UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X]             QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED:  MARCH 31, 2015

OR

[  ]             TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER:  1-33796

CHIMERA INVESTMENT CORPORATION
(Exact name of Registrant as specified in its Charter)
 
 
MARYLAND  26-0630461 
(State or other jurisdiction of incorporation or organization)  (IRS Employer Identification No.) 
                                                                                                     
1211 AVENUE OF THE AMERICAS
NEW YORK, NEW YORK
(Address of principal executive offices)

10036
 (Zip Code)

(646) 454-3759
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes þ No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  þ  Accelerated filer o  Non-accelerated filer o Smaller reporting company  o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
 
 
Class Outstanding at April 30, 2015 
Common Stock, $.01 par value  205,581,569 
 
 
 

 
 
CHIMERA INVESTMENT CORPORATION
FORM 10-Q
TABLE OF CONTENTS

Part I.     FINANCIAL INFORMATION
 
   
Item 1.  Consolidated Financial Statements:
 
   
1
   
2
   
3
   
4
   
5
   
43
   
68
   
72
   
   
73
   
73
   
73
   
Item 5. Other Information  73
   
74
   
S-1
 
 
i

 
 
CHIMERA  INVESTMENT CORPORATION
(dollars in thousands, except share and per share data)
             
             
   
March 31, 2015
   
December 31, 2014
 
Assets:
           
Cash and cash equivalents
  $ 119,517     $ 164,620  
Non-Agency RMBS, at fair value
    3,707,439       3,404,149  
Agency RMBS, at fair value
    7,163,144       8,441,522  
Securitized loans held for investment, net of allowance for loan losses of $0 million and $7 million, respectively
    -       626,112  
Securitized loans held for investment, at fair value
    5,132,902       4,699,215  
Receivable for investments sold
    962,121       1,572,056  
Accrued interest receivable
    74,596       71,099  
Other assets
    171,152       172,601  
Derivatives, at fair value, net
    9,788       3,631  
Total assets (1)
  $ 17,340,659     $ 19,155,005  
                 
Liabilities:
               
Repurchase agreements, RMBS ($9.3 billion and $9.3 billion pledged as collateral, respectively)
  $ 8,296,224     $ 8,455,381  
Securitized debt, collateralized by Non-Agency RMBS  ($2.4 billion and $2.5 billion pledged as collateral, respectively)
    671,604       704,915  
Securitized debt, collateralized by loans held for investment ($0 million and $626 million pledged as collateral, respectively)
    -       521,997  
Securitized debt at fair value, collateralized by loans held for investment ($5.1 billion and $4.7 pledged as collateral, respectively)
    4,198,192       3,868,366  
Payable for investments purchased
    489,784       1,845,282  
Accrued interest payable
    39,371       31,888  
Dividends payable
    98,679       92,483  
Accounts payable and other liabilities
    715       2,469  
Investment management fees and expenses payable to affiliate
    10,368       10,357  
Derivatives, at fair value
    12,527       14,177  
Total liabilities (1)
    13,817,464       15,547,315  
                 
Commitments and Contingencies (See Note 16)
               
                 
Stockholders' Equity:
               
Preferred Stock: par value $0.01 per share; 100,000,000 shares authorized, 0 shares issued and outstanding, respectively
  $ -     $ -  
Common stock: par value $0.01 per share; 300,000,000 shares authorized, 205,576,893 and 205,546,144 shares issued and outstanding, respectively
    10,277       10,275  
Additional paid-in-capital
    3,606,642       3,606,191  
Accumulated other comprehensive income
    1,005,507       1,046,680  
Accumulated deficit
    (1,099,231 )     (1,055,456 )
Total stockholders' equity
  $ 3,523,195     $ 3,607,690  
Total liabilities and stockholders' equity
  $ 17,340,659     $ 19,155,005  
                 
(1) The Company's consolidated statements of financial condition include assets of consolidated variable interest entities ("VIEs") that can only be used to settle obligations and liabilities of the VIE for which creditors do not have recourse to the primary beneficiary (Chimera Investment Corp.). As of March 31, 2015 and December 31, 2014, total assets of consolidated VIEs were $7,676,037 and $7,924,232, respectively, and total liabilities of consolidated VIEs were $4,885,312 and $5,111,348, respectively. See Note 8 for further discussion.
 
                 
See accompanying notes to consolidated financial statements.
               
 
 
1

 
 
CHIMERA INVESTMENT CORPORATION
(dollars in thousands, except share and per share data)
 
             
   
For the Quarter Ended
 
Net Interest Income:
 
March 31, 2015
   
March 31, 2014
 
Interest income (1)
  $ 243,145     $ 120,667  
Interest expense (2)
    60,456       22,425  
Net interest income
    182,689       98,242  
                 
Other-than-temporary impairments:
               
Total other-than-temporary impairment losses
    (1,052 )     (400 )
Portion of loss recognized in other comprehensive income
    (6,763 )     (1,134 )
Net other-than-temporary credit impairment losses
    (7,815 )     (1,534 )
                 
Other investment gains (losses):
               
Net unrealized gains (losses) on derivatives
    4,055       (2,198 )
Realized gains (losses) on terminations of interest rate swaps
    (68,579 )     -  
Net realized gains (losses) on derivatives
    (42,086 )     (5,748 )
Net gains (losses) on derivatives
    (106,610 )     (7,946 )
Net unrealized gains (losses) on financial instruments at fair value
    (10,425 )     15,010  
Net realized gains (losses) on sales of investments
    29,565       8,377  
Loss on Extinguishment of Debt
    -       (2,184 )
Total other gains (losses)
    (87,470 )     13,257  
                 
Other expenses:
               
Management fees
    10,326       6,221  
Expense recoveries from Manager
    (1,113 )     (681 )
Net management fees
    9,213       5,540  
General and administrative expenses
    11,149       4,055  
Total other expenses
    20,362       9,595  
                 
Income before income taxes
    67,042       100,370  
Income taxes
    1       2  
Net income
  $ 67,041     $ 100,368  
                 
Net income per share available to common shareholders:
               
Basic
  $ 0.33     $ 0.50  
Diluted
  $ 0.33     $ 0.50  
                 
Weighted average number of common shares outstanding:
               
Basic
    205,527,476       205,452,523  
Diluted
    205,566,956       205,517,753  
                 
Comprehensive income (loss):
               
Net income
  $ 67,041     $ 100,368  
Other comprehensive income:
               
Unrealized gains (losses) on available-for-sale securities, net
    (19,912 )     37,503  
Reclassification adjustment for net losses included in net income for other-than-temporary credit impairment losses
    7,815       1,534  
Reclassification adjustment for net realized losses (gains) included in net income
    (29,076 )     (8,377 )
Other comprehensive income (loss)
    (41,173 )     30,660  
Comprehensive income
  $ 25,868     $ 131,028  
                 
(1) Includes interest income of consolidated VIEs of $150,618 and $85,211 for the quarters ended March 31, 2015 and 2014 respectively. See Note 8 for further discussion.
 
(2) Includes interest expense of consolidated VIEs of $46,753 and $20,699 for the quarters ended March 31, 2015 and 2014 respectively. See Note 8 for further discussion.
 
                 
See accompanying notes to consolidated financial statements.
               
