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 also invest in real estate-related joint ventures and 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. The global outbreak of COVID-19 that began in early 2020, 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 Third Quarter of 2020
Capital Markets Activity.
● We filed a shelf registration statement as a "well-known seasoned issuer," which registered an unlimited and indeterminate amount of debt or equity securities for future issuance and sale. The shelf registration statement was declared effective upon filing; and
● We amended the equity distribution agreement with JMP under which we may offer and sell up to 10,000,000 common shares in "At-The-Market" equity offerings. We sold 3,579,266 shares under this agreement and received net proceeds of $40.5 million, which a portion of the proceeds was used to redeem 2,736,894 OP Units totaling $29.7 million.
Agency Business Activity. Loan originations and sales totaled $1.48 billion and $1.22 billion, respectively, and our fee-based servicing portfolio grew 5% to $22.56 billion.
Structured Business Activity.
● Our Structured loan and investment portfolio grew 3% to $5.10 billion on loan originations totaling $291.8 million, partially offset by loan runoff of $206.0 million;
● We recorded income of $32.3 million and received a $15.0 million cash distribution from our residential mortgage business joint venture; and
● We sold our hotel property and recognized a $1.9 million loss. We also recorded a $2.5 million charge for a litigation settlement, which is included in selling and administrative expenses.
Dividend. We raised our quarterly common dividend to $0.32 per share, our second quarterly increase, reflecting a 7% year-to-date increase, which is payable on November 30, 2020 to common stockholders of record as of the close of business on November 16, 2020
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 have and may continue to 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.
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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 and third quarters of 2020 we raised $130.5 million through two private placement debt offerings and sales of our common stock through our “At-The-Market” equity offering sales agreements.
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 0.3% of our $16.46 billion Fannie Mae DUS portfolio and approximately 5.9% of our $4.69 billion Freddie Mac portfolio. We are closely monitoring and managing the requests for forbearances and there could potentially be additional economic stress in the fourth 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.
Changes in Financial Condition
Assets — Comparison of balances at September 30, 2020 to December 31, 2019:
Our Structured loan and investment portfolio balance was $5.10 billion and $4.29 billion at September 30, 2020 and December 31, 2019, respectively. This increase was primarily due to loan originations exceeding loan payoffs and paydowns by $808.0 million. See below for details.
Our portfolio had a weighted average current interest pay rate of 5.39% and 5.98% at September 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 5.93% and 6.68% at September 30, 2020 and December 31, 2019, respectively. Advances on our financing facilities totaled $4.52 billion and $3.93 billion at September 30, 2020 and December 31, 2019, respectively, with a weighted average funding cost of 2.66% and 3.82%, respectively, which excludes financing costs. Including financing costs, the weighted average funding rate was 3.09% and 4.35% at September 30, 2020 and December 31, 2019, respectively.
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Activity from our Structured Business portfolio is comprised of the following ($ in thousands):
Three Months Ended
Nine Months Ended
September 30, 2020
September 30, 2020
Loans originated (1)
$
291,758
$
1,448,468
Number of loans
13
80
Weighted average interest rate
5.51
%
5.69
%
(1) We committed to fund two SFR build-to-rent bridge loans totaling $75.3 million in the third quarter of 2020.
Loan paid-off / paid-down
$
206,028
$
640,494
Number of loans
15
56
Weighted average interest rate
5.92
%
6.69
%
Loans extended
$
197,488
$
686,401
Number of loans
15
40
Loans held-for-sale from the Agency Business decreased $230.2 million, primarily related to loan sales exceeding originations by $211.0 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
Nine Months Ended
September 30, 2020
September 30, 2020
Loan
Loan
Originations
Loan Sales
Originations
Loan Sales
Fannie Mae
$
1,117,679
$
1,038,053
$
2,839,833
$
2,856,020
Freddie Mac
252,014
116,628
587,445
468,019
FHA
100,345
64,781
193,821
118,218
Private Label
5,840
—
337,307
727,154
Total
$
1,475,878
$
1,219,462
$
3,958,406
$
4,169,411
Capitalized mortgage servicing rights increased $48.8 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 September 30, 2020, the weighted average estimated life remaining of our MSRs was 8.3 years.
Securities held-to-maturity increased $29.6 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.
Investments in equity affiliates increased $40.5 million, primarily due to income from our investment in a residential mortgage banking business of $56.1 million, partially offset by a $15.0 million cash distribution received from the same investment.
