three and nine months ended September 30, 2023 (dollars in thousands):

Collateral						Three Months Ended September 30, 2023						Nine Months Ended September 30, 2023
Agency RMBS						$	296					$	287
Non-Agency RMBS(1)						70,673						66,072
Non-Agency CMBS(1)						33,408						40,982
Residential Whole Loans						4,188						4,498
Commercial Loans						48,032						44,516
Other securities						8,861						12,849
Total						$	165,458					$	169,204
Maximum borrowings during the period(2)						$	177,644					$	190,356

(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 September 30, 2023. We were in compliance with the terms of such financial tests as of September 30, 2023.

Securitized Debt

Residential Mortgage-Backed Notes

Arroyo Trust 2019-2

The following table summarizes the consolidated Arroyo Trust 2019's issued mortgage-backed notes at September 30, 2023 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			$	142,973		3.3%			$	142,973		4/25/2049
Class A-2			7,668			3.5%			7,668			4/25/2049
Class A-3			12,148			3.8%			12,148			4/25/2049
Class M-1			25,055			4.8%			25,055			4/25/2049
Subtotal			$	187,844					$	187,844
Less: Unamortized deferred financing costs			N/A						1,932
Total			$	187,844					$	185,912

Arroyo Trust 2020-1

The following table summarizes the consolidated Arroyo Trust 2020's issued mortgage-backed notes at September 30, 2023 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			$	66,276		1.7%			$	66,276		3/25/2055
Class A-1B			7,865			2.1%			7,865			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			$	117,361					$	117,361
Less: Unamortized deferred financing costs			N/A						1,176
Total			$	117,361					$	116,185

Arroyo Trust 2022-1

The following table summarizes the consolidated Arroyo Trust 2022-1's issued mortgage-backed notes at September 30, 2023 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			$	196,149		2.5%			$	174,066		12/25/2056
Class A-1B			82,942			3.3%			68,578			12/25/2056
Class A-2			21,168			3.6%			15,527			12/25/2056
Class A-3			28,079			3.7%			19,864			12/25/2056
Class M-1			17,928			3.7%			11,374			12/25/2056
Total			$	346,266					$	289,409

Arroyo Trust 2022-2

The following table summarizes the consolidated Arroyo Trust 2022-2's issued mortgage-backed notes at September 30, 2023 which is classified as "Securitized debt, net" on the Consolidated Balance Sheets (dollars in thousands):

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Classes			Principal Balance			Coupon			Fair Value			Contractual Maturity
Issued Mortgage-Backed Notes
Class A-1			$	243,033		5.0%			$	230,646		7/25/2057
Class A-2			20,687			5.0%			19,097			7/25/2057
Class A-3			25,208			5.0%			23,219			7/25/2057
Class M-1			17,694			5.0%			13,277			7/25/2057
Total			$	306,622					$	286,239

Commercial Mortgage-Backed Notes

We hold a controlling financial variable interest in CSMC USA and are required to consolidate the CMBS VIE. Refer to Note 7, "Financings" for details. The following table summarizes the consolidated CSMC USA's commercial mortgage pass-through certificates at September 30, 2023 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		%	$	100,388		9/11/2025
Class A-2			531,700			4.0		%	453,714			9/11/2025
Class B			136,400			4.2		%	107,723			9/11/2025
Class C			94,500			4.3		%	71,132			9/11/2025
Class D			153,950			4.4		%	109,772			9/11/2025
Class E			180,150			4.4		%	96,059			9/11/2025
Class F			153,600			4.4		%	62,063			9/11/2025
Class X-1(1)			n/a			0.5		%	4,785			9/11/2025
Class X-2(1)			n/a			—		%	994			9/11/2025
			$	1,370,691					$	1,006,630

(1) Class X-1 and X-2 are interest-only classes with notional balances of $652.1 million and $733.5 million as of September 30, 2023, 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 bond represents a controlling financial interest, which resulted in consolidation of the trust. The bond had a fair market value of $6.0 million at September 30, 2023, and our exposure to loss is limited to our ownership interest in this bond.

Convertible Senior Unsecured Notes

2024 Notes

As of September 30, 2023, 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 September 30, 2023, our total non-recourse financing is comprised of $877.7 million of securitized debt issued in connection with our four Residential Whole Loan securitizations and $1.0 billion of securitized debt from owning a Non-Agency CMBS bond with a fair value of $6.0 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)			September 30, 2023						December 31, 2022
Recourse and non-recourse financing			$	2,139,035					$	2,335,323
Non-recourse financing
Arroyo 2019-2			185,912						213,885
Arroyo 2020-1			116,185						124,934
Arroyo 2022-1			289,409						318,219
Arroyo 2022-2			286,239						324,035
CMSC USA			1,006,630						1,077,611
Total recourse financing			$	254,660					$	276,639
Stockholders' equity			$	77,986					$	94,804
Recourse leverage			3.3x						2.9x

Hedging Activity

The following tables summarize the hedging activity during the nine months ended September 30, 2023 (dollars in thousands):

			Notional Amount at												Settlements, Terminations or Expirations						Notional Amount at
Derivative Instrument			December 31, 2022						Acquisitions												September 30, 2023
Fixed pay interest rate swaps			$	158,000					$	—					$	(76,000)					$	82,000
Total derivative instruments			$	158,000					$	—					$	(76,000)					$	82,000

			Fair Value at						Acquisitions						Settlements, Terminations or Expirations						Realized Gains / Losses						Mark-to-market						Fair Value at
Derivative Instrument			December 31, 2022																														September 30, 2023
Fixed pay interest rate swaps			$	(60)					$	—					$	992					$	(992)					$	(785)					$	(845)
Total derivative instruments			$	(60)					$	—					$	992					$	(992)					$	(785)					$	(845)

Dividends

During the nine months ended September 30, 2023, we declared dividends totaling $1.05 per share generating a dividend yield of approximately 14.9% based on the stock closing price of $9.40 on September 30, 2023.

 

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 seeking alternative financing arrangements to preserve long-term shareholder value. The decrease in book value from $14.69 as of June 30, 2023, to $12.89 as of September 30, 2023, was primarily driven by the decreased value of our residential whole loan and securitized commercial loan portfolios of $50.4 million and $12.7 million, respectively.

Pending Merger Agreement

On June 28, 2023, the Company announced that Terra Property Trust, Inc. (“TPT”), an externally managed real estate investment trust (“REIT”) that originates, invests in, and manages loans and assets secured by commercial real estate (“CRE”), and the Company entered into a definitive merger agreement (the "TPT Merger Agreement") under which TPT and WMC agreed to combine.

On August 8, 2023, the Company terminated the TPT Merger Agreement, and concurrently entered into an Agreement and Plan of Merger (the “MITT Merger Agreement”), dated August 8, 2023, by and among AG Mortgage Investment Trust, Inc., a Maryland corporation (“MITT"), AGMIT Merger Sub, LLC, a Delaware limited liability company (“Merger Sub”), the Company, and, solely for the purposes of Section 3.3(a), Section 3.3(i), Article V, Section 6.13, Section 7.2, Section 7.3 and Article IX therein, AG REIT Management, LLC, a Delaware limited liability company (“MITT Manager”),pursuant to which the Company will merge with and into Merger Sub, with Merger Sub surviving as a wholly owned subsidiary of MITT (the “Merger”). Due to the termination of the TPT Merger Agreement, the Company was obligated to pay or cause to be paid to TPT a termination fee of $3 million. Concurrently with the execution of the MITT Merger Agreement, MITT paid the $3 million termination fee directly to TPT on behalf of the Company on August 8, 2023.