 
 
2

 
 
CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands, except per share data)
 
                               
   
Common
Stock Par
Value
   
Additional
Paid-in Capital
   
Accumulated
Other
Comprehensive Income
   
Accumulated
Deficit
   
Total
 
Balance, December 31, 2013
  $ 10,272     $ 3,605,241     $ 990,803     $ (1,274,806 )   $ 3,331,510  
Net income
    -       -       -       100,368       100,368  
Other comprehensive income (loss)
    -       -       30,660       -       30,660  
Proceeds from restricted stock grants
    1       65       -       -       66  
Common dividends declared, $0.45 per share
    -       -       -       (92,454 )     (92,454 )
Balance, March 31, 2014
  $ 10,273     $ 3,605,306     $ 1,021,463     $ (1,266,892 )   $ 3,370,150  
                                         
Balance, December 31, 2014
  $ 10,275     $ 3,606,191     $ 1,046,680     $ (1,055,456 )   $ 3,607,690  
Net income (loss)
    -       -       -       67,041       67,041  
Cumulative effect of accounting change (1)
    -       -       -       (12,137 )     (12,137 )
Other comprehensive income (loss)
    -       -       (41,173 )     -       (41,173 )
Proceeds from restricted stock grants
    2       451       -       -       453  
Common dividends declared, $0.48 per share
    -       -       -       (98,679 )     (98,679 )
Balance, March 31, 2015
  $ 10,277     $ 3,606,642     $ 1,005,507     $ (1,099,231 )   $ 3,523,195  
                                         
(1) Adoption of ASU No. 2014-13, Measuring the financial Assets and the financial Liabilities as a Consolodiated Collateralized Financing Entity. See Note 2(p), Recent Accounting Pronouncements for further discussion.
                                         
See accompanying notes to consolidated financial statements.
                                       
 
 
3

 
 
CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands)
 
             
             
   
March 31, 2015
   
March 31, 2014
 
Cash Flows From Operating Activities:
 
Net income
  $ 67,041     $ 100,368  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
(Accretion) amortization of investment discounts/premiums, net
    (12,897      (19,791
Accretion (amortization) of securitized debt discounts/premiums, net
    1,384       2,913  
Net unrealized losses (gains) on derivatives
    (4,055 )     2,198  
Net realized losses (gains) on option contracts settled
     -        308  
Proceeds (payments) for derivative sales and settlements
     (7,387      -  
Margin (paid) received on derivatives
     3,635        -  
Net unrealized losses (gains) on financial instruments at fair value
    10,425       (15,010 )
Net realized losses (gains) on sales of investments
    (29,565 )     (8,377 )
Net other-than-temporary credit impairment losses
    7,815       1,534  
Loss on extinguishment of debt
     -        2,184  
Provision for loan losses, net
    -       319  
Equity-based compensation expense
     453        66  
Changes in operating assets:                 
Decrease (increase) in accrued interest receivable, net       (3,497      4,674  
Decrease (increase) in other assets  
     (5,082      (6,862
Changes in operating liabilities:  
               
Increase (decrease) in accounts payable and other liabilities      (1,754      (236
Increase (decrease) in investment management fees and expenses payable to affiliate
     11        (294
Increase (decrease) in accrued interest payable, net
     7,483        35  
Net cash provided by (used in) operating activities
   34,010      64,029  
Cash Flows From Investing Activities:
 
Agency RMBS portfolio:
 
Purchases
  $ (2,549,198 )   $ (17,613 )
Sales
    2,734,874       397,572  
Principal payments
     343,066        60,367  
Non-Agency RMBS portfolio:
 
Purchases
    (478,933 )     (136,525 )
Sales
    109,020       16,234  
Principal payments
     70,149        81,694  
Securitized loans held for investment:
               
Principal payments
     167,400        34,002  
Net cash provided by (used in) investing activities
   396,378      435,731  
Cash Flows From Financing Activities:
 
Proceeds from repurchase agreements
   12,717,788    $    1,894,296  
Payments on repurchase agreements
     (12,876,945      (1,990,937
Payments on securitized debt borrowings, collateralized by loans held for investment
     (189,727      (32,993
Payments on securitized debt borrowings, collateralized by Non-Agency RMBS
     (34,124      (53,177
Repurchase of securitized debt borrowings, collateralized by Non-Agency RMBS
     -        (56,072
Common dividends paid
    (92,483 )     (297,904 )
Net cash provided by (used in) financing activities
   (475,491    (536,787
Net increase (decrease) in cash and cash equivalents
   (45,103    (37,027
Cash and cash equivalents at beginning of period
    164,620       77,629  
Cash and cash equivalents at end of period
   119,517      40,602  
                 
Supplemental disclosure of cash flow information:
 
Interest received
   226,749      102,748  
Interest paid
  $ 54,359     $ 19,477  
Management fees and expenses paid to affiliate
   10,315      6,515  
                 
Non-cash investing activities:
 
Receivable for investments sold    962,121      88,536  
Payable for investments purchased
   489,784      176,152  
Net change in unrealized gain (loss) on available-for sale securities    (41,173    30,660  
                 
Non-cash financing activities:
 
Common dividends declared, not yet paid
   98,679      92,454  
                 
See accompanying notes to consolidated financial statements.
 
 
 
4

 
 
CHIMERA INVESTMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
1.   Organization

Chimera Investment Corporation (the “Company”) was organized in Maryland on June 1, 2007.  The Company commenced operations on November 21, 2007 when it completed its initial public offering.  The Company elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, and regulations promulgated thereunder (the “Code”).  The Company formed the following wholly-owned qualified REIT subsidiaries:  Chimera Securities Holdings, LLC in July 2008; Chimera Asset Holding LLC and Chimera Holding LLC in June 2009; and Chimera Special Holding LLC in January 2010 which is a wholly-owned subsidiary of Chimera Asset Holding LLC.  In July 2010, the Company formed CIM Trading Company LLC (“CIM Trading”), a wholly-owned taxable REIT subsidiary (“TRS”).  In October 2013, the Company formed Chimera Funding TRS LLC (“CIM Funding TRS”), which is a wholly-owned TRS. In March 2015, the Company formed Chimera Mortgage Securities LLC, which is a wholly-owned qualified REIT subsidiary (“QRS”).

Annaly Capital Management, Inc. (“Annaly”) owns approximately 4.4% of the Company’s common shares as of March 31, 2015.  The Company is managed by Fixed Income Discount Advisory Company (“FIDAC”), an investment advisor registered with the Securities and Exchange Commission (“SEC”).  FIDAC is a wholly-owned subsidiary of Annaly.

2.  Summary of the Significant Accounting Policies

(a) Basis of Presentation and Consolidation

The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included.  Certain prior year amounts have been reclassified to conform to the current year’s presentation.  All per share amounts, common shares outstanding and restricted shares for the first quarter of 2015 and all prior periods reflect the Company's 1-for-5 reverse stock split, which was effective April 6, 2015.

The consolidated financial statements include, on a consolidated basis, the Company’s accounts, the accounts of its wholly-owned subsidiaries, and variable interest entities (“VIEs”) in which the Company is the primary beneficiary. All intercompany balances and transactions have been eliminated in consolidation.

The Company uses securitization trusts considered to be VIEs in its securitization and re-securitization transactions.  VIEs are defined as entities in which equity investors (i) do not have the characteristics of a controlling financial interest, or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The entity that consolidates a VIE is known as its primary beneficiary, and is generally the entity with (i) the power to direct the activities that most significantly impact the VIEs’ economic performance, and (ii) the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE.  For VIEs that do not have substantial on-going activities, the power to direct the activities that most significantly impact the VIEs’ economic performance may be determined by an entity’s involvement with the design and structure of the VIE.

The trusts are structured as pass through entities that receive principal and interest on the underlying collateral and distribute those payments to the certificate holders.  The assets held by the securitization entities are restricted in that they can only be used to fulfill the obligations of the securitization entity.  The Company’s risks associated with its involvement with these VIEs are limited to its risks and rights as a certificate holder of the bonds it has retained.  There have been no recent changes to the nature of risks associated with the Company’s involvement with VIEs.
 
 
5

 

Determining the primary beneficiary of a VIE requires significant judgment.  The Company determined that for the securitizations it consolidates, its ownership of substantially all subordinate interests provides the Company with the obligation to absorb losses or the right to receive benefits from the VIE that could be significant to the VIE.  In addition, the Company has the power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance (“power”) such as rights to direct servicer activity or the Company was determined to have power in connection with its involvement with the purpose and design of the VIE.

The Company’s interest in the assets held by these securitization vehicles, which are consolidated on the Company’s Statements of Financial Condition, is restricted by the structural provisions of these entities, and a recovery of the Company’s investment in the vehicles will be limited by each entity’s distribution provisions. The liabilities of the securitization vehicles, which are also consolidated on the Company’s Statements of Financial Condition, are non-recourse to the Company, and can generally only be satisfied from each securitization vehicle’s respective asset pool.

The securitization entities are comprised of senior classes of residential mortgage backed securities (“RMBS”) and residential mortgage loans.  See Notes 3, 4 and 8 for further discussion of the characteristics of the securities and loans in the Company’s portfolio.
 
