Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the unaudited consolidated interim financial statements, and related notes and the section entitled “Forward-Looking Statements” included herein.
Overview
Through our Structured Business, we invest in a diversified portfolio of structured finance assets in the multifamily, single-family rental and commercial real estate markets, primarily consisting of bridge and mezzanine loans, including junior participating interests in first mortgages, preferred and direct equity. We may also directly acquire real property and invest in real estate-related notes and certain mortgage-related securities.
Through our Agency Business, we originate, sell and service a range of multifamily finance products through Fannie Mae and Freddie Mac, Ginnie Mae, FHA and HUD. We retain the servicing rights and asset management responsibilities on substantially all loans we originate and sell under the GSE and HUD programs. We are an approved Fannie Mae DUS lender nationally, a Freddie Mac Multifamily Conventional Loan lender, seller/servicer, in New York, New Jersey and Connecticut, a Freddie Mac affordable, manufactured housing, senior housing and SBL lender, seller/servicer, nationally and a HUD MAP and LEAN senior housing/healthcare lender nationally. We also originate and sell finance products through CMBS programs and during the second half of 2019, we began to originate and service permanent financing loans underwritten using the guidelines of our existing agency loans sold to the GSEs, which we refer to as "Private Label" loans. We pool and securitize the Private Label loans and sell certain securities in the securitizations to third-party investors, while retaining the highest risk bottom tranche certificate.
We conduct our operations to qualify as a REIT. A REIT is generally not subject to federal income tax on its REIT—taxable income that is distributed to its stockholders, provided that at least 90% of its REIT—taxable income is distributed and provided that certain other requirements are met.
Our operating performance is primarily driven by the following factors:
Net interest income earned on our investments. Net interest income represents the amount by which the interest income earned on our assets exceeds the interest expense incurred on our borrowings. If the yield on our assets increases or the cost or borrowings decreases, this will have a positive impact on earnings. However, if the yield earned on our assets decreases or the cost of borrowings increases, this will have a negative impact on earnings. Net interest income is also directly impacted by the size and performance of our asset portfolio. We recognize the bulk of our net interest income from our Structured Business. Additionally, we recognize net interest income from loans originated through our Agency Business, which are generally sold within 60 days of origination.
Fees and other revenues recognized from originating, selling and servicing mortgage loans through the GSE and HUD programs. Revenue recognized from the origination and sale of mortgage loans consists of gains on sale of loans (net of any direct loan origination costs incurred), commitment fees, broker fees, loan assumption fees and loan origination fees. These gains and fees are collectively referred to as gain on sales, including fee-based services, net. We record income from MSRs at the time of commitment to the borrower, which represents the fair value of the expected net future cash flows associated with the rights to service mortgage loans that we originate, with the recognition of a corresponding asset upon sale. We also record servicing revenue which consists of fees received for servicing mortgage loans, net of amortization on the MSR assets recorded. Although we have long-established relationships with the GSE and HUD agencies, our operating performance would be negatively impacted if our business relationships with these agencies deteriorate. Additionally, we also recognize revenue from originating, selling and servicing our Private Label loans.
Income earned from our structured transactions. Our structured transactions are primarily comprised of investments in equity affiliates, which represent unconsolidated joint venture investments formed to acquire, develop and/or sell real estate-related assets. Operating results from these investments can be difficult to predict and can vary significantly period-to-period. If interest rates were to rise, it is likely that income from these investments would be significantly impacted, particularly from our investment in a residential mortgage banking business, since rising interest rates generally decrease the demand for residential real estate loans and the number of loan originations. In addition, we periodically receive distributions from our equity investments. It is difficult to forecast the timing of such payments, which can be substantial in any given quarter. We account for structured transactions within our Structured Business.
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Credit quality of our loans and investments, including our servicing portfolio. Effective portfolio management is essential to maximize the performance and value of our loan and investment and servicing portfolios. Maintaining the credit quality of the loans in our portfolios is of critical importance. Loans that do not perform in accordance with their terms may have a negative impact on earnings and liquidity.
COVID-19 Impact. During the first half of 2020, the global outbreak of COVID-19 has forced many countries, including the United States, to declare national emergencies, to institute "stay-at-home" orders, to close financial markets and to restrict operations of non-essential businesses. Such actions are creating significant disruptions in global supply chains, and adversely impacting many industries. COVID-19 could have a continued and prolonged adverse impact on economic and market conditions and could trigger a period of global economic slowdown. The impact of COVID-19 on companies is evolving rapidly, and the extent and duration of the economic fallout from this pandemic, both globally and to our business, remain unclear and present risk with respect to our financial condition, results of operations, liquidity, and ability to pay distributions. We expect the effects of the COVID-19 pandemic to negatively impact our financial performance and operating results for the remainder of 2020.
Significant Developments During the Second Quarter of 2020
Capital Markets Activity. We raised $89.5 million of capital through the issuances of 8.00% senior unsecured debt and sales of our common stock through an “At-The-Market” equity offering sales agreement. We used the net proceeds from these capital raises to redeem secured indebtedness, make investments related to our business and for general corporate purposes.
Financing Activity.
● We closed our first Private Label multifamily mortgage loan securitization totaling $727.2 million, of which we retained the most subordinate certificates totaling $63.6 million. The securitization is backed by a pool of 40 fixed rate, 10-year mortgage loans secured by first priority mortgage liens on 49 multifamily properties; and
● We completed the unwind of our $70.0 million Debt Fund and redeemed all the outstanding notes with a portion of the proceeds from our senior unsecured notes issued in March 2020.
Agency Business Activity.