Pursuant to, and subject to the terms and conditions set forth in, the MITT Merger Agreement, each outstanding share of the Company’s common stock would be converted into the right to receive (i) 1.498 shares of MITT common stock and (ii) the per share portion of a cash payment from the MITT Manager equal to the lesser of $7 million or approximately 9.9% of the aggregate per share merger consideration (any difference between $7 million and such lower amount would be used to benefit the combined company post closing by offsetting reimbursable expenses that would otherwise be payable to the MITT Manager). Additionally, the MITT Manager, which would be the manager of the combined company, would waive $2.4 million of management fees in the first year post-closing. Cash will be paid in lieu of fractional shares of MITT common stock that would have been received as a result of the Merger.

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On November 7, 2023, the Company adjourned its special meeting of stockholders until December 5, 2023, at 9:00 a.m. Pacific Time, due to a lack of quorum and to allow further solicitation of proxies from the Company’s common stockholders for the approval of the merger at the special meeting.

At a special meeting of MITT stockholders held on November 7, 2023, MITT stockholders approved the issuance of

MITT’s common stock to be issued in connection with the proposed Merger.

The transaction has been approved by the Board of Directors of the Company and is subject to customary closing conditions. The transaction is expected to close during the fourth quarter of 2023.

Results of Operations 

Comparison of the three months ended September 30, 2023 to the three months ended September 30, 2022.

General

During the third quarter of 2023, we continued to take actions to strengthen our balance sheet.

During the three months ended September 30, 2023, we received approximately $407 thousand from the repayment or paydown of Commercial Whole Loans, Non-Agency CMBS, and Other Securities, and $28.8 million from the sale or repayment of Residential Whole Loans, and Non-Agency RMBS. We also purchased $11.0 million of Non-Agency RMBS. Due to spread widening during the quarter, we experienced a decline in the fair value of our residential whole loan and mortgage backed securities investments. Overall, our net loss was $8.7 million, or $1.45 per basic and diluted weighted common share, for the three months ended September 30, 2023.

In contrast, for the three months ended September 30, 2022, we sold approximately $11.7 million of residential whole loans and repurchased $1.0 million aggregate principal amount outstanding of our 2022 Notes at par. Due to spread widening, we experienced a significant decline in the fair value of residential whole loan investments. This decline in fair value of $45.3 million was offset by $3.6 million of unrealized gains on derivatives due to our hedging activity. We also reduced the fair value of CRE 3, a commercial junior mezzanine loan by $18.1 million, as a senior lender consummated a foreclosure on the equity interest in the property. See Note 6 for further discussion. Overall, our net loss was $40.0 million, or $6.63 per basic and diluted weighted common share, for the three months ended September 30, 2022.

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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 September 30, 2023 and September 30, 2022 (dollars in thousands):

Three Months Ended September 30, 2023						Average Amortized Cost of Assets						Total Interest Income						Yield on Average Assets
Investments
Agency RMBS						$	65					$	4					24.41		%
Non-Agency CMBS						86,522						2,008						9.21		%
Non-Agency RMBS						31,903						450						5.60		%
Residential Whole Loans						1,122,987						12,732						4.50		%
Residential Bridge Loans						2,587						—						—		%
Commercial Loans						79,839						1,931						9.60		%
Securitized Commercial Loan						1,315,805						22,574						6.81		%
Other securities						18,889						439						9.22		%
Total investments						$	2,658,597					$	40,138					5.99		%
						Average Carrying Value						Total Interest Expense						Average Cost of Funds(1)
Borrowings
Repurchase agreements						$	165,458					$	3,797					9.10		%
Convertible senior unsecured notes, net						84,613						1,865						8.74		%
Securitized debt						2,256,492						31,314						5.51		%
Total borrowings						$	2,506,563					$	36,976					5.85		%
Net interest income and net interest margin(2)												$	3,162					0.47		%

Three Months Ended September 30, 2022						Average Amortized Cost of Assets						Total Interest Income						Yield on Average Assets
Investments
Agency RMBS						$	53					$	2					14.97		%
Non-Agency CMBS						109,898						2,336						8.43		%
Non-Agency RMBS						36,075						472						5.19		%
Residential Whole Loans						1,248,772						13,884						4.41		%
Residential Bridge Loans						5,585						28						1.99		%
Commercial Loans						191,929						1,540						3.18		%
Securitized Commercial Loan						1,288,238						22,099						6.81		%
Other securities						42,768						1,045						9.69		%
Total investments						$	2,923,318					$	41,406					5.62		%
						Average Carrying Value						Total Interest Expense						Average Cost of Funds(1)
Borrowings
Repurchase agreements						$	265,444					$	2,187					3.27		%
Convertible senior unsecured notes, net						109,329						2,402						8.72		%
Securitized debt						2,348,073						31,118						5.26		%
Total borrowings						$	2,722,846					$	35,707					5.20		%
Net interest income and net interest margin(2)												$	5,699					0.77		%

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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 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 September 30, 2023, and September 30, 2022, we earned interest income on our investments of approximately $40.1 million and $41.4 million, respectively. The decrease of approximately $1.3 million was mainly due to the sale of mortgage-backed securities in the last quarter of 2022 and the first three quarters of 2023, the effect of which was partially offset by increased interest rates.

Interest Expense

Interest expense increased from $35.7 million for the three months ended September 30, 2022 to $37.0 million for the three months ended September 30, 2023. The increase in interest expense was primarily attributable to increased borrowing costs on our repurchase facilities due to increasing market interest rates, offset by a decrease in interest expense incurred when compared to the same period in the prior year as the balance on our outstanding repurchase agreements declined period over period.

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 September 30, 2023 and September 30, 2022 (dollars in thousands):

 

			For the three months ended September 30, 2023																								For the three months ended September 30, 2022
			Proceeds (Payments)						Gross Gains						Gross Losses						Net Gain  (Loss)						Proceeds (Payments)						Gross Gains						Gross Losses						Net Gain (Loss)
Residential Whole Loans			$	—					$	—					$	(29)					$	(29)					$	11,736					$	43					$	(76)					$	(33)
Convertible senior unsecured notes(1)			—						—						—						—						(1,000)						—						(2)						(2)
Total			$	—					$	—					$	(29)					$	(29)					$	10,736					$	43					$	(78)					$	(35)

(1)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 September 30, 2023						Three months ended September 30, 2022
Agency RMBS			$	(2)					$	(8)
Non-Agency CMBS			(5,344)						(628)
Non-Agency RMBS			(878)						(2,506)
Residential whole loans			(21,026)						(45,327)
Residential bridge loans			(1)						25
Commercial Loans			143						(17,729)
Securitized Commercial Loan			(19,735)						(78,046)
Other securities			396						(2,409)
Securitized debt			39,085						103,046
Total			$	(7,362)					$	(43,582)

Gain (loss) on derivatives, net

    As of September 30, 2023, we had interest rate swaps with a notional amount of $82.0 million and no 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 September 30, 2023 and September 30, 2022 (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 September 30, 2023
Interest rate swaps						$	—					$	1,008					$	—					$	(777)					$	846					$	1,077
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives						—						—						(14)						70						24						80
Total						$	—					$	1,008					$	(14)					$	(707)					$	870					$	1,157
Three months ended September 30, 2022
Interest rate swaps						$	(3,371)					$	3,423					$	—					$	4,790					$	298					$	5,140
Interest rate swaptions						(161)						—						—						—						—						(161)
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives						—						—						(5)						(54)						16						(43)
Credit default swaps						(273)						—						—						283						—						10
TBAs						1,319						—						—						(1,383)						—						(64)
Total						$	(2,486)					$	3,423					$	(5)					$	3,636					$	314					$	4,882

(1) Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.