(b) Statements of Financial Condition Presentation

The Company’s Consolidated Statements of Financial Condition include both the Company’s direct assets and liabilities and the assets and liabilities of consolidated securitization vehicles. Assets of each consolidated VIE can only be used to satisfy the obligations of that VIE, and the liabilities of consolidated VIEs are non-recourse to the Company.  The Company is not obligated to provide, nor does it intend to provide, any financial support to these consolidated securitization vehicles. The notes to the consolidated financial statements describe the Company’s direct assets and liabilities and the assets and liabilities of consolidated securitization vehicles.  See Note 8 for additional information related to the Company’s investments in consolidated securitization vehicles.

(c) Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and cash deposited overnight in money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation. There were no restrictions on cash and cash equivalents at March 31, 2015 and December 31, 2014.

(d) Agency and Non-Agency Mortgage-Backed Securities

The Company invests in mortgage backed securities (“MBS”) representing interests in obligations backed by pools of mortgage loans.  The Company delineates between Agency MBS and Non-Agency MBS as follows: Agency MBS are mortgage pass-through certificates, collateralized mortgage obligations (“CMOs”), and other MBS representing interests in or obligations backed by pools of mortgage loans issued or guaranteed by agencies of the U.S. Government, such as Ginnie Mae, or federally chartered corporations such as Freddie Mac or Fannie Mae where principal and interest repayments are guaranteed by the respective agency of the U.S. Government or federally chartered corporation. Non-Agency RMBS are not issued or guaranteed by a U.S. Government Agency or other institution and are subject to credit risk.  Repayment of principal and interest on Non-Agency RMBS is subject to the performance of the mortgage loans or MBS collateralizing the obligation.

The Company also invests in Interest Only Agency MBS strips and Non-Agency RMBS strips (“IO MBS strips”).  IO MBS strips represent the Company’s right to receive a specified proportion of the contractual interest flows of the collateral. Interest income on IO MBS strips is accrued based on the outstanding notional balance and the security’s contractual terms, and amortization of any premium is calculated in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 325-40, Beneficial Interests in Securitized Financial Assets (“ASC 325-40”).  The Company accounts for IO MBS strips at fair value with changes in fair value recognized in the Company’s Consolidated Statements of Operations and Comprehensive Income.

The Company classifies the majority of its MBS as available-for-sale and records investments at estimated fair value as described in Note 5 of these consolidated financial statements.  The Company includes unrealized gains and losses considered to be temporary on all MBS in Other comprehensive income (“OCI”) in the Consolidated Statements of Operations and Comprehensive Income.  For IO strips and certain other MBS investments, the Company has elected the fair value option and these investments are recorded at estimated fair value and all unrealized gains and losses are included in earnings in the Consolidated Statements of Operations and Comprehensive Income.  From time to time, as part of the overall management of its portfolio, the Company may sell any of its investments and recognize a realized gain or loss as a component of earnings in the Consolidated Statements of Operations and Comprehensive Income utilizing the average cost method.
 
 
6

 

The Company’s accounting policy for interest income and impairment related to its MBS is as follows:

Interest Income Recognition

The recognition of interest income on MBS securities varies depending on the characteristics of the security as follows:

Agency MBS and Non-Agency RMBS of High Credit Quality

FASB ASC 310-20, Nonrefundable Fees and Other Costs (“ASC 310-20”) is applied to the recognition of interest income for the following securities:

Agency MBS
Non-Agency RMBS that meet all of the following conditions at the acquisition date (referred to hereafter as “Non-Agency RMBS of High Credit Quality”):

1.  
Rated AA or higher by a nationally recognized credit rating agency using the lowest rating available.
2.  
The Company expects to collect all of the security’s contractual cash flows.
3.  
The security cannot be contractually prepaid such that the Company would not recover substantially all of its recorded investment.

Under ASC 310-20, interest income, including premiums and discounts associated with the acquisition of these securities, is recognized over the life of such securities using the interest method based on the contractual cash flows of the security. In applying the interest method, the Company considers estimates of future principal prepayments in the calculation of the effective yield. Differences that arise between previously anticipated prepayments and actual prepayments received, as well as changes in future prepayment assumptions, result in a recalculation of the effective yield on the security on a quarterly basis. This recalculation results in the recognition of an adjustment to the carrying amount of the security based on the revised prepayment assumptions and a corresponding increase or decrease in reported interest income.

Non-Agency RMBS Not of High Credit Quality

Non-Agency RMBS purchased at a discount and not of high credit quality at the time of purchase are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”) or ASC 325-40 (referred to hereafter as “Non-Agency RMBS Not of High Credit Quality”).

Non-Agency RMBS are accounted for under ASC 310-30 if the following conditions are met as of the acquisition date:

1.  
There is evidence of deterioration in credit quality of the security from its inception.
2.  
It is probable that the Company will be unable to collect all contractual cash flows of the security.

Non-Agency RMBS that are not within the scope of ASC 310-30 are accounted for under ASC 325-40 if at the acquisition date:

1.  
The security is not of high credit quality (defined as rated below AA or is unrated), or
2.  
The security can contractually be prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment.

Interest income on Non-Agency RMBS Not of High Credit Quality is recognized using the interest method based on management’s estimates of cash flows expected to be collected. The effective interest rate on these securities is based on management’s estimate for each security of the projected cash flows, which are estimated based on observation of current market information and include assumptions related to fluctuations in prepayment speeds and the timing and amount of credit losses. Quarterly, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on inputs and analyses received from external sources, internal models, and the Company’s judgments about prepayment rates, the timing and amount of credit losses, and other factors. Changes in the amount or timing of cash flows from those originally projected, or from those estimated at the last evaluation date, are considered to be either positive changes or adverse changes. For securities accounted for under ASC 325-40, any positive or adverse change in cash flows that does not result in the recognition of an other-than-temporary impairment (“OTTI”) results in a prospective increase or decrease in the effective interest rate used to recognize interest income. For securities accounted for under ASC 310-30, only significant positive changes are reflected prospectively in the effective interest rate used to recognize interest income.  Adverse changes in cash flows expected to be collected are generally treated consistently for MBS accounted for under ASC 325-40 and ASC 310-30, and generally result in recognition of an OTTI with no change in the effective interest rate used to recognize interest income.
 
 
7

 

Impairment

Considerations Applicable to all MBS

When the fair value of an available-for-sale MBS is less than its amortized cost the security is considered impaired.  On a quarterly basis the Company evaluates its securities for OTTI.  If the Company intends to sell an impaired security, or it is more-likely-than-not that the Company will be required to sell an impaired security before its anticipated recovery, then the Company must recognize an OTTI through a charge to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the measurement date.  If the Company does not intend to sell an impaired security and it is not more-likely-than-not that it would be required to sell an impaired security before recovery, the Company must further evaluate the security for impairment due to credit losses. The credit component of OTTI is recognized in earnings and the remaining or non-credit component is recorded as a component of OCI. Following the recognition of an OTTI through earnings, a new amortized cost basis is established for the security and subsequent recovery in fair value may not be adjusted through current earnings.  Subsequent recoveries are amortized into income over the remaining life of the security as an adjustment to yield.

When evaluating whether the Company intends to sell an impaired security or will more-likely-than-not be required to sell an impaired security before recovery, the Company makes judgments that consider among other things, its liquidity, leverage, contractual obligations, and targeted investment strategy to determine its intent and ability to hold the investments that are deemed impaired.  The determination as to whether an OTTI exists is subjective as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of future conditions.  As a result, the determination of OTTI and its timing and amount is based on estimates that may change materially over time.

The Company’s estimate of the amount and timing of cash flows for its MBS is based on its review of the underlying securities or mortgage loans securing the MBS.  The Company considers historical information available and expected future performance of the underlying securities or mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, extent of credit support available, Fair Isaac Corporation (“FICO”) scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as reports by credit rating agencies, general market assessments and dialogue with market participants.  As a result, substantial judgment is used in the Company’s analysis to determine the expected cash flows for its MBS.