● Loan originations and sales totaled $1.40 billion and $1.99 billion, respectively, and our fee-based servicing portfolio grew 7% to $21.58 billion. Our loan sales and servicing portfolio totals include the Private Label loans sold and securitized in May 2020; and
● We recorded losses on derivative instruments totaling $7.1 million related to our derivative instruments used to hedge interest rate exposure.
Structured Business Activity.
● Our Structured loan and investment portfolio grew 4% to $4.98 billion on loan originations totaling $300.5 million, partially offset by loan runoff of $159.2 million; and
● We recorded income of $20.9 million from our residential mortgage business joint venture.
Dividend. We raised our quarterly cash dividend to $0.31 per share, which is payable on August 31, 2020 to common stockholders of record on August 17, 2020.
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Current Market Conditions, Risks and Recent Trends
As discussed throughout this quarterly report on Form 10-Q, the COVID-19 pandemic has impacted the global economy in an unprecedented way, swiftly halting activity across many industries, and causing significant disruption and liquidity constraints in many market segments, including the financial services, real estate and credit markets. The impact of COVID-19 on companies is evolving rapidly, and the extent and duration of the economic fallout from this pandemic remain unclear. COVID-19 could have a continued and prolonged adverse impact on economic and market conditions and could trigger a period of global economic slowdown. Adverse economic conditions could result in declining real estate values, increased payment delinquencies and defaults and increased loan modifications and foreclosures, all of which could significantly impact our results of operations, financial condition, business prospects and our ability to make distributions to our stockholders.
The pandemic has caused a dislocation in the capital markets resulting in a significant reduction of available liquidity. Many commercial mortgage REITs are suffering from the reduced available liquidity as access to capital is critical to grow their business. Despite this reduction in liquidity, during the second quarter of 2020 we raised $70.8 million through two private placement debt offerings and raised an additional $18.7 million from sales of our common stock through our “At-The-Market” equity offering sales agreement.
Our Agency Business requires limited capital to grow, as originations are financed through warehouse facilities for generally up to 60 days before the loans are sold, therefore this lack of liquidity has not and should not, impact our ability to grow this business. On the other side, our Structured Business is more reliant on the capital markets to grow, and therefore, we expect growth in this business to be limited until liquidity is more readily available. In our Structured Business, 80% of our portfolio is in multifamily assets with most of these loans containing interest reserves and/or replenishment obligations by our borrowers.
In our Agency Business, we have received requests for forbearances related to approximately 0.4% of our $15.67 billion Fannie Mae DUS portfolio and approximately 6.1% of our $4.56 billion Freddie Mac portfolio. We are closely monitoring and managing the requests for forbearances and there could potentially be additional economic stress in the third quarter.
The federal government, Fannie Mae and Freddie Mac have made certain forbearance and non-eviction programs available to borrowers and tenants should they need to counteract any short-term pressure on their properties from COVID-19 and its impact on the economy. For borrowers, in order to qualify for a forbearance, they need to demonstrate they have been adversely affected by the pandemic and their ability to make their loan payments has been impacted. All loan and rent payments that are suspended remain the obligations of the borrowers and tenants and we are offering tenants of our borrowers impacted by the COVID-19 pandemic financial assistance through a $2.0 million rental assistance program that we launched in April 2020.
Interest rates have trended downward over the past several quarters and are currently at historically low levels. While lower interest rates generally have a positive impact on origination volume as borrowers look to refinance loans to take advantage of lower rates, our net interest income may be negatively impacted as higher yielding loans are paid off and replaced with lower yielding loans. We are somewhat insulated from decreasing interest rates, since a large portion of our structured loan portfolio has LIBOR floors, which could increase our net interest income in the future if rates remain at these historically low levels.
We are a national originator with Fannie Mae and Freddie Mac, and the GSEs remain the most significant providers of capital to the multifamily market. In September 2019, the Federal Housing Finance Agency's ("FHFA") announced a revised cap structure to its previously released GSE 2019 Scorecard. The loan origination caps for both Fannie Mae and Freddie Mac were adjusted to $100 billion for each enterprise for a combined total of $200 billion ("2019/2020 Caps") and will run for a five-quarter period through the end of 2020. The new caps also mandate that 37.5% be directed towards mission driven business or affordable housing. The 2019/2020 Caps apply to all multifamily business and has no exclusions. Our originations with the GSEs are highly profitable executions as they provide significant gains from the sale of our loans, non-cash gains related to MSRs and servicing revenues. Therefore, a decline in our GSE originations could negatively impact our financial results. We are unsure whether the FHFA will impose stricter limitations on GSE multifamily production volume in the future.
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Changes in Financial Condition
Assets — Comparison of balances at June 30, 2020 to December 31, 2019:
Our Structured loan and investment portfolio balance was $4.98 billion and $4.29 billion at June 30, 2020 and December 31, 2019, respectively. This increase was primarily due to loan originations exceeding loan payoffs and paydowns by $722.2 million. See below for details.
Our portfolio had a weighted average current interest pay rate of 5.57% and 5.98% at June 30, 2020 and December 31, 2019, respectively. Including certain fees earned and costs associated with the structured portfolio, the weighted average current interest rate was 6.10% and 6.68% at June 30, 2020 and December 31, 2019, respectively. Advances on our financing facilities totaled $4.54 billion and $3.93 billion at June 30, 2020 and December 31, 2019, respectively, with a weighted average funding cost of 2.68% and 3.82%, respectively, which excludes financing costs. Including financing costs, the weighted average funding rate was 3.14% and 4.35% at June 30, 2020 and December 31, 2019, respectively.
