MFA FINANCIAL, INC. In this Quarterly Report on Form 10-Q, we refer to
The following discussion should be read in conjunction with our financial
statements and accompanying notes included in Item 1 of this Quarterly Report on
Form 10-Q as well as our Annual Report on Form 10-K for the year ended
Forward Looking Statements
When used in this Quarterly Report on Form 10-Q, in future filings with theSEC or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "will," "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "could," "would," "may," the negative of these words or similar expressions, are intended to identify "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act and, as such, may involve known and unknown risks, uncertainties and assumptions. These forward-looking statements include information about possible or assumed future results with respect to our business, financial condition, liquidity, results of operations, plans and objectives. Statements regarding the following subjects, among others, may be forward-looking: risks related to the ongoing spread of the novel coronavirus and the COVID-19 pandemic, including its effects on the general economy and our business, financial position and results of operations (including, among other potential effects, increased delinquencies and greater than expected losses in our whole loan portfolio); changes in interest rates and the market (i.e., fair) value of our residential whole loans, MBS and other assets; changes in the prepayment rates on residential mortgage assets, an increase of which could result in a reduction of the yield on certain investments in its portfolio and could require us to reinvest the proceeds received by it as a result of such prepayments in investments with lower coupons, while a decrease in which could result in an increase in the interest rate duration of certain investments in our portfolio making their valuation more sensitive to changes in interest rates and could result in lower forecasted cash flows; credit risks underlying our assets, including changes in the default rates and management's assumptions regarding default rates on the mortgage loans in our residential whole loan portfolio; our ability to borrow to finance our assets and the terms, including the cost, maturity and other terms, of any such borrowings; implementation of or changes in government regulations or programs affecting our business; our estimates regarding taxable income the actual amount of which is dependent on a number of factors, including, but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market discount on residential whole loans and the extent of prepayments, realized losses and changes in the composition of our residential whole loan portfolios that may occur during the applicable tax period, including gain or loss on any MBS disposals and whole loan modifications, foreclosures and liquidations; the timing and amount of distributions to stockholders, which are declared and paid at the discretion of our Board and will depend on, among other things, our taxable income, our financial results and overall financial condition and liquidity, maintenance of our REIT qualification and such other factors as the Board deems relevant; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended (or the Investment Company Act), including statements regarding the concept release issued by theSEC relating to interpretive issues under the Investment Company Act with respect to the status under the Investment Company Act of certain companies that are engaged in the business of acquiring mortgages and mortgage-related interests; our ability to continue growing our residential whole loan portfolio, which is dependent on, among other things, the supply of loans offered for sale in the market; expected returns on our investments in nonperforming residential whole loans (or NPLs), which are affected by, among other things, the length of time required to foreclose upon, sell, liquidate or otherwise reach a resolution of the property underlying the NPL, home price values, amounts advanced to carry the asset (e.g., taxes, insurance, maintenance expenses, etc. on the underlying property) and the amount ultimately realized upon resolution of the asset; targeted or expected returns on our investments in recently-originated loans, the performance of which is, similar to our other mortgage loan investments, subject to, among other things, differences in prepayment risk, credit risk and financing cost associated with such investments; risks associated with our investments in MSR-related assets, including servicing, regulatory and economic risks, risks associated with our investments in loan originators, risks associated with investing in real estate assets, including changes in business conditions and the general economy and risks associated with our expected acquisition ofLima One Holdings, LLC , including the timing and expected benefits of such acquisition. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with theSEC , could cause our actual results to differ materially from those projected in any forward-looking statements we make. All forward-looking statements are based on beliefs, assumptions and expectations of our future performance, taking into account all information currently available. Readers are cautioned not to place undue 54 -------------------------------------------------------------------------------- Table of Contents reliance on these forward-looking statements, which speak only as of the date on which they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Recent Developments
Acquisition of
Subsequent to the end of the first quarter of 2021, we signed an agreement with entities affiliated withMagnetar Capital (or, the Magnetar entities) to acquire the membership interests held by them inLima One Holdings, LLC , the parent entity ofLima One Capital, LLC , a leading nationwide originator and servicer of business purpose loans. The all-cash transaction, the consummation of which is subject to the receipt of certain regulatory approvals and third-party consents, is expected to close in the third fiscal quarter of 2021. Upon closing, we will own substantially all of the equity interests inLima One Holdings, LLC , which will result in the consolidation of Lima One's financial results in our financial statements following the closing.
Business/General
We are an internally-managed REIT primarily engaged in the business of investing, on a leveraged basis, in residential mortgage assets, including residential whole loans, residential mortgage securities and MSR-related assets. Our principal business objective is to deliver shareholder value through the generation of distributable income and through asset performance linked to residential mortgage credit fundamentals. We selectively invest in residential mortgage assets with a focus on credit analysis, projected prepayment rates, interest rate sensitivity and expected return. AtMarch 31, 2021 , we had total assets of approximately$6.7 billion , of which$5.2 billion , or 77%, represented residential whole loans acquired through interests in certain trusts established to acquire the loans. Our Purchased Performing Loans, which as ofMarch 31, 2021 comprised approximately 63% of our residential whole loans, include: (i) loans to finance (or refinance) one-to-four family residential properties that are not considered to meet the definition of a "Qualified Mortgage" in accordance with guidelines adopted by theConsumer Financial Protection Bureau (or Non-QM loans), (ii) short-term business purpose loans collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit (or Rehabilitation loans or Fix and Flip loans), (iii) loans to finance (or refinance) non-owner occupied one-to-four family residential properties that are rented to one or more tenants (or Single-family rental loans), and (iv) previously originated loans secured by residential real estate that is generally owner occupied (or Seasoned performing loans). In addition, atMarch 31, 2021 , we had approximately$350.1 million in investments in Securities, at fair value, which represented approximately 5% of our total assets. At such date, our Securities, at fair value portfolio included MSR-related assets, CRT securities and RPL/NPL MBS. Our MSR-related assets include term notes whose cash flows are considered to be largely dependent on MSR collateral and loan participations to provide financing to mortgage originators that own MSRs. Our remaining investment-related assets, which represent approximately 5% of our total assets atMarch 31, 2021 , were primarily comprised of REO, capital contributions made to loan origination partners and MBS and loan-related receivables. The results of our business operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income and the market value of our assets, which is driven by numerous factors, including the supply and demand for residential mortgage assets in the marketplace, the terms and availability of adequate financing, general economic and real estate conditions (both on a national and local level), the impact of government actions in the real estate and mortgage sector, and the credit performance of our credit sensitive residential mortgage assets. Changes in these factors, or uncertainty in the market regarding the potential for changes in these factors, can result in significant changes in the value and/or performance of our investment portfolio. Further, our GAAP results may be impacted by market volatility, resulting in changes in market values of certain financial instruments for which changes in fair value are recorded in net income each period, such certain residential whole loans andCRT Securities . Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds, the behavior of which involves various risks and uncertainties. Interest rates and conditional prepayment rates (or CPRs) (which measure the amount of unscheduled principal prepayment on an asset as a percentage of the asset balance), 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 financial results are impacted by estimates of credit losses that are required to be recorded when loans that are not accounted for at fair value through net income are acquired or originated, as well as changes in these credit loss estimates that will be required to be made periodically. 55