Other, net

For the three months ended September 30, 2023 and September 30, 2022, "Other, net" was income of $181 thousand and a loss of $61 thousand, respectively. The balance is mainly comprised of income on cash balances, miscellaneous net

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interest income (expense) on cash collateral for our repurchase agreements and derivatives, and miscellaneous fees and expenses on residential mortgage loans.

Expenses

 

Management Fee

 

We incurred management fee expense of approximately $974 thousand and $850 thousand for the three months ended September 30, 2023 and September 30, 2022, respectively. Although the Management Fee remained constant period over period, our Manager waived 25% of the calculated Management Fee in 2022, which was not extended into 2023. The management fee incurred for the three months ended September 30, 2023 reflects a reduction in the equity basis for which the management fee is calculated from the comparative period.

The management fees, expense reimbursements, and the relationship between our Manager and the Company 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 $353 thousand and $343 thousand for the three months ended September 30, 2023, and September 30, 2022, respectively. Other operating costs comprise bank fees, trustee fees, and asset management/loan servicing fees for loans acquired serving released.

Transaction Costs

We incurred transaction costs of $3.0 million and $2.6 million for the three months ended September 30, 2023 and September 30, 2022, respectively. The amounts in the current and prior period reflect costs incurred in connection with the strategic review process.

General and Administrative Expenses

 

We incurred general and administrative expenses of approximately $4.5 million and $2.8 million for the three months ended September 30, 2023, and September 30, 2022, respectively. This increase is the result of the recognition of the $3.0 million termination fee paid to Terra Property Trust, Inc. ("TPT") during the third quarter of 2023 on August 8, 2023 for the termination of the merger agreement entered into by and among TPT, WMC and other parties thereto. This termination fee of $3.0 million was recognized as an expense in General and Administrative Expenses. Simultaneously, we recognized $3.0 million in Other Income (Loss), as the termination fee was paid on our behalf by MITT. This increase was partially offset by a decrease in professional fees related to expected reductions and the elimination of certain audit and compliance costs.

Comparison of the nine months ended September 30, 2023 to the nine months ended September 30, 2022.

General

During the first three quarters of 2023, we continued to make progress towards strengthening our balance sheet, improving liquidity, and the transition of our portfolio to residential investments.

During the nine months ended September 30, 2023, we acquired $11.0 million in Non-Agency RMBS securities and $4.7 million in Other Securities. We sold $15.3 million of Other Securities, $8.8 million in Commercial Loans, and recognized $20.6 million in basis recovery on the maturity of one of our CMBS securities. These sales combined with the CMBS maturity resulted in the recognition of a $83.9 million realized loss, offset by an $76.1 million unrealized gain, which was primarily comprised of the reversal of previously-recognized unrealized losses on the sale of the CRE 3 Commercial Loan. An increase in interest expense and transaction costs of $5.7 million incurred in connection with the strategic review process were the primary drivers of a net loss of $10.8 million, or $1.80 per basic and diluted weighted common share for the nine months ended September 30, 2023. During the third quarter of 2023, there was a $3.0 million termination fee paid to Terra Property Trust, Inc. ("TPT") for the for the termination of the merger agreement entered into by and among TPT, WMC and other parties

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thereto on August 8, 2023. This termination fee was recognized as an expense in General and Administrative Expenses. Simultaneously, we recognized $3.0 million in Other Income (Loss), as the termination fee was paid on our behalf by MITT.

In contrast, for the nine months ended September 30, 2022, we acquired $405.3 million of residential whole loans, sold $42.3 million of investments, including Non-Agency RMBS and CMBS, sold $11.7 million in residential whole loans, realized a gain on the sale of a REO hotel of $12.2 million, and repurchased $1.0 million aggregate principal amount of our existing 2022 Notes at par. We also reduced the fair value of CRE 3, a commercial junior mezzanine loan by $18.1 million, as a senior lender consummated a foreclosure on the equity interest in the property. See Note 6 for further discussion. Also, due to spread widening, we experienced a significant decline in the fair value of our residential whole loan investments. This decline in fair value of $125.5 million, coupled with transaction costs incurred in the securitizations of Arroyo 2022-1 and Arroyo 2022-2 of $5.6 million were key contributors to the generation of a net loss of $88.3 million, or $14.63 per basic and diluted weighted common share for the nine months ended September 30, 2022.

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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 nine months ended September 30, 2023 and September 30, 2022 (dollars in thousands):

Nine Months Ended September 30, 2023						Average Amortized Cost of Assets						Total Interest Income						Yield on Average Assets
Investments
Agency RMBS						$	59					$	10					22.66		%
Non-Agency CMBS						89,400						6,240						9.33		%
Non-Agency RMBS						31,129						1,309						5.62		%
Residential Whole Loans						1,151,875						39,025						4.53		%
Residential Bridge Loans						2,929						24						1.10		%
Commercial Loans						80,038						5,520						9.22		%
Securitized Commercial Loan						1,301,538						67,355						6.92		%
Other securities						23,839						1,734						9.73		%
Total investments						$	2,680,807					$	121,217					6.05		%
						Average Carrying Value						Total Interest Expense						Average Cost of Funds(1)
Borrowings
Repurchase agreements						$	169,204					$	9,852					7.78		%
Convertible senior unsecured notes, net						84,204						5,595						8.88		%
Securitized debt						2,278,038						94,243						5.53		%
Total borrowings						$	2,531,446					$	109,690					5.79		%
Net interest income and net interest margin(2)												$	11,527					0.57		%

Nine Months Ended September 30, 2022						Average Amortized Cost of Assets						Total Interest Income						Yield on Average Assets
Investments
Agency RMBS						$	59					$	9					20.39		%
Non-Agency CMBS						142,362						7,436						6.98		%
Non-Agency RMBS						43,815						1,663						5.07		%
Residential Whole Loans						1,165,929						34,712						3.98		%
Residential Bridge Loans						5,688						64						1.50		%
Commercial Loans						192,079						4,046						2.82		%
Securitized Commercial Loan						1,274,894						65,957						6.92		%
Other securities						45,340						2,738						8.07		%
Total investments						$	2,870,166					$	116,625					5.43		%
						Average Carrying Value						Total Interest Expense						Average Cost of Funds(1)
Borrowings
Repurchase agreements						$	402,870					$	8,288					2.75		%
Convertible senior unsecured notes, net						113,670						7,499						8.82		%
Securitized debt						2,129,146						84,621						5.31		%
Total borrowings						$	2,645,686					$	100,408					5.07		%
Net interest income and net interest margin(2)												$	16,217					0.76		%

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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 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 nine months ended September 30, 2023, and September 30, 2022, we earned interest income on our investments of approximately $121.2 million and $116.6 million, respectively. The increase of approximately $4.6 million was mainly due to an increase in interest rates.