Activity from our Structured Business portfolio was comprised of the following ($ in thousands):
Three Months Ended
Six Months Ended
June 30, 2020
June 30, 2020
Loans originated
$
300,481
$
1,156,710
Number of loans
20
67
Weighted average interest rate
5.93
%
5.74
%
Loan paid-off / paid-down
$
159,174
$
434,466
Number of loans
20
41
Weighted average interest rate
6.85
%
7.06
%
Loans extended
$
121,799
$
495,013
Number of loans
8
26
Loans held-for-sale from the Agency Business decreased $501.0 million, primarily related to loan sales exceeding originations by $467.4 million as noted in the following table (in thousands). Loan sales includes $727.2 million of Private Label loans which were sold in connection with our first Private Label multifamily mortgage loan securitization in the second quarter of 2020. Our GSE loans are generally sold within 60 days, while our Private Label loans are generally expected to be sold and securitized within 180 days from the loan origination date.
Three Months Ended
Six Months Ended
June 30, 2020
June 30, 2020
Loan
Loan
Originations
Loan Sales
Originations
Loan Sales
Fannie Mae
$
1,140,181
$
1,063,923
$
1,722,154
$
1,817,967
Freddie Mac
135,720
171,688
335,431
351,391
FHA
75,533
30,124
93,476
53,437
Private Label
49,122
727,154
331,467
727,154
Total
$
1,400,556
$
1,992,889
$
2,482,528
$
2,949,949
Capitalized mortgage servicing rights increased $26.9 million, primarily due to MSRs recorded on new loan originations, partially offset by amortization and write-offs. Our capitalized mortgage servicing rights represent the estimated value of our rights to service mortgage loans for others. At June 30, 2020, the weighted average estimated life remaining of our MSRs was 8.2 years.
Securities held-to-maturity increased $30.3 million, primarily due to the purchase, at a discount, of APL certificates in connection with our Private Label securitization totaling $37.9 million, partially offset by principal payments received from underlying loan payoffs in our Freddie Mac SBL B Piece bonds.
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Investments in equity affiliates increased $23.2 million, primarily due to income from our investment in a residential mortgage banking business of $23.8 million.
Liabilities – Comparison of balances at June 30, 2020 to December 31, 2019:
Credit facilities and repurchase agreements decreased $442.7 million, primarily due to loan sales exceeding originations by $467.4 million in our Agency Business, as described above.
Collateralized loan obligations increased $384.4 million, primarily due to the issuance of a new CLO, where we issued $668.0 million of notes to third party investors, partially offset by the unwind of a CLO totaling $282.9 million.
In April 2020, we completed the unwind of our $70.0 million Debt Fund, as described above.
Senior unsecured notes increased $342.0 million, primarily due to our issuances of $345.8 million of new notes.
Convertible senior unsecured notes decreased $18.9 million, primarily due to partial redemptions of our 5.25% and 5.375% Convertible Notes.
Due to related party was $0.6 million and $13.1 million at June 30, 2020 and December 31, 2019, respectively, and consisted of loan payoffs, holdbacks and escrows to be remitted to our affiliated servicing operations related to real estate transactions.
Allowance for loss-sharing obligations increased $38.6 million, primarily due to the adoption of CECL in the first quarter of 2020. See Note 2 for details.
Other liabilities increased $35.7 million, primarily due to $39.8 million of accrued dividends that were paid in July 2020.
Equity
During the first half of 2020, we sold 3,308,008 shares of our common stock through our “At-The-Market” agreement, raising net proceeds of $38.0 million. We also issued 363,013 million shares of our common stock in connection with settlements of our convertible notes. In February 2020, we used a portion of the net proceeds from our public offering in December 2019 to purchase an aggregate of 747,500 shares of our common stock and OP Units from our chief executive officer and ACM. In addition, through June 30, 2020, we repurchased 993,106 shares of our common stock under our share repurchase program.
Distributions – Dividends declared (on a per share basis) for the six months ended June 30, 2020 were as follows:
Common Stock
Preferred Stock
Dividend (1)
Declaration Date
Dividend
Declaration Date
Series A
Series B
Series C
February 13, 2020
$
0.30
January 31, 2020
$
0.515625
$
0.484375
$
0.53125
May 6, 2020
$
0.30
May 1, 2020
$
0.515625
$
0.484375
$
0.53125
(1) The dividend declared on May 1, 2020 was for March 1, 2020 through May 31, 2020 and the dividend declared on January 31, 2020 was for December 1, 2019 through February 29, 2020.
Common Stock — On July 29, 2020, the Board of Directors declared a cash dividend of $0.31 per share of common stock. The dividend is payable on August 31, 2020 to common stockholders of record as of the close of business on August 17, 2020.
Preferred Stock — On July 29, 2020, the Board of Directors declared a cash dividend of $0.515625 per share of 8.25% Series A preferred stock; a cash dividend of $0.484375 per share of 7.75% Series B preferred stock; and a cash dividend of $0.53125 per share of 8.50% Series C preferred stock. These amounts reflect dividends from June 1, 2020 through August 31, 2020 and are payable on August 31, 2020 to preferred stockholders of record on August 15, 2020.
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Deferred Compensation
We issued 344,919 shares of restricted stock to our employees, including our chief executive officer, 36,396 shares to the independent members of the Board of Directors and up to 275,569 shares of performance-based restricted stock units to our chief executive officer in the first quarter of 2020. See Note 16 for details.
In addition, we also withheld 143,096 shares of restricted common stock from employees to net settle and pay their respective withholding taxes in connection with awards that vested.
Agency Servicing Portfolio
The following table sets forth the characteristics of our loan servicing portfolio collateralizing our mortgage servicing rights and servicing revenue ($ in thousands):
June 30, 2020
Wtd. Avg.
Wtd. Avg.
