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 (§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  ☒    No  ☐

 

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐  (Do not check if a smaller reporting company)	Smaller reporting company	☐

 

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the factors discussed under “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q and “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015;

 

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general volatility of the capital markets;

 

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The Company accounts for income taxes in accordance with ASC 740, Income Taxes. ASC 740 requires the recording of deferred income taxes that reflect the net tax effect of temporary differences between the carrying amounts of the Company’s assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, including operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in earnings in the period that includes the enactment date. The Company assesses its tax positions for all open tax years and determines if it has any material unrecognized liabilities in accordance with ASC 740. The Company records these liabilities to the extent it deems them more-likely-than-not to be incurred. The Company records interest and penalties related to income taxes within the provision for income taxes in the consolidated statements of income (loss). The Company has not incurred any interest or penalties.

Realized Gain (Loss) on RMBS and Derivatives, Net

The following table presents gains and losses on sales of RMBS and derivatives for the periods indicated (dollars in thousands):

		Three Months Ended March 31,
		2016				2015
Realized gain (loss) on RMBS, net
Gain on RMBS		$	320			$	307
Loss on RMBS			-				-
Net realized gain (loss) on RMBS			320				307
Realized gain (loss) on derivatives, net			(1,461	)			(1,242	)
Unrealized gain (loss) on derivatives, net			(5,198	)			(2,542	)
Total		$	(6,339	)		$	(3,477	)

 

The gain and loss on RMBS presented above represent the amounts reclassified from other comprehensive income (loss) in earnings.

Repurchase Agreements and Interest Expense

The Company finances its investments in RMBS with short-term borrowings under uncommitted master repurchase agreements. The repurchase agreements are generally short-term debt, which expire within one year. Borrowings under repurchase agreements generally bear interest rates of a specified margin over one-month LIBOR. The repurchase agreements are treated as collateralized financing transactions and are carried at their contractual amounts, as specified in the respective agreements. Interest is recorded at the contractual amount on an accrual basis.

Federal Home Loan Bank of Indianapolis Advances

Advances from the Federal Home Loan Bank of Indianapolis (“FHLBI”) are secured by the pledge of Agency RMBS, have varying amortization structures and maturities and bear interest at rates set by FHLBI based on market conditions and a number of criteria, including the size of the transaction and the FHLBI’s cost of funds. Advances are treated as collateralized financing transactions and are carried at their contractual amounts. Interest is recorded at the contractual amount on an accrual basis.

Dividends Payable

Because the Company is organized and operated so as to qualify as a REIT under the Code, it is required by law to distribute annually at least 90% of its REIT taxable income, which it does in the form of quarterly dividend payments. The Company accrues the dividend payable on the accounting date, which causes an offsetting reduction in retained earnings.

Comprehensive Income

Comprehensive income is defined as the change in equity of a business enterprise during a period resulting from transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. For the Company’s purposes, comprehensive income represents net income, as presented in the consolidated statements of income, adjusted for unrealized gains or losses on RMBS, which are designated as available for sale.

Business Combinations

Business combinations are accounted for under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations. Under the acquisition method the acquiring entity in a business combination recognizes 100 percent of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceeds the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the consolidated statement of income (loss) from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. We applied this guidance to the Aurora acquisition.

 

Recent Accounting Pronouncements

Business Combinations – In September 2015, the Financial Accounting Standards Board (“FASB”) issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which amends ASC 805, Business Combinations. ASU 2015-16 requires that an acquirer recognize adjustments to previously identified provisional amounts in the reporting period in which the adjustment amounts are determined. ASU 2015-16 requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public business entities, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. Adoption of ASU 2015-16 did not have a material impact on the consolidated statement of income (loss) or earnings per share.

Revenue Recognition – In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition requirements in ASC 606, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for fiscal years and interim periods beginning after December 15, 2017. Entities have the option of using either a full retrospective or a modified approach to adopt the guidance in ASU 2014-09. Management is currently evaluating the impact ASU 2014-09 may have on its consolidated financial statements.

Transfers and Servicing – In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, which amends ASC 860, Transfers and Servicing. ASU 2014-11, which affects all entities that enter into repurchase-to-maturity transactions or repurchase financings, requires two accounting changes. First, ASU 2014-11 changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting. Second, for repurchase financing arrangements, ASU 2014-11 requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty, which will result in secured borrowing accounting for the repurchase agreement. ASU 2014-11 also requires disclosures for certain transactions comprising (1) a transfer of a financial asset accounted for as a sale and (2) an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. For those transactions outstanding at the reporting date, the transferor is required to disclose additional information by type of transaction. ASU 2014-11 also requires certain disclosures for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. The accounting changes in ASU 2014-11 are effective for public business entities for the first interim or annual period beginning after December 15, 2014. For public business entities, the disclosure for certain transactions accounted for as a sale is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015, with early adoption prohibited. Adoption of ASU 2014-11 did not have a material impact on the consolidated balance sheet, statement of income (loss), or earnings per share.