Interest Expense

Interest expense increased from $100.4 million for the nine months ended September 30, 2022 to $109.7 million for the nine months ended September 30, 2023. The increase in interest expense was primarily a result increased borrowing costs on our repurchase facilities due to increasing market interest rates, offset by lower repurchase borrowings resulting from a smaller investment portfolio.

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 nine months ended September 30, 2023 and September 30, 2022 (dollars in thousands):

 

			For the nine months ended September 30, 2023																								For the nine months ended September 30, 2022
			Proceeds (Payments)						Gross Gains						Gross Losses						Net Gain  (Loss)						Proceeds (Payments)						Gross Gains						Gross Losses						Net Gain (Loss)
Non-Agency CMBS			$	—					$	—					$	(1,239)					$	(1,239)					$	10,152					$	—					$	(43,934)					$	(43,934)
Non-Agency RMBS			—						—						(48)						(48)						27,729						255						(1,425)						(1,170)
Other securities			15,324						649						(2,028)						(1,379)						4,406						—						(478)						(478)
Residential Whole-Loans			—						—						(29)						(29)						11,736						43						(76)						(33)
Commercial Loans(1)			8,776						—						(81,223)						(81,223)						—						—						—						—
Disposition of REO(2)			(28)						—						(28)						(28)						54,681						12,198						—						12,198
Convertible senior unsecured notes(3)			—						—						—						—						(11,689)						—						(134)						(134)
Total			$	24,072					$	649					$	(84,595)					$	(83,946)					$	97,015					$	12,496					$	(46,047)					$	(33,551)

(1)Realized gains/losses recognized on the sale of the CRE 3 loan in February 2023. See Note 6, "Commercial Loans" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional details.

(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" to the Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for additional 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): 

			Nine months ended September 30, 2023						Nine months ended September 30, 2022
Agency RMBS			$	—					$	(59)
Non-Agency CMBS			(10,314)						42,869
Non-Agency RMBS			(750)						(8,420)
Residential Whole Loans			(14,582)						(125,482)
Residential Bridge Loans			7						(58)
Commercial Loans			80,560						(19,876)
Securitized Commercial Loans			(93,785)						(203,828)
Other securities			1,939						(8,677)
Securitized debt			113,025						257,231
Total			$	76,100					$	(66,300)

Gain (loss) on derivatives, net

    As of September 30, 2023, we had interest rate swaps with a notional amount of $82.0 million, and no 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 nine months ended September 30, 2023 and September 30, 2022 (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
Nine months ended September 30, 2023
Interest rate swaps						$	—					$	(992)					$	—					$	(785)					$	2,832					$	1,055
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives						—						—						(16)						135						47						166
Total						$	—					$	(992)					$	(16)					$	(650)					$	2,879					$	1,221
Nine months ended September 30, 2022
Interest rate swaps						$	(3,371)					$	14,744					$	—					$	3,670					$	(255)					$	14,788
Interest rate swaptions						(161)						—						—						—						—						(161)
Agency and Non-Agency Interest-Only Strips— accounted for as derivatives						—						—						(120)						(270)						160						(230)
Credit default swaps						(242)						—						—						393						—						151
TBAs						2,051						—						—						—						—						2,051
Total						$	(1,723)					$	14,744					$	(120)					$	3,793					$	(95)					$	16,599

(1)Contractual interest income (expense), net on derivative instruments includes interest settlement paid or received.

Other, net

 

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For the nine months ended September 30, 2023 and September 30, 2022, "Other, net" was an income of $424 thousand and a loss of $252 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.

Expenses

 

Management Fee

 

We incurred management fee expense of approximately $2.9 million and $3.0 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. The decline in management fees reflects a reduction in the equity basis from which the management fee is calculated.

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 $932 thousand and $901 thousand for the nine months ended September 30, 2023, and September 30, 2022, 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 $5.7 million and $5.6 million for the nine months ended September 30, 2023 and September 30, 2022, respectively. Transaction costs for the nine months ended September 30, 2023 represent expenses incurred during the strategic review process during 2023, while transaction costs for the nine months ended September 30, 2022 primarily represent costs related to Arroyo 2022-1 and Arroyo 2022-2 securitizations.

General and Administrative Expenses

 

We incurred general and administrative expenses of approximately $9.6 million and $7.6 million for the nine months ended September 30, 2023, and September 30, 2022, respectively. This increase is the result of the recognition of the $3.0 million termination fee paid to Terra Property Trust, Inc. ("TPT") for the termination of the Agreement and Plan of Merger during the third quarter of 2023 on August 8, 2023. This increase was partially offset by a decrease in professional fees related to expected reductions and the elimination of certain audit and compliance costs.

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

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

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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.

   

The table below reconciles Net Income (Loss) to Distributable Earnings for the three and nine months ended September 30, 2023 and September 30, 2022:

(dollars in thousands)						Three months ended September 30, 2023						Three months ended September 30, 2022						Nine months ended September 30, 2023						Nine months ended September 30, 2022
Net loss attributable to common stockholders and participating securities						$	(8,705)					$	(40,010)					$	(10,771)					$	(88,250)
Income tax provision						—						266						—						276
Net loss before income taxes						(8,705)						(39,744)						(10,771)						(87,974)
Adjustments:
Investments:
Net unrealized (gain) loss on investments and securitized debt						7,362						43,582						(76,100)						66,300
Net realized loss on investments						29						33						83,946						36,902
Realized loss on foreign currency transactions						—						1						—						1
One-time transaction costs						3,033						2,632						5,660						5,708
Derivative Instruments:
Net realized (gain) loss on derivatives						(1,008)						(929)						992						(12,982)
Net unrealized (gain) loss on derivatives						707						(3,636)						650						(3,793)
Other:
Realized loss on extinguishment of convertible senior unsecured notes						—						2						—						134
Amortization of discount on convertible senior unsecured notes						172						209						515						648
Non-cash stock-based compensation expense						101						100						301						335
Total adjustments						10,396						41,994						15,964						93,253
Distributable Earnings						$	1,691					$	2,250					$	5,193					$	5,279

 

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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 September 30, 2023						Three months ended September 30, 2022						Nine months ended September 30, 2023						Nine months ended September 30, 2022
Net interest income						$	3,162					$	5,699					$	11,527					$	16,217
Interest income from IOs and IIOs accounted for as derivatives						10						11						31						40
Net interest income (expense) from interest rate swaps						846						298						2,832						(255)
Adjusted net interest income						4,018						6,008						14,390						16,002
Total expenses						(5,816)						(6,645)						(16,095)						(17,069)
Non-cash stock-based compensation						101						100						301						335
One-time transaction costs						3,033						2,632						5,660						5,708
Amortization of discount on convertible unsecured senior notes						172						209						515						648
Interest income on cash balances and other income (loss), net						181						(52)						424						(213)
Income attributable to non-controlling interest						2						(2)						(2)						(133)
Distributable Earnings						$	1,691					$	2,250					$	5,193					$	5,278

 

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, Arroyo 2022-1, and Arroyo 2022-2). Management believes 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 September 30, 2023						$	77,986					$	12.89
Adjustments to deconsolidate VIEs and reflect the Company's interest in the securities owned
Deconsolidation of VIEs assets						(2,011,891)						(332.57)
Deconsolidation of VIEs liabilities						1,892,277						312.80
Interest in securities of VIEs owned, at fair value						140,699						23.26
Economic Book Value at September 30, 2023						$	99,071					$	16.38

Adjusted Net Investment Income and Net Interest Margin

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Adjusted net investment income is a non-GAAP financial measure that is an adjustment to net income which excludes the net interest income for third-party consolidated VIEs, and includes premium amortization for interest rate swaps included in gain/loss on derivative instruments. Adjusted net investment income is used as an input when calculating net interest margin in the below tables and gives investors another view of portfolio performance. Adjusted net investment income may not be comparable to similar measures presented by other companies, as it is a non-GAAP financial measure that is not based on a comprehensive set of accounting rules or principles and therefore may be defined differently by other companies. Adjusted net investment income should be considered in addition to, not as a substitute for, or superior to, financial measures determined in accordance with GAAP.