Considerations Applicable to Non-Agency RMBS of High Credit Quality

The impairment assessment for Non-Agency RMBS of High Credit Quality involves comparing the present value of the remaining cash flows expected to be collected to the amortized cost of the security at the assessment date.  The discount rate used to calculate the present value of the expected future cash flows is based on the security’s effective interest rate as calculated under ASC 310-20 (i.e., the  discount rate implicit in the security as of the last measurement date).   If the present value of the remaining cash flows expected to be collected is less than the amortized cost basis, an OTTI is recognized in earnings for the difference. This amount is considered to be the credit loss component; the remaining difference between amortized cost and the fair value of the security is considered to be the portion of loss recognized in other comprehensive income.

 
8

 
 
Considerations Applicable to Non-Agency RMBS Not of High Credit Quality

Non-Agency RMBS within the scope of ASC 325-40 or ASC 310-30 are considered other-than-temporarily impaired when the following two conditions exist: (1) the fair value is less than the amortized cost basis, and (2) there has been an adverse change in cash flows expected to be collected from the last measurement date (i.e., adverse changes in either the amount or timing of cash flows from those previously expected).

The OTTI is separated into a credit loss component that is recognized in earnings and the portion of loss recognized in other comprehensive income. The credit component is comprised of the impact of the fair value decline due to changes in assumptions related to default (collection) risk and prepayments. The portion of loss recognized in other comprehensive income comprises the change in fair value of the security due to all other factors, including changes in benchmark interest rates and market liquidity.  In determining the OTTI related to credit losses for securities, the Company compares the present value of the remaining cash flows adjusted for prepayments expected to be collected at the current financial reporting date to the present value of the remaining cash flows expected to be collected at the original purchase date (or the last date those estimates were revised for accounting purposes).  The discount rate used to calculate the present value of expected future cash flows is the effective interest rate used for income recognition purposes as determined under ASC 325-40 or ASC 310-30.

The determination of whether an OTTI exists and, if so, the extent of the credit component is subject to significant judgment and management’s estimates of both historical information available at the time of assessment, the current market environment, as well as the Company’s estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of OTTI constitutes an accounting estimate that may change materially over time.

Investments for which the Company has elected the fair value option are not evaluated for OTTI as all changes in fair value are reflected in earnings.

(e) Securitized Loans Held for Investment

Prime residential mortgage loans:

A portion of the securitized loan portfolio is comprised primarily of non-conforming, single family, owner occupied, jumbo, prime loans that are not guaranteed as to repayment of principal or interest.  These securitized loans are serviced and may be modified, in the event of a default, by a third-party servicer.  The Company generally has the ability to approve certain loan modifications and determine the course of action to be taken as it relates to certain loans in default, including whether or not to proceed with foreclosure.  These mortgage loans are designated as held for investment.  Interest income on loans held for investment is recognized over the expected life of the loans using the interest method with changes in yield reflected in earnings on a prospective basis.  As of January 1, 2015, the securitized loan portfolio comprised primarily of non-conforming, single family, owner occupied, jumbo, prime loans is carried at fair value with changes in fair value recorded in earnings.  Prior to January 1, 2015, this loan portfolio was carried at amortized cost, net of the allowance for loan losses.

The allowance for loan losses as of December 31, 2014 was $7 million.  The allowance for loan losses consists of a general reserve and a specific reserve.  The general reserve is based on historical loss rates for pools of loans with similar credit characteristics, adjusted for current trends and market conditions, including current trends in delinquencies and severities.  The specific reserve reflects consideration of loans more than 60 days delinquent, loans in foreclosure and borrowers that have declared bankruptcy.  The specific loan loss provision related to these loans is primarily the difference between the unpaid principal balance and the estimated fair value of the property securing the mortgage, less estimated costs to sell.  Loan modifications made by the servicer are evaluated to determine if they constitute troubled debt restructurings (“TDRs”).  A restructuring of a loan constitutes a TDR if the servicer, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. Impairment of a modified loan considered to be a TDR is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate at inception. If the present value of expected cash flows is less than the recorded investment in the loan, an allowance for loan losses is recognized with a corresponding charge to the provision for loan losses.
 
 
9

 

The Company estimates the fair value of securitized loans as described in Note 5 of these consolidated financial statements.

Seasoned sub-prime residential mortgage loans:

A portion of the securitized loan portfolio is comprised of seasoned sub-prime residential mortgage loans that are not guaranteed as to repayment of principal or interest. These securitized loans are serviced and may be modified, in the event of default, by a third-party servicer.  The Company generally has the ability to approve certain loan modifications and determine the course of action to be taken as it relates to certain loans in default, including whether or not to proceed with foreclosure.  These mortgage loans are designated as held for investment.  Interest income on loans held for investment is recognized over the expected life of the loans using the interest method with changes in yield reflected in earnings on a prospective basis.  The securitized loan portfolio comprised primarily of seasoned sub-prime residential mortgage loans is carried at fair value with changes in fair value recorded in earnings.  As these loans are carried at fair value, no allowance for loan losses is required.

The Company estimates the fair value of securitized loans as described in Note 5 of these consolidated financial statements.

All residential mortgage loans:

Interest is accrued on all securitized loans held for investment when due.  Interest which is not received at the due date is written off when it becomes delinquent.  Nonrefundable fees and costs related to acquiring the Company’s securitized residential mortgage loans are recognized as expenses over the life of the associated debt using the interest method of amortization.  Income recognition is suspended for loans when, based on information from the servicer, a full recovery of interest or principal becomes doubtful.

Real estate owned (“REO”) represents properties which the Company has received the legal title of the property to satisfy the outstanding loan.  REO is re-categorized from loan to REO when the Company takes legal title of the property.  REO assets are measured and reported at the estimated fair value less the estimated cost to sell at the end of each reporting period.  At the time the asset is re-categorized, any difference between the previously recorded loan balance and the carrying value of the REO at the time the Company takes legal title of the property, is recognized as a loss.  The Company recognized a loss of $4 million for the quarter ended March 31, 2015 related to REO which is presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statement of Operations and Comprehensive Income.  All REO assets of the Company are held-for-sale and it is the Company’s intention to sell the property in the shortest time possible to maximize their return and recovery on the previously recorded loan.  Total REO assets at March 31, 2015 and December 31, 2014 is $9 million and $8 million, respectively, and is recorded in other assets on the Company’s consolidated statements of financial condition.

(f) Repurchase Agreements

The Company finances the acquisition of a significant portion of its mortgage-backed securities with repurchase agreements. The Company has evaluated each agreement and has determined that each of the repurchase agreements be accounted for as secured borrowings.

(g) Securitized Debt, collateralized by Non-Agency RMBS and Securitized Debt, collateralized by loans held for investment

Certain re-securitization transactions classified as Securitized Debt, collateralized by Non-Agency RMBS reflect the transfer to a trust of fixed or adjustable rate MBS which are classified as Non-Agency RMBS that pay interest and principal to the debt holders of that re-securitization.  Re-securitization transactions completed by the Company that did not qualify as sales are accounted for as secured borrowings.  The associated securitized debt is carried at amortized cost, net of any unamortized premiums or discounts.

Certain transactions involving residential mortgage loans are accounted for as secured borrowings, and are recorded as Securitized loans held for investment and the corresponding debt as Securitized debt, collateralized by loans held for investment in the Consolidated Statements of Financial Condition.  These securitizations are collateralized by residential adjustable or fixed rate mortgage loans that have been placed in a trust and pay interest and principal to the debt holders of that securitization.  As of January 1, 2015, securitized debt, collateralized by loans held for investment, is carried at fair value. Prior to January 1, 2015, securitized debt, collateralized by loans held for investment, was carried at amortized cost.
 
 
10

 

The Company recognizes interest expense on securitized debt over the expected life of the debt using the interest method with changes in yield reflected in earnings on a prospective basis.  Fees associated with the debt issuance of jumbo prime residential mortgage loans are also amortized using the interest method.  Unamortized fees associated with debt issuance are included in other assets.

The Company estimates the fair value of its securitized debt as described in Note 5 to these consolidated financial statements.

(h) Fair Value Option

Interest-Only MBS:

The Company has elected the fair value option to account for IO MBS strips to simplify the reporting of changes in fair value.  The IO MBS strips are included in MBS, at fair value, on the accompanying Consolidated Statements of Financial Condition.

