The following discussion and analysis should be read in conjunction with our interim consolidated financial statements and the accompanying notes included in "Part I, Item 1. Consolidated Financial Statements" of this Quarterly Report on Form 10-Q. General We are a public residential real estate finance company focused on acquiring, investing in and managing residential mortgage assets inthe United States . We were incorporated inMaryland onOctober 31, 2012 , and we commenced operations on or aboutOctober 9, 2013 following the completion of our initial public offering and a concurrent private placement. Our common stock, our 8. 20% Series A Cumulative Redeemable Preferred Stock (our "Series A Preferred Stock") and our 8.250% Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (our "Series B Preferred Stock") are listed and traded on theNew York Stock Exchange under the symbols "CHMI," "CHMI-PRA" and "CHMI-PRB," respectively. We are externally managed by our Manager,Cherry Hill Mortgage Management, LLC , anSEC -registered investment adviser. Our principal objective is to generate attractive current yields and risk-adjusted total returns for our stockholders over the long term, primarily through dividend distributions and secondarily through capital appreciation. We attempt to attain this objective by selectively constructing and actively managing a portfolio of Servicing Related Assets (as defined below) and residential mortgage-backed securities ("RMBS") and, subject to market conditions, other cash flowing residential mortgage assets. We are subject to the risks involved with real estate and real estate-related debt instruments. These include, among others, the risks normally associated with changes in the general economic climate, changes in the mortgage market, changes in tax laws, interest rate levels, and the availability of financing. We elected to be taxed as a REIT forU.S. federal income tax purposes commencing with our short taxable year endedDecember 31, 2013 . We operate so as to continue to qualify to be taxed as a REIT. Our asset acquisition strategy focuses on acquiring a diversified portfolio of residential mortgage assets that balances the risk and reward opportunities our Manager observes in the marketplace.Aurora Financial Group, Inc. ("Aurora"), our licensed mortgage subsidiary, invests in mortgage servicing rights ("MSRs" or "Servicing Related Assets") on residential mortgage loans that are owned by, or securitized through, a government agency or government sponsored enterprise. We finance our Servicing Related Assets with leverage, the amount of which will vary from time to time depending on the particular characteristics of our portfolio, the availability of financing and market conditions. In addition to Servicing Related Assets, we invest in RMBS, primarily those backed by 30-, 20- and 15-year fixed rate mortgages that offer what we believe to be favorable prepayment and duration characteristics. Our RMBS consist primarily of Agency RMBS on which the payments of principal and interest are guaranteed by aU.S. government agency or a government sponsored enterprise (an "Agency"). We have also invested in collateralized mortgage obligations guaranteed by an Agency ("Agency CMOs") consisting of interest only securities ("IOs") as well as non-Agency collateralized mortgage obligations that are either risk-sharing securities issued by Fannie Mae or Freddie Mac or private label securities that are issued by a non-government related entity. We finance our RMBS with leverage, the amount of which will vary from time to time depending on the particular characteristics of our portfolio, the availability of financing and market conditions. We do not have a targeted leverage ratio for our RMBS. Our borrowings for RMBS consist of short-term borrowings under master repurchase agreements. Subject to maintaining our qualification as a REIT, we utilize derivative financial instruments (or hedging instruments) to hedge our exposure to potential interest rate mismatches between the interest we earn on our assets and our borrowing costs caused by fluctuations in short-term interest rates. In utilizing leverage and interest rate hedges, our objectives include, where desirable, locking in, on a long-term basis, a spread between the yield on our assets and the cost of our financing in an effort to improve returns to our stockholders.
We also operate our business in a manner that permits us to maintain our exclusion from registration as an investment company under the Investment Company Act.