Real estate owned decreased $10.3 million as a result of the sale of our hotel property in the third quarter of 2020.
Due from related party increased $13.2 million, due to an increase in funds from payoffs to be remitted by our affiliated servicing operations related to real estate transactions at the end of the reporting period. These amounts were remitted to us in October 2020.
Other assets increased $49.7 million, primarily due to an increase in our operating lease right-of-use assets as a result of an office lease extension.
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Liabilities – Comparison of balances at September 30, 2020 to December 31, 2019:
Credit facilities and repurchase agreements decreased $228.3 million, primarily due to loan sales exceeding originations by $211.0 million in our Agency Business, as described above.
Collateralized loan obligations increased $385.9 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.
Senior unsecured notes increased $342.5 million, primarily due to our issuances of $275.0 million of 4.50% notes and $70.8 million of 8.00% notes.
Convertible senior unsecured notes decreased $17.4 million, primarily due to partial redemption of our 5.25% Convertible Notes.
Allowance for loss-sharing obligations increased $36.5 million, primarily due to the adoption of CECL in the first quarter of 2020. See Note 2 for details.
Other liabilities increased $47.0 million, primarily due to an increase in our operating lease liabilities as a result of an office lease extension.
Equity
During the nine months ended September 30, 2020, we sold 6,887,274 shares of our common stock through our “At-The-Market” agreement, raising net proceeds of $78.5 million and we used a portion of such proceeds to redeem 2,736,894 OP Units for cash totaling $29.7 million. We also issued 363,013 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 September 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 nine months ended September 30, 2020 are 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
July 29, 2020
$
0.31
July 29, 2020
$
0.515625
$
0.484375
$
0.53125
(1) The dividend declared on July 29, 2020 was for June 1, 2020 through August 31, 2020, 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 October 28, 2020, the Board of Directors declared a cash dividend of $0.32 per share of common stock. The dividend is payable on November 30, 2020 to common stockholders of record as of the close of business on November 16, 2020.
Preferred Stock — On October 28, 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 $0.53125 per share of 8.50% Series C preferred stock. These amounts reflect dividends from September 1, 2020 through November 30, 2020 and are payable on November 30, 2020 to preferred stockholders of record on November 15, 2020.
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Deferred Compensation
During the first quarter of 2020, we issued 344,919 shares of restricted stock to our employees, including our chief executive officer, 36,396 shares to the independent members of the Board of Directors and up to 275,569 shares of performance-based restricted stock units to our chief executive officer. We also withheld 143,096 shares of restricted common stock from employees to net settle and pay their respective withholding taxes in connection with awards that vested.
During the first quarter of 2020, 421,348 shares of performance-based restricted stock units previously granted to our chief executive officer fully vested and were net settled for 215,014 common shares. In addition, during the third quarter of 2020, our chief executive officer was granted 313,152 shares of performance-based restricted stock as a result of achieving goals related to the integration of the Acquisition and 357,569 shares of performance-based restricted stock granted in 2017 vested, which were net settled for 182,467 common shares.
See Note 16 for details.
Agency Servicing Portfolio
The following table sets forth the characteristics of our loan servicing portfolio collateralizing our mortgage servicing rights and servicing revenue ($ in thousands):
September 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
$
16,462,041
2,547
3.0
8.8
96
%
4
%
4.25
%
7.49
%
0.39
%
Freddie Mac
4,687,197
1,418
2.6
11.9
93
%
7
%
4.08
%
11.30
%
0.57
%
Private Label
727,063
40
0.8
9.4
100
%
—
%
3.81
%
—
%
—
%
FHA
685,263
89
3.5
32.6
100
%
—
%
3.57
%
33.71
%
—
%
Total
$
22,561,564
4,094
2.8
10.2
96
%
4
%
4.18
%
8.84
%
0.40
%
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 September 30, 2020 and December 31, 2019, delinquent loans totaled $91.2 million and $59.2 million, respectively, of which $11.9 million and $33.5 million, respectively, were in the foreclosure process. In addition, at December 31, 2019, loans collateralizing our servicing portfolio totaling $3.2 million were in bankruptcy.
Our servicing portfolio represents commercial real estate loans originated in our Agency Business, which are generally transferred or sold within 60 days from the date the loan is funded. Primarily all of the loans in our servicing portfolio are collateralized by multifamily properties. In addition, we are generally required to share in the risk of any losses associated with loans sold under the Fannie Mae DUS program, see Note 11.