Changes in fair value are presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statements of Operations and Comprehensive Income.  Included in Non-Agency RMBS, at fair value on the Consolidated Statements of Financial Condition are IO MBS strips carried at fair value with changes in fair value reflected in earnings of $290 million and $214 million as of March 31, 2015 and December 31, 2014.  Included in Agency MBS, at fair value on the Consolidated Statements of Financial Condition are IO MBS strips carried at fair value with changes in fair value reflected in earnings of $264 million and $186 million as of March 31, 2015 and December 31, 2014.  Interest income reported on all IO securities was $13 million and $10 million for the quarters ended March 31, 2015 and 2014, respectively.

Non-Agency RMBS:

The Company has elected the fair value option for certain interests in MBS which we refer to as the overcollateralization class of the MBS pass through structure.  The cash flows for these holdings are generally subordinate to all other interests of the trusts and generally only pay out funds when certain ratios are met and excess cash holdings, as determined by the trustee, are available for distribution to the overcollateralization class.  Many of the investments in this group have no current cash flows and may not ever pay cash flows, depending on the loss experience of the collateral group supporting the investment.  Estimating future cash flows for this group of MBS investments is highly judgmental and uncertain; therefore, the Company has elected to carry these holdings at fair value with changes in fair value reflected in earnings.

Changes in fair value are presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statement of Operations and Comprehensive Income.  The fair value of the Non-Agency RMBS carried at fair value with changes in fair value reflected in earnings is $11 million as of March 31, 2015.  There were no Non-Agency RMBS carried at fair value with changes in fair value reflected in earnings as of December 31, 2014.

Securitized Loans Held for Investment:

Upon the adoption of ASU 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity on January 1, 2015, the securitized loans held for investment comprised primarily of non-conforming, single family, owner occupied, jumbo, prime loans were carried at fair value.  Therefore, as of January 1, 2015, all securitized loans held for investment are carried at fair value with changes in fair value reflected in earnings.  The Company carries securitized loans held for investment at fair value as it may resecuritize these loans in the future.  Additionally, the fair value option allows both the loans and related financing to be consistently reported at fair value and to achieve operational and valuation simplifications.

Changes in fair value of securitized loans held for investment are presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statement of Operations and Comprehensive Income.
 
 
11

 

As of December 31, 2014, $626 million of securitized loans held for investment comprised primarily of non-conforming, single family, owner occupied, jumbo, prime loans were carried at amortized cost, net of an allowance for loan losses.

Securitized Debt, Collateralized by Loans Held for Investment:

As of January 1, 2015, the Company has elected the fair value option for all of the Company’s securitized debt, collateralized by loans held for investment. The Company has elected fair value option for these financings as it may call or restructure these debt financings in the future.  Additionally, the fair value option allows both the loans and related financing to be consistently reported at fair value and to achieve operational and valuation simplifications.

As of December 31, 2014, $522 million of securitized debt collateralized primarily by non-conforming, single family, owner occupied, jumbo, prime loans were carried at amortized cost.  Upon the adoption of ASU 2014-13 on January 1, 2015, the securitized debt collateralized primarily by non-conforming, single family, owner occupied, jumbo, prime loans were carried at fair value.

Changes in fair value of securitized loans held for investment are presented in Net unrealized gains (losses) on financial instruments at fair value on the Consolidated Statement of Operations and Comprehensive Income.

(i) Derivative Financial Instruments

The Company’s investment policies permit it to enter into derivative contracts, including interest rate swaps, swaptions, mortgage options, futures, and interest rate caps to manage its interest rate risk and, from time to time, enhance investment returns. The Company’s derivatives are recorded as either assets or liabilities in the Consolidated Statements of Financial Condition and measured at fair value.  These derivative financial instrument contracts are not designated as hedges for GAAP; therefore, all changes in fair value are recognized in earnings.  The Company estimates the fair value of its derivative instruments as described in Note 5 of these consolidated financial statements.  Net payments on derivative instruments are included in the Consolidated Statements of Cash Flows as a component of net income.  Unrealized gains (losses) on derivatives are removed from net income to arrive at cash flows from operating activities.

The Company elects to net the fair value of its derivative contracts by counterparty when appropriate.  These contracts contain legally enforceable provisions that allow for netting or setting off of all individual derivative receivables and payables with each counterparty and, therefore, the fair value of those derivative contracts are reported net by counterparty.  The credit support annex provisions of the Company’s derivative contracts allow the parties to mitigate their credit risk by requiring the party which is in a net payable position to post collateral. As the Company elects to net by counterparty the fair value of derivative contracts, it also nets by counterparty any cash collateral exchanged as part of the derivative.

(j) Fair Value Disclosure

A complete discussion of the methodology utilized by the Company to estimate the fair value of its financial instruments is included in Note 5 to these consolidated financial statements.
 
(k) Sales, Securitizations, and Re-Securitizations

The Company periodically enters into transactions in which it sells financial assets, such as MBS, and mortgage loans.  Gains and losses on sales of assets are calculated using the average cost method whereby the Company records a gain or loss on the difference between the average amortized cost of the asset and the proceeds from the sale.  In addition, the Company from time to time securitizes or re-securitizes assets and sells tranches in the newly securitized assets.  These transactions may be recorded as either sales and the assets contributed to the securitization are removed from the Consolidated Statements of Financial Condition and a gain or loss is recognized, or as secured borrowings whereby the assets contributed to the securitization are not derecognized but rather the debt issued by the securitization entity are recorded to reflect the term financing of the assets.  In these securitizations and re-securitizations, the Company may retain senior or subordinated interests in the securitized or re-securitized assets.  In transfers that are considered secured borrowings, no gain or loss is recognized.  Any difference in the proceeds received and the carrying value of the transferred asset is recorded as a premium or discount and amortized into earnings as an adjustment to yield.

 
12

 
 
(l) Income Taxes
 
The Company has elected to be taxed as a REIT and intends to comply with the provision of the Code, with respect thereto.  Accordingly, the Company will not be subject to federal, state or local income tax to the extent that qualifying distributions are made to stockholders and as long as certain asset, income, distribution and stock ownership tests are met. If the Company failed to qualify as a REIT and did not qualify for certain statutory relief provisions, the Company would be subject to federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the REIT qualification was lost. The Company, CIM Trading and CIM Funding TRS made joint elections to treat CIM Trading and CIM Funding TRS as TRS’s. As such, CIM Trading and CIM Funding TRS are taxable as domestic C corporations and subject to federal, state, and local income taxes based upon their respective taxable income.
 
A tax position is recognized only when, based on management’s judgment regarding the application of income tax laws, it is more likely than not that the tax position will be sustained upon examination.  The Company does not have any unrecognized tax positions that would affect its financial statements or require disclosure.  No accruals for penalties and interest were necessary as of March 31, 2015 or 2014.

(m) Net Income per Share

The Company calculates basic net income per share by dividing net income for the period by the basic weighted-average shares of its common stock outstanding for that period.  Diluted net income per share takes into account the effect of dilutive instruments such as unvested restricted stock. All per share amounts, common shares outstanding and restricted shares for the first quarter of 2015 and all prior periods reflect the Company's 1-for-5 reverse stock split, which was effective April 6, 2015.

(n) Stock-Based Compensation

The Company accounts for stock-based compensation awards granted to the employees of FIDAC and FIDAC’s affiliates at the fair value of the stock-based compensation provided.  The Company measures the fair value of the equity instrument using the stock prices and other measurement assumptions as of the earlier of either the date at which a performance commitment by the recipient is reached or the date at which the recipient’s performance is complete. Stock compensation expense related to the grants of stock is recognized over the vesting period of such grants based on the fair value of the stock on each vesting date at which the recipient’s performance is complete.

Compensation expense for equity based awards granted to the Company’s independent directors is recognized pro-rata over the vesting period of such awards, based upon the fair value of such awards at the grant date.

(o) Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could be materially different than anticipated in those estimates, which could have a material adverse impact on the Company’s results of operations and its financial condition. Management has made significant estimates in accounting for income recognition and OTTI on Agency and Non-Agency RMBS and IO MBS (Note 3), valuation of Agency MBS and Non-Agency RMBS (Notes 3 and 5), residential mortgage loans (Note 4), securitized debt  (Note7) and derivative instruments (Notes 5 and 9).  Actual results could differ materially from those estimates.
 