45 -------------------------------------------------------------------------------- Table of Contents EffectiveJanuary 1, 2020 ,Cherry Hill Operating Partnership LP , the Company's operating partnership subsidiary (the "Operating Partnership"), contributed substantially all of its assets toCHMI Sub-REIT, Inc. (the "Sub-REIT) in exchange for all of the common stock of the Sub-REIT. As a result of this contribution, the Sub-REIT is a wholly-owned subsidiary of theOperating Partnership and operations formerly conducted by theOperating Partnership through its subsidiaries are now conducted by the Sub-REIT through those same subsidiaries. The Sub-REIT has elected to be taxed as a REIT under the Code commencing with the taxable year endingDecember 31, 2020 . OnMarch 29, 2017 , we issued and sold 5,175,000 shares of common stock, par value$0.01 per share, raising approximately$81.1 million after underwriting discounts and commissions but before expenses of approximately$229,000 . All of the net proceeds were used to invest in RMBS. OnAugust 17, 2017 , we issued and sold 2,400,000 shares of our Series A Preferred Stock, raising approximately$58.1 million after underwriting discounts and commissions but before expenses of approximately$193,000 . All of the net proceeds from the Series A Preferred Stock offering were also invested in RMBS. InApril 2018 , the Company initiated an at-the-market offering program (the "Preferred Series A ATM Program") pursuant to which it may offer through one or more sales agents and sell from time to time up to$35 million of its Series A Preferred Stock at prices prevailing at the time, subject to volume and other regulatory limitations. The Company did not issue and sell any shares of the Series A Preferred Stock during the three and six-month periods endedJune 30, 2020 . During the three-month period endedJune 30, 2019 , the Company issued and sold 13,949 shares of Series A Preferred Stock under the Preferred Series A ATM Program. The shares were sold at a weighted average price of$25.80 per share for gross proceeds of approximately$360,000 before fees of approximately$6,000 .
On
InAugust 2018 , the Company initiated an at-the-market offering program (the "Common Stock ATM Program") pursuant to which it may offer through one or more sales agents and sell from time to time up to$50 million of our common stock at prices prevailing at the time, subject to volume and other regulatory limitations. The Company did not issue and sell any common stock under the Common Stock ATM Program during the three and six-month periods endedJune 30, 2020 . During the three-month period endedJune 30, 2019 , the Company issued and sold 225,646 shares of common stock under the Common Stock ATM Program. The shares were sold at a weighted average price of$17.40 per share for gross proceeds of approximately$3.9 million before fees of approximately$79,000 .
On
InSeptember 2019 , we initiated a share repurchase program that allows for the repurchase of up to an aggregate of$10.0 million of our common stock. Shares may be repurchased from time to time through privately negotiated transactions or open market transactions, pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or by any combination of such methods. The manner, price, number and timing of share repurchases are subject to a variety of factors, including market conditions and applicableSEC rules. The share repurchase program does not require the purchase of any minimum number of shares, and, subject toSEC rules, purchases may be commenced or suspended at any time without prior notice. Unless sooner terminated or extended, the share repurchase program expires onSeptember 3, 2020 . During the three-month period endedJune 30, 2020 , the Company did not repurchase any common stock pursuant to the repurchase program. During the six-month period endedJune 30, 2020 , the Company repurchased 142,531 shares of its common stock pursuant to the repurchase program for approximately$1.8 million . In the period from the program's inception throughDecember 31, 2019 , the Company repurchased 235,950 shares of its common stock pursuant to the repurchase program for approximately$3.5 million . 46 -------------------------------------------------------------------------------- Table of Contents A significant portion of the paydowns of the RMBS acquired as a result of these equity offerings have been or will be deployed into the acquisition of MSRs. The Company may also sell certain of these RMBS and deploy the net proceeds from such sales to the extent necessary to fund the purchase price of MSRs.