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With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of certain of our residential mortgage assets and, correspondingly, our stockholders' equity to decline; (iii) coupons on our adjustable-rate assets to reset, on a delayed basis, to higher interest rates; (iv) prepayments on our assets to decline, thereby slowing the amortization of purchase premiums and the accretion of our purchase discounts, and slowing our ability to redeploy capital to generally higher yielding investments; and (v) the value of our derivative hedging instruments, if any, and, correspondingly, our stockholders' equity to increase. Conversely, decreases in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to decrease; (ii) the value of certain of our residential mortgage assets and, correspondingly, our stockholders' equity to increase; (iii) coupons on our adjustable-rate assets, on a delayed basis, to lower interest rates; (iv) prepayments on our assets to increase, thereby accelerating the amortization of purchase premiums and the accretion of our purchase discounts, and accelerating the redeployment of our capital to generally lower yielding investments; and (v) the value of our derivative hedging instruments, if any, and, correspondingly, our stockholders' equity to decrease. In addition, our borrowing costs and credit lines are further affected by the type of collateral we pledge and general conditions in the credit market. Our investments in residential mortgage assets expose us to credit risk, meaning that we are generally subject to credit losses due to the risk of delinquency, default and foreclosure on the underlying real estate collateral. Our investment process for credit sensitive assets focuses primarily on quantifying and pricing credit risk. With respect to investments in Purchased Performing Loans, we believe that sound underwriting standards, including low LTVs at origination, significantly mitigate our risk of loss. Further, we believe the discounted purchase prices paid on certain non-performing and Purchased Credit Deteriorated Loans mitigate our risk of loss in the event that, as we expect on most such investments, we receive less than 100% of the par value of these investments. Premiums arise when we acquire an MBS at a price in excess of the aggregate principal balance of the mortgages securing the MBS (i.e., par value) or when we acquire residential whole loans at a price in excess of their aggregate principal balance Conversely, discounts arise when we acquire an MBS at a price below the aggregate principal balance of the mortgages securing the MBS or when we acquire residential whole loans at a price below their aggregate principal balance. Accretable purchase discounts on these investments are accreted to interest income. Purchase premiums, which are primarily carried on certain of our Non-QM and business purpose loans, are amortized against interest income over the life of the investment using the effective yield method, adjusted for actual prepayment activity. An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase premiums, thereby reducing the interest income earned on these assets. CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. In particular, CPR reflects the conditional repayment rate (or CRR), which measures voluntary prepayments of a loan, and the conditional default rate (or CDR), which measures involuntary prepayments resulting from defaults. CPRs on our residential mortgage securities and whole loans may differ significantly. For the three months endedMarch 31, 2021 , the average CPR on our Non-QM loan portfolio was 30.2%. For the three months endedMarch 31, 2021 , the average CPR on our Single-family rental loan portfolio was 12.2%. It is generally our business strategy to hold our residential mortgage assets as long-term investments. On at least a quarterly basis, excluding investments for which the fair value option has been elected or for which specialized loan accounting is otherwise applied, we assess our ability and intent to continue to hold each asset and, as part of this process, we monitor our investments in securities that are designated as AFS for impairment. A change in our ability and/or intent to continue to hold any of these securities that are in an unrealized loss position, or a deterioration in the underlying characteristics of these securities, could result in our recognizing future impairment charges or a loss upon the sale of any such security. Our residential mortgage investments have longer-term contractual maturities than our financing liabilities. Even though the majority of our investments have interest rates that adjust over time based on short-term changes in corresponding interest rate indices (typically following an initial fixed-rate period for our Hybrids), the interest rates we pay on our borrowings will typically change at a faster pace than the interest rates we earn on our investments. In order to reduce this interest rate risk exposure, we may enter into derivative instruments, which in the past have generally been comprised of Swaps. The majority of our Swap derivative instruments have generally been designated as cash-flow hedges against a portion of our then current and forecasted LIBOR-based repurchase agreements. Following the significant interest rate decreases that occurred late in the first quarter of 2020, we unwound all of our Swap transactions at the end of the first quarter of 2020. 56 -------------------------------------------------------------------------------- Table of Contents Recent Market Conditions and Our Strategy
First quarter 2021 Portfolio Activity and impact on financial results:
At
The following table presents the activity for our residential mortgage asset
portfolio for the three months ended
December 31,
(In Millions) 2020 Runoff (1) Acquisitions Other (2) March 31, 2021 Change
Residential whole loans and
REO $ 5,575 $ (484) $ 253 $ 65 $ 5,409 $ (166)
Securities, at fair value 400 (59) - 10 351 (49)
Totals $ 5,975 $ (543) $ 253 $ 75 $ 5,760 $ (215)
(1) Primarily includes principal repayments, cash collections on Purchased
Credit Deteriorated Loans and sales of REO.
(2) Primarily includes changes in fair value and adjustments to record lower of
cost or estimated fair value adjustments on REO.
At March 31, 2021 , our total recorded investment in residential whole loans and
REO was $5.4 billion , or 93.9% of our residential mortgage asset portfolio. Of
this amount, (i) $3.9 billion is presented as Residential whole loans, at
carrying value (of which $3.3 billion were Purchased Performing Loans and $612.4
million were Purchased Credit Deteriorated Loans), and (ii) $1.3 billion is
presented as Residential whole loans, at fair value, in our consolidated balance
sheets. For the three months ended March 31, 2021 , we recognized approximately
$45.3 million of income on Residential whole loans, at carrying value in
Interest Income on our consolidated statements of operations, representing an
effective yield of 4.42% (excluding servicing costs), with Purchased Performing
Loans generating an effective yield of 4.31% and Purchased Credit Deteriorated
Loans generating an effective yield of 5.00%. In addition, we recorded a net
gain on residential whole loans measured at fair value through earnings of $49.8
million in Other Income, net in our consolidated statements of operations for
the three months ended March 31, 2021 . At March 31, 2021 and December 31, 2020 ,
we had REO with an aggregate carrying value of $220.4 million and $249.7
million , respectively, which is included in Other assets on our consolidated
balance sheets.
In response to the financial impact of COVID-19 on borrowers, and in compliance
with various federal and state guidelines, starting in the first quarter of
2020, we offered short-term relief to certain borrowers who were contractually
current at the time the pandemic started to impact the economy. Under the terms
of such plans, for certain borrowers a deferral plan was entered into where
missed payments were deferred to the maturity of the related loan, with a
corresponding change to the loan's next payment due date. In addition, certain
borrowers were granted up to a seven-month "zero pay" forbearance with payments
required to resume at the conclusion of the plan. For these borrowers,
delinquent payments were permitted to be placed on specified repayment plans.
While the majority of the borrowers granted relief have resumed making payments
at the conclusion of such deferral and forbearance periods, certain borrowers,
particularly in our Non-QM loan portfolio, continue to be impacted financially
by COVID-19 and have not yet resumed payments. When these borrowers became more
than 90 days delinquent on payments, any interest income receivable related to
the associated loans was reversed in accordance with our non-accrual policies.
At March 31, 2021 , Non-QM loans with an amortized cost of $135.3 million , or
6.1% of the portfolio, were more than 90 days delinquent. For these and other
borrowers that have been impacted by the COVID-19, we are continuing to evaluate
loss mitigation options with respect to these loans, including forbearance,
repayment plans, loan modification and foreclosure. In addition, at March 31,
2021 , Rehabilitation Loans to fix and flip borrowers with an amortized cost of
$137.0 million , or 29.5% of the portfolio, were more than 90 days delinquent.
Because rehabilitation loans are shorter term and repayment is usually dependent
on completion of the rehabilitation project and sale of the property, the
strategy to resolve delinquent rehabilitation loans differs from owner occupied
loans. Consequently, forbearance and repayment plans are offered less
frequently. However, we seek to work with delinquent fix and flip borrowers
whose projects are close to completion or are listed for sale in order to
provide the borrower the opportunity to sell the property and repay our loan. In
circumstances where the borrower is not able to complete the project or we are
not able to work with the borrower to our mutual benefit, we pursue foreclosure
or other forms of resolution.
At March 31, 2021 , our Securities, at fair value totaled $350.1 million and
included $244.7 million of MSR-related assets, $103.8 million of CRT securities
and $1.6 million of RPL/NPL MBS. The net yield on our Securities, at fair value
was 22.25% for the first quarter of 2021, compared to 5.22% for the first
quarter 2020. The increase in the net yield on our Securities, at fair value
portfolio reflects accretion income of approximately $8.1 million recognized in
the current year quarter due to the redemption of a RPL/NPL MBS security that
had been previously purchased at a discount.
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We adopted the new accounting standard addressing the measurement of credit
losses on financial instruments (CECL) on January 1, 2020 . CECL requires that
reserves for credit losses be estimated at the reporting date based on expected
cash flows for the life of the loan or financial asset, including anticipated
prepayments and reasonable and supportable forecasts of future economic
conditions. For the first quarter of 2021, we recorded a reversal of provision
for credit losses on residential whole loans held at carrying value of $22.8
million . The reversal for the period primarily reflects an adjustment to certain
macro-economic inputs to our loan loss estimates and lower loan balances. The
total allowance for credit losses recorded on residential whole loans held at
carrying value at March 31, 2021 was $63.2 million . In addition, as of March 31,
2021 , CECL reserves for credit losses totaling approximately $796,000 were
recorded related to undrawn commitments on loans held at carrying value.
During the first quarter of 2021, we continued to execute on our strategy of
entering into more durable forms of financing by completing a securitization
consisting of $217.5 million of business purpose rental loans, generating
approximately $48.4 million of additional liquidity. As the weighted average
coupon of the bonds sold was approximately 1.06%, this transaction is expected
to lower the funding rate of the underlying assets by more than 150 basis
points. During the first quarter, we also completed a securitization transaction
collateralized by non-performing loans with an unpaid principal balance of
$325.7 million and REO with an estimated value of $50.6 million , which lowered
the funding rate for the associated assets by approximately 168 basis points.
Subsequent to the end of the first quarter, we completed another securitization
of Non-QM loans of $394.2 million , with a weighted average cost of bonds sold of
1.37%, lowering the funding rate of financing by approximately 203 basis points.