Net interest margin is a non-GAAP financial measure calculated by dividing annualized adjusted net investment income for the period by adjusted total investments for the period. Net interest margin provides investors visibility into the Company’s profitability of interest income versus interest expense after excluding consolidating VIEs and adding the net effect of our interest rate swaps and derivatives. However, since net interest margin is an adjusted measure derived from net investment income (non-GAAP), and differs from net income (loss) as computed in accordance with GAAP, which may not be comparable to similar measures provided by other companies, it should be considered as supplementary to, and not as a substitute for, net income margin computed by net income (loss) in accordance with GAAP.

The following tables set forth certain information regarding our non-GAAP adjusted 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 and nine months ended September 30, 2023 and September 30, 2022 (dollars in thousands):

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Three Months Ended September 30, 2023						Average Amortized Cost of Assets(1)						Total Interest Income(2)						Yield on Average Assets
Investments
Agency RMBS						$	925					$	14					6.00		%
Non-Agency CMBS						86,522						2,008						9.21		%
Non-Agency RMBS						31,903						450						5.60		%
Residential Whole Loans						1,122,987						12,732						4.50		%
Residential Bridge Loans						2,587						—						—		%
Commercial Loans						79,839						1,931						9.60		%
Securitized Commercial Loan						1,315,805						22,574						6.81		%
Other securities						18,889						439						9.22		%
Total investments						2,659,457						40,148						5.99		%
Adjustments:
Securitized Commercial Loan from consolidated VIE						(1,315,805)						(22,574)						6.81		%
Investments in consolidated VIE eliminated in consolidation						14,316						225						6.24		%
Adjusted total investments						$	1,357,968					$	17,799					5.20		%
						Average Carrying Value						Total Interest Expense						Average Effective Cost of Funds
Borrowings
Repurchase agreements						$	165,458					$	3,797					9.10		%
Convertible senior unsecured notes, net						84,613						1,865						8.74		%
Securitized debt						2,256,492						31,314						5.51		%
Interest rate swaps						n/a						(846)						(0.13)		%
Total borrowings						2,506,563						36,130						5.72		%
Adjustments:
Securitized debt from consolidated VIE(3)						(1,295,836)						(21,764)						6.66		%
Adjusted total borrowings						$	1,210,727					$	14,366					4.71		%
Adjusted net investment income and net interest margin												$	3,433					1.00		%

(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 September 30, 2022						Average Amortized Cost of Assets(1)						Total Interest Income(2)						Yield on Average Assets
Investments
Agency RMBS						$	902					$	13					5.72		%
Non-Agency CMBS						109,898						2,336						8.43		%
Non-Agency RMBS						36,075						472						5.19		%
Residential whole loans						1,248,772						13,884						4.41		%
Residential bridge loans						5,585						28						1.99		%
Commercial Loans						191,929						1,540						3.18		%
Securitized Commercial Loan						1,288,238						22,099						6.81		%
Other securities						42,768						1,045						9.69		%
Total investments						2,924,167						41,417						5.62		%
Adjustments:
Securitized Commercial Loan from consolidated VIE						(1,288,238)						(22,099)						6.81		%
Investments in consolidated VIE eliminated in consolidation						14,079						220						6.20		%
Adjusted total investments						$	1,650,008					$	19,538					4.70		%
						Average Carrying Value						Total Interest Expense						Average Effective Cost of Funds
Borrowings
Repurchase agreements						$	265,444					$	2,187					3.27		%
Convertible senior unsecured notes, net						109,329						2,402						8.72		%
Securitized debt						2,348,073						31,118						5.26		%
Interest rate swaps						n/a						(298)						0.04		%
Total borrowings						2,722,846						35,409						5.05		%
Adjustments:
Securitized debt from consolidated VIE(3)						(1,270,756)						(21,132)						6.60		%
Adjusted total borrowings						$	1,452,090					$	14,277					3.90		%
Adjusted net investment income and net interest margin												$	5,261					1.26		%

(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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Nine months ended September 30, 2023						Average Amortized Cost of Assets(1)						Total Interest Income(2)						Yield on Average Assets
Investments
Agency RMBS						$	921					$	41					5.95		%
Non-Agency CMBS						89,400						6,240						9.33		%
Non-Agency RMBS						31,129						1,309						5.62		%
Residential whole loans						1,151,875						39,025						4.53		%
Residential bridge loans						2,929						24						1.10		%
Commercial Loans						80,038						5,520						9.22		%
Securitized Commercial Loan						1,301,538						67,355						6.92		%
Other securities						23,839						1,734						9.73		%
Total investments						2,681,669						121,248						6.05		%
Adjustments:
Securitized Commercial Loan from consolidated VIE						(1,301,538)						(67,355)						6.92		%
Investments in consolidated VIE eliminated in consolidation						14,196						671						6.32		%
Adjusted total investments						$	1,394,327					$	54,564					5.23		%
						Average Carrying Value						Total Interest Expense						Average Effective Cost of Funds
Borrowings
Repurchase agreements						$	169,204					$	9,852					7.78		%
Convertible senior unsecured notes, net						84,204						5,595						8.88		%
Securitized debt						2,278,038						94,243						5.53		%
Interest rate swaps						n/a						(2,832)						(0.15)		%
Total borrowings						2,531,446						106,858						5.64		%
Adjustments:
Securitized debt from consolidated VIE(3)						(1,289,428)						(64,801)						6.72		%
Adjusted total borrowings						$	1,242,018					$	42,057					4.53		%
Adjusted net investment income and net interest margin												$	12,507					1.20		%

(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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Nine months ended September 30, 2022						Average Amortized Cost of Assets(1)						Total Interest Income(2)						Yield on Average Assets
Investments
Agency RMBS						$	1,023					$	49					6.40		%
Non-Agency CMBS						142,362						7,436						6.98		%
Non-Agency RMBS						43,815						1,663						5.07		%
Residential whole loans						1,165,929						34,712						3.98		%
Residential bridge loans						5,688						64						1.50		%
Commercial Loans						192,079						4,046						2.82		%
Securitized Commercial Loan						1,274,894						65,957						6.92		%
Other securities						45,340						2,738						8.07		%
Total investments						2,871,130						116,665						5.43		%
Adjustments:
Securitized Commercial Loan from consolidated VIE						(1,274,894)						(65,957)						6.92		%
Investments in consolidated VIE eliminated in consolidation						13,966						659						6.31		%
Adjusted total investments						$	1,610,202					$	51,367					4.27		%
						Average Carrying Value						Total Interest Expense						Average Effective Cost of Funds
Borrowings
Repurchase agreements						$	402,870					$	8,288					2.75		%
Convertible senior unsecured notes, net						113,670						7,499						8.82		%
Securitized debt						2,129,146						84,621						5.31		%
Interest rate swaps						n/a						255						0.01		%
Total borrowings						2,645,686						100,663						5.09		%
Adjustments:
Securitized debt from consolidated VIE(3)						(1,264,942)						(62,940)						6.65		%
Adjusted total borrowings						$	1,380,744					$	37,723					3.65		%
Adjusted net investment income and net interest margin												$	13,644					1.13		%

(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.