 
13

 

(p) Recent Accounting Pronouncements

Interest—Imputation of Interest (Subtopic 835-30)

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issue Costs.  This update changes the presentation of debt issuance costs in financial statements. Under the ASU, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense.  As of March 31, 2015, the Company has unamortized debt issuance costs of $4 million.  The guidance in the ASU is effective for the Company as of January 1, 2016.  Early adoption is allowed.  The guidance would be applied retrospectively to all prior periods.  As the unamortized debt issuance costs is not significant, the guidance in this ASU is not expected to have a significant impact on the consolidated financial statements.

Consolidations (Subtopic 810)

In February 2015, the FASB issued ASU No. 2015-02, Amendments to the Consolidation Analysis.  This update affects the following areas of the consolidation analysis: limited partnerships and similar entities, evaluation of fees paid to a decision maker or service provider as a variable interest and in determination of the primary beneficiary, effect of related parties on the primary beneficiary determination and for certain investment funds.  The guidance in the ASU is effective for the Company as of January 1, 2016.  Early adoption is allowed.  Fees paid to the Company are not significant, therefore, the guidance in this ASU is not expected to have a significant impact on the consolidated financial statements.

Presentation of Financial Statements—Going Concern (Subtopic 205-40)

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.  This update provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires the Company to perform interim and annual assessments of its ability to continue as a going concern within one year of the date the financial statements are issued. The Company must provide certain disclosures if conditions or events raise substantial doubt about its ability to continue as a going concern. The ASU applies to all entities and is effective for the Company beginning January 1, 2017.  Early adoption is permitted.  The Company does not expect this update to have any impact as we do not expect to have the conditions or events which would raise substantial doubt about the Company’s ability to continue as a going concern.

Consolidations (Subtopic 810)

In August 2014, the FASB issued ASU No. 2014-13, Measuring the Financial Assets and the Financial Liabilities of a Consolidated Collateralized Financing Entity.  This update provides a measurement alternative for consolidated qualifying collateralized financing entities (CFEs).  The update defines a CFE as a variable interest entity that holds financial assets, issues beneficial interests in those assets and has no more than nominal equity. The beneficial interests have contractual recourse only to the related assets of the CFE and are classified as financial liabilities. Under the alternative, the Company may elect to measure both the CFE’s financial assets and financial liabilities using the fair value of either the CFE’s financial assets or financial liabilities, whichever is more observable. The guidance is aimed at eliminating the measurement difference that sometimes arises when a CFE’s financial assets and financial liabilities are independently measured at fair value, as required by ASC 820.  The Company adopted the guidance in this standard beginning January 1, 2015.

Upon adoption of this guidance, the Company elected the fair value option for certain consolidated VIEs holding securitized loans held for investment and the related securitized debt which qualified as CFEs.  As the fair value of the securitized debt of these CFEs is more observable, the fair value of the securitized loans will be based on the fair value of the securitized debt.  The adoption of this update resulted in a net reduction in equity of $12 million as of January 1, 2015.   A complete discussion of the methodology utilized by the Company to estimate the fair value of its financial instruments impacted by this standard is included in Note 5 to these consolidated financial statements.
 
The following table summarized the adjustments made to the Company's consolidated assets, liabilities and equity as of January 1, 2015:
 
    Effect of accounting standard  
   
Balance
   
Reclass to fair value
   
Fair value adjustment
   
Total
 
Assets:
  (dollars in thousands)  
Securitized loans held for investment, net of allowance for loan losses
  $ 626,112     $ (626,112 )   $ -     $ -  
Securitized loans held for investment, at fair value
    4,699,215       626,112       (19,283 )     5,306,501  
Total Securitized loans held for investment
  $ 5,325,327     $ -     $ (19,283 )   $ 5,306,501  
                                 
Liabilities:
                               
Securitized debt, collateralized by loans held for investment
  $ 521,997     $ (521,997 )   $ -     $ -  
Securitized debt at fair value, collateralized by loans held for investment
    3,868,366       521,997       (7,146 )     4,383,217  
Total Securitized debt
  $ 4,390,363     $ -     $ (7,146 )   $ 4,383,217  
                                 
Total effect of accounting standard on retained earnings
                  $ (12,137 )        

Transfers and Servicing (Subtopic 860)

In June 2014, the FASB issued ASU No. 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  This update makes limited amendments to the guidance in ASC 860 on accounting for certain repurchase agreements.  The ASU requires entities to account for repurchase-to-maturity transactions as secured borrowings, rather than as sales with forward repurchase agreements.  The ASU defines a repurchase-to-maturity transaction as a repo that (1) settles at the maturity of the transferred financial asset and (2) does not require the transferor to reacquire the transferred financial asset.   In addition, the ASU eliminates accounting guidance on linked repurchase financing transactions.  The ASU also expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers accounted for as secured borrowings.  The guidance in this update was effective for the Company beginning January 1, 2015, except for the disclosure requirements for transactions accounted for as secured borrowings, which are required to be presented by the Company in the second quarter of 2015.  The adoption of this standard did not have any impact on the consolidated financial statements of the Company.
 
 
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Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40)

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure.  This update clarifies when the Company is considered to have obtained physical possession, from an in-substance possession or foreclosure, of a residential real estate property collateralizing a mortgage loan.  Current guidance indicates that the Company should reclassify a collateralized mortgage loan such that the loan should be derecognized and the collateral asset recognized when it determines that there has been an in-substance repossession or foreclosure by the Company.  This update defines the term in substance repossession or foreclosure to reduce diversity in interpretation of when such an event occurs.  The guidance in this update was effective for the Company beginning January 1, 2015 and did not have a significant impact on the consolidated financial statements of the Company.

3.  Mortgage-Backed Securities

The Company classifies its Non-Agency RMBS as senior, senior IO, subordinated, or subordinated IO.  The Company also invests in residential and commercial Agency MBS.  Senior interests in Non-Agency RMBS are considered to be entitled to the first principal repayments in their pro-rata ownership interests at the acquisition date.  The total fair value of the Non-Agency RMBS that are held by consolidated re-securitization trusts was $2.4 billion and $2.5 billion at March 31, 2015 and December 31, 2014, respectively.  See Note 8 of these consolidated financial statements for further discussion of consolidated VIEs.

The following tables present the principal or notional value, total premium, total discount, amortized cost, fair value, gross unrealized gains, gross unrealized losses, and net unrealized gain (loss) related to the Company’s available-for-sale RMBS portfolio as of March 31, 2015 and December 31, 2014, by asset class.

March 31, 2015
 
(dollars in thousands)
 
     
Principal or Notional Value
   
Total
Premium
   
Total Discount
   
Amortized Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Net
Unrealized
Gain/(Loss)
 
Non-Agency RMBS
                                               
 
Senior
  $ 3,723,013     424     (1,610,813 )   $ 2,112,624     $ 2,929,431     817,742     (935 )   $ 816,807  
 
Senior, interest-only
    6,175,346       298,763       -       298,763       283,883       24,105       (38,985 )     (14,880 )
 
Subordinated
    711,445       11,500       (341,527 )     381,418       487,800       108,637       (2,255 )     106,382  
 
Subordinated, interest-only
    214,350       9,353       -       9,353       6,325       117       (3,145 )     (3,028 )
Agency MBS
                                                               
 
Residential
    6,060,500       313,504       -       6,374,004       6,447,127       85,564       (12,441 )     73,123  
 
Commercial
    432,042       13,166       (1,593 )     443,615       451,901       8,958       (672 )     8,286  
 
Interest-only
    5,888,224       265,304       -       265,304       264,116       3,701       (4,889 )     (1,188 )
Total
    $ 23,204,920     $ 912,014     $ (1,953,933 )   $ 9,885,081     $ 10,870,583     $ 1,048,824     $ (63,322 )   $ 985,502  
                                                                   
December 31, 2014
 
(dollars in thousands)
 
     
Principal or Notional Value
   
Total
Premium
   
Total Discount
   
Amortized Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Net
Unrealized
Gain/(Loss)
 
Non-Agency RMBS
                                                               
 
Senior
  $ 3,435,362     -     (1,542,907 )   $ 1,892,455     $ 2,735,780     843,680     (355 )   $ 843,325  
 
Senior, interest-only
    5,221,937       227,305       -       227,305       207,216       17,378       (37,467 )     (20,089 )
 
Subordinated
    690,599       -       (344,033 )     346,566       454,348       108,091       (309 )     107,782  
 
Subordinated, interest-only
    216,403       9,577       -       9,577       6,805       194       (2,966 )     (2,772 )
Agency RMBS
                                                               
 
Residential
    7,774,266       387,174       (1,624 )     8,159,816       8,255,419       108,802       (13,199 )     95,603  
 
Interest-only
    3,884,523       189,797       -       189,797       186,103       1,326       (5,020 )     (3,694 )
Total
    $ 21,223,090     $ 813,853     $ (1,888,564 )   $ 10,825,516     $ 11,845,671     $ 1,079,471     $ (59,316 )   $ 1,020,155  
 
 
15

 

The table below presents changes in Accretable Yield, or the excess of the security’s cash flows expected to be collected over the Company’s investment, solely as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.
 