Additionally, on January 6, 2021 , we redeemed all of our outstanding $100
million aggregate principal amount of 8.00% Senior Notes Due 2042.
Our GAAP book value per common share was $4.63 as of March 31, 2021 . Book value
per common share increased from $4.54 as of December 31, 2020 . Economic book
value per common share, a non-GAAP financial measure of our financial position
that adjusts GAAP book value by the amount of unrealized mark-to-market gains on
our residential whole loans held at carrying value, was $5.09 as of March 31,
2021 , an increase from $4.92 as of December 31, 2020 . Increases in GAAP and
Economic book value during the first quarter of 2021 reflect higher asset prices
for residential mortgage assets. For additional information regarding the
calculation of Economic book value per share, including a reconciliation to GAAP
book value per share, refer to page 71 under the heading "Economic Book Value."
Information About Our Assets
The table below presents certain information about our asset allocation at
March 31, 2021 :
ASSET ALLOCATION
Residential Whole
Loans, at Carrying Residential Whole Securities, at fair Real Estate Other,
(Dollars in Millions) Value (1) Loans, at Fair Value value Owned net (2) Total
Fair Value/Carrying Value $ 3,869 $ 1,320 $ 350 $ 220 $ 890 $ 6,649
Payable for Unsettled Purchases - (112) - - - (112)
Financing Agreements with
non-mark-to-market collateral provisions (795) (239) - (7) - (1,041)
Financing Agreements with mark-to-market
collateral provisions (732) (236) (201) (11) - (1,180)
Less Securitized Debt (1,314) (224) - (11) - (1,549)
Less Convertible Senior Notes - - - - (225) (225)
Net Equity Allocated $ 1,028 $ 509 $ 149 $ 191 $ 665 $ 2,542
Debt/Net Equity Ratio (3) 2.8 x 1.6 x 1.3 x 0.2 x 1.6 x
(1)Includes $2.2 billion of Non-QM loans, $450.7 million of Rehabilitation
loans, $449.0 million of Single-family rental loans, $128.0 million of Seasoned
performing loans, and $612.4 million of Purchased Credit Deteriorated Loans. At
March 31, 2021 , the total fair value of these loans is estimated to be
approximately $4.1 billion .
(2)Includes $780.7 million of cash and cash equivalents, $5.2 million of
restricted cash, and $81.4 million of capital contributions made to loan
origination partners, as well as other assets and other liabilities.
(3)Total Debt/Net Equity ratio represents the sum of borrowings under our
financing agreements noted above as a multiple of net equity allocated.
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Residential Whole Loans
The following table presents the contractual maturities of our residential whole loan portfolios atMarch 31, 2021 . Amounts presented do not reflect estimates of prepayments or scheduled amortization. Residential Whole Purchased Purchased Credit Loans, at Fair Value (In Thousands) Performing Loans (1) Deteriorated Loans (2) (3) Amount due: Within one year $ 450,625 $ 708 $ 3,913 After one year: Over one to five years 35,896 3,401 4,390 Over five years 2,801,169 640,502 1,199,694 Total due after one year $ 2,837,065 $ 643,903 $ 1,204,084 Total residential whole loans $ 3,287,690 $ 644,611 $ 1,207,997 (1)Excludes an allowance for credit losses of$31.0 million atMarch 31, 2021 . (2)Excludes an allowance for credit losses of$32.2 million atMarch 31, 2021 . (3)Excluded from the table above are approximately$112.2 million of Residential whole loans, at fair value for which the closing of the purchase transaction had not occurred as ofMarch 31, 2021 . The following table presents, atMarch 31, 2021 , the dollar amount of certain of our residential whole loans, contractually maturing after one year, and indicates whether the loans have fixed interest rates or adjustable interest rates: Purchased Purchased Credit Residential Whole Performing Loans Deteriorated Loans Loans, at Fair Value (In Thousands) (1)(2) (1)(3) (1)(4) Interest rates: Fixed $ 987,320 $ 477,770 $ 905,397 Adjustable 1,849,745 166,133 298,687 Total$ 2,837,065 $ 643,903 $ 1,204,084 (1)Includes loans on which borrowers have defaulted and are not making payments of principal and/or interest as ofMarch 31, 2021 . (2)Excludes an allowance for credit losses of$31.0 million atMarch 31, 2021 . (3)Excludes an allowance for credit losses of$32.2 million atMarch 31, 2021 . (4)Excluded from the table above are approximately$112.2 million of Residential whole loans, at fair value for which the closing of the purchase transaction had not occurred as ofMarch 31, 2021 . 59 -------------------------------------------------------------------------------- Table of Contents Securities, at Fair Value The following table presents information with respect to our Securities, at fair value atMarch 31, 2021 andDecember 31, 2020 : (Dollars in Thousands) March 31, 2021 December 31, 2020 MSR-Related Assets Face/Par$ 247,263 $ 249,769 Fair Value 244,700 238,999 Amortized Cost 185,621 184,908 Weighted average yield 12.10 % 12.30 % Weighted average time to maturity 8.2 years 8.7 years CRT Securities Face/Par$ 103,898 $ 104,031 Fair Value 103,826 104,234 Amortized Cost 86,826 86,214 Weighted average yield 8.30 % 7.37 % Weighted average time to maturity 19.5 years 19.7 years RPL/NPL MBS Face/Par$ 1,589 $ 54,998 Fair Value 1,589 53,946 Amortized Cost 1,588 46,862 Weighted average yield 9.38 % 7.55 % Weighted average time to maturity 26.3 years 28.7 years Tax Considerations
Current period estimated taxable income
We estimate that for the three months endedMarch 31, 2021 , our taxable income was approximately$9.4 million . We have until the filing of our 2020 tax return (due not later thanOctober 15, 2021 ) to declare the distribution of any 2020 REIT taxable income not previously distributed.
Key differences between GAAP net income and REIT Taxable Income
The determination of taxable income attributable to residential whole loans and securities is dependent on a number of factors, including principal payments, defaults, loss mitigation efforts and loss severities. In estimating taxable income for such investments during the year, management considers estimates of the amount of discount expected to be accreted. Such estimates require significant judgment and actual results may differ from these estimates. Potential timing differences can arise with respect to the accretion of discount and amortization of premium into income as well as the recognition of gain or loss for tax purposes as compared to GAAP. For example: a) while our REIT uses fair value accounting for GAAP in some instances it generally is not used for purposes of determining taxable income; b) impairments generally are not recognized by us for income tax purposes until the asset is written-off or sold; c) capital losses may only be recognized by us to the extent of its capital gains; capital losses in excess of capital gains generally are carried over by us for potential offset against future capital gains; and d) tax hedge gains and losses resulting from the termination of interest rate swaps by us generally are amortized over the remaining term of the swap.
Securitization
Generally, securitization transactions for GAAP and Tax can be characterized as
either sales or financings, depending on transaction type, structure and
available elections. For GAAP purposes, our securitizations have been treated as
on-balance sheet financing transactions. For tax purposes, they have been
characterized as both financing and sale transactions.
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Where a securitization has been characterized as a sale, gain or loss is
recognized for tax purposes. In addition, we own or may in the future acquire
interests in securitization and/or re-securitization trusts, in which several of
the classes of securities are or will be issued with original issue discount (or
OID). As the holder of the retained interests in the trust, for tax purposes we
generally will be required to include OID in our current gross interest income
over the term of the applicable securities as the OID accrues. The rate at which
the OID is recognized into taxable income is calculated using a constant rate of
yield to maturity, with realized losses impacting the amount of OID recognized
in REIT taxable income once they are actually incurred. REIT taxable income may
be recognized in excess of economic income (i.e., OID) or in advance of the
corresponding cash flow from these assets, thereby affecting our dividend
distribution requirement to stockholders.
For securitization and/or re-securitization transactions that were treated as a
sale of the underlying collateral for tax purposes, the unwinding of any such
transaction will likely result in taxable income or loss. Given that
securitization and re-securitization transactions are typically accounted for as
financing transactions for GAAP purposes, such income or loss is not likely to
be recognized for GAAP. As a result, the income recognized from securitization
and re-securitization transactions may differ for tax and GAAP purposes.
Whether our investments are held by our REIT or one of its Taxable REIT Subsidiaries (TRS)
Net income generated by our TRS subsidiaries is included in consolidated GAAP net income, but may not be included in REIT taxable income in the same period. REIT taxable income generally does not include taxable income of the TRS unless and until it is distributed to the REIT. For example, because our securitization transactions that are treated as a sale for tax purposes are undertaken by a domestic TRS any gain or loss recognized on the sale is not included in our REIT taxable income until it is distributed by the TRS. Similarly, the income earned from loans, securities, REO and other investments held by our domestic TRS is excluded from REIT taxable income until it is distributed by the TRS. Net income of our foreign domiciled TRS subsidiaries is included in REIT taxable income as if distributed to the REIT in the taxable year it is earned by the foreign domiciled TRS.