Annualized
Servicing
Age of
Portfolio
Prepayments
Delinquencies
Portfolio
Loan
Portfolio
Maturity
Interest Rate Type
Wtd. Avg.
as a Percentage
as a Percentage
Product
UPB
Count
(in years)
(in years)
Fixed
Adjustable
Note Rate
of Portfolio (1)
of Portfolio (2)
Fannie Mae
$
15,672,931
2,459
3.0
8.7
96
%
4
%
4.34
%
4.93
%
0.37
%
Freddie Mac
4,560,382
1,430
2.5
12.3
95
%
5
%
4.13
%
5.75
%
0.69
%
Private Label
727,132
40
0.5
9.6
100
%
0
%
3.81
%
0.00
%
0.00
%
FHA
621,487
86
3.8
32.2
100
%
0
%
3.71
%
28.44
%
0.00
%
Total
$
21,581,932
4,015
2.8
10.2
96
%
4
%
4.26
%
5.61
%
0.42
%
December 31, 2019
Fannie Mae
$
14,832,844
2,349
3.0
8.6
95
%
5
%
4.52
%
11.37
%
0.23
%
Freddie Mac
4,534,714
1,475
2.2
12.6
96
%
4
%
4.23
%
11.37
%
0.57
%
FHA
691,519
92
3.6
32.1
100
%
0
%
3.71
%
3.98
%
0.00
%
Total
$
20,059,077
3,916
2.9
10.3
95
%
5
%
4.43
%
11.12
%
0.30
%
(1) Prepayments reflect loans repaid prior to six months from the loan’s maturity. The majority of our loan servicing portfolio has a prepayment protection term and therefore, we may collect a prepayment fee which is included as a component of servicing revenue, net.
(2) Delinquent loans reflect loans that are contractually 60 days or more past due. As of June 30, 2020 and December 31, 2019, delinquent loans totaled $89.7 million and $59.2 million, respectively, of which $7.3 million and $33.5 million, respectively, were in the foreclosure process. In addition, at December 31, 2019, loans collateralizing our servicing portfolio totaling $3.2 million were in bankruptcy.
Our servicing portfolio represents commercial real estate loans originated in our Agency Business, which are generally transferred or sold within 60 days from the date the loan is funded. Primarily all of the loans in our servicing portfolio are collateralized by multifamily properties. In addition, we are generally required to share in the risk of any losses associated with loans sold under the Fannie Mae DUS program, see Note 11.
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Comparison of Results of Operations for the Three Months Ended June 30, 2020 and 2019
The following table provides our consolidated operating results ($ in thousands):
Three Months Ended June 30,
Increase / (Decrease)
2020
2019
Amount
Percent
Interest income
$
83,080
$
82,171
$
909
1
%
Interest expense
41,302
48,284
(6,982)
(14)
%
Net interest income
41,778
33,887
7,891
23
%
Other revenue:
Gain on sales, including fee-based services, net
26,366
14,211
12,155
86
%
Mortgage servicing rights
32,417
18,709
13,708
73
%
Servicing revenue, net
13,506
12,612
894
7
%
Property operating income
751
3,147
(2,396)
(76)
%
(Loss) gain on derivative instruments, net
(7,368)
742
(8,110)
nm
Other income, net
1,049
651
398
61
%
Total other revenue
66,721
50,072
16,649
33
%
Other expenses:
Employee compensation and benefits
34,438
29,022
5,416
19
%
Selling and administrative
8,606
10,481
(1,875)
(18)
%
Property operating expenses
1,035
2,691
(1,656)
(62)
%
Depreciation and amortization
1,961
1,909
52
3
%
Impairment loss on real estate owned
—
1,000
(1,000)
nm
Provision for loss sharing (net of recoveries)
2,395
368
2,027
nm
Provision for credit losses (net of recoveries)
12,714
—
12,714
nm
Total other expenses
61,149
45,471
15,678
34
%
Income before extinguishment of debt, income from equity affiliates and income taxes
47,350
38,488
8,862
Loss on extinguishment of debt
(1,592)
—
(1,592)
nm
Income from equity affiliates
20,408
3,264
17,144
nm
Provision for income taxes
(12,077)
(4,350)
(7,727)
178
%
Net income
54,089
37,402
16,687
45
%
Preferred stock dividends
1,888
1,888
—
—
Net income attributable to noncontrolling interest
8,110
6,598
1,512
23
%
Net income attributable to common stockholders
$
44,091
$
28,916
$
15,175
52
%
nm — not meaningful
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The following table presents the average balance of our Structured Business interest-earning assets and interest-bearing liabilities, associated interest income (expense) and the corresponding weighted average yields ($ in thousands):
Three Months Ended June 30,
2020
2019
Average
Interest
W/A Yield /
Average
Interest
W/A Yield /
Carrying
Income /
Financing
Carrying
Income /
Financing
Value (1)
Expense
Cost (2)
Value (1)
Expense
Cost (2)
Structured Business interest-earning assets:
Bridge loans
$
4,330,308
$
63,560
5.90
%
$
3,242,179
$
63,794
7.89
%
Preferred equity investments
206,000
5,679
11.09
%
181,584
5,121
11.31
%
Mezzanine / junior participation loans
177,909
3,359
7.59
%
174,447
5,268
12.11
%
Other
99,793
1,132
4.56
%
24,332
226
3.73
%
Core interest-earning assets
4,814,010
73,730
6.16
%
3,622,542
74,409
8.24
%
Cash equivalents
373,281
565
0.61
%
436,813
1,735
1.59
%
Total interest-earning assets
$
5,187,291
$
74,295
5.76
%
$
4,059,355
$
76,144
7.52
%
Structured Business interest-bearing liabilities:
CLO
$
2,532,593
$
13,941
2.21
%
$
1,723,310
$
20,993
4.89
%
Warehouse lines
913,548
7,635
3.36
%
923,768
11,877
5.16
%
Unsecured debt
912,118
13,306
5.87
%
480,822
8,212
6.85
%
Trust preferred
154,336
1,551
4.04
%
154,336
2,160
5.61
%
Debt fund
20,000
306
6.15
%
70,000
1,474
8.45
%
Total interest-bearing liabilities
$
4,532,595
36,739
3.26
%
$
3,352,236
44,716
5.35
%
Net interest income
$
37,556
$
31,428
(1) Based on UPB for loans, amortized cost for securities and principal amount of debt.