 

Stock Compensation – In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved After the Requisite Service Period, which amends ASC 718, Compensation – Stock Compensation. ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. Adoption of ASU 2014-12 did not have a material impact on the consolidated balance sheet, statement of income (loss), or earnings per share.

Going Concern – In August 2014, the FASB issued ASU 2014-15, Disclosures of Uncertainties about an Entity’s Ability to Continue as a Going Concern, which amends ASC Subtopic 205-40, Presentation of Financial Statements – Going Concern. ASU 2014-15 provides guidance in GAAP about management’s responsibility to evaluate whether there are conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date that the financial statements are issued and to provide related footnote disclosures of the relevant facts and circumstances. ASU 2014-15 is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter, with early adoption permitted. Management does not expect the adoption of ASU 2014-15 to have an impact on its consolidated financial statements.

Changes in Presentation

Certain prior period amounts have been reclassified to conform to current period presentation.

 

Note 3 — Segment Reporting

The Company conducts its business through the following segments: (i) investments in RMBS; (ii) investments in Servicing Related Assets; and (iii) “All Other” which consists primarily of general and administrative expenses, including fees to the directors and management fees pursuant to the Management Agreement (See Note 7). For segment reporting purposes, the Company does not allocate interest income on short-term investments or general and administrative expenses.

Summary financial data on the Company’s segments is given below, together with a reconciliation to the same data for the Company as a whole (dollars in thousands):

		Servicing Related Assets				RMBS				All Other				Total
Three Months Ended March 31, 2016
Interest income		$	1,444			$	3,744			$	-			$	5,188
Interest expense			340				1,317				-				1,657
Net interest income			1,104				2,427				-				3,531
Servicing fee income			1,495				-				-				1,495
Servicing costs			402				-				-				402
Net servicing income			1,093				-				-				1,093
Other income			(4,539	)			(6,339	)			-				(10,878	)
Other operating expenses			-				-				1,498				1,498
Provision for corporate business taxes			-				-				(590	)			(590	)
Net income (loss)		$	(2,342	)		$	(3,912	)		$	(908	)		$	(7,162	)
Three Months Ended March 31, 2015
Interest income		$	2,575			$	3,252			$	-			$	5,827
Interest expense			-				1,235				-				1,235
Net interest income			2,575				2,017				-				4,592
Servicing fee income			-				-				-				-
Servicing costs			-				-				-				-
Net servicing income			-				-				-				-
Other income			(2,117	)			(3,477	)			-				(5,594	)
Other operating expenses			-				-				1,432				1,432
Provision for corporate business taxes			-				-				-				-
Net income (loss)		$	458			$	(1,460	)		$	(1,432	)		$	(2,434	)
Balance Sheet
March 31, 2016
Investments		$	92,604			$	508,159			$	-			$	600,763
Other assets			3,665				17,718				13,046				34,429
Total assets			96,269				525,877				13,046				635,192
Debt			23,836				445,624				-				469,460
Other liabilities			2,007				9,734				5,034				16,775
Total liabilities			25,843				455,358				5,034				486,235
GAAP book value		$	70,426			$	70,519			$	8,012			$	148,957
December 31, 2015
Investments		$	97,803			$	508,242			$	-			$	606,045
Other assets			3,562				13,984				12,749				30,295
Total assets			101,365				522,226				12,749				636,340
Debt			24,313				447,810				-				472,123
Other liabilities			1,883				4,903				5,094				11,880
Total liabilities			26,196				452,713				5,094				484,003
GAAP book value		$	75,169			$	69,513			$	7,655			$	152,337

Note 4 — Investments in RMBS

All of the Company’s RMBS are classified as available for sale and are, therefore, reported at fair value with changes in fair value recorded in other comprehensive income except for securities that are OTTI. There were no OTTI securities as of March 31, 2016 and December 31, 2015 (dollars in thousands):

Summary of RMBS Assets

As of March 31, 2016

 

		Original								Gross Unrealized												Number			Weighted Average
Asset Type		Face Value				Book Value				Gains				Losses				Carrying Value(A)				of Securities			Rating		Coupon				Yield(C)				Maturity (Years)(D)
RMBS
Fannie Mae		$	342,288			$	315,200			$	4,888			$	(64	)		$	320,024				46		(B)			3.77	%			3.59	%			23
Freddie Mac			190,523				178,119				2,620				-				180,739				23		(B)			3.62	%			3.35	%			25
CMOs			17,896				7,706				6				(316	)			7,396				5		Unrated			4.35	%			6.96	%			10
Total/Weighted Average		$	550,707			$	501,025			$	7,514			$	(380	)		$	508,159				74					3.72	%			3.56	%			24