Consequently, our REIT taxable income calculated in a given period may differ significantly from our GAAP net income.
Regulatory Developments
The U.S. Congress ,U.S. Federal Reserve ,U.S. Treasury ,Federal Deposit Insurance Corporation ,SEC and other governmental and regulatory bodies have taken actions in response to the 2007-2008 financial crisis. In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (or the Dodd-Frank Act) created a new regulator, an independent bureau housed within theU.S. Federal Reserve System known as theConsumer Financial Protection Bureau (or theCFPB ). TheCFPB has broad authority over a wide range of consumer financial products and services, including mortgage lending and servicing. One portion of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act (or Mortgage Reform Act), contains underwriting and servicing standards for the mortgage industry, restrictions on compensation for mortgage loan originators, and various other requirements related to mortgage origination and servicing. In addition, the Dodd-Frank Act grants enforcement authority and broad discretionary regulatory authority to theCFPB to prohibit or condition terms, acts or practices relating to residential mortgage loans that theCFPB finds abusive, unfair, deceptive or predatory, as well as to take other actions that theCFPB finds are necessary or proper to ensure responsible affordable mortgage credit remains available to consumers. The Dodd-Frank Act also affects the securitization of mortgages (and other assets) with requirements for risk retention by securitizers and requirements for regulating rating agencies. Numerous regulations have been issued pursuant to the Dodd-Frank Act, including regulations regarding mortgage loan servicing, underwriting and loan originator compensation and others could be issued in the future. As a result, we are unable to fully predict at this time how the Dodd-Frank Act, as well as other laws or regulations that may be adopted in the future, will affect our business, results of operations and financial condition, or the environment for repurchase financing and other forms of borrowing, the investing environment for Agency MBS, Non-Agency MBS and/or residential mortgage loans, the securitization industry, Swaps and other derivatives. We believe that the Dodd-Frank Act and the regulations promulgated thereunder are likely to continue to increase the economic and compliance costs for participants in the mortgage and securitization industries, including us. 61 -------------------------------------------------------------------------------- Table of Contents In addition to the regulatory actions implemented under the Dodd-Frank Act, onAugust 31, 2011 , theSEC issued a concept release under which it is reviewing interpretive issues related to Section 3(c)(5)(C) of the Investment Company Act. Section 3(c)(5)(C) excludes from the definition of "investment company" entities that are primarily engaged in, among other things, "purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." Many companies that engage in the business of acquiring mortgages and mortgage-related instruments seek to rely on existing interpretations of theSEC Staff with respect to Section 3(c)(5)(C) so as not to be deemed an investment company for the purpose of regulation under the Investment Company Act. In connection with the concept release, theSEC requested comments on, among other things, whether it should reconsider its existing interpretation of Section 3(c)(5)(C). To date, the SEC has not taken or otherwise announced any further action in connection with the concept release. TheFederal Housing Finance Agency (or FHFA) and both houses ofCongress have discussed and considered various measures intended to restructure theU.S. housing finance system and the operations of Fannie Mae and Freddie Mac.Congress may continue to consider legislation that would significantly reform the country's mortgage finance system, including, among other things, eliminating Freddie Mac and Fannie Mae and replacing them with a single new MBS insurance agency. Many details remain unsettled, including the scope and costs of the agencies' guarantee and their affordable housing mission, some of which could be addressed even in the absence of large-scale reform. OnMarch 27, 2019 , thenPresident Trump issued a memorandum on federal housing finance reform that directed the Secretary of theTreasury to develop a plan for administrative and legislative reforms as soon as practicable to achieve the following housing reform goals: 1) ending the conservatorships of the Government-sponsored enterprises (or GSEs) upon the completion of specified reforms; 2) facilitating competition in the housing finance market; 3) establishing regulation of the GSEs that safeguards their safety and soundness and minimizes the risks they pose to the financial stability ofthe United States ; and 4) providing that the federal government is properly compensated for any explicit or implicit support it provides to the GSEs or the secondary housing finance market. OnSeptember 5, 2019 , in response to thenPresident Trump's memorandum, theU.S. Department of the Treasury released a plan, developed in conjunction with the FHFA, theDepartment of Housing and Urban Development , and other government agencies, which includes legislative and administrative reforms to achieve each of these reform goals. At this point, it remains unclear whether any of these legislative or regulatory reforms will be enacted or implemented. The prospects for passage of any of these plans are uncertain, but the proposals underscore the potential for change to Fannie Mae and Freddie Mac. While the likelihood of enactment of major mortgage finance system reform in the short term remains uncertain, it is possible that the adoption of any such reforms could adversely affect the types of assets we can buy, the costs of these assets and our business operations. A reduction in the ability of mortgage loan originators to access Fannie Mae and Freddie Mac to sell their mortgage loans may adversely affect the mortgage markets generally and adversely affect the ability of mortgagors to refinance their mortgage loans. In addition, any decline in the value of securities issued by Fannie Mae and Freddie Mac may affect the value of MBS in general. With the start of a new Presidential administration inJanuary 2021 , it is unclear whether, and if so on what timeline, the new administration will address the conservatorships of the GSEs and any comprehensive housing reform. OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act (or CARES Act) was signed into law. Among the provisions in this wide-ranging law are protections for homeowners experiencing financial difficulties due to COVID-19, including forbearance provisions and procedures. Borrowers with federally backed mortgage loans, regardless of delinquency status, may request loan forbearance for a six-month period, which could be extended for another six-month period if necessary. Although the initial deadline to request forbearance on federally backed loans was set to expire under the CARES Act onDecember 31, 2020 , FHFA andCFPB have announced extensions of several measures to align COVID-19 mortgage relief policies across the federal government, including additional three-month extensions of COVID-19 forbearance or payment deferral options for certain borrowers. Federally backed mortgage loans are loans secured by first- or subordinate-liens on 1-4 family residential real property, including individual units of condominiums and cooperatives, which are insured or guaranteed pursuant to certain government housing programs, such as by theFederal Housing Administration , orU.S. Department of Agriculture , or are purchased or securitized by Fannie Mae or Freddie Mac. The CARES Act also includes a temporary 60 day foreclosure moratorium that applies to federally backed mortgage loans, which lasted untilJuly 24, 2020 . However, the foreclosure moratorium has since been extended several times to at leastJune 30, 2021 by Fannie Mae and Freddie Mac,Federal Housing Administration and theU.S. Department of Agriculture . Various states and local jurisdictions also have imposed foreclosure moratoriums. InDecember 2020 , the Consolidated Appropriations Act, 2021 was signed into law, which is an Omnibus spending bill that included a second COVID-19 stimulus bill (or Second Stimulus). In addition to providing stimulus checks for individuals and families, the Second Stimulus provides for, among other things, (i) an extension of federal unemployment insurance benefits, (ii) funding to help individuals connect remotely during the pandemic, (iii) tax credits for companies offering paid sick leave and (iv) funding for vaccine distribution and development. As further described below, the Second Stimulus provided an 62 -------------------------------------------------------------------------------- Table of Contents additional$25 billion in tax-free rental assistance and an executive order byPresident Biden extended the temporary eviction moratorium promulgated by theCDC (described below) throughMarch 31, 2021 . OnSeptember 1, 2020 , theCenters for Disease Control and Prevention (orCDC ) issued an order effectiveSeptember 4, 2020 throughDecember 31, 2020 temporarily halting residential evictions to prevent the further spread of COVID-19. The Second Stimulus extended the order toJanuary 31, 2021 and, onJanuary 20, 2021 , PresidentJoseph Biden signed an executive order that, among other things, further extended the temporary eviction moratorium promulgated by theCDC throughMarch 31, 2021 . TheCDC order has since been further extended throughJune 30, 2021 . TheCDC order will likely prevent some mortgagors from evicting certain tenants who are not current on their monthly payments of rent and who qualify for relief under theCDC order, which may present a greater risk that the mortgagor will stop making monthly mortgage loan payments. TheCDC order by its terms does not preempt or preclude state and local jurisdictions from more expansive orders currently in place or from imposing additional or more restrictive requirements than theCDC order to provide greater public health protection and, across the country, similar moratoriums are in place in various states and local jurisdictions to stop evictions and foreclosures in an effort to lessen the financial burden created by COVID-19. TheCDC 's moratorium and any other similar state moratoriums or bans could adversely impact the cash flow on mortgage loans.The Biden Administration may pass additional stimulus bills, foreclosure relief measures and may further extend foreclosure and eviction moratoriums that may continue to adversely impact the cash flow on mortgage loans. 63 -------------------------------------------------------------------------------- Table of Contents Results of Operations
Quarter Ended
General
For the first quarter of 2021, we had a net income available to our common stock and participating securities of$77.3 million , or$0.17 per basic and diluted common share, compared to net loss available to common stock and participating securities for the first quarter of 2020 of$914.2 million , or$2.02 per basic and diluted common share. This increase in net income available to common stock and participating securities primarily reflects higher Other income and a reversal of provision for credit losses on residential whole loans held at carrying value, partially offset by lower net interest income from our investments. The prior period results were significantly impacted by the unprecedented disruption in residential mortgage markets due to concerns related to COVID-19 that required management to take actions to bolster and stabilize our balance sheet, and improve our liquidity position. The actions included disposing our Agency and Legacy Non-Agency MBS portfolios, substantially reducing our investments in MSR-related assets, RPL/NPL MBS and CRT securities and sales of certain residential whole loans. These disposals resulted in net realized losses for the first quarter of 2020 totaling$238.4 million and contributed to the reduction in net interest income from our investments in the current period. Further, during the first quarter of 2020, we recorded impairment losses on certain residential mortgage securities and MSR-related assets of$344.3 million and also recorded impairment losses on other assets of$75.4 million , primarily related to write-downs of the carrying values of investments in certain loan originators. During the three months endedMarch 31, 2020 , we also incurred$4.5 million of professional services and other costs in connection with negotiating forbearance arrangements with our lenders and recorded losses totaling$4.3 million on terminated Swaps that had previously been designated as hedges for accounting purposes. Further, under the new accounting standard for estimating credit losses that we were require to adopt during the first quarter of 2020, we recorded a provision for credit losses on residential whole loans held at carrying value of$74.9 million . We also recorded a valuation allowance of$70.2 million to adjust the carrying value of certain residential whole loans to their estimated fair value as these loans were designated as being held-for-sale atMarch 31, 2020 .
Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned or paid. Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our investments. Interest rates and CPRs (which measure the amount of unscheduled principal prepayment on a bond or loan as a percentage of its unpaid balance) vary according to the type of investment, conditions in the financial markets and other factors, none of which can be predicted with any certainty.
The changes in average interest-earning assets and average interest-bearing liabilities and their related yields and costs are discussed in greater detail below under "Interest Income" and "Interest Expense."
For the first quarter of 2021, our net interest spread and margin were 1.86% and 2.46%, respectively, compared to a net interest spread and margin of 1.82% and 2.20%, respectively, for the first quarter of 2020. Our net interest income decreased by$29.9 million , or 48.49%, to$31.8 million for the first quarter of 2021 compared to net interest income of$61.7 million for the first quarter of 2020. For the first quarter of 2021, net interest income for our Securities, at fair value portfolio decreased by approximately$17.3 million compared to the first quarter of 2020, primarily due to lower average amounts invested in these securities due to portfolio sales in the first and second quarters of 2020. Net interest income also includes lower net interest income from residential whole loans held at carrying value of approximately$14.9 million for the first quarter of 2021 compared to the first quarter of 2020, primarily due to lower average amounts invested in and lower yields earned on these assets, and an increase in financing rates on our financing agreements. This was partially offset by a decrease in our average repurchase agreement borrowings to finance our residential whole loans at carrying value portfolio and lower funding costs for these assets. In addition, onJanuary 6, 2021 , we completed the redemption of our Senior Notes which resulted in lower interest expense for the first quarter of 2021 of$1.9 million compared to the first quarter of 2020. Net interest income for the first quarter of 2021 also includes$6.2 million of interest expense associated with residential whole loans held at fair value, reflecting a$3.5 million decrease in borrowing costs related to these investments compared to the first quarter of 2020. Coupon interest income received from residential whole loans held at fair value is presented as a component of the total income earned on these investments and therefore is included in Other Income, net rather than net interest income. 64
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Analysis of Net Interest Income
The following table sets forth certain information about the average balances of our assets and liabilities and their related yields and costs for the three months endedMarch 31, 2021 and 2020. Average yields are derived by dividing annualized interest income by the average amortized cost of the related assets, and average costs are derived by dividing annualized interest expense by the daily average balance of the related liabilities, for the periods shown. The yields and costs include premium amortization and purchase discount accretion, which are considered adjustments to interest rates. Three Months Ended March 31, 2021 2021 2020 Average Average (Dollars in Thousands) Average Balance Interest Yield/Cost Average Balance Interest Yield/Cost
Assets:
Interest-earning assets: Residential whole loans, at carrying value (1)$ 4,099,845 $ 45,340 4.42 %$ 6,584,538 $ 83,486 5.07 % Securities, at fair value (2)(3) 295,840 16,459 22.25 4,486,660 58,581 5.22 Cash and cash equivalents 775,172 54 0.03 206,899 486 0.94 Other interest-earning assets - - - 129,947 2,907 8.95 Total interest-earning assets 5,170,857 61,853 4.78 11,408,044 145,460 5.10 Total non-interest-earning assets 1,619,140 2,278,808 Total assets$ 6,789,997 $ 13,686,852 Liabilities and stockholders' equity: Interest-bearing liabilities: Collateralized financing agreements (4)(5)$ 2,360,566 $ 17,861 3.03 %$ 9,233,822 $ 72,698 3.11 % Securitized debt (6) 1,524,275 8,189 2.15 558,007 5,161 3.66 Convertible Senior Notes 225,285 3,909 6.94 224,071 3,888 6.94 Senior Notes 4,444 111 8.31 96,866 2,012 8.31 Total interest-bearing liabilities 4,114,570 30,070 2.92 10,112,766 83,759 3.28 Total non-interest-bearing liabilities 149,032 153,893 Total liabilities 4,263,602 10,266,659 Stockholders' equity 2,526,395 3,420,193 Total liabilities and stockholders' equity$6,789,997 $13,686,852 Net interest income/net interest rate spread (7)$ 31,783 1.86 %$ 61,701 1.82 % Net interest-earning assets/net interest margin (8)$ 1,056,287 2.46 %$ 1,295,278 2.20 % (1)Excludes residential whole loans held at fair value that are reported as a component of total non-interest-earning assets. Includes Non-QM loans held-for-sale with a net carrying value of$895.3 million atMarch 31, 2020 . (2)Yields presented throughout this Quarterly Report on Form 10-Q are calculated using average amortized cost data for securities which excludes unrealized gains and losses and includes principal payments receivable on securities. For GAAP reporting purposes, purchases and sales are reported on the trade date. Average amortized cost data used to determine yields is calculated based on the settlement date of the associated purchase or sale as interest income is not earned on purchased assets and continues to be earned on sold assets until settlement date. (3)The net yield of 22.25% includes$8.1 million of accretion recognized on the redemption of an RPL/NPL MBS security that was purchased at a discount. Excluding this accretion, the yield reported would have been 11.26%. (4)Collateralized financing agreements include the following: Secured term notes, Non-mark-to-market term-asset based financing, and repurchase agreements. For additional information, see Note 6, included under Item 1 of this Quarterly Report on Form 10-Q. (5)Average cost of repurchase agreements in the prior year period includes the cost of Swaps allocated based on the proportionate share of the overall estimated weighted average portfolio duration. (6)Includes both Securitized debt, at carrying value and Securitized debt, at fair value. (7)Net interest rate spread reflects the difference between the yield on average interest-earning assets and average cost of funds. (8)Net interest margin reflects annualized net interest income divided by average interest-earning assets. 65 -------------------------------------------------------------------------------- Table of Contents Rate/Volume Analysis The following table presents the extent to which changes in interest rates (yield/cost) and changes in the volume (average balance) of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) the changes attributable to changes in volume (changes in average balance multiplied by prior rate); (ii) the changes attributable to changes in rate (changes in rate multiplied by prior average balance); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately, based on absolute values, to the changes due to rate and volume. Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020 Total Net Increase/(Decrease) due to Change in Interest (In Thousands) Volume Rate Income/Expense Interest-earning assets: Residential whole loans, at carrying value (1)$ (28,497) $ (9,649) $ (38,146) Securities, at fair value (94,447) 52,325 (42,122) Cash and cash equivalents 378 (810) (432) Other interest-earning assets (1,454) (1,453) (2,907) Total net change in income from interest-earning assets$ (124,020) $ 40,413 $ (83,607)
Interest-bearing liabilities: Residential whole loan at carrying value financing agreements
$ (23,470) $ (4,314) $ (27,784) Residential whole loan at fair value financing agreements (1,004) (684) (1,688) Securities, at fair value repurchase agreements (20,501) (4,355) (24,856) REO financing agreements 51 52 103 Other repurchase agreements (306) (306) (612) Securitized debt 5,757 (2,729) 3,028 Convertible Senior Notes and Senior Notes (1,608) (272) (1,880) Total net change in expense from interest-bearing liabilities$ (41,081) $ (12,608) $ (53,689) Net change in net interest income$ (82,939) $ 53,021 $ (29,918)
(1)Excludes residential whole loans held at fair value, which are reported as a component of non-interest-earning assets.