(2) Weighted average yield calculated based on annualized interest income or expense divided by average carrying value.
Net Interest Income
The increase in interest income was due to an increase of $2.8 million, or 46%, from our Agency Business, partially offset by a decrease of $1.8 million, or 2%, from our Structured Business. The increase from our Agency Business was primarily due to Private Label loan originations over the past several quarters resulting in an increase in the average loans held-for-sale balance prior to securitization in May 2020, partially offset by a decrease in the 10-year treasury note rate in 2020. The decrease from our Structured Business was primarily due to a 25% decrease in the average yield on core interest-earning assets as a result of lower rates on originations as compared to loan runoff, a decrease in the average LIBOR rate and default interest and fees on a loan that paid off during the second quarter of 2019, substantially offset by an increase in our average core interest-earning assets from loan originations exceeding loan runoff.
The decrease in interest expense was primarily due to a decrease of $8.0 million, or 18%, from our Structured Business. The decrease in our Structured Business was the result of a 39% decrease in the average cost of our interest-bearing liabilities, mainly from decreases in LIBOR and lower rates on recently issued debt, partially offset by a 35% increase in the average balance of our interest-bearing liabilities, due to growth in our loan portfolio and the issuance of additional unsecured debt.
Agency Business Revenue
The increase in gain on sales, including fee-based services, net was primarily due to a 116% increase ($1.07 billion) in loan sales volume including the $727.2 million Private Label securitization, partially offset by a 14% decrease in the sales margin as a result of lower margins on Fannie Mae and Private Label loan sales.
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The increase in income from MSRs was primarily due to an 87% increase in the MSR rate (income from MSRs as a percentage of loan commitment volume) from 1.44% to 2.69%, mainly due to an increase in the average servicing fee on loan commitments, partially offset by a 7% decrease in loan commitment volume.
(Loss) Gain on Derivative Instruments, Net
The loss on derivative instruments in the second quarter of 2020 was primarily due to our Agency Business, which was the result of changes in the fair value of rate lock commitments and losses recognized on our Swap Futures held in connection with our Private Label loans. See Note 12 for details.
Other Expenses
The increase in employee compensation and benefits expense was primarily due to a $3.0 million increase in commissions in our Agency Business resulting from higher loan sales volume including the $727.2 million Private Label securitization in May 2020 as well as increased headcount in both businesses associated with each business’s portfolio growth.
The decrease in selling and administrative expense was primarily due to a decrease of $1.8 million, or 34%, from our Structured Business, which was mainly due to decreases in professional fees.
Impairment loss on real estate owned was $1.0 million in the three months ended June 30, 2019, which relates to an impairment charge taken on our hotel property. See Note 9.
The increases in our provision for loss sharing and provision for credit losses were primarily due to CECL reserves recorded in connection with the adoption of ASU 2016-13 in 2020. See Note 2 for details.
Loss on Extinguishment of Debt
The loss on extinguishment of debt of $1.6 million in the second quarter of 2020 relates to the loss recognized in connection with the unwind of the Debt Fund.
Income from Equity Affiliates
Income from equity affiliates in the second quarter of 2020 and 2019 primarily reflects income from our investment in a residential mortgage banking business of $20.9 million and $2.7 million, respectively, and a distribution from an equity investment totaling $0.6 million in the second quarter of 2019.
Provision for Income Taxes
In the three months ended June 30, 2020, we recorded a tax provision of $12.1 million, which consisted of a deferred tax provision of $10.9 million and a current tax provision of $1.2 million. In the three months ended June 30, 2019, we recorded a tax provision of $4.4 million, which consisted of a current tax provision of $3.5 million and a deferred tax provision of $0.9 million.
Net Income Attributable to Noncontrolling Interest
The noncontrolling interest relates to the outstanding OP Units issued as part of the Acquisition. There were 20,369,265 OP Units and 20,484,094 OP Units outstanding as of June 30, 2020 and 2019, respectively, which represented 15.4% and 17.9% of our outstanding stock at June 30, 2020 and 2019, respectively.