   
For the Quarter Ended
 
   
March 31, 2015
   
March 31, 2014
 
   
(dollars in thousands)
 
Balance at beginning of period
  $ 1,534,497     $ 1,794,577  
Purchases
    84,753       24,289  
Accretion
    (69,705 )     (77,285 )
Reclassification (to) from non-accretable difference
    7,182       (13,980 )
Sales and deconsolidation
    (19,865 )     (1,126 )
Balance at end of period
  $ 1,536,862     $ 1,726,475  

The table below presents the outstanding principal balance and related amortized cost at March 31, 2015 and December 31, 2014 as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.
 
   
For the Quarter Ended
   
For the Year Ended
 
   
March 31, 2015
   
December 31, 2014
 
   
(dollars in thousands)
 
Outstanding principal balance:
       
Beginning of period
  $ 3,325,335     $ 3,949,664  
End of period
  $ 3,511,739     $ 3,325,335  
                 
Amortized cost:
               
Beginning of period
  $ 1,741,780     $ 2,027,738  
End of period
  $ 1,876,822     $ 1,741,780  
 
The following tables present the gross unrealized losses and estimated fair value of the Company’s RMBS by length of time that such securities have been in a continuous unrealized loss position at March 31, 2015 and December 31, 2014.  All securities in an unrealized loss position have been evaluated by the Company for OTTI as discussed in Note 2(d).
 
March 31, 2015
 
(dollars in thousands)
 
                                                       
   
Unrealized Loss Position for Less than 12 Months
   
Unrealized Loss Position for 12 Months or More
   
Total
 
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
 
Non-Agency RMBS
                                                     
Senior
  $ 107,083     $ (935 )     8     $ -     $ -       -     $ 107,083     $ (935 )     8  
Senior, interest-only
    56,227       (9,281 )     44       95,551       (29,704 )     57       151,778       (38,985 )     101  
Subordinated
    1,785       (2,143 )     8       11,721       (112 )     3       13,506       (2,255 )     11  
Subordinated, interest-only
    3,721       (3,005 )     1       1,358       (140 )     3       5,079       (3,145 )     4  
Agency MBS
                                                                       
Residential
    659,701       (3,286 )     11       681,541       (9,155 )     11       1,341,242       (12,441 )     22  
Commercial
    56,937       (672 )     3       -       -       -       56,937       (672 )     3  
Interest-only
    90,386       (3,121 )     14       9,643       (1,768 )     3       100,029       (4,889 )     17  
Total
  $ 975,840     $ (22,443 )     89     $ 799,814     $ (40,879 )     77     $ 1,775,654     $ (63,322 )     166  
                                                                         
December 31, 2014
 
(dollars in thousands)
 
                                                                         
   
Unrealized Loss Position for Less than 12 Months
   
Unrealized Loss Position for 12 Months or More
   
Total
 
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
   
Estimated
Fair
Value
   
Unrealized Losses
   
Number of Securities
 
Non-Agency RMBS
                                                                       
Senior
  $ 29,789     $ (355 )     3     $ -     $ -       -     $ 29,789     $ (355 )     3  
Senior, interest-only
    23,479       (3,066 )     24       96,754       (34,401 )     53       120,233       (37,467 )     77  
Subordinated
    19,380       (7 )     2       11,605       (302 )     4       30,985       (309 )     6  
Subordinated, interest-only
    4,373       (2,709 )     2       1,074       (257 )     2       5,447       (2,966 )     4  
Agency MBS
                                                                       
Residential
    219,808       (198 )     7       701,442       (13,001 )     11       921,250       (13,199 )     18  
Interest-only
    112,014       (3,616 )     12       10,467       (1,404 )     3       122,481       (5,020 )     15  
Total
  $ 408,843     $ (9,951 )     50     $ 821,342     $ (49,365 )     73     $ 1,230,185     $ (59,316 )     123  
 
At March 31, 2015, the Company did not intend to sell any of its RMBS that were in an unrealized loss position, and it was not more likely than not that the Company would be required to sell these RMBS before recovery of their amortized cost basis, which may be at their maturity. With respect to RMBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these RMBS is either expressly prohibited, not probable, or is limited to specified events of default, none of which have occurred as of March 31, 2015.
 
 
16

 

Gross unrealized losses on the Company’s Agency pass-through MBS were $13 million at both March 31, 2015 and December 31, 2014. Given the inherent credit quality of Agency MBS, the Company does not consider any of the current impairments on its Agency pass-through MBS to be credit related.  In evaluating whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at March 31, 2015 and December 31, 2014, unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency RMBS (excluding Non-Agency RMBS IO strips which are accounted for under the fair value option with changes in fair value recorded in earnings) were $3 million and $1 million at March 31, 2015 and December 31, 2014, respectively. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but rather are due to other factors. The Company has reviewed its Non-Agency RMBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in cash flows expected to be collected for such RMBS, which considers recent bond performance and expected future performance of the underlying collateral.

A summary of the OTTI included in earnings for the quarters ended March 31, 2015 and 2014 is presented below.

   
For the Quarter Ended
 
   
March 31, 2015
   
March 31, 2014
 
   
(dollars in thousands)
 
Total other-than-temporary impairment losses
  $ (1,052 )   $ (400 )
Portion of loss recognized in other comprehensive income (loss)
    (6,763 )     (1,134 )
Net other-than-temporary credit impairment losses
  $ (7,815 )   $ (1,534 )

The following table presents a roll forward of the credit loss component of OTTI on the Company’s Non-Agency RMBS for which a portion of loss was previously recognized in OCI.  The table delineates between those securities that are recognizing OTTI for the first time as opposed to those that have previously recognized OTTI.

   
For the Quarter Ended
 
   
March 31, 2015
   
March 31, 2014
 
   
(dollars in thousands)
 
Cumulative credit loss beginning balance   $ 507,548     $ 524,432  
Additions:                 
Other-than-temporary impairments not previously recognized
    7,815       1,534  
Reductions for securities sold or deconsolidated during the period
    (1,319 )     (1,670 )
Increases related to other-than-temporary impairments on securities with
previously recognized other-than-temporary impairments
    -       -  
Reductions for increases in cash flows expected to be collected that are
recognized over the remaining life of the security
    (158 )     (2,813 )
Cumulative credit loss ending balance    $ 513,886     $ 521,483  

Cash flows generated to determine net other-than-temporary credit impairment losses recognized in earnings are estimated using significant unobservable inputs.  The significant inputs used to measure the component of OTTI recognized in earnings for the Company’s Non-Agency RMBS are summarized as follows:
 
 
17

 

   
 For the Quarter Ended
   
March 31, 2015
March 31, 2014
Loss Severity
   
 
Weighted Average
69%
72%
 
Range
51% - 78%
43% - 80%
       
60+ days delinquent
   
 
Weighted Average
22%
36%
 
Range
15% - 33%
17% - 47%
       
Credit Enhancement (1)
   
 
Weighted Average
10%
8%
 
Range
0% - 18%
0% - 14%
       
3 Month CPR
   
 
Weighted Average
8%
11%
 
Range
5% - 15%
10% - 11%
       
12 Month CPR
   
 
Weighted Average
8%
12%
 
Range
3% - 16%
11% - 19%
       
(1) Calculated as the combined credit enhancement to the Re-REMIC and underlying from each of their respective capital structures.
 