Recent Developments
As the novel coronavirus (COVID-19) pandemic and its effects on the economy escalated inthe United States in earlyMarch 2020 , the financial markets started to melt down. The widening of nominal spreads resulted in a sudden and severe decline in the mark-to-market values assigned by repurchase agreement counterparties to the Company's Agency RMBS assets. The crisis in the Agency RMBS market was closely followed by a substantial widening of spreads on credit assets and a reduction in available liquidity to finance credit assets. including, the credit risk transfer securities issued by Fannie Mae and Freddie Mac held as part of the CMOs in the Company's portfolio. The Company continues to meet all of the margin calls received. In order to rebuild the Company's liquidity and to reduce the leverage employed by the Company, the Company undertook sales of Agency RMBS in its portfolio reducing the amount of its assets from$2,347.1 million atDecember 31, 2019 to$1,557.2 million atMarch 31, 2020 . The shelter in place restrictions imposed by the federal and state governments have resulted in historic increases in the level of unemployment and the imposition of forbearance restrictions on lenders and servicers such as the Company's mortgage company subsidiary, Aurora. The Company is not yet able to estimate the likely number of borrowers on loans serviced by Aurora that will take advantage of the forbearance programs. The Company continued to reduce the leverage on its portfolio during the second quarter by judiciously selling Agency RMBS in its portfolio thereby reducing the amount of its RMBS from$1,557.2 million atMarch 31, 2020 to$1,524.9 million atJune 30, 2020 . The Company continues to hold an increased amount of unrestricted cash due to the uncertainty surrounding the reopening of the economy and the continued spread of COVID-19. The Company completed the sale of its portfolio of Ginnie Mae MSRs back to Freedom Mortgage atJune 30, 2020 . The sale was the result of a strategic decision and was not related to the forbearance programs instituted by the Agencies. Based on information currently available to the Company, the Company continues to believe that it will be able to satisfy all of its servicing obligations in 2020. The Company has been working remotely since early March. The transition has been virtually seamless due to the Company's use of a cloud-based solution in its regular operations, and the Company does not anticipate any operational issues arising from working remotely for as long as is necessary.
Factors Impacting our Operating Results
Our income is generated primarily by the net spread between the income we earn on our assets and the cost of our financing and hedging activities as well as the amortization of any purchase premiums or the accretion of discounts. Our net income includes the actual interest payments we receive on our RMBS, the net servicing fees we receive on our MSRs and the accretion/amortization of any purchase discounts/premiums. Changes in various factors such as market interest rates, prepayment speeds, estimated future cash flows, servicing costs and credit quality could affect the amount of premium to be amortized or discount to be accreted into interest income for a given period. Prepayment speeds vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be affected by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers whose mortgage loans underlay the MSRs held by Aurora or the non-Agency RMBS held in our portfolio. 47
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Set forth below is the positive gross spread between the yield on RMBS and our costs of funding those assets at the end of each of the quarters indicated below: Average Net Yield Spread at Period End Average Net Average Average Interest Rate Quarter Ended Asset Yield Cost of Funds Spread June 30, 2020 3.33 % 0.19 % 3.15 % March 31, 2020 3.53 % 1.34 % 2.19 % December 31, 2019 3.72 % 1.84 % 1.88 % September 30, 2019 3.77 % 2.13 % 1.64 %
The Average Cost of Funds also includes the benefits of related swaps.
Changes in the Market Value of Our Assets
We hold our Servicing Related Assets as long-term investments. Our MSRs are carried at their fair value with changes in their fair value recorded in other income or loss in our interim consolidated statements of income (loss). Those values may be affected by events or headlines that are outside of our control, such as events impacting theU.S. or global economy generally or theU.S. residential market specifically, and events or headlines impacting the parties with which we do business. See "Part I, Item 1A. Risk Factors - Risks Related to Our Business" in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 and "Part II, Item 1A. Risk Factors" in this Quarterly Report on Form 10-Q. Our RMBS are carried at their fair value, as available-for-sale in accordance with ASC 320, Investments - Debt and Equity Securities, with changes in fair value recorded through accumulated other comprehensive income (loss), a component of stockholders' equity. As a result, we do not expect that changes in the market value of our RMBS will normally impact our operating results, but such changes will affect our book value. However, at least on a quarterly basis, we assess both our ability and intent to continue to hold our RMBS as long-term investments. As part of this process, we monitor our RMBS for credit related impairment or impairment on securities the Company (i) intends to sell, (ii) will more likely than not be required to sell before recovering their cost basis, or (iii) does not expect to recover the entire amortized cost basis, even if the Company does not intend to sell the securities, or the Company believes it is more likely than not that it will be required to sell the security before recovering its cost basis. A change in our ability and/or intent to continue to hold any of our RMBS could result in our recognizing an impairment charge or realizing losses while holding these assets.