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Comparison of Results of Operations for the Six Months Ended June 30, 2020 and 2019
The following table provides our consolidated operating results ($in thousands):
Six Months Ended June 30,
Increase / (Decrease)
2020
2019
Amount
Percent
Interest income
$
171,606
$
153,448
$
18,158
12
%
Interest expense
91,284
90,149
1,135
1
%
Net interest income
80,322
63,299
17,023
27
%
Other revenue:
Gain on sales, including fee-based services, net
40,671
30,600
10,071
33
%
Mortgage servicing rights
54,351
32,941
21,410
65
%
Servicing revenue, net
26,809
26,164
645
2
%
Property operating income
2,943
5,950
(3,007)
(51)
%
Loss on derivative instruments, net
(58,099)
(1,723)
(56,376)
nm
Other income, net
2,351
989
1,362
138
%
Total other revenue
69,026
94,921
(25,895)
(27)
%
Other expenses:
Employee compensation and benefits
68,690
60,786
7,904
13
%
Selling and administrative
19,658
20,242
(584)
(3)
%
Property operating expenses
3,478
5,086
(1,608)
(32)
%
Depreciation and amortization
3,908
3,821
87
2
%
Impairment loss on real estate owned
—
1,000
(1,000)
nm
Provision for loss sharing (net of recoveries)
23,932
822
23,110
nm
Provision for credit losses (net of recoveries)
67,096
—
67,096
nm
Total other expenses
186,762
91,757
95,005
104
%
(Loss) income before extinguishment of debt, income from equity affiliates and income taxes
(37,414)
66,463
(103,877)
nm
Loss on extinguishment of debt
(3,546)
(128)
(3,418)
nm
Income from equity affiliates
24,401
5,415
18,986
nm
Benefit from (provision for) income taxes
2,293
(4,341)
6,634
nm
Net (loss) income
(14,266)
67,409
(81,675)
nm
Preferred stock dividends
3,777
3,777
—
—
Net (loss) income attributable to noncontrolling interest
(2,824)
12,066
(14,890)
nm
Net (loss) income attributable to common stockholders
$
(15,219)
$
51,566
$
(66,785)
nm
nm – not meaningful
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The following table presents the average balance of our Structured Business interest-earning assets and interest-bearing liabilities, associated interest income (expense) and the corresponding weighted average yields ($ in thousands):
Six Months Ended June 30,
2020
2019
Average
Interest
W/A Yield /
Average
Interest
W/A Yield /
Carrying
Income /
Financing
Carrying
Income /
Financing
Value (1)
Expense
Cost (2)
Value (1)
Expense
Cost (2)
Structured Business interest-earning assets:
Bridge loans
$
4,222,173
$
128,022
6.10
%
$
3,135,639
$
119,541
7.69
%
Preferred equity investments
203,987
11,555
11.39
%
181,611
10,169
11.29
%
Mezzanine / junior participation loans
177,219
8,208
9.31
%
153,110
9,098
11.98
%
Other
92,983
2,999
6.49
%
12,234
226
3.73
%
Core interest-earning assets
4,696,362
150,784
6.46
%
3,482,594
139,034
8.05
%
Cash equivalents
408,153
1,988
0.98
%
355,817
2,919
1.65
%
Total interest-earning assets
$
5,104,515
$
152,772
6.02
%
$
3,838,411
$
141,953
7.46
%
Structured Business interest-bearing liabilities:
CLO
$
2,392,239
$
32,438
2.73
%
$
1,666,731
$
39,464
4.77
%
Warehouse lines
994,085
18,737
3.79
%
823,886
21,056
5.15
%
Unsecured debt
804,862
23,993
5.99
%
441,727
15,329
7.00
%
Trust preferred
154,336
3,385
4.41
%
154,336
4,303
5.62
%
Debt fund
45,000
1,585
7.08
%
70,000
2,821
8.13
%
Total interest-bearing liabilities
$
4,390,522
80,138
3.67
%
$
3,156,680
82,973
5.30
%
Net interest income
$
72,634
$
58,980
(1) Based on UPB for loans, amortized cost for securities and principal amount of debt.
(2) Weighted average yield calculated based on annualized interest income or expense divided by average carrying value.
Net Interest Income
The increase in interest income was due to increases of $10.8 million, or 8%, from our Structured Business and $7.3 million, or 64%, from our Agency Business. The increase from our Structured Business was primarily due to a 35% increase in our average core interest-earning assets, as a result of loan originations exceeding loan runoff, partially offset by a 20% decrease in the average yield on core interest-earning assets, largely due to lower rates on originations as compared to loan runoff, a decrease in the average LIBOR rate and default interest and fees on a loan that paid off during the second quarter of 2019. The increase from our Agency Business was primarily due to Private Label loan originations over the past several quarters resulting in an increase in the average loans held-for-sale balance prior to securitization in May 2020, partially offset by a decrease in the 10-year treasury note rate in 2020.
The increase in interest expense was due to an increase of $4.0 million, or 55%, from our Agency Business, partially offset by a decrease of $2.8 million, or 3%, from our Structured Business. The increase from our Agency Business was primarily due to a $436.0 million increase in the average debt balance used to finance the increase in the average loans held-for-sale balance, partially offset by a decrease in the average LIBOR rate. The decrease in our Structured Business was the result of a 31% decrease in the average cost of our interest-bearing liabilities, mainly from decreases in LIBOR and lower rates on recently issued debt, substantially offset by an increase in the average balance of our interest-bearing liabilities, due to growth in our loan portfolio and the recent issuance of additional unsecured debt.
Agency Business Revenue
The increase in gain on sales, including fee-based services, net was primarily due to a 46% increase ($925.1 million) in loan sales volume, partially offset by a 9% decrease in the sales margin.
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The increase in income from MSRs was primarily due to a 43% increase in the MSR rate from 1.53% to 2.20%, mainly due to an increase in the average servicing fee on loan commitments, along with a 15% increase in loan commitment volume.
Loss on Derivative Instruments, Net
The increase in loss on derivative instruments was primarily due to an increase of $53.4 million from our Agency Business, which was primarily due to losses recognized on our Swap Futures held in connection with our Private Label loans. See Note 12 for details.
Other Expenses
The increase in employee compensation and benefits expense was primarily due to an increase in commissions in our Agency Business as described above as well as increased headcount in both businesses associated with each business’s portfolio growth.
Impairment loss on real estate owned was $1.0 million in the six months ended June 30, 2019, which relates to an impairment charge taken on our hotel property in the second quarter of 2019. See Note 9.
The increases in our provision for loss sharing and provision for credit losses were primarily due to CECL reserves recorded in connection with the adoption of ASU 2016-13 in 2020. See Note 2 for details.