 

As of December 31, 2015

 

		Original								Gross Unrealized												Number			Weighted Average
Asset Type		Face Value				Book Value				Gains				Losses				Carrying Value(A)				of  Securities			Rating		Coupon				Yield(C)				Maturity (Years)(D)
RMBS
Fannie Mae		$	329,767			$	308,367			$	1,961			$	(1,556	)		$	308,772				44		(B)			3.77	%			3.59	%			24
Freddie Mac			208,154				193,567				821				(977	)			193,411				24		(B)			3.61	%			3.48	%			24
CMOs			16,646				6,493				-				(434	)			6,059				4		Unrated			4.55	%			7.39	%			10
Total/Weighted Average		$	554,567			$	508,427			$	2,782			$	(2,967	)		$	508,242				72					3.72	%			3.60	%			23

 

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Summary of RMBS Assets by Maturity

As of March 31, 2016

		Original								Gross Unrealized												Number			Weighted Average
Asset Type		Face Value				Book Value				Gains				Losses				Carrying Value(A)				of Securities			Rating		Coupon				Yield(C)				Maturity (Years)(D)
Less than 1 Year		$	-			$	-			$	-			$	-			$	-				-					-				-				-
1-5 Years			-				-				-				-				-				-					-				-				-
5-10 Years			5,500				5,553				-				(159	)			5,394				3		(B)			4.77	%			4.57	%			9
Over 10 Years			545,207				495,472				7,514				(221	)			502,765				71		(B)			3.71	%			3.55	%			24
Total/Weighted Average		$	550,707			$	501,025			$	7,514			$	(380	)		$	508,159				74					3.72	%			3.56	%			24

 

As of December 31, 2015

 

		Original								Gross Unrealized												Number			Weighted Average
Asset Type		Face Value				Book Value				Gains				Losses				Carrying Value(A)				of  Securities			Rating		Coupon				Yield(C)				Maturity (Years)(D)
Less than 1 Year		$	-			$	-			$	-			$	-			$	-				-					-				-				-
1-5 Years			-				-				-				-				-				-					-				-				-
5-10 Years			5,500				5,553				-				(216	)			5,337				3		(B)			4.76	%			4.96	%			9
Over 10 Years			549,067				502,874				2,782				(2,751	)			502,905				69		(B)			3.71	%			3.59	%			24
Total/Weighted Average		$	554,567			$	508,427			$	2,782			$	(2,967	)		$	508,242				72					3.72	%			3.60	%			23

 

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At March 31, 2016 and December 31, 2015, the Company pledged Agency RMBS investments with a carrying value of approximately $416.1 million and $399.8 million, respectively, as collateral for repurchase agreements. At March 31, 2016, and December 31, 2015, the Company pledged Agency RMBS investments with a carrying value of approximately $51.8 million and $83.2 million, respectively, as collateral for FHLBI advances. At March 31, 2016 and December 31, 2015, the Company did not have any securities purchased from and financed with the same counterparty that did not meet the conditions of ASC 860, Transfers and Servicing, to be considered linked transactions and, therefore, classified as derivatives.

Unrealized losses that are considered other-than-temporary are recognized currently in earnings. During the three month periods ended March 31, 2016 and 2015, the Company did not record any OTTI charges. Based on management’s analysis of these securities, the performance of the underlying loans and changes in market factors, management determined that unrealized losses as of the balance sheet date on the Company’s securities were primarily the result of changes in market factors, rather than issuer-specific credit impairment. The Company performed analyses in relation to such securities, using management’s best estimate of their cash flows, which support its belief that the carrying values of such securities were fully recoverable over their expected holding period. Such market factors include changes in market interest rates and credit spreads, or certain macroeconomic events, which did not directly impact the Company’s ability to collect amounts contractually due. Management continually evaluates the credit status of each of the Company’s securities and the collateral supporting those securities. This evaluation includes a review of the credit of the issuer of the security (if applicable), the credit rating of the security (if applicable), the key terms of the security (including credit support), debt service coverage and loan to value ratios, the performance of the pool of underlying loans and the estimated value of the collateral supporting such loans, including the effect of local, industry and broader economic trends and factors. In connection with the above, the Company weighs the fact that all of its investments in Agency RMBS are guaranteed by U.S. government agencies or U.S. government sponsored entities.