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 and nine months ended September 30, 2023 and September 30, 2022: 

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(dollars in thousands)						Three months ended September 30, 2023						Three months ended September 30, 2022						Nine months ended September 30, 2023						Nine months ended September 30, 2022
Coupon interest income:
Agency RMBS						$	—					$	—					$	—					$	13
Non-Agency CMBS						1,657						1,949						5,234						7,050
Non-Agency RMBS						756						446						1,960						1,804
Residential Whole Loans						13,563						14,829						41,313						39,972
Residential Bridge Loans						—						28						24						64
Commercial Loans						1,898						1,540						5,421						4,046
Securitized Commercial Loan						15,510						15,510						46,023						46,023
Other securities						583						860						2,079						2,515
Subtotal coupon interest						33,967						35,162						102,054						101,487
Premium accretion, discount amortization and amortization of basis, net:
Agency RMBS						4						2						10						(4)
Non-Agency CMBS						351						387						1,006						386
Non-Agency RMBS						(306)						26						(651)						(141)
Residential Whole Loans						(831)						(945)						(2,288)						(5,260)
Commercial Loans						33						—						99						—
Securitized Commercial Loan						7,064						6,589						21,332						19,934
Other securities						(144)						185						(345)						223
Subtotal accretion and amortization						6,171						6,244						19,163						15,138
Interest income						$	40,138					$	41,406					$	121,217					$	116,625
Contractual interest income, net of amortization of basis on Agency and Non-Agency Interest-Only Strips, classified as derivatives(1):
Coupon interest income						$	24					$	16					$	47					$	160
Amortization of basis						(14)						(5)						(16)						(120)
Subtotal						10						11						31						40
Total adjusted interest income						$	40,148					$	41,417					$	121,248					$	116,665

(1)Reported in "Gain 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 and nine months ended September 30, 2023 and September 30, 2022: 

						Three months ended September 30, 2023												Three months ended September 30, 2022												Nine months ended September 30, 2023												Nine months ended September 30, 2022
(dollars in thousands)						Reconciliation						Cost of Funds/ Effective Borrowing Costs						Reconciliation						Cost of Funds/ Effective Borrowing Costs						Reconciliation						Cost of Funds/ Effective Borrowing Costs						Reconciliation						Cost of Funds/ Effective Borrowing Costs
Interest expense						$	36,976					5.85		%				$	35,707					5.20		%				$	109,690					5.79		%				$	100,408					5.07		%
Adjustments:
Interest expense on Securitized debt from consolidated VIE						(21,764)						(6.66)		%				(21,132)						(6.60)		%				(64,801)						(6.72)		%				(62,940)						(6.65)		%
Net interest (received) paid - interest rate swaps						(846)						(0.13)		%				(298)						0.04		%				(2,832)						(0.15)		%				255						0.01		%
Effective Cost of Funds						$	14,366					4.71		%				$	14,277					3.90		%				$	42,057					4.53		%				$	37,723					3.65		%
Weighted average borrowings						$	1,210,727											$	1,452,090											$	1,242,018											$	1,380,744

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 uses of funds consisted of IRS variation margin settlements, payments made to the Manager for management fees incurred and other vendor services, and payments of interest on outstanding borrowings. These uses were partially offset by our principal sources of funds, which generally consist of borrowings under repurchase agreements, Residential Whole Loan securitizations, payments of principal and interest we receive on our investment portfolio, and cash generated from investment sales.

We 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 September 30, 2023, we had $24.6 million in cash and cash equivalents. Our other sources of liquidity include 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 and used in Operations

For the nine months ended September 30, 2023, net cash used in operating activities was approximately $1.8 million. This was primarily attributable to additional transaction costs associated with the pending merger and a lower net interest margin. For the nine months ended September 30, 2022, net cash provided by operating activities was approximately $13.1 million. This was primarily attributable to margin settlements of interest rate swaps, the net interest income on our investments, realized gain on the sale of an REO hotel, less operating expenses, and general and administrative expenses.

Cash Provided by and Used in Investing Activities

 

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For the nine months ended September 30, 2023, net cash provided by investing activities was approximately $116.3 million. This was primarily attributable to the maturity of a CMBS bond held by the REIT, plus principal payments made on our outstanding loans and MBS securities, supplemented by cash received from the sales of the CRE 3 loan and Other Securities. For the nine months ended September 30, 2022, net cash used in investing activities was approximately $100.2 million. This was primarily attributable to purchases of Non-Agency RMBS and Residential Whole Loans during the period, which was partially offset by receipts of principal payments and payoffs on our investments and the sale of an REO hotel.

Cash Provided by and Used in Financing

 

For the nine months ended September 30, 2023, net cash used in financing activities was approximately $108.1 million. This was primarily attributable to repayments on repurchase agreement borrowings, coupled with repayments on securitized debt. For the nine months ended September 30, 2022, net cash provided by financing activities was approximately $102.3 million. This was attributable to the Arroyo 2022-1 and Arroyo 2022-2 securitizations, and was partially offset by a net decrease in repurchase agreement borrowings, paydowns in our securitized debt, and extinguishment of convertible senior unsecured notes.

Repurchase Agreements

As of September 30, 2023, we had borrowings under four of our master repurchase agreements of approximately $170.8 million. The following tables present our repurchase agreement borrowings by type of collateral pledged, as of September 30, 2023 and September 30, 2022, and the respective effective cost of funds (Non-GAAP financial measure) for the three and nine months ended September 30, 2023 and September 30, 2022, respectively (dollars in thousands). See “Non-GAAP Financial Measures” for more information:

 

			September 30, 2023																		Three months ended September 30, 2023												Nine months ended September 30, 2023
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 Cost of Funds						Weighted Average Effective Cost of Funds (Non-GAAP)(1)						Weighted Average Haircut end of period
Agency RMBS, at fair value			$	351					$	297					5.98		%				5.36		%				5.36		%				5.59		%				5.59		%				25.00		%
Non-Agency CMBS, at fair value(2)			31,621						53,038						7.79		%				7.80		%				7.80		%				7.06		%				7.06		%				37.67		%
Non-Agency RMBS, at fair value			77,751						83,029						10.80		%				10.96		%				10.96		%				8.40		%				8.40		%				7.25		%
Residential Whole Loans, at fair value(3)(4)			2,562						6,598						7.56		%				7.77		%				7.77		%				6.69		%				6.69		%				43.00		%
Residential Bridge Loans, at fair value(3)			1,641						2,782						7.56		%				7.56		%				7.56		%				7.56		%				7.56		%				43.00		%
Commercial Loans, at fair value(3)			48,032						66,202						7.56		%				7.60		%				7.60		%				7.84		%				7.84		%				28.23		%
Other securities, at fair value			8,860						15,645						8.09		%				8.15		%				8.15		%				7.17		%				7.17		%				42.72		%
Interest rate swaps			n/a						n/a						n/a						—						(2.03)		%				n/a						(2.24)		%				n/a
Total			$	170,818					$	227,591					9.10		%				9.10		%				7.08		%				7.78		%				5.55		%				21.54		%

(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 $846 thousand and $2.8 million received for the three and nine months ended September 30, 2023. 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.