Loss on Extinguishment of Debt
The loss on extinguishment of debt in 2020 was primarily due to losses recognized in connection with the unwind of both CLO VIII and the Debt Fund as well as the conversion of our 5.375% and 5.25% Convertible Notes.
Income from Equity Affiliates
Income from equity affiliates in the first half of 2020 and 2019 primarily reflects income from our investment in a residential mortgage banking business of $23.8 million and $3.5 million, respectively, and distributions from an equity investment totaling $1.1 million and $1.9 million, respectively.
Benefit from (Provision for) Income Taxes
In the six months ended June 30, 2020, we recorded a tax benefit of $2.3 million, which consisted of a deferred tax benefit of $9.0 million and a current tax provision of $6.7 million. In the six months ended June 30, 2019, we recorded a tax provision of $4.3 million, which consisted of a current tax provision of $7.6 million and a deferred tax benefit of $3.3 million.
Net Income Attributable to Noncontrolling Interest
The noncontrolling interest relates to the outstanding OP Units issued as part of the Acquisition. There were 20,369,265 OP Units and 20,484,094 OP Units outstanding as of June 30, 2020 and 2019, respectively, which represented 15.4% and 17.9% of our outstanding stock at June 30, 2020 and 2019, respectively.
Liquidity and Capital Resources
Sources of Liquidity. Liquidity is a measure of our ability to meet our potential cash requirements, including ongoing commitments to repay borrowings, satisfaction of collateral requirements under the Fannie Mae DUS risk-sharing agreement and, as an approved designated seller/servicer of Freddie Mac's SBL program, operational liquidity requirements of the GSE agencies, fund new loans and investments, fund operating costs and distributions to our stockholders, as well as other general business needs. Our primary sources of funds for liquidity consist of proceeds from equity and debt offerings, proceeds from CLOs and securitizations, debt facilities and cash flows from operations. We closely monitor our liquidity position and believe our existing sources of funds and access to additional liquidity will be adequate to meet our liquidity needs.
We are monitoring the COVID-19 pandemic and its impact on our financing sources, borrowers and their tenants, and the economy as a whole. The magnitude and duration of the pandemic, and its impact on our operations and liquidity, are uncertain and continue to
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evolve. To the extent that our financing sources, borrower’s and their tenants continue to be impacted by the pandemic, or by the other risks disclosed in our filings with the SEC, it would have a material adverse effect on our liquidity and capital resources.
We had approximately $4.54 billion in total structured debt outstanding at June 30, 2020. Of this total, approximately $3.64 billion, or 80%, does not contain mark-to-market provisions and is comprised of non-recourse CLO vehicles, senior unsecured debt and junior subordinated notes, the majority of which have maturity dates in 2022, or later. The remaining $906.2 million of debt is in warehouse and repurchase facilities with several different banks that we have long-standing relationships with and substantially all of which have maturity extension options. While we expect to extend or renew all of our facilities as they mature, given the current market environment, we believe that the extension terms may be less favorable than the terms of our current facilities.
In addition to our ability to extend our warehouse and repurchase facilities, we have approximately $450 million in cash and available liquidity as well as other liquidity sources, including our $21.58 billion agency servicing portfolio, which is mostly prepayment protected and generates approximately $95 million a year in recurring cash flow.
At June 30, 2020, we had $138.2 million of securities financed with $57.0 million of debt that was subject to margin calls related to changes in interest spreads. During the six months ended June 30, 2020, we significantly reduced the UPB of this debt by $160.1 million through a debt restructuring and the use of proceeds from our senior notes issued in the second quarter of 2020 and have further reduced this debt to currently approximately $42.0 million.
To maintain our status as a REIT under the Internal Revenue Code, we must distribute annually at least 90% of our REIT-taxable income. These distribution requirements limit our ability to retain earnings and thereby replenish or increase capital for operations. However, we believe that our capital resources and access to financing will provide us with financial flexibility and market responsiveness at levels sufficient to meet current and anticipated capital requirements.
Cash Flows. Cash flows provided by operating activities totaled $533.7 million during the six months ended June 30, 2020 and consisted primarily of net cash inflows of $497.2 million as a result of loan sales exceeding loan originations in our Agency Business.
Cash flows used in investing activities totaled $727.9 million during the six months ended June 30, 2020. Loan and investment activity (originations and payoffs/paydowns) comprise the bulk of our investing activities. Loan originations from our Structured Business totaling $1.12 billion, net of payoffs and paydowns of $459.5 million, resulted in net cash outflows of $657.5 million. Cash outflows also included $37.9 million to purchase APL certificates.
Cash flows provided by financing activities totaled $162.7 million during the six months ended June 30, 2020 and consisted primarily of net proceeds of $385.1 million from CLO activity and $345.8 million received from the issuances of senior unsecured notes, partially offset by net cash outflows of $440.2 million from debt facility activities (facility paydowns were greater than funded loan originations), $70.0 million for the unwind of the Debt Fund and $43.1 million of distributions to our stockholders and OP Unit holders.
Agency Business Requirements. The Agency Business is subject to supervision by certain regulatory agencies. Among other things, these agencies require us to meet certain minimum net worth, operational liquidity and restricted liquidity collateral requirements, purchase and loss obligations and compliance with reporting requirements. Our adjusted net worth and operational liquidity exceeded the agencies' requirements as of June 30, 2020. Our restricted liquidity and purchase and loss obligations were satisfied with letters of credit totaling $50.0 million and $4.4 million of cash collateral. See Note 14 for details about our performance regarding these requirements.
We also enter into contractual commitments with borrowers providing rate lock commitments while simultaneously entering into forward sale commitments with investors. These commitments are outstanding for short periods of time (generally less than 60 days) and are described in Note 12.