 

These factors include underlying loan default expectations and loss severities, which are analyzed in connection with a particular security’s credit support, as well as prepayment rates. The result of this evaluation is considered when determining management’s estimate of cash flows and in relation to the amount of the unrealized loss and the period elapsed since it was incurred. Significant judgment is required in this analysis. The following tables summarize the Company’s securities in an unrealized loss position as of the dates indicated (dollars in thousands):

 

RMBS Unrealized Loss Positions

As of March 31, 2016

		Original								Gross								Number				Weighted Average
Asset Type		Face Value				Book Value				Unrealized Losses				Carrying Value(A)				of Securities				Rating		Coupon				Yield(C)				Maturity (Years)(D)
Less than Twelve Months		$	33,101			$	34,495			$	(187	)		$	34,308				7			(B)			3.94	%			3.72	%			20
Twelve or More Months			28,577				17,577				(193	)			17,384				4			(B)			3.15	%			4.15	%			15
Total/Weighted Average		$	61,678			$	52,072			$	(380	)		$	51,692				11						3.68	%			3.86	%			19

 

As of December 31, 2015

 

		Original								Gross								Number				Weighted Average
Asset Type		Face Value					Book Value			Unrealized Losses					Carrying Value(A)			of Securities				Rating			Coupon				Yield(C)			Maturity (Years)(D)
Less than Twelve Months		$	271,585			$	274,996			$	(2,749	)		$	272,247				39			(B)			3.65	%			3.48	%			24
Twelve or More Months			11,146				940				(218	)			722				1			(B)			3.00	%			25.37	%			17
Total/Weighted Average		$	282,731			$	275,936			$	(2,967	)		$	272,969				40						3.65	%			3.55	%			24

 

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(A)	See Note 9 regarding the estimation of fair value, which is equal to carrying value for all securities.

(B)	The Company used an implied AAA rating for the Fannie Mae and Freddie Mac securities, other than CMOs, which are unrated.

(C)	The weighted average yield is based on the most recent annualized monthly interest income, divided by the Book Value. Prior period amounts have been reclassified to conform to current period presentation.

(D)	The weighted average stated maturity. The Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases which may be maturity.

Note 5 — Investments in Servicing Related Assets

Excess MSRs

In October 2013, the Company entered into an agreement (“MSR Agreement 1”) with Freedom Mortgage Corporation (“Freedom Mortgage”) to invest in Excess MSRs with Freedom Mortgage. Freedom Mortgage originated the mortgage servicing rights on the related pool of residential fixed rate Ginnie Mae-eligible FHA and VA mortgage loans with an aggregate unpaid principal balance (“UPB”) of approximately $10.0 billion (“MSR Pool 1”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of approximately 28 basis points (“bps”) on the performing UPB, as well as any ancillary income from MSR Pool 1. Pursuant to MSR Agreement 1, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 1 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 8 bps. The remainder, or “excess mortgage servicing amount,” is initially equal to a weighted average of 20 bps.

The Company acquired the right to receive 85% of the excess mortgage servicing amount on MSR Pool 1 and, subject to certain limitations and pursuant to a recapture agreement (the “MSR Pool 1—Recapture Agreement”), 85% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool l (which loans then become part of MSR Pool 1) for approximately $60.6 million. Freedom Mortgage has co-invested, pari passu with the Company, in 15% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 85%, of such termination payment.

The value, and absolute amount, of recapture activity tends to vary inversely with the direction of interest rates. When interest rates are falling, recapture rates tend to be higher due to increased opportunities for borrowers to refinance. As interest rates increase, however, there is likely to be less recapture activity.

In October 2013, the Company entered into an agreement (“MSR Agreement 2”) with Freedom Mortgage to invest with Freedom Mortgage in another pool of Excess MSRs. Freedom Mortgage acquired the mortgage servicing rights from a third-party seller on a pool of residential Ginnie Mae-eligible VA hybrid adjustable rate mortgage loans with an outstanding principal balance of approximately $10.7 billion (“MSR Pool 2”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of 44 bps on the performing UPB, as well as any ancillary income from MSR Pool 2. Pursuant to MSR Agreement 2, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 2 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 10 bps. Therefore, the remainder, or “excess mortgage servicing amount” is initially equal to a weighted average of 34 bps.

 

The Company acquired the right to receive 50% of the excess mortgage servicing amount on MSR Pool 2 and, subject to certain limitations and pursuant to a recapture agreement (the “MSR Pool 2—Recapture Agreement”), 50% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool 2 (which loans then become part of MSR Pool 2) for approximately $38.4 million. Freedom Mortgage has co-invested, pari passu with the Company, in 50% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 50%, of such termination payment.