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Comparison of Results of Operations for the Three Months Ended September 30, 2020 and 2019
The following table provides our consolidated operating results ($ in thousands):
Three Months Ended September 30,
Increase / (Decrease)
2020
2019
Amount
Percent
Interest income
$
81,701
$
80,509
$
1,192
1
%
Interest expense
37,888
48,064
(10,176)
(21)
%
Net interest income
43,813
32,445
11,368
35
%
Other revenue:
Gain on sales, including fee-based services, net
19,895
21,298
(1,403)
(7)
%
Mortgage servicing rights
42,357
29,911
12,446
42
%
Servicing revenue, net
13,348
13,790
(442)
(3)
%
Property operating income
1,033
2,237
(1,204)
(54)
%
Loss on derivative instruments, net
(753)
(5,003)
4,250
(85)
%
Other income, net
1,050
325
725
nm
%
Total other revenue
76,930
62,558
14,372
23
%
Other expenses:
Employee compensation and benefits
32,962
32,861
101
—
%
Selling and administrative
9,356
10,882
(1,526)
(14)
%
Property operating expenses
1,300
2,563
(1,263)
(49)
%
Depreciation and amortization
1,922
1,841
81
4
%
Provision for loss sharing (net of recoveries)
(2,227)
735
(2,962)
nm
%
Provision for credit losses (net of recoveries)
(7,586)
—
(7,586)
nm
%
Total other expenses
35,727
48,882
(13,155)
(27)
%
Income before sale of real estate, income from equity affiliates and income taxes
85,016
46,121
38,895
84
%
Loss on sale of real estate
(1,868)
—
(1,868)
nm
%
Income from equity affiliates
32,358
3,718
28,640
nm
%
Provision for income taxes
(17,785)
(6,623)
(11,162)
169
%
Net income
97,721
43,216
54,505
126
%
Preferred stock dividends
1,888
1,888
—
—
%
Net income attributable to noncontrolling interest
13,836
7,363
6,473
88
%
Net income attributable to common stockholders
$
81,997
$
33,965
$
48,032
141
%
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 September 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
$
4,522,755
$
64,838
5.70
%
$
3,496,683
$
60,716
6.89
%
Preferred equity investments
209,106
5,539
10.54
%
181,430
5,445
11.91
%
Mezzanine / junior participation loans
176,238
3,617
8.16
%
213,568
6,115
11.36
%
Other
76,710
943
4.89
%
45,903
324
2.80
%
Core interest-earning assets
4,984,809
74,937
5.98
%
3,937,584
72,600
7.31
%
Cash equivalents
346,140
534
0.61
%
325,294
1,229
1.50
%
Total interest-earning assets
$
5,330,949
$
75,471
5.63
%
$
4,262,878
$
73,829
6.87
%
Structured Business interest-bearing liabilities:
CLO
$
2,532,593
$
12,284
1.93
%
$
1,892,274
$
19,970
4.19
%
Warehouse lines
951,678
7,478
3.13
%
921,160
11,525
4.96
%
Unsecured debt
949,240
14,182
5.94
%
480,733
8,294
6.84
%
Trust preferred
154,336
1,308
3.37
%
154,336
2,070
5.32
%
Debt fund
—
—
—
%
70,000
1,350
7.65
%
Total interest-bearing liabilities
$
4,587,847
35,252
3.06
%
$
3,518,503
43,209
4.87
%
Net interest income
$
40,219
$
30,620
(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 mostly due to a $1.6 million increase in our Structured Business primarily due to an increase in our average core interest-earning assets from loan originations exceeding loan runoff, substantially offset by a decrease in the average yield on core interest-earning assets. The decrease in the average yield was due to lower rates on originations as compared to loan runoff, a decrease in the average LIBOR and 10-year treasury note rates and lower fees on early runoff, partially offset by the amortization of the discount related to our APL certificates.
The decrease in interest expense was primarily due to decreases of $8.0 million, or 18%, from our Structured Business and $2.2 million, or 46%, from our Agency Business. The decrease in our Structured Business was the result of a 37% 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 30% increase in the average balance of our interest-bearing liabilities, due to growth in our loan portfolio and the issuance of additional unsecured debt. The decrease in our Agency Business was primarily due to a 37% decrease in the average cost of our interest-bearing liabilities as a result of decreases in LIBOR.