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The following table presents certain quarterly information regarding our net
interest spread and net interest margin for the quarterly periods presented:
Total Interest-Earning Assets and Interest-
Bearing Liabilities
Net Interest Net Interest
Quarter Ended Spread (1) Margin (2)
March 31, 2021 1.86 % 2.46 %
December 31, 2020 1.07 1.49
September 30, 2020 0.03 0.76
June 30, 2020 (0.90) 0.02
March 31, 2020 1.82 2.20
(1)Reflects the difference between the yield on average interest-earning assets
and average cost of funds.
(2)Reflects annualized net interest income divided by average interest-earning
assets.
The following table presents the components of the net interest spread earned on
our Residential whole loans, at carrying value for the quarterly periods
presented:
Purchased Performing Loans Purchased Credit Deteriorated Loans Total Residential Whole Loans, at Carrying Value
Net Net Net
Net Cost of Interest Net Cost of Interest Net Cost of Interest
Quarter Ended Yield (1) Funding (2) Spread (3) Yield (1) Funding (2) Spread (3) Yield (1) Funding (2) Spread (3)
March 31, 2021 4.31 % 2.46 % 1.85 % 5.00 % 2.86 % 2.14 % 4.42 % 2.53 % 1.89 %
December 31, 2020 4.57 2.77 1.80 5.16 3.02 2.14 4.66 2.81 1.85
September 30, 2020 4.58 3.42 1.16 4.89 3.22 1.67 4.63 3.39 1.24
June 30, 2020 5.17 6.34 (1.17) 5.07 6.03 (0.96) 5.15 6.30 (1.15)
March 31, 2020 5.10 3.44 1.66 4.84 3.39 1.45 5.07 3.43 1.64
(1)Reflects annualized interest income on Residential whole loans, at carrying
value divided by average amortized cost of Residential whole loans, at carrying
value. Excludes servicing costs.
(2)Reflects annualized interest expense divided by average balance of repurchase
agreements and securitized debt. Total Residential whole loans, at carrying
value cost of funding includes 3 basis points associated with Swaps to hedge
interest rate sensitivity on these assets for the quarter ended March 31, 2020 .
Cost of funding for the quarter ended June 30, 2020 includes the impact of
amortization of $10.7 million of losses previously recorded in OCI related to
Swaps unwound during the quarter ended March 31, 2020 that had been previously
designated as hedges for accounting purposes. The amortization of these losses
increased the funding cost by 116 basis points for Purchased Performing Loans,
107 basis points for Purchased Credit Deteriorated Loans, and 115 basis points
for total Residential whole loans, at carrying value during the quarter ended
June 30, 2020 . At June 30, 2020 , following the closing of certain financing
transactions and our exit from forbearance arrangements, and an evaluation of
our anticipated future financing transactions, $49.9 million of unamortized
losses on Swaps previously designated as hedges for accounting purposes was
transferred from OCI to earnings, as it was determined that certain financing
transactions that were previously expected to be hedged by these Swaps were no
longer probable of occurring. In addition, cost of funding for the quarter ended
June 30, 2020 was significantly higher than for prior periods as it reflects
default interest and/or higher rates charged by lenders while we were under a
forbearance agreement. During the quarter ended September 30, 2020 , we
transferred from AOCI to earnings approximately $7.2 million of losses on Swaps
that had been previously designated as hedges for accounting purposes as we had
assessed that the underlying transactions were no longer probable of occurring.
(3)Reflects the difference between the net yield on average Residential whole
loans, at carrying value and average cost of funds on Residential whole loans,
at carrying value.
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The following table presents the components of the net interest spread earned on
our residential mortgage securities and MSR-related assets for the quarterly
periods presented:
Securities, at fair value
Net Interest
Net Cost of Rate
Quarter Ended Yield (1)(2) Funding (3) Spread (4)
March 31, 2021 22.25 % 2.02 % 20.23 %
December 31, 2020 10.15 2.69 7.46
September 30, 2020 9.80 3.49 6.31
June 30, 2020 8.20 5.81 2.39
March 31, 2020 5.22 2.53 2.69
(1)Reflects annualized interest income divided by average amortized cost.
Impairment charges recorded on MSR-related assets resulted in a lower amortized
cost basis which impacted the calculation of net yields in subsequent periods.
(2)The net yield of 22.25% includes $8.1 million of accretion recognized on the
redemption of an RPL/NPL MBS security that was purchased at a discount.
Excluding this accretion, the yield reported would have been 11.26%.
(3)Reflects annualized interest expense divided by average balance of repurchase
agreements, including the cost of Swaps allocated based on the proportionate
share of the overall estimated weighted average portfolio duration and
securitized debt. Agency MBS cost of funding includes 78 basis points and Legacy
Non-Agency MBS cost of funding includes 52 basis points associated with Swaps to
hedge interest rate sensitivity on these assets for the quarter ended March 31,
2020 . Cost of funding for the quarter ended June 30, 2020 includes the impact of
amortization of $278,000 of losses previously recorded in OCI related to Swaps
unwound during the quarter ended March 31, 2020 that had been previously
designated as hedges for accounting purposes. The amortization of these losses
increased the funding cost by 174 basis points for total RPL/NPL MBS during the
quarter ended June 30, 2020 . At June 30, 2020 , following the closing of certain
financing transactions and our exit from forbearance arrangements, and an
evaluation of our anticipated future financing transactions, $49.9 million of
unamortized losses on Swaps previously designated as hedges for accounting
purposes was transferred from OCI to earnings, as it was determined that certain
financing transactions that were previously expected to be hedged by these Swaps
were no longer probable of occurring. In addition, during the quarter ended
September 30, 2020 , we transferred from AOCI to earnings approximately
$7.2 million of losses on Swaps that had been previously designated as hedges
for accounting purposes as we had assessed that the underlying transactions were
no longer probable of occurring.
(4)Reflects the difference between the net yield on average and average cost of
funds.
Interest Income
Interest income on our residential whole loans held at carrying value decreased
by $38.1 million , or 45.7%, for the first quarter of 2021, to $45.3 million
compared to $83.5 million for the first quarter of 2020. This decrease primarily
reflects a $2.5 billion decrease in the average balance of this portfolio to
$4.1 billion for the first quarter of 2021 from $6.6 billion for the first
quarter of 2020 and a decrease in the yield (excluding servicing costs) to 4.42%
for the first quarter of 2021 from 5.07% for the first quarter of 2020.
Due to the previously discussed asset sales and impairment charges, the average
amortized cost of our Securities, at fair value portfolio decreased $4.2 billion
to $295.8 million for the first quarter of 2021 from $4.5 billion for the first
quarter of 2020 and interest income on our Securities, at fair value portfolio
decreased $42.1 million to $16.5 million for the first quarter of 2021 from
$58.6 million for the first quarter of 2020. The net yield on our Securities, at
fair value was 22.25% for the first quarter of 2021, compared to 5.22% for the
first quarter 2020. The increase in the net yield on our Securities, at fair
value portfolio primarily reflects accretion income of approximately $8.1
million recognized in the current quarter due to the redemption of a security
that had been previously purchased at a discount.
Interest Expense
Our interest expense for the first quarter of 2021 decreased by$53.7 million , or 64.1%, to$30.1 million , from$83.8 million for the first quarter of 2020. This decrease primarily reflects a decrease in our average repurchase agreement borrowings to finance our residential mortgage asset portfolio partially offset by an increase in financing rates on our financing agreements. OnJanuary 6, 2021 , we completed the redemption of our Senior Notes, which resulted in lower interest expense for the first quarter of 2021 of$1.9 million compared to the first quarter of 2020. The effective interest rate paid on our borrowings decreased to 2.92% for the first quarter of 2021, from 3.28% for the first quarter of 2020. 68
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Provision for Credit and Valuation Losses on Residential Whole Loans Held at Carrying Value and Other Financial Instruments
For the first quarter of 2021, we recorded a reversal of provision for credit losses on residential whole loans held at carrying value of$22.8 million (which includes a reversal of provision for credit losses on undrawn commitments of$378,000 ) compared to a provision of$150.7 million for the first quarter of 2020. The reversal for the period primarily reflects an adjustment to certain macro-economic inputs to our loan loss estimates and lower loan balances. As previously discussed, onJanuary 1, 2020 , we adopted the new accounting standard addressing the measurement of CECL. With respect to our residential whole loans held at carrying value and other financial instruments, CECL requires that reserves for credit losses are estimated at the reporting date based on expected cash flows over the life of the loan or financial instrument, including anticipated prepayments and reasonable and supportable forecasts of future economic conditions.