Upon completion of the IPO and the concurrent private placement, the Company also entered into a flow and bulk Excess MSR purchase agreement related to future purchases of Excess MSRs from Freedom Mortgage. On February 28, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the first quarter of 2014 with an UPB of approximately $76.8 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $567,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On March 31, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by a third party originator with an aggregate UPB of approximately $159.8 million. Freedom Mortgage purchased the MSRs on these mortgage loans from a third party on January 31, 2014. The Company acquired an approximate 71% interest in the Excess MSRs for approximately $946,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On June 30, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the second quarter of 2014 with an aggregate UPB of approximately $98.1 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $661,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

The mortgage loans underlying the Excess MSRs purchased in 2014 are collectively referred to as “Pool 2014,” and the recapture provisions, which are identical, are collectively referred to as the “Pool 2014—Recapture Agreement.”

MSRs

On May 29, 2015, in conjunction with the acquisition of Aurora, we acquired MSRs on conventional mortgage loans with an aggregate UPB of approximately $718.4 million. We have not entered into a recapture agreement covering the MSRs as of March 31, 2016.

On June 10, 2015, the Company agreed to transfer the direct servicing of the MSR portfolio to Freedom Mortgage pursuant to a subservicing agreement with Freedom Mortgage. The transfer occurred in September 2015. Pending the transfer, the former servicing employees of Aurora, now employees of Freedom Mortgage, directly serviced the portfolio for Aurora. The servicing, which was provided at cost pursuant to the Management Agreement with the Manager and the Services Agreement between the Manager and Freedom Mortgage. The cost for such services during the third quarter of 2015 is included in servicing costs on the consolidated statements of income (loss).

On October 30, 2015, Aurora acquired a portfolio of MSRs on loans owned or securitized by Fannie Mae or Freddie Mac with an aggregate unpaid principal balance of approximately $1.4 billion.

 

On January 29, 2016, Aurora acquired a portfolio of MSRs on mortgage loans owned or securitized by Fannie Mae with an aggregate unpaid principal balance of approximately $463 million.

 

The following is a summary of the Company’s Servicing Related Assets (dollars in thousands):

Servicing Related Assets Summary

As of March 31, 2016

		Unpaid Principal  Balance				Amortized Cost Basis(A)				Carrying Value(B)				Weighted Average Coupon				Weighted Average Maturity (Years)(C)				Changes in  Fair Value Recorded in Other Income  (Loss)(D)
Pool 1		$	7,142,753			$	36,623			$	37,528				3.51	%			25.8			$	(2,449	)
Pool 1 - Recapture Agreement			-				2,025				1,566												1,105
Pool 2			6,999,638				21,533				29,467				2.82	%			26.8				(1,288	)
Pool 2 - Recapture Agreement			-				1,632				945												377
Pool 2014			254,898				1,548				1,317				3.65	%			27.2				(52	)
Pool 2014 - Recapture Agreement			-				-				-												-
MSRs (E)			2,405,863				24,013				21,781				3.78	%			22.6				(2,232	)
Total		$	16,803,152			$	87,374			$	92,604				3.26	%			25.8			$	(4,539	)

 

As of December 31, 2015

		Unpaid Principal Balance				Amortized Cost Basis(A)				Carrying Value(B)				Weighted Average Coupon				Weighted Average  Maturity  (Years)(C)				Changes in Fair Value Recorded in Other Income (Loss)(D)
Pool 1		$	7,416,465			$	39,483			$	42,837				3.51	%			26.0			$	(2,822	)
Pool 1 - Recapture Agreement			-				2,209				645				-				-				331
Pool 2			7,279,706				23,116				32,338				2.78	%			27.1				2,626
Pool 2 - Recapture Agreement			-				1,780				716				-				-				(324	)
Pool 2014			265,890				1,685				1,506				3.65	%			27.4				170
Pool 2014 - Recapture Agreement			-				-				-				-				-				-
MSRs (E)			2,016,351				20,884				19,761				3.76	%			22.7				(1,123	)
Total		$	16,978,412			$	89,157			$	97,803				3.23	%			26.1			$	(1,142	)

 

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(E)	MSR cost basis consists of the carrying value of the prior period, adjusted for any acquisitions made during the current period.

 

The tables below summarize the geographic distribution for the states representing 5% or greater of the underlying residential mortgage loans of the Servicing Related Assets:

Geographic Concentration of Servicing Related Assets

As of March 31, 2016

 

		Percentage of Total Outstanding Unpaid Principal Balance
California			12.0	%
Texas			9.2	%
Florida			6.5	%
Virginia			5.9	%
North Carolina			5.1	%
New Jersey			5.1	%
All other			56.2	%
Total			100.0	%

 

As of December 31, 2015

 

		Percentage of Total Outstanding Unpaid Principal Balance
California			12.3	%
Texas			9.4	%
Florida			6.5	%
Virginia			6.0	%
North Carolina			5.2	%
Washington			5.1	%
Georgia			5.0	%
All other			50.5	%
Total			100.0	%

 

Geographic concentrations of investments expose the Company to the risk of economic downturns within the relevant states. Any such downturn in a state where the Company holds significant investments could affect the underlying borrower’s ability to make the mortgage payment and, therefore, could have a meaningful, negative impact on the Company’s Servicing Related Assets.