Impact of Changes in Market Interest Rates on Our Assets
The value of our assets may be affected by prepayment rates on mortgage loans. Prepayment speed is the measurement of how quickly borrowers pay down the unpaid principal balance ("UPB") of their loans or how quickly loans are otherwise liquidated or charged off. Generally, in a declining interest rate environment, prepayment speeds tend to increase. Conversely, in an increasing interest rate environment, prepayment speeds tend to decrease. When we acquire Servicing Related Assets or RMBS, we anticipate that the underlying mortgage loans will prepay at a projected rate generating an expected cash flow (in the case of Servicing Related Assets) and yield. If we purchase assets at a premium to par value and borrowers prepay their mortgage loans faster than expected, the corresponding prepayments on our assets may reduce the expected yield on such assets because we will have to amortize the related premium on an accelerated basis. In addition, we will have to reinvest the greater amounts of prepayments in that lower rate environment thereby affecting future yields on our assets. If we purchase assets at a discount to par value, and borrowers prepay their mortgage loans slower than expected, the decrease in corresponding prepayments may reduce the expected yield on assets because we will not be able to accrete the related discount as quickly as originally anticipated. 48 -------------------------------------------------------------------------------- Table of Contents If prepayment speeds are significantly greater than expected, the fair value of the Servicing Related Assets could be less than their fair value as previously reported on our interim consolidated balance sheets. Such a reduction in the fair value of the Servicing Related Assets would have a negative impact on our book value. Furthermore, a significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from the Servicing Related Assets, and we could receive substantially less than what we paid for such assets. We do not utilize derivatives to hedge against changes in the fair value of the Servicing Related Assets. Our balance sheet, results of operations and cash flows are susceptible to significant volatility due to changes in the fair value of, or cash flows from, the Servicing Related Assets as interest rates change. A slower than anticipated rate of prepayment due to an increase in market interest rates also will cause the life of the related RMBS to extend beyond that which was projected. As a result, we would have an asset with a lower yield than current investments for a longer period of time. In addition, if we have hedged our interest rate risk, extension may cause the security to be outstanding longer than the related hedge, thereby reducing the protection intended to be provided by the hedge. Voluntary and involuntary prepayment rates may be affected by a number of factors including, but not limited to, the availability of mortgage credit, the relative economic vitality of, or natural disasters affecting, the area in which the related properties are located, the servicing of the mortgage loans, possible changes in tax laws, other opportunities for investment, homeowner mobility and other economic, social, geographic, demographic and legal factors, none of which can be predicted with any certainty. We attempt to reduce the exposure of our MSRs to voluntary prepayments through the structuring of recapture agreements with Aurora's subservicers. InJune 2016 , Aurora entered into a joint marketing recapture agreement with Freedom Mortgage. Pursuant to this agreement, Freedom Mortgage attempts to refinance certain mortgage loans underlying Aurora's MSR portfolio subserviced by Freedom Mortgage. If a loan is refinanced, Aurora will pay Freedom Mortgage a fee for its origination services. Freedom Mortgage will be entitled to sell the loan for its own benefit and will transfer the related MSR to Aurora. The agreement had an initial term of one year, subject to automatic renewals of one year each. This agreement continues in effect since the termination of the subservicing agreement was not, and now will not be, completed by the transfer of the Ginnie Mae MSRs to another subservicer. For a further discussion of the subservicing agreement, see "Part I, Item 1. Notes to Consolidated Financial Statements-Note 7. Transactions with Affiliates and Affiliated Entities". During the three months endedJune 30, 2020 , 1,171 loans with an aggregate unpaid principal balance of approximately$268.3 million had been refinanced by Freedom Mortgage. However, since the portfolio was being sold to Freedom Mortgage atJune 30, 2020 , these loans were treated as loans pending re-pooling and included in the sale. No fees were payable in connection with these loans. Aurora received no MSRs under this joint marketing recapture agreement during the three and six-month periods endedJune 30, 2020 . During the three-month period endedJune 30, 2019 , Aurora received MSRs with an aggregate UPB of approximately$1.0 million and paid fees of approximately$1,000 to Freedom Mortgage under this joint marketing recapture agreement. During the six-month period endedJune 30, 2019 , Aurora received MSRs with an aggregate UPB of approximately$4.4 million and paid fees of approximately$5,200 to Freedom Mortgage under this joint marketing recapture agreement. This agreement will be terminated when the subservicing agreement with Freedom Mortgage is terminated.