Other Income/(Loss), net
For the first quarter of 2021, Other Income, net increased by$844.3 million , to$53.5 million compared to a$790.8 million loss for the first quarter of 2020. The components of Other Income/(Loss), net for the first quarter of 2021 and 2020 are summarized in the table below: Quarter Ended March 31, (In Thousands) 2021 2020
Net gain/(loss) on residential whole loans measured at fair value through earnings
$ 49,809 $ (52,760)
Liquidation gains on Purchased Credit Deteriorated Loans and other loan related income
1,248 1,429
Impairment and other losses on securities available-for-sale and other assets
- (419,651)
Net unrealized gain/(loss) on securities, at fair value measured at fair value through earnings
101 (77,961)
Net realized gain on sales of securities, at fair value - (238,380)
Other 2,359 (3,440)
Total Other Income/(Loss), net $ 53,517 $ (790,763) Operating and Other Expense
For the first quarter of 2021, we had compensation and benefits and other general and administrative expenses of$15.2 million , or 2.41% of average equity, compared to$13.5 million , or 1.58% of average equity, for the first quarter of 2020. Compensation and benefits expense decreased by approximately$462,000 to$8.4 million for the first quarter of 2021, compared to$8.9 million for the first quarter of 2020, primarily reflecting the reduction in workforce that occurred in the third quarter of 2020 partially offset by higher expense in connection with long-term incentive awards in the current year period. Our other general and administrative expenses increased by$2.2 million to$6.8 million for the quarter endedMarch 31, 2021 , compared to$4.6 million for the first quarter of 2020, primarily due to higher costs associated with deferred compensation to Directors in the current year period, which were impacted by the changes in our stock price, higher costs for corporate insurance, systems consulting, administrative expenses associated with financing arrangements and the write-off of certain deferred financing costs, partially offset by a decrease in provision for income taxes. and lower information technology costs associated with data and analytical tools. In addition, during the first quarter of 2020, we also incurred professional service and other costs of$4.5 million related to negotiating forbearance arrangements with our lenders entering into new financing arrangements and reinstating prior financing arrangements on the exit from forbearance. Operating and Other Expense for the first quarter of 2021 also includes$7.3 million of loan servicing and other related operating expenses related to our residential whole loan activities. These expenses decreased compared to the prior year period by approximately$4.0 million , or 35.3%, primarily due to lower servicing fees and non-recoverable advances on our residential whole loan and REO portfolios, partially offset by costs related to loan securitization activities. 69 -------------------------------------------------------------------------------- Table of Contents Selected Financial Ratios
The following table presents information regarding certain of our financial ratios at or for the dates presented:
Return on Total Average Book Value Economic Book
Return on Average Total Stockholders' per Share Value per Share
Average Total Stockholders' Equity to Total Dividend Payout of Common of Common Stock
At or for the Quarter Ended Assets (1) Equity (2)(3) Average Assets (4) Ratio (5) Leverage Multiple (6) Stock (7) (8)
March 31, 2021 4.55 % 13.54 % 37.21 % 0.44 1.6 $ 4.63 $ 5.09
December 31, 2020 2.12 7.24 35.72 0.94 1.7 4.54 4.92
September 30, 2020 4.17 13.85 33.23 0.29 1.9 4.61 4.92
June 30, 2020 4.33 15.70 30.08 - 2.0 4.51 4.46
March 31, 2020 (26.72) (26.58) 24.99 - 3.4 4.34 4.09
(1)Reflects annualized net income available to common stock and participating
securities divided by average total assets.
(2)Reflects annualized net income divided by average total stockholders' equity.
(3)For the quarter ended March 31, 2020 , the amount calculated reflects the
quarterly net income divided by average total stockholders' equity.
(4)Reflects total average stockholders' equity divided by total average assets.
(5)Reflects dividends declared per share of common stock divided by earnings per
share.
(6)Represents the sum of our borrowings under financing agreements and payable
for unsettled purchases divided by stockholders' equity.
(7)Reflects total stockholders' equity less the preferred stock liquidation
preference divided by total shares of common stock outstanding.
(8)"Economic book value" is a non-GAAP financial measure of our financial
position. To calculate our Economic book value, our portfolios of Residential
whole loans, at carrying value are adjusted to their fair value, rather than the
carrying value that is required to be reported under the GAAP accounting model
applied to these loans. For additional information please refer to page 71 under
the heading "Economic Book Value."
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Reconciliation of GAAP and Non-GAAP Financial Measures
Economic Book Value
"Economic book value" is a non-GAAP financial measure of our financial position. To calculate our Economic book value, our portfolios of Residential whole loans at carrying value are adjusted to their fair value, rather than the carrying value that is required to be reported under the GAAP accounting model applied to these loans. This adjustment is also reflected in the table below in our end of period stockholders' equity. Management considers that Economic book value provides investors with a useful supplemental measure to evaluate our financial position as it reflects the impact of fair value changes for all of our residential mortgage investments, irrespective of the accounting 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 following table provides a reconciliation of our GAAP book value per common share to our non-GAAP Economic book value per common share as of the quarterly periods below: (In Thousands, Except Per Share December 31, September 30, Amounts) March 31, 2021 2020 2020 June 30, 2020 March 31, 2020 GAAP Total Stockholders' Equity$ 2,542.3 $ 2,524.8 $ 2,565.7 $ 2,521.1 $ 2,440.7 Preferred Stock, liquidation preference (475.0) (475.0) (475.0) (475.0)
(475.0)
GAAP Stockholders' Equity for book value per common share 2,067.3 2,049.8 2,090.7 2,046.1 1,965.7 Adjustments: Fair value adjustment to Residential whole loans, at carrying value 203.0 173.9 141.1 (25.3) (113.5) Stockholders' Equity including fair value adjustment to Residential whole loans, at carrying value (Economic book value)$ 2,270.3 $
2,223.7
GAAP book value per common share $ 4.63
$ 5.09 $ 4.92 $ 4.92 $ 4.46 $ 4.09
Number of shares of common stock
outstanding 446.1 451.7 453.3 453.2 453.1
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None that we expect would materially impact us.
Liquidity and Capital Resources
General
Our principal sources of cash generally consist of borrowings under repurchase agreements and other collateralized financings, payments of principal and interest we receive on our investment portfolio, cash generated from our operating results and, to the extent such transactions are entered into, proceeds from capital market and structured financing transactions. Our most significant uses of cash are generally to pay principal and interest on our financing transactions, to purchase residential mortgage assets, to make dividend payments on our capital stock, to fund our operations, to meet margin calls and to make other investments that we consider appropriate. We seek to employ a diverse capital raising strategy under which we may issue capital stock and other types of securities. To the extent we raise additional funds through capital market transactions, we currently anticipate using the net proceeds from such transactions to acquire additional residential mortgage-related assets, consistent with our investment policy, and for working capital, which may include, among other things, the repayment of our financing transactions. There can be no assurance, however, that we will be able to access the capital markets at any particular time or on any particular terms. We have available for issuance an unlimited amount (subject to the terms and limitations of our charter) of common stock, preferred stock, depository shares representing preferred stock, warrants, debt securities, rights and/or units pursuant to our automatic shelf registration statement and, atMarch 31, 2021 , we had approximately 8.6 million shares of common stock available for issuance pursuant to our DRSPP shelf registration statement. During the three months endedMarch 31, 2021 , we issued 105,272 shares of common stock through our DRSPP, raising net proceeds of approximately$388,173 . During the three months endedMarch 31, 2021 , we did not sell any shares of common stock through our at-the-market equity offering program. During the three months endedMarch 31, 2021 , we repurchased 5,946,678 shares of our common stock through the stock repurchase program at an average cost of$4.09 per share and a total cost of approximately$24.3 million , net of fees and commissions paid to the sales agents of approximately$59,000 . AtMarch 31, 2021 , approximately$141.4 million remained outstanding for future repurchases under the repurchase program.