Note 6 — Equity and Earnings per Share

Equity Incentive Plan

During 2013, the board of directors approved, and the Company’s sole stockholder at the time adopted, the Cherry Hill Mortgage Investment Corporation 2013 Equity Incentive Plan (“2013 Plan”). The 2013 Plan provides for the grant of options to purchase shares of the Company’s common stock, stock awards, stock appreciation rights, performance units, incentive awards and other equity-based awards, including long term incentive plan units (“LTIP-OP Units”) of the Company’s operating partnership, Cherry Hill Operating Partnership, LP (the “Operating Partnership”).

 

The following tables present certain information about the Company’s 2013 Plan as of the dates indicated:

Equity Incentive Plan Information

As of March 31, 2016

 

		Number of Securities Issued or to be Issued Upon Exercise				Number of Securities Remaining Available For Future Issuance Under Equity Compensation Plans
Equity compensation Plans Approved By Shareholders							1,377,112
LTIP-OP Units			103,850
Shares of Common Stock			19,038
Equity Compensation Plans Not Approved By Shareholders							-

As of December 31, 2015

 

		Number of Securities Issued or to be Issued Upon Exercise				Number of Securities Remaining Available For Future Issuance Under Equity Compensation Plans
Equity compensation Plans Approved By Shareholders							1,377,112
LTIP-OP Units			103,850
Shares of Common Stock			19,038
Equity Compensation Plans Not Approved By Shareholders							-

 

LTIP-OP Units are a special class of partnership interest in the Operating Partnership. LTIP-OP Units may be issued to eligible participants for the performance of services to or for the benefit of the Operating Partnership. Initially, LTIP-OP Units do not have full parity with the Operating Partnership’s common units of limited partnership interest (“OP Units”) with respect to liquidating distributions; however, LTIP-OP Units receive, whether vested or not, the same per-unit distributions as OP Units and are allocated their pro-rata share of the Company’s net income or loss. Under the terms of the LTIP-OP Units, the Operating Partnership will revalue its assets upon the occurrence of certain specified events, and any increase in the Operating Partnership’s valuation from the time of grant of the LTIP-OP Units until such event will be allocated first to the holders of LTIP-OP Units to equalize the capital accounts of such holders with the capital accounts of the holders of OP Units. Upon equalization of the capital accounts of the holders of LTIP-OP Units with the other holders of OP Units, the LTIP-OP Units will achieve full parity with OP Units for all purposes, including with respect to liquidating distributions. If such parity is reached, vested LTIP-OP Units may be converted into an equal number of OP Units at any time and, thereafter, enjoy all the rights of OP Units, including redemption/exchange rights. Each LTIP-OP Unit awarded is deemed equivalent to an award of one share under the 2013 Plan and reduces the 2013 Plan’s share authorization for other awards on a one-for-one basis.

 

An LTIP-OP Unit and a share of common stock of the Company have substantially the same economic characteristics in as much as they effectively share equally in the net income or loss of the Operating Partnership. Holders of LTIP-OP Units that have reached parity with OP Units have the right to redeem their LTIP-OP Units, subject to certain restrictions. The redemption is required to be satisfied in shares of common stock, cash, or a combination thereof, at the Company’s option, calculated as follows: one share of the Company’s common stock, or cash equal to the fair value of a share of the Company’s common stock at the time of redemption, for each LTIP-OP Unit. When an LTIP-OP Units holder redeems an OP Unit (as described above), non-controlling interest in the Operating Partnership is reduced and the Company’s equity is increased.

The table below sets forth certain information regarding the LTIP-OP Units that have been granted by the board of directors (dollars in thousands, except per share data):

LTIP-OP Unit Grant Information

 

Grant Date		Number of Grantees				Stock Price on Grant Date				Number of Units Granted				Aggregate Fair Market Value
September 9, 2015			12			$	15.80				35,000			$	553
June 10, 2014			10			$	19.33				31,350			$	606
October 9, 2013			11			$	20.00				37,500			$	750

 

Except for 7,500 LTIP-OP Units that were granted to the Company’s independent directors at the time of the IPO, which vested immediately, LTIP-OP Units vest ratably over the first three year anniversaries of the grant date. The fair value of each LTIP-OP Unit was determined based on the initial offering price of the Company’s common stock in the case of the grant to the independent directors and based on the closing price of the Company’s common stock on the applicable grant date in all other cases.