(4)Value of collateral pledged includes one REO property with a carrying value of $2.3 million at September 30, 2023.

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			September 30, 2022																		Three months ended September 30, 2022												Nine months ended September 30, 2022
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)(1)						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			$	317					$	233					3.15		%				2.47		%				2.47		%				1.60		%				1.60		%				25.00		%
Non-Agency CMBS, at fair value(2)			55,155						90,107						2.28		%				2.31		%				2.31		%				2.07		%				2.07		%				40.00		%
Non-Agency RMBS, at fair value			76,171						122,401						5.05		%				3.89		%				3.89		%				3.04		%				3.04		%				41.26		%
Residential Whole Loans, at fair value(3)			4,827						7,214						5.16		%				2.40		%				2.40		%				2.73		%				2.73		%				48.34		%
Residential Bridge Loans(3)			2,895						5,120						5.60		%				4.72		%				4.72		%				3.53		%				3.53		%				25.00		%
Commercial Loans, at fair value(3)			53,662						81,326						4.72		%				4.27		%				4.27		%				3.34		%				3.34		%				31.57		%
Other securities, at fair value			25,914						38,310						2.54		%				2.57		%				2.57		%				2.27		%				2.27		%				36.90		%
Interest rate swaps			n/a						n/a						n/a						n/a						(0.45)		%				n/a						0.08		%				n/a
Total			$	218,941					$	344,711					3.98		%				3.27		%				2.82		%				2.75		%				2.84		%				38.70		%

(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 $298 thousand received and $255 thousand paid for the three and nine months ended September 30, 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 the 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.

Contractual Obligations and Commitments

 

Our contractual obligations as of September 30, 2023 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			$	107,534					$	63,284					$	—					$	—					$	170,818
Contractual interest on repurchase agreements			10,843						6,125						—						—						16,968
Convertible senior unsecured notes			86,250						—						—						—						86,250
Contractual interest on convertible senior unsecured notes			8,733						—						—						—						8,733
Securitized debt(2)			—						1,370,690						—						958,094						2,328,784
Contractual interest on securitized debt			90,829						125,529						69,399						932,861						1,218,618
Total			$	304,189					$	1,565,628					$	69,399					$	1,890,955					$	3,830,171

(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 $2.5 billion. Assumes entire outstanding principal balance at September 30, 2023 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

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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 our earnings potential and our transition to a residential focused investment portfolio. Future waivers, if any, will be at the Manager's discretion.

 

Off-Balance Sheet Arrangements

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 September 30, 2023, 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 caps that result in some portion of the interest being deferred and added to the principal outstanding or a portion of the

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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 September 30, 2023, 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%						(51.83)		%				(1.08)		%
+0.50%						(25.90)		%				(0.54)		%
-0.50%						25.88		%				0.56		%
-1.00%						51.85		%				1.13		%

 

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 September 30, 2023. 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.

 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.

 

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 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

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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.

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.

 

Inflation Risk

 

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 September 30, 2023. 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 September 30, 2023 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 September 30, 2023, the Company was not involved in any material legal proceedings.

ITEM 1A. RISK FACTORS

     Other than as set forth below, 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, 2022, as filed with the SEC on March 13, 2023. 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.

Risks Related to the Merger

The failure to complete the Merger in a timely manner or at all could negatively impact the market price of our common stock as well as adversely affect our business, financial condition, operating results and cash flows.

On August 8, 2023, we entered into an Agreement and Plan of Merger (the “MITT Merger Agreement”) with AG Mortgage Investment Trust, Inc., a Maryland corporation (“MITT”), AGMIT Merger Sub, LLC, a Delaware limited liability company and wholly owned subsidiary of MITT (“Merger Sub”), the Company, and, solely for the purposes of Section 3.3(a), Section 3.3(i), Article V, Section 6.13, Section 7.2, Section 7.3 and Article IX therein, AG REIT Management, LLC, a Delaware limited liability company (“MITT Manager”), pursuant to which the Company will merge with and into Merger Sub, with Merger Sub surviving as a wholly owned subsidiary of MITT (the “Merger”). Pursuant to, and subject to the terms and conditions set forth in, the MITT Merger Agreement, each outstanding share of the Company’s common stock would be converted into the right to receive (i) 1.498 shares of MITT common stock and (ii) the per share portion of a cash payment from the MITT Manager equal to the lesser of $7 million or approximately 9.9% of the aggregate per share merger consideration (any difference between $7 million and such lower amount would be used to benefit the combined company post closing by offsetting reimbursable expenses that would otherwise be payable to the MITT Manager). Additionally, the MITT Manager, which would be the manager of the combined company, would waive $2.4 million of management fees in the first year post-closing. Cash will be paid in lieu of fractional shares of MITT common stock that would have been received as a result of the Merger.

On November 7, 2023, the Company adjourned its special meeting of stockholders until December 5, 2023, at 9:00 a.m. Pacific Time, due to a lack of quorum and to allow further solicitation of proxies from the Company’s common stockholders for the approval of the merger at the special meeting.

At a special meeting of MITT stockholders held on November 7, 2023, MITT stockholders approved the issuance of

MITT’s common stock to be issued in connection with the proposed Merger.

There are no assurances that all of the conditions necessary to consummate the Merger will be satisfied or waived or that the conditions will be satisfied or waived in the time frame expected.

Completion of the Merger is subject to several conditions beyond our control that may prevent, delay or otherwise adversely affect its completion in a material way, including the approval of our stockholders. The Merger cannot be completed until the conditions to closing are satisfied or (if permissible under applicable law) waived. We cannot guarantee that the closing conditions set forth in the MITT Merger Agreement, including the approval of our stockholders, will be satisfied or, even if satisfied, that no event of termination will take place. In addition, developments beyond our control, including but not limited to changes in domestic or global economic conditions, may affect the timing or success of the Merger. In the event that the Merger is not completed for any reason, the holders of our common stock will not receive any consideration for their shares of common stock in connection with the proposed Merger. Instead, we will remain an independent public company and the holders of our common stock will continue to own their shares of common stock.

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If the Merger or a similar transaction is not completed, the share price of our common stock may drop to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. In addition, in the event the Merger is not consummated, under circumstances specified in the MITT Merger Agreement, we may be required to pay a termination fee of $3.0 million, a failure to complete the Merger may result in negative publicity, negative impressions of us in the financial markets and investment community and negative responses from employees, partners and other third parties. Any disruption to our business resulting from the announcement and pendency of the Merger and from intensifying competition from our competitors, including any adverse changes in our relationships with our employees, partners and other third parties, could continue or accelerate in the event of a failure to complete the Merger. There can be no assurance that our business, financial condition, operating results and cash flows will not be adversely affected, as compared to the condition prior to the announcement of the Merger, if the Merger is not consummated.