Financing agreements
Our borrowings under financing agreements include a combination of shorter term and longer arrangements. Certain of these arrangements are collateralized directly by our residential mortgage investments or otherwise have recourse to us, while securitized debt financing is non-recourse financing. Further, certain of our financing agreements contain terms that allow the lender to make margin calls on us based on changes in the value of the underlying collateral securing the borrowing. As ofMarch 31, 2021 , we had$1.2 billion of total unpaid principal balance related to asset-backed financing agreements with mark-to-market collateral provisions and$2.6 billion of total unpaid principal balance related to asset-backed financing agreements that do not include mark-to-market collateral provisions. Repurchase agreements and other forms of collateralized financing are renewable at the discretion of our lenders and, as such, our lenders could determine to reduce or terminate our access to future borrowings at virtually any time. The terms of the repurchase transaction borrowings under our master repurchase agreements, as such terms relate to repayment, margin requirements and the segregation of all securities that are the subject of repurchase transactions, generally conform to the terms contained in the standard master repurchase agreement published by theSecurities Industry and Financial Markets Association (orSIFMA ) or the global master repurchase agreement published bySIFMA and theInternational Capital Market Association . In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts (or the percentage amount by which the collateral value is contractually required to exceed the loan amount), purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default and setoff provisions. Other non-repurchase agreement financing arrangements also contain provisions governing collateral maintenance. With respect to margin maintenance requirements for agreements secured by harder to value assets, such as residential whole loans, Non-Agency MBS and MSR-related assets, margin calls are typically determined by our counterparties based on their assessment of changes in the fair value of the underlying collateral and in accordance with the agreed upon haircuts specified in the transaction confirmation with the counterparty. We address margin call requests in accordance with the required terms specified in the applicable agreement and such requests are typically satisfied by posting additional cash or 72 -------------------------------------------------------------------------------- Table of Contents collateral on the same business day. We review margin calls made by counterparties and assess them for reasonableness by comparing the counterparty valuation against our valuation determination. When we believe that a margin call is unnecessary because our assessment of collateral value differs from the counterparty valuation, we typically hold discussions with the counterparty and are able to resolve the matter. If this is not successful, we will look to resolve the dispute based on the remedies available to us under the terms of the repurchase agreement, which in some instances may include the engagement of a third-party to review collateral valuations. For certain other agreements that do not include such provisions, we could resolve the matter by substituting collateral as permitted in accordance with the agreement or otherwise request the counterparty to return the collateral in exchange for cash to unwind the financing. For additional information regarding our various types of financing arrangements, including those of with non-mark-to-market terms and the haircuts for those agreements with mark-to-market collateral provisions, see Note 6, included under Item 1 of this Quarterly Report on Form 10-Q. We expect that we will continue to pledge residential mortgage assets as part of certain of our ongoing financing arrangements. When the value of our residential mortgage assets pledged as collateral experiences rapid decreases, margin calls under our financing arrangements could materially increase, causing an adverse change in our liquidity position. Additionally, if one or more of our financing counterparties choose not to provide ongoing funding, our ability to finance our long-maturity assets would decline or otherwise become available on possibly less advantageous terms. Further, when liquidity tightens, our counterparties to our short term arrangements with mark-to-market collateral provisions may increase their required collateral cushion (or margin) requirements on new financings, including financings that we roll with the same counterparty, thereby reducing our ability to use leverage. Access to financing may also be negatively impacted by ongoing volatility in financial markets, thereby potentially adversely impacting our current or future lenders' ability or willingness to provide us with financing. In addition, there is no assurance that favorable market conditions will exist to permit us to consummate additional securitization transactions if we determine to seek that form of financing. Our ability to meet future margin calls will be affected by our ability to use cash or obtain financing from unpledged collateral, the amount of which can vary based on the market value of such collateral, our cash position and margin requirements. Our cash position fluctuates based on the timing of our operating, investing and financing activities and is managed based on our anticipated cash needs. (See our Consolidated Statements of Cash Flows, included under Item 1 of this Quarterly Report on Form 10-Q and "Interest Rate Risk" included under Item 3 of this Quarterly Report on Form 10-Q.) AtMarch 31, 2021 , we had a total of$3.8 billion of residential whole loans and securities and$5.2 million of restricted cash pledged to our financing counterparties. AtMarch 31, 2021 , we had access to various sources of liquidity including$780.7 million of cash and cash equivalents. Our sources of liquidity do not include restricted cash. In addition, atMarch 31, 2021 , we had$73.9 million of unencumbered residential whole loans. Further, we believe that we have unused capacity in certain borrowing lines, given that the amount currently borrowed is less than the maximum advance rate permitted by the facility. This unused capacity serves to act as a buffer against potential margin calls on certain pledged assets in the events that asset prices do not decline by more than a specified amount.
The table below presents certain information about our borrowings under asset-backed financing agreements and securitized debt:
Asset-backed Financing Agreements Securitized Debt
Quarterly Maximum Quarterly Maximum
Average End of Period Balance at Any Average End of Period Balance at AnyQuarter Ended (1) Balance Balance Month-End Balance Balance Month-End (In Thousands) March 31, 2021$ 2,362,791 $ 2,221,570 $ 2,443,149 $ 1,535,995 $ 1,548,920 $ 1,602,148 December 31, 2020 2,833,649 2,497,290 2,823,306 1,202,292 1,514,509 1,514,509 September 30, 2020 3,511,453 3,217,678 3,613,968 610,120 837,683 837,683 June 30, 2020 4,736,610 3,692,845 5,024,926 538,245 516,102 541,698 March 31, 2020 9,233,808 7,768,180 9,486,555 558,007 533,733 594,458 (1)The information presented in the table above excludes$230.0 million of Convertible Senior Notes issued inJune 2019 and$100.0 million of Senior Notes issued inApril 2012 . The outstanding balance of the Convertible Senior Notes have been unchanged since issuance. During the first quarter of 2021, we redeemed all our outstanding Senior Notes. 73 -------------------------------------------------------------------------------- Table of Contents Cash Flows and Liquidity for the Three Months EndedMarch 31, 2021 Our cash, cash equivalents and restricted cash decreased by$35.7 million during the three months endedMarch 31, 2021 , reflecting:$345.5 million provided by our investing activities,$405.3 million used in our financing activities and$24.2 million provided by our operating activities. AtMarch 31, 2021 , our debt-to-equity multiple was 1.6 times compared to 1.7 times atDecember 31, 2020 . AtMarch 31, 2021 , we had borrowings under asset-backed financing agreements of$2.2 billion , of which$2.0 billion were secured by residential whole loans,$200.7 million were secured by securities and$17.8 million were secured by REO. In addition, atMarch 31, 2021 , we had securitized debt of$1.5 billion in connection with our loan securitization transactions. AtDecember 31, 2020 , we had borrowings under asset-backed financing agreements of$2.5 billion , of which$2.3 billion were secured by residential whole loans,$213.9 million were secured by securities and$13.7 million were secured by REO. In addition, atDecember 31, 2020 , we had securitized debt of$1.5 billion in connection with our loan securitization transactions. During the three months endedMarch 31, 2021 ,$345.5 million was provided by our investing activities. We paid$184.7 million for purchases of residential whole loans, loan related investments and capitalized advances. During the three months endedMarch 31, 2021 , we received$425.3 million of principal payments on residential whole loans and loan related investments and$50.6 million of proceeds on sales of REO. In addition, during the three months endedMarch 31, 2021 , we received cash of$58.9 million from prepayments and scheduled amortization on our securities. In connection with our repurchase agreement financings and Swaps (if any), we routinely receive margin calls/reverse margin calls from our counterparties and make margin calls to our counterparties. Margin calls and reverse margin calls, which requirements vary over time, may occur daily between us and any of our counterparties when the value of collateral pledged changes from the amount contractually required. The value of securities pledged as collateral fluctuates reflecting changes in: (i) the face (or par) value of our assets; (ii) market interest rates and/or other market conditions; and (iii) the market value of our Swaps. Margin calls/reverse margin calls are satisfied when we pledge/receive additional collateral in the form of additional assets and/or cash.
The table below summarizes our margin activity with respect to our repurchase agreement financings and derivative hedging instruments for the quarterly periods presented:
Collateral Pledged to Meet Margin Calls
Fair Value of Aggregate Assets Cash and Net Assets
Securities Pledged For Securities Received for Received/(Pledged) for
For the Quarter Ended (1) Pledged Cash Pledged Margin Calls Reverse Margin Calls Margin Activity
(In Thousands)
March 31, 2021 $ - $ - $ - $ - $ -
December 31, 2020 - 2,004 2,004 - (2,004)
September 30, 2020 - 2,526 2,526 2,199 (327)
June 30, 2020 - 108,999 108,999 322,682 213,683
March 31, 2020 30,187 213,392 243,579 67,343 (176,236)
(1) Excludes variation margin payments on the Company's cleared Swaps which are treated as a legal settlement of the exposure under the Swap contract.
We are subject to various financial covenants under our financing agreements, which include minimum liquidity and net worth requirements, net worth decline limitations and maximum debt-to-equity ratios. We were in compliance with all financial covenants as ofMarch 31, 2021 . During the three months endedMarch 31, 2021 , we paid$34.0 million for cash dividends on our common stock and dividend equivalents and paid cash dividends of$8.2 million on our preferred stock. OnMarch 12, 2021 , we declared our first quarter 2021 dividend on our common stock of$0.075 per share; onApril 30, 2021 , we paid this dividend, which totaled approximately$33.6 million , including dividend equivalents of approximately$120,000 . 74
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