With respect to our business operations, increases in interest rates, in general, may over time cause:
• the interest expense associated with our borrowings to increase;
• the value of our assets to fluctuate;
• the coupons on any adjustable-rate and hybrid RMBS we may own to reset,
although on a delayed basis, to higher interest rates;
• prepayments on our RMBS to slow, thereby slowing the amortization of our
purchase premiums and the accretion of our purchase discounts; and
• an increase in the value of any interest rate swap agreements we may enter into
as part of our hedging strategy. 49
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Conversely, decreases in interest rates, in general, may over time cause:
• prepayments on our RMBS to increase, thereby accelerating the amortization of
our purchase premiums and the accretion of our purchase discounts;
• the interest expense associated with our borrowings to decrease;
• the value of our assets to fluctuate;
• a decrease in the value of any interest rate swap agreements we may enter into
as part of our hedging strategy; and
• coupons on any adjustable-rate and hybrid RMBS assets we may own to reset,
although on a delayed basis, to lower interest rates.
Effects of Spreads on our Assets
The spread between the yield on our assets and our funding costs affects the performance of our business. Wider spreads imply greater income on new asset purchases but may have a negative impact on our stated book value. Wider spreads may also negatively impact asset prices. In an environment where spreads are widening, counterparties may require additional collateral to secure borrowings which may require us to reduce leverage by selling assets. Conversely, tighter spreads imply lower income on new asset purchases but may have a positive impact on stated book value of our existing assets. In this case, we may be able to reduce the amount of collateral required to secure borrowings.
Credit Risk
We are subject to varying degrees of credit risk in connection with our assets. Although we expect relatively low credit risk with respect to our portfolios of Agency RMBS, we are subject to the credit risk of borrowers under the loans backing CMOs we own and to the credit enhancements built into the CMO structure. We also are subject to the credit risk of the borrowers under the loans that Aurora services. Through loan level due diligence, we attempt to mitigate this risk by seeking to acquire high quality assets at appropriate prices given anticipated and unanticipated losses. We also conduct ongoing monitoring of acquired MSRs. Nevertheless, unanticipated credit losses could occur which could adversely impact our operating results.
Critical Accounting Policies and Use of Estimates
Our financial statements are prepared in accordance with GAAP, which requires the use of estimates that involve the exercise of judgment and the use of assumptions as to future uncertainties. In accordance withSEC guidance, the following discussion addresses the accounting policies that we apply with respect to our operations. Our most critical accounting policies involve decisions and assessments that could affect our reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, as well as our reported amounts of revenues and expenses. We believe that the decisions and assessments upon which our financial statements are based were reasonable at the time made and based upon information available to us at that time. Our critical accounting policies and accounting estimates may be expanded over time as we diversify our portfolio. The material accounting policies and estimates that we expect to be most critical to an investor's understanding of our financial results and condition and require complex management judgment are discussed below.