The following tables present a summary of unrealized gains and losses at March 31, 2015 and December 31, 2014.  IO MBS included in the tables below represent the right to receive a specified portion of the contractual interest cash flows of the underlying principal balance of specific securities.  At March 31, 2015, IO MBS had a net unrealized loss of $19 million and had an amortized cost of $573 million.  At December 31, 2014, IO MBS had a net unrealized loss of $27 million and had an amortized cost of $427 million. The fair value of IOs at March 31, 2015 and December 31, 2014 was $554 million, and $400 million, respectively. All changes in fair value of IOs are reflected in Net Income in the Consolidated Statements of Operations and Comprehensive Income.

March 31, 2015
 
(dollars in thousands)
 
                                       
     
Gross Unrealized Gain Included in Accumulated Other Comprehensive Income
   
Gross Unrealized Gain Included in Accumulated Deficit
   
Total Gross
Unrealized Gain
   
Gross Unrealized Loss Included in Accumulated Other Comprehensive Income
   
Gross Unrealized Loss Included in Accumulated Deficit
   
Total Gross
Unrealized Loss
 
Non-Agency RMBS
                                   
 
Senior
  $ 817,742     $ -     $ 817,742     $ (935 )   $ -     $ (935 )
 
Senior, interest-only
    -       24,105       24,105       -       (38,985 )     (38,985 )
 
Subordinated
    108,637       -       108,637       (2,255 )     -       (2,255 )
 
Subordinated, interest-only
    -       117       117       -       (3,145 )     (3,145 )
Agency MBS
                                               
 
Residential
    85,564       -       85,564       (12,441 )     -       (12,441 )
 
Commercial
    8,958       -       8,958       (672 )     -       (672 )
 
Interest-only
    -       3,701       3,701       -       (4,889 )     (4,889 )
Total
    $ 1,020,901     $ 27,923     $ 1,048,824     $ (16,303 )   $ (47,019 )   $ (63,322 )
                                                   
December 31, 2014
 
(dollars in thousands)
 
                                                   
     
Gross Unrealized Gain Included in Accumulated Other Comprehensive Income
   
Gross Unrealized Gain Included in Accumulated Deficit
   
Total Gross
Unrealized Gain
   
Gross Unrealized Loss Included in Accumulated Other Comprehensive Income
   
Gross Unrealized Loss Included in Accumulated Deficit
   
Total Gross
Unrealized Loss
 
Non-Agency RMBS
                                               
 
Senior
  $ 843,680     $ -     $ 843,680     $ (355 )   $ -     $ (355 )
 
Senior, interest-only
    -       17,378       17,378       -       (37,467 )     (37,467 )
 
Subordinated
    108,091       -       108,091       (309 )     -       (309 )
 
Subordinated, interest-only
    -       194       194       -       (2,966 )     (2,966 )
Agency MBS
                                               
 
Residential
    108,802       -       108,802       (13,199 )     -       (13,199 )
 
Interest-only
    -       1,326       1,326       -       (5,020 )     (5,020 )
Total
    $ 1,060,573     $ 18,898     $ 1,079,471     $ (13,863 )   $ (45,453 )   $ (59,316 )
 
 
18

 
 
Changes in prepayments, actual cash flows, and cash flows expected to be collected, among other items, are affected by the collateral characteristics of each asset class. The Company chooses assets for the portfolio after carefully evaluating each investment’s risk profile.

The following tables provide a summary of the Company’s RMBS portfolio at March 31, 2015 and December 31, 2014.

   
March 31, 2015
 
   
Principal or
Notional Value
at Period-End
(dollars in
thousands)
Weighted
Average
Amortized
Cost Basis
Weighted
Average Fair
Value
Weighted
Average
Coupon
Weighted
Average Yield
at Period-End
(1)
Non-Agency RMBS
 
Senior
  $ 3,723,013     $ 56.75     $ 78.68       3.9 %     14.6 %
Senior, interest-only
  $ 6,175,346     $ 4.84     $ 4.60       1.7 %     13.0 %
Subordinated
  $ 711,445     $ 53.61     $ 68.56       3.1 %     13.2 %
Subordinated, interest-only
  $ 214,350     $ 4.36     $ 2.95       0.8 %     9.4 %
Agency MBS
         
Residential pass-through
  $ 6,060,500     $ 105.17     $ 106.38       3.9 %     2.4 %
Commercial pass-through
  $ 432,042     $ 102.68     $ 104.60       4.0 %     4.1 %
Interest-only
  $ 5,888,224     $ 4.51     $ 4.49       1.0 %     5.9 %
                                         
(1) Bond Equivalent Yield at period end.
 
                                         
   
December 31, 2014
 
   
Principal or
Notional Value
at Period-End
(dollars in
thousands)
   
Weighted
Average
Amortized
Cost Basis
   
Weighted
Average Fair
Value
   
Weighted
Average
Coupon
   
Weighted
Average Yield
at Period-End
(1)
 
Non-Agency RMBS
 
Senior
  $ 3,435,362     $ 55.09     $ 79.63       4.3 %     15.9 %
Senior, interest-only
  $ 5,221,937     $ 4.35     $ 3.97       1.6 %     14.4 %
Subordinated
  $ 690,599     $ 50.18     $ 65.79       3.1 %     10.6 %
Subordinated, interest-only
  $ 216,403     $ 4.43     $ 3.14       0.9 %     9.2 %
Agency MBS
         
Pass-through
  $ 7,774,266     $ 104.96     $ 106.19       4.0 %     3.2 %
Interest-only
  $ 3,884,523     $ 4.89     $ 4.79       0.9 %     3.1 %
                                         
(1) Bond Equivalent Yield at period end.
 
 
The following table presents the weighted average credit rating, based on the lowest rating available, of the Company’s Non-Agency RMBS portfolio at March 31, 2015 and December 31, 2014.

 
March 31, 2015
December 31, 2014
AAA
0.7%
0.9%
AA
0.4%
0.4%
A
0.0%
0.0%
BBB
0.3%
0.4%
BB
2.6%
1.9%
B
4.7%
5.6%
Below B or not rated
91.3%
90.8%
Total
100.0%
100.0%

Actual maturities of MBS are generally shorter than the stated contractual maturities.  Actual maturities of the Company’s MBS are affected by the contractual lives of the underlying mortgages, periodic payments of principal and prepayments of principal.  The following tables provide a summary of the fair value and amortized cost of the Company’s MBS at March 31, 2015 and December 31, 2014 according to their estimated weighted-average life classifications.  The weighted-average lives of the MBS in the tables below are based on lifetime expected prepayment rates using an industry prepayment model for the Agency MBS portfolio and the Company’s prepayment assumptions for the Non-Agency RMBS.  The prepayment model considers current yield, forward yield, steepness of the interest rate curve, current mortgage rates, mortgage rates of the outstanding loan, loan age, margin, and volatility.
 
 
19

 
 
 
March 31, 2015
(dollars in thousands)
                               
   
Weighted Average Life
 
                               
   
Less than one year
   
Greater than one
year and less than
five years
   
Greater than five
years and less
than ten years
   
Greater than ten
years
   
Total
 
Fair value
                             
Non-Agency RMBS                              
Senior   $ 823     $ 416,994     $ 1,637,858     $ 873,756     $ 2,929,431  
Senior interest-only     1,062       60,607       157,264       64,950       283,883  
Subordinated     -       55,323       285,019       147,458       487,800  
Subordinated interest-only     -       -       5,080       1,245       6,325  
Agency MBS                                        
Residential     -       6,380,492       66,635       -       6,447,127  
Commercial     -       -       30,401       421,500       451,901  
Interest-only     -       86,305       177,811       -       264,116  
Total fair value
  $ 1,885     $ 6,999,721     $ 2,360,068     $ 1,508,909     $ 10,870,583  
Amortized cost
                                       
Non-Agency RMBS                                        
Senior   $ 472     $ 325,679     $ 1,187,714     $ 598,759     $ 2,112,624  
Senior interest-only     1,821       70,303       164,522       62,117       298,763  
Subordinated     -