As of March 31, 2016, 37,950 LTIP-OP Units have vested. The Company recognized approximately $147,000 and $102,000 in share-based compensation expense in the three month periods ended March 31, 2016 and 2015, respectively. There was approximately $781,000 of total unrecognized share-based compensation expense as of March 31, 2016, related to the 65,900 non-vested LTIP-OP Units. This unrecognized share-based compensation expense is expected to be recognized ratably over the remaining vesting period of up to three years. The aggregate expense related to the LTIP-OP Unit grants is presented as “General and administrative expense” in the Company’s consolidated income statement.

On January 27, 2014, the Company granted each of the independent directors pursuant to the 2013 Plan 530 shares of common stock (for a total of 1,590 shares), which were fully vested on the date of grant, and 2,651 restricted shares of common stock (for a total of 7,953 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. They are no longer subject to forfeiture and are vested.

On September 9, 2015, the Company granted each of the independent directors pursuant to the 2013 Plan 3,165 restricted shares of common stock (for a total of 9,495 shares) which were subject to forfeiture in certain circumstances within one year from the grant date. This unrecognized share-based compensation expense is expected to be recognized ratably over the remaining vesting period of up to three years.

As of March 31, 2016, 1,377,112 shares of common stock remain available for future issuance under the 2013 Plan.

Non-Controlling Interests in Operating Partnership

Non-controlling interests in the Operating Partnership in the accompanying consolidated financial statements relate to LTIP-OP Units in the Operating Partnership held by parties other than the Company.

As of March 31, 2016, the non-controlling interest holders in the Operating Partnership owned 103,850 LTIP-OP Units, or approximately 1.4% of the Operating Partnership. Pursuant to ASC 810, Consolidation, changes in a parent’s ownership interest (and transactions with non-controlling interest unit holders in the Operating Partnership) while the parent retains its controlling interest in its subsidiary should be accounted for as equity transactions. The carrying amount of the non-controlling interest will be adjusted to reflect the change in its ownership interest in the subsidiary, with the offset to equity attributable to the Company.

 

Earnings per Share

The Company is required to present both basic and diluted earnings per share (“EPS”). Basic EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted EPS is calculated by dividing net income (loss) applicable to common stockholders by the weighted average number of shares of common stock outstanding plus the additional dilutive effect of common stock equivalents during each period. In accordance with ASC 260, Earnings Per Share, if there is a loss from continuing operations, the common stock equivalents are deemed anti-dilutive and earnings (loss) per share is calculated excluding the potential common shares.

 

The following table presents basic earnings per share of common stock for the periods indicated (dollars in thousands, except per share data):

Earnings per Share Information

		Three Months Ended March 31,
		2016				2015
Numerator:
Net income attributable to common stockholders and participating securities		$	(7,162	)		$	(2,434	)
Net income allocable to common stockholders		$	(7,063	)		$	(2,412	)
Denominator:
Weighted average common shares outstanding			7,509,543				7,509,543
Weighted average diluted shares outstanding			7,519,038				7,509,543
Basic and Dilutive:
Basic earnings per share		$	(0.94	)		$	(0.32	)
Diluted earnings per share		$	(0.94	)		$	(0.32	)

 

There were no participating securities or equity instruments outstanding that were anti-dilutive for purposes of calculating earnings per share for the periods presented.

Note 7 — Transactions with Affiliates and Affiliated Entities

Manager

The Company has entered into a management agreement with the Manager, pursuant to which the Manager provides for the day-to-day management of the Company’s operations (the “Management Agreement”). The Management Agreement requires the Manager to manage the Company’s business affairs in conformity with the policies that are approved and monitored by the Company’s board of directors. The Management Agreement terminates on October 22, 2020, subject to automatic renewal for successive one-year terms and to certain termination rights. The Manager’s performance is reviewed prior to any renewal and may be terminated by the Company for cause without payment of a termination fee, or may be terminated without cause with payment of a termination fee, as defined in the Management Agreement, equal to three times the average annual management fee amount earned by the Manager during the two four-quarter periods ending as of the end of the most recently completed fiscal quarter prior to the effective date of the termination, upon either the affirmative vote of at least two-thirds of the members of the board of directors or the affirmative vote of the holders of at least a majority of the outstanding common stock. Pursuant to the Management Agreement, the Manager, under the supervision of the Company’s board of directors, formulates investment strategies, arranges for the acquisition of assets, arranges for financing, monitors the performance of the Company’s assets and provides certain advisory, administrative and managerial services in connection with the operations of the Company. For performing these services, the Company pays the Manager a quarterly management fee equal to the product of one quarter of the 1.5% Management Fee Annual Rate and the Stockholders’ Equity, adjusted as set forth in the Management Agreement, calculated and payable quarterly in arrears.