Classification of
ASC 320, Investments - Debt and Equity Securities, requires that at the time of purchase, we designate a security as either trading, available-for-sale, or held-to-maturity depending on our ability and intent to hold such security to maturity. Securities available-for-sale will be reported at fair value, while securities held-to-maturity will be reported at amortized cost. Although we may hold most of our securities until maturity, we may, from time to time, sell any of our securities as part of our overall management of our asset portfolio. Accordingly, we elect to classify all of our RMBS as available-for-sale. All assets classified as available-for-sale will be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. See "-Fair Valued Assets and Liabilities." 50
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When the estimated fair value of a security is less than amortized cost, we consider whether the impairment should be recognized in earnings or other comprehensive income (loss). A security is deemed impaired if (i) we intend to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovering our cost basis, or (iii) we do not expect to recover the entire amortized cost basis of the security even if we do not intend to sell the security or believe it is more likely than not that we will be required to sell the security before recovering our cost basis. If the security is deemed to be impaired, the resulting accounting treatment depends on the factors causing the impairment. If the impairment has resulted from (i) our intention to sell the security, or (ii) our judgment that it is more likely than not that we will be required to sell the security before recovering our cost basis, an impairment loss is recognized in current earnings equal to the difference between our amortized cost basis and fair value. If the impairment has resulted from our conclusion that we will not recover our cost basis even if we do not intend to sell the security, the credit loss portion of the impairment is recorded in current earnings and the portion of the loss related to other factors, such as changes in interest rates, continues to be recognized in accumulated other comprehensive income (loss). Determining whether there is an impairment may require management to exercise significant judgment and make significant assumptions, including, but not limited to, estimated cash flows, estimated prepayments, expected losses, and expected changes in interest rates. As a result, actual impairment losses could differ from reported amounts. Such judgments and assumptions are based upon a number of factors, including (i) the credit of the issuer or the borrower, (ii) the credit rating of the security, (iii) the key terms of the security, (iv) the performance of the loan or underlying loans, including debt service coverage and loan-to-value ratios, (v) the value of the collateral for the loan or underlying loans, (vi) the effect of local, industry, and broader economic factors, and (vii) the historical and anticipated trends in defaults and loss severities for similar securities.
Fair Valued Assets and Liabilities
ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority to data lacking transparency (i.e., unobservable inputs). Additionally, ASC 820 requires an entity to consider all aspects of nonperformance risk, including the entity's own credit standing, when measuring the fair value of a liability.
ASC 820 establishes a three-level hierarchy to be used when measuring and disclosing fair value. An instrument's categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. Following is a description of the three levels:
• Level 1 inputs are quoted prices in active markets for identical assets or
liabilities as of the measurement date under current market conditions.
Additionally, the entity must have the ability to access the active market and
the quoted prices cannot be adjusted by the entity.
• Level 2 inputs include quoted prices in active markets for similar assets or
liabilities; quoted prices in inactive markets for identical or similar assets
or liabilities; or inputs that are observable or can be corroborated by
observable market data by correlation or other means for substantially the
full-term of the assets or liabilities.
• Level 3 unobservable inputs are supported by little or no market activity. The
unobservable inputs represent the assumptions that management believes market
participants would use to price the assets and liabilities, including risk.
Generally, Level 3 assets and liabilities are valued using pricing models,
discounted cash flow methodologies, or similar techniques that require significant judgment or estimation. The level in the fair value hierarchy within which the entirety of a fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. We have used Level 2 for our RMBSs, our derivative assets and liabilities and Level 3 for our Servicing Related Assets. 51
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When available, we use quoted market prices to determine the fair value of an asset or liability. If quoted market prices are not available, we will consult independent pricing services or third-party broker quotes, provided that there is no ongoing material event that affects the issuer of the securities being valued or the market. If there is such an ongoing event, or if quoted market prices are not available, we will determine 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.
Investments in MSRs
The Company has elected the fair value option to record its investments in MSRs in order to provide users of our interim consolidated financial statements with better information regarding the effects of prepayment risk and other market factors on the MSRs. Under this election, the Company records a valuation adjustment on its investments in MSRs on a quarterly basis to recognize the changes in fair value of its MSRs in net income as described below. The Company's MSRs represent the right to service mortgage loans. As an owner and manager of MSRs, the Company may be obligated to fund advances of principal and interest payments due to third-party owners of the loans, but not yet received from the individual borrowers. These advances are reported as servicing advances within the "Receivables and other assets" line item on the interim consolidated balance sheets. Although transactions in MSRs are observable in the marketplace, the valuation includes unobservable market data inputs (prepayment speeds, delinquency levels, costs to service and discount rates). Changes in the fair value of MSRs as well as servicing fee income and servicing expenses are reported on the interim consolidated statements of income (loss). In determining the valuation of MSRs, management uses internally developed models that are primarily based on observable market-based inputs but which also include unobservable market data inputs. For additional information on our fair value methodology, see "Part I, Item 1. Notes to Consolidated Financial Statements-Note 9. Fair Value."