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Debt Instruments. We maintain various forms of short-term and long-term financing arrangements. Borrowings underlying these arrangements are primarily secured by a significant amount of our loans and investments and substantially all of our loans held-for-sale. The following is a summary of our debt facilities ($ in thousands):
June 30, 2020
Maturity
Debt Instruments
Commitment (1)
UPB (2)
Available
Dates (3)
Structured Business
Credit facilities and repurchase agreements
$
1,732,257
$
906,188
$
826,069
2020 - 2022
Collateralized loan obligations (4)
2,532,593
2,532,593
—
2020 - 2025
Senior unsecured notes
670,750
670,750
—
2023 - 2027
Convertible senior unsecured notes
278,490
278,490
—
2020 - 2022
Junior subordinated notes
154,336
154,336
—
2034 - 2037
Structured Business total
5,368,426
4,542,357
826,069
Agency Business
Credit facilities (4)
2,050,000
334,722
1,715,278
2020 - 2022
Consolidated total
$
7,418,426
$
4,877,079
$
2,541,347
(1) Includes temporary increases to committed amounts which have not expired as of June 30, 2020.
(2) Excludes the impact of deferred financing costs.
(3) See Note 14 for a breakdown of debt maturities by year.
(4) The ASAP agreement we have with Fannie Mae has no expiration date.
The debt facilities, including their restrictive covenants, are described in Note 10.
Contractual Obligations. During the six months ended June 30, 2020, the following significant changes were made to our contractual obligations disclosed in our 2019 Annual Report; (1) closed CLO XIII issuing $668.0 million of investment grade notes to third party investors; (2) unwound CLO VIII redeeming $282.9 million of outstanding notes; (3) unwound the Debt Fund and redeemed all of its outstanding notes; (4) issued a total of $345.8 million of senior unsecured notes; and (5) modified existing credit facilities.
See Note 10 for details and refer to Note 14 for a description of our debt maturities by year and unfunded commitments as of June 30, 2020.
Off-Balance Sheet Arrangements. At June 30, 2020, we had no off-balance sheet arrangements.
Derivative Financial Instruments
We enter into derivative financial instruments in the normal course of business to manage the potential loss exposure caused by fluctuations of interest rates. See Note 12 for details.
Critical Accounting Policies
Please refer to Note 2 of the Notes to Consolidated Financial Statements in our 2019 Annual Report for a discussion of our critical accounting policies. During the six months ended June 30, 2020, there were no material changes to these policies, except for the credit loss policy established in connection with the adoption of ASU 2016-13. See Note 2 for details.
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Non-GAAP Financial Measures
Core Earnings. Beginning in the first quarter of 2020, we are presenting core earnings as our non-GAAP financial measure in replacement of adjusted funds from operations (“AFFO”). Core earnings is comparable to our previous AFFO metric, revised to exclude provisions for credit losses (including CECL) related to our structured loan portfolio, securities held-to-maturity and loss-sharing obligations related to the Fannie Mae program. We are presenting core earnings because we believe it is an important supplemental measure of our operating performance and is frequently used by peers, analysts, investors and other parties in the evaluation of REITs. Prior period amounts presented below have been conformed to reflect this change.
We define core earnings as net income (loss) attributable to common stockholders (computed in accordance with GAAP) adjusted for accounting items such as depreciation and amortization (adjusted for unconsolidated joint ventures), non-cash stock-based compensation expense, income from MSRs, amortization and write-offs of MSRs, gains and losses on derivative instruments primarily associated with Private Label loans that have not yet been sold and securitized, the tax impact on cumulative gains or losses on derivative instruments associated with Private Label loans that were sold during the periods presented, changes in fair value of GSE-related derivatives that temporarily flow through earnings, deferred tax (benefit) provision, provisions for credit losses (including CECL) and the amortization of the convertible senior notes conversion option. We also add back one-time charges such as acquisition costs and one-time gains or losses on the early extinguishment of debt.
Core earnings is not intended to be an indication of our cash flows from operating activities (determined in accordance with GAAP) or a measure of our liquidity, nor is it entirely indicative of funding our cash needs, including our ability to make cash distributions. Our calculation of core earnings may be different from the calculations used by other companies and, therefore, comparability may be limited.
Core earnings is as follows ($ in thousands, except share and per share data):
Three Months Ended June 30,
Six Months Ended June 30,
2020
2019
2020
2019
Net income (loss) attributable to common stockholders
$
44,091
$
28,916
$
(15,219)
$
51,566
Adjustments:
Net income (loss) attributable to noncontrolling interest
8,110
6,598
(2,824)
12,066
Income from mortgage servicing rights
(32,417)
(18,709)
(54,351)
(32,941)
Deferred tax provision (benefit)
10,879
918
(9,025)
(3,250)
Amortization and write-offs of MSRs
15,542
16,914
33,283
33,654
Depreciation and amortization
2,906
2,853
5,863
5,717
Loss on extinguishment of debt
1,592
—
3,546
128
Provision for credit losses
15,109
368
91,028
822
(Gain) loss on derivative instruments, net
(7,371)
(742)
43,360
1,723
Stock-based compensation
1,915
1,502
5,432
5,258
Core earnings (1)
$
60,356
$
38,618
$
101,093
$
74,743
Diluted core earnings per share (1)
$
0.46
$
0.34
$
0.77
$
0.67
Diluted weighted average shares outstanding (1)
131,882,398
113,624,384
131,166,018
110,779,680
(1) Amounts are attributable to common stockholders and OP Unit holders. The OP Units are redeemable for cash, or at our option for shares of our common stock on a one-for-one basis.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.