 

The Manager is a party to a services agreement (the “Services Agreement”) with Freedom Mortgage, pursuant to which Freedom Mortgage provides to the Manager the personnel, services and resources as needed by the Manager to enable the Manager to carry out its obligations and responsibilities under the Management Agreement. The Company is a named third-party beneficiary to the Services Agreement and, as a result, has, as a non-exclusive remedy, a direct right of action against Freedom Mortgage in the event of any breach by the Manager of any of its duties, obligations or agreements under the Management Agreement that arise out of or result from any breach by Freedom Mortgage of its obligations under the Services Agreement. The Services Agreement will terminate upon the termination of the Management Agreement. Pursuant to the Services Agreement, the Manager will make certain payments to Freedom Mortgage in connection with the services provided. All of the Company’s executive officers and the officers of the Manager are also officers or employees of Freedom Mortgage. As a result, the Management Agreement between the Company and the Manager was negotiated between related parties, and the terms, including fees payable, may not be as favorable to the Company as if it had been negotiated with an unaffiliated third party. Both the Manager and Freedom Mortgage are controlled by Mr. Stanley Middleman, who is also a shareholder of the Company.

 

The Management Agreement provides that the Company will reimburse the Manager for various expenses incurred by the Manager or its officers, and agents on the Company’s behalf, including costs of software, legal, accounting, tax, administrative and other similar services rendered for the Company by providers retained by the Manager. “Due to affiliates” consisted of the following for the periods indicated (dollars in thousands):

Management Fee to Affiliate

 

	Three Months Ended March 31,
	2016				2015
Management fees		$	560			$	560
Expense reimbursement			130				130
Total		$	690			$	690

 

Subservicing Agreement

Freedom Mortgage is directly servicing the Company’s portfolio of Fannie Mae and Freddie Mac MSRs pursuant to a subservicing agreement entered into on June 10, 2015. The agreement has an initial term of three (3) years, expiring on September 1, 2018, and is subject to automatic renewal for additional three year terms unless either party chooses not to renew. The agreement may be terminated without cause by either party by giving notice as specified in the agreement.  Under that agreement, Freedom Mortgage agrees to service the applicable mortgage loans in accordance with applicable law and the requirements of the applicable agency. The Company pays fees for specified services.

Other Affiliated Entities

The Company, through one of its subsidiaries, has entered into an uncommitted master repurchase agreement with Freedom Mortgage pursuant to which the Company may, from time to time, purchase a newly issued Ginnie Mae RMBS, subject to Freedom Mortgage’s agreement to repurchase the security at a future date, generally no more than 120 days later. The Company simultaneously re-hypothecates the security to one of its counterparties with whom it has a repurchase agreement, for an identical term.  Each transaction is done at market rates. For the three- month period ended March 31, 2016, the Company earned approximately $2,000 in income and had a corresponding expense of less than $1,000.

 

See Note 5 for a discussion of the co-investments in Excess MSRs with Freedom Mortgage and the services provided by Freedom Mortgage during the period prior to transfer to Freedom Mortgage of the direct servicing obligations for the MSRs. See Note 10 for a discussion of the Acknowledgement Agreement among the Company, Freedom Mortgage and Ginnie Mae entered into in connection with the co-investments in Excess MSRs.

Note 8 — Derivative Instruments

Interest Rate Swap Agreements, Swaptions, TBAs and Treasury Futures

In order to help mitigate exposure to higher short-term interest rates in connection with its repurchase agreements, the Company enters into interest rate swap agreements. These agreements establish an economic fixed rate on related borrowings because the variable-rate payments received on the interest rate swap agreements largely offset interest accruing on the related borrowings, leaving the fixed-rate payments to be paid on the interest rate swap agreements as the Company’s effective borrowing rate, subject to certain adjustments including changes in spreads between variable rates on the interest rate swap agreements and actual borrowing rates. A swaption is an option granting its owner the right but not the obligation to enter into an underlying swap. The Company’s interest rate swap agreements and swaptions have not been designated as hedging instruments for GAAP purposes.

In order to help mitigate duration risk and basis risk management, the Company utilizes treasury futures and forward-settling purchases and sales of RMBS where the underlying pools of mortgage loans are TBAs. Pursuant to these TBA transactions, the Company agrees to purchase or sell, for future delivery, RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular RMBS to be delivered is not identified until shortly before the TBA settlement date.

 

The following table summarizes the outstanding notional amounts of derivative instruments as of the dates indicated (dollars in thousands):

 

Non-hedge derivatives		March 31, 2016				December 31, 2015
Notional amount of interest rate swaps		$	286,750			$	300,300
Notional amount of swaptions			85,000				85,000
Notional amount of TBAs, net			-				-
Notional amount of Treasury Futures			3,000				-
Total notional amount		$	374,750			$	385,300