Revenue Recognition on Investments in MSRs
Mortgage servicing fee income represents revenue earned for servicing mortgage loans. The servicing fees are based on a contractual percentage of the outstanding principal balance and are recognized as revenue as the related mortgage payments are collected. Corresponding costs to service are charged to expense as incurred. Approximately$11.4 million and$16.6 million in reimbursable servicing advances were receivable atJune 30, 2020 andDecember 31, 2019 , respectively, and have been classified within "Receivables and other assets" on the interim consolidated balance sheets. Servicing fee income received and servicing expenses incurred are reported on the interim consolidated statements of income (loss). The difference between the fair value of MSRs and their amortized cost basis is recorded on the interim consolidated statements of income (loss) as "Unrealized loss on investments in Servicing Related Assets." Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the MSRs and, therefore, may differ from their effective yields.
Revenue Recognition on Securities
Interest income from coupon payments is accrued based on the outstanding principal amount of the RMBS and their contractual terms. Premiums and discounts associated with the purchase of the RMBS are amortized or accreted into interest income over the projected lives of the securities using the effective interest method. Our policy for estimating prepayment speeds for calculating the effective yield is to evaluate historical performance, consensus prepayment speeds, and current market conditions. Adjustments are made for actual prepayment activity.
Repurchase Transactions
We finance the acquisition of our RMBS for our portfolio through repurchase transactions under master repurchase agreements. Repurchase transactions are treated as collateralized financing transactions and are carried at their contractual amounts as specified in the respective transactions. Accrued interest payable is included in "Accrued expenses and other liabilities" on the interim consolidated balance sheets. Securities financed through repurchase transactions remain on our consolidated balance sheet as an asset and cash received from the purchaser is recorded on our consolidated balance sheet as a liability. Interest paid in accordance with repurchase transactions is recorded in interest expense on the interim consolidated statements of income (loss). 52
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Income Taxes
The Company elected to be taxed as a REIT under the Code commencing with its short taxable year endedDecember 31, 2013 . The Company expects to continue to qualify to be treated as a REIT.U.S. federal income tax law generally requires that a REIT distribute annually at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate income tax rates to the extent that it annually distributes less than 100% of its taxable income. The Company's taxable REIT subsidiary,CHMI Solutions, Inc. and its wholly-owned subsidiary, Aurora, are subject toU.S. federal income taxes on their taxable income. The Company accounts for income taxes in accordance with ASC 740, Income Taxes. ASC 740 requires the recording of deferred income taxes that reflect the net tax effect of temporary differences between the carrying amounts of the Company's assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, including operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period that includes the enactment date. The Company assesses its tax positions for all open tax years and determines if it has any material unrecognized liabilities in accordance with ASC 740. The Company records these liabilities to the extent it deems them more-likely-than-not to be incurred. The Company records interest and penalties related to income taxes within the provision for income taxes in the interim consolidated statements of income (loss). The Company has not incurred any interest or penalties. 53