The MITT Merger Agreement contains provisions that could discourage or deter a potential competing acquirer that might be willing to pay more to effect an alternative transaction with us.

Under the MITT Merger Agreement, we are generally not permitted to solicit or discuss takeover proposals with third parties, subject to certain exceptions. Further, subject to limited exceptions, the MITT Merger Agreement contains restrictions on our ability to pursue other alternatives to the Merger and, in specified circumstances, could require us to pay MITT a termination fee of $3.0 million. Such restrictions may discourage or deter a third party that may be willing to pay more than MITT for our common stock from considering or proposing an alternative transaction with us. Notwithstanding the foregoing, in no event will the termination fee be paid to MITT more than once.

We may be subject to litigation challenging the Merger.

Any litigation challenging the Merger may require significant management time and attention and significant legal expenses and may result in unfavorable outcomes, which could delay or prevent the Merger from being completed or have a material adverse effect on our business, financial condition, results of operations and cash flows.

The completion of the transaction contemplated by the MITT Merger Agreement may trigger change in control or other similar provisions in certain agreements to which we are a party.

If we are unable to negotiate waivers of those provisions, the counterparties may exercise their rights and remedies under the agreements, potentially terminating the agreements or seeking monetary damages. Even if we are able to negotiate waivers, the counterparties may require a fee for such waivers or seek to renegotiate the agreements on terms less favorable to us.

We have incurred and will continue to incur substantial transaction fees and costs in connection with the Merger.

We have incurred and expect to continue to incur significant costs, expenses and fees for professional services and other transaction costs in connection with the Merger. A material portion of these expenses are payable by us whether or not the Merger is completed. Further, while we have assumed that a certain amount of additional transaction expenses will be incurred, factors beyond our control could affect the total amount or the timing of these expenses. Many of the expenses that will be incurred, by their nature, are difficult to estimate accurately. These expenses may exceed the costs historically borne by us. These costs could adversely affect our business, financial condition, operating results and cash flows.

The U.S. and global capital markets are subject to systemic risk that could adversely affect our business, financial condition and results of operations.

Issuers, national and regional banks, financial institutions and other participants in the U.S. and global capital markets are closely interrelated as a result of credit, trading, clearing, technology and other relationships. A significant adverse development (such as a bank run, insolvency, bankruptcy or default) with one or more national or regional banks, financial institutions, or other participants in the financial or capital markets may spread to others and lead to significant concentrated or market-wide problems (such as defaults, liquidity problems, impairment charges, additional bank runs and/or losses) for other participants in these markets. Future developments, including actions taken by the U.S. Department of Treasury, FDIC, Federal Reserve Board, and systemic risk in the U.S. and global banking sectors and broader economies in general, are difficult to assess and quantify, and the form and magnitude of such developments or other actions of the U.S. Department of Treasury,

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FDIC and Federal Reserve Board may remain unknown for significant periods of time and could have an adverse effect on our business, financial condition and results of operations.

For example, in response to the rapidly declining financial condition of regional banks Silicon Valley Bank (“SVB”) Signature Bank (“Signature”) and First Republic Bank ("First Republic"), the California Department of Financial Protection and Innovation (the “CDFPI”) and the New York State Department of Financial Services (the “NYSDFS”) closed SVB, Signature and First Republic on March 10, 2023, March 12, 2023 and May 1, 2023, respectively, and the Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver for SVB, Signature and First Republic. Although the U.S. Department of the Treasury, the Federal Reserve and the FDIC have taken measures to stabilize the financial system, uncertainty and liquidity concerns in the broader financial services industry remain. Additionally, should there be additional systemic pressure on the financial system and capital markets, we cannot assure you of the response of any government or regulator, and any response may not be as favorable to industry participants as the measures currently being pursued. In addition, highly publicized issues related to the U.S. and global capital markets in the past have led to significant and widespread investor concerns over the integrity of the capital markets. The current situation related to SVB, Signature and First Republic could in the future lead to further rules and regulations for public companies, banks, financial institutions and other participants in the U.S. and global capital markets, and complying with the requirements of any such rules or regulations may be burdensome. Even if not adopted, evaluating and responding to any such proposed rules or regulations could results in increased costs and require significant attention from management.

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.

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Exhibit No.						Description
2.1*						Agreement and Plan of Merger, dated as of June 27, 2023, by and among Western Asset Mortgage Capital Corporation, Maverick Merger Sub, LLC, and Terra Property Trust, Inc., incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, filed on June 28, 2023.**
2.2*						Agreement and Plan of Merger, dated as of August 8, 2023, by and among Western Asset Mortgage Capital Corporation, AG Mortgage Investment Trust, Inc., AGMIT Merger Sub, LLC and AG REIT Management, LLC, incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K, filed on August 9, 2023).**
3.1*						Amended and restated certificate of incorporation of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 3.1 to Amendment No. 10 Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012.
3.2*						Amendment to the amended and restated certificate of incorporation of Western Asset Mortgage Capital Corporation, dated June 3, 2016, incorporated by reference to Exhibit 3.3 to the Annual Report on Form 10-K, filed March 7, 2017.
3.3*						Amendment to the amended and restated certificate of incorporation of Western Asset Mortgage Capital Corporation, dated July 8, 2022, incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K, filed on July 11, 2022.
3.4*						Amended and restated bylaws of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 3.2 to Amendment No. 10 to Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012
4.1*						Specimen Common Stock Certificate of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 4.1 to Amendment No. 10 to Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012.
4.2*						Indenture, dated as of October 2, 2017, between Western Asset Mortgage Capital Corporation and Wells Fargo Bank, National Association, incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K, filed on October 3, 2017.
4.3*						First Supplemental Indenture, dated as of October 2, 2017, 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.
4.4*						Form of 6.75% Convertible Senior Notes due 2022 (attached as Exhibit A to the First Supplemental Indenture filed as Exhibit 4.3 hereto), incorporated by reference to Exhibit 4.3 to the Current Report on Form 8-K, filed on October 3, 2017.
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						Rule 13a-14(a) / 15d-14(a) Certification of Chief Executive Officer.
31.2						Rule 13a-14(a) / 15d-14(a) Certification of Chief Financial Officer.
32.1						Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.
101						The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2023, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets as of September 30, 2023 and December 31, 2022; (ii) the Consolidated Statements of Operations for the three and nine months ended September 30, 2023 and 2022; (iii) the Consolidated Statements of Changes in Equity for the three and nine months ended September 30, 2023 and 2022; (iv) the Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2023 and 2022; 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).

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Amended and restated certificate of incorporation of Western Asset Mortgage Capital Corporation, incorporated by reference to Exhibit 3.1 to Amendment No. 10 Form S-11 (Registration Statement No. 333-159962), filed May 8, 2012

__________________________________

*Fully or partly previously filed.

** The schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish supplementally a copy of such schedules and exhibits, or any section thereof, to the SEC upon request.

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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)
			November 8, 2023
			By:			/s/ ROBERT W. LEHMAN
			Robert W. Lehman
			Chief Financial Officer
			November 8, 2023

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