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Results of Operations
Presented below is a comparison of the Company's results of operations for the periods indicated (dollars in thousands):
Results of Operations Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Income Interest income$ 10,132 $ 17,216 $ 30,381 $ 34,185 Interest expense 3,425 11,707 15,716 22,451 Net interest income 6,707 5,509 14,665 11,734 Servicing fee income 18,032 18,362 37,551 35,550 Servicing costs 6,594 4,103 12,716 7,924 Net servicing income 11,438 14,259 24,835 27,626 Other income (loss) Realized loss on RMBS, available-for-sale, net (1,769 ) - (19,312 ) - Realized loss on investments in MSRs, net (11,347 ) - (11,347 ) - Realized gain (loss) on derivatives, net 4,558 (365 ) (14,198 ) (7,841 ) Realized loss on acquired assets, net (548 ) - (502 ) - Unrealized gain (loss) on derivatives, net (4,581 ) (3,819 ) 47,619 (12,091 ) Unrealized loss on investments in Servicing Related Assets (17,025 ) (44,042 ) (110,878 ) (71,217 ) Total Loss (12,567 ) (28,458 ) (69,118 ) (51,789 ) Expenses General and administrative expense 1,420 1,138 4,176 2,101 Management fee to affiliate 1,974 1,934 3,939 3,743 Total Expenses 3,394 3,072 8,115 5,844 Loss Before Income Taxes (15,961 ) (31,530 ) (77,233 ) (57,633 ) Benefit from corporate business taxes (5,837 ) (4,372 ) (22,349 ) (9,337 ) Net Loss (10,124 ) (27,158 ) (54,884 ) (48,296 ) Net loss allocated to noncontrolling interests in Operating Partnership 180 438 1,014 787 Dividends on preferred stock 2,461 2,593 4,920 4,434 Net Loss Applicable to Common Stockholders$ (12,405 ) $ (29,313 ) $ (58,790 ) $ (51,943 ) 54
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Presented below is summary financial data on our segments together with a reconciliation to the same data for the Company as a whole, for the periods indicated (dollars in thousands):
Segment Summary Data Servicing Related Assets RMBS All Other Total Income Statement Three Months EndedJune 30, 2020 Interest income $ 479$ 9,653 $ -$ 10,132 Interest expense 438 2,987 - 3,425 Net interest income 41 6,666 - 6,707 Servicing fee income 18,032 - - 18,032 Servicing costs 6,594 - - 6,594 Net servicing income 11,438 - - 11,438 Other expense (25,044 ) (5,668 ) - (30,712 ) Other operating expenses 1,135 - 2,259 3,394 Benefit from corporate business taxes (5,837 ) - - (5,837 ) Net Income (Loss) $ (8,863 )$ 998 $ (2,259 ) $ (10,124 ) Three Months EndedJune 30, 2019 Interest income$ 214 $ 17,002 $ -$ 17,216 Interest expense 446 11,261 - 11,707 Net interest income (expense) (232 ) 5,741 - 5,509 Servicing fee income 18,362 - - 18,362 Servicing costs 4,103 - - 4,103 Net servicing income 14,259 - - 14,259 Other expense (29,136 ) (19,090 ) - (48,226 ) Other operating expenses 388 - 2,684 3,072 Benefit from corporate business taxes (4,372 ) - - (4,372 ) Net Loss$ (11,125 ) $ (13,349 ) $ (2,684 ) $ (27,158 ) Six Months EndedJune 30, 2020 Interest income$ 2,120 $ 28,261 $ -$ 30,381 Interest expense 2,147 13,569 - 15,716 Net interest income (expense) (27 ) 14,692 - 14,665 Servicing fee income 37,551 - - 37,551 Servicing costs 12,716 - - 12,716 Net servicing income 24,835 - - 24,835 Other expense (103,116 ) (5,502 ) - (108,618 ) Other operating expenses 1,735 - 6,380 8,115 Benefit from corporate business taxes (22,349 ) - - (22,349 ) Net Income (Loss)$ (57,694 ) $ 9,190 $ (6,380 ) $ (54,884 ) Six Months EndedJune 30, 2019 Interest income$ 472 $ 33,713 $ -$ 34,185 Interest expense 1,634 20,817 - 22,451 Net interest income (expense) (1,162 ) 12,896 - 11,734 Servicing fee income 35,550 - - 35,550 Servicing costs 7,924 - - 7,924 Net servicing income 27,626 - - 27,626 Other expense (54,103 ) (37,046 ) - (91,149 ) Other operating expenses 880 - 4,964 5,844 Benefit from corporate business taxes (9,337 ) - - (9,337 ) Net Loss$ (19,182 ) $ (24,150 ) $ (4,964 ) $ (48,296 ) 55
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