Agency Business Revenue
The decrease in gain on sales, including fee-based services, net was primarily due to an 18% decrease ($269.0 million) in loan sales volume, partially offset by a 14% increase in the sales margin as a result of higher margins on Fannie Mae, Freddie Mac and FHA loan sales.
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The increase in income from MSRs was primarily due to a 37% increase in the MSR rate (income from MSRs as a percentage of loan commitment volume) from 2.02% to 2.77%, mainly due to an increase in the average servicing fee on loan commitments, and a 3% increase in loan commitment volume.
Other Revenue
The decreases in both property operating income and expenses were primarily due to lower occupancy at our hotel property as a result of the COVID-19 pandemic and the sale of the hotel in September 2020.
The losses on derivative instruments in both the third quarter of 2020 and 2019 were primarily from our Agency Business and were predominantly from changes in the fair value of our rate lock commitments. See Note 12 for details.
Other Expenses
The decrease in selling and administrative expense was primarily due to decreases in general administrative expenses, mainly due to travel restrictions from the COVID-19 pandemic, partially offset by the $2.5 million litigation settlement on the hotel property we sold in the third quarter of 2020.
The decreases in provision for loss sharing and provision for credit losses were primarily due the reversal of CECL reserves in connection with improved market conditions and expected future forecasts.
Loss on Sale of Real Estate
The loss recorded in the third quarter of 2020 was from the hotel property we sold in September 2020.
Income from Equity Affiliates
Income from equity affiliates in the third quarter of 2020 and 2019 primarily reflects income from our investment in a residential mortgage banking business of $32.3 million and $2.6 million, respectively, and a distribution from an equity investment totaling $1.2 million in the third quarter of 2019.
Provision for Income Taxes
In the three months ended September 30, 2020, we recorded a tax provision of $17.8 million, which consisted of current and deferred tax provisions of $13.9 million and $3.9 million, respectively. In the three months ended September 30, 2019, we recorded a tax provision of $6.6 million, which consisted of a current tax provision of $4.4 million and a deferred tax provision of $2.2 million. The tax provision increase is primarily due to an increase in income generated from our residential mortgage banking business joint venture and growth in our agency business.
Net Income Attributable to Noncontrolling Interest
The noncontrolling interest relates to the outstanding OP Units issued as part of the Acquisition. There were 17,632,371 OP Units and 20,484,094 OP Units outstanding as of September 30, 2020 and 2019, respectively, which represented 13.2% and 17.8% of our outstanding stock at September 30, 2020 and 2019, respectively.
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Comparison of Results of Operations for the Nine Months Ended September 30, 2020 and 2019
The following table provides our consolidated operating results ($in thousands):
Nine Months Ended September 30,
Increase / (Decrease)
2020
2019
Amount
Percent
Interest income
$
253,307
$
233,957
$
19,350
8
%
Interest expense
129,172
138,213
(9,041)
(7)
%
Net interest income
124,135
95,744
28,391
30
%
Other revenue:
Gain on sales, including fee-based services, net
60,566
51,897
8,669
17
%
Mortgage servicing rights
96,708
62,852
33,856
54
%
Servicing revenue, net
40,156
39,954
202
1
%
Property operating income
3,976
8,187
(4,211)
(51)
%
Loss on derivative instruments, net
(58,852)
(6,726)
(52,126)
nm
%
Other income, net
3,404
1,314
2,090
159
%
Total other revenue
145,958
157,478
(11,520)
(7)
%
Other expenses:
Employee compensation and benefits
101,652
93,647
8,005
9
%
Selling and administrative
29,013
31,122
(2,109)
(7)
%
Property operating expenses
4,778
7,649
(2,871)
(38)
%
Depreciation and amortization
5,830
5,663
167
3
%
Impairment loss on real estate owned
—
1,000
(1,000)
nm
%
Provision for loss sharing (net of recoveries)
21,706
1,557
20,149
nm
%
Provision for credit losses (net of recoveries)
59,510
—
59,510
nm
%
Total other expenses
222,489
140,638
81,851
58
%
Income before extinguishment of debt, sale of real estate, income from equity affiliates and income taxes
47,604
112,584
(64,980)
(58)
%
Loss on extinguishment of debt
(3,546)
(128)
(3,418)
nm
%
Loss on sale of real estate
(1,868)
—
(1,868)
nm
%
Income from equity affiliates
56,758
9,133
47,625
nm
%
Provision for income taxes
(15,493)
(10,963)
(4,530)
41
%
Net income
83,455
110,626
(27,171)
(25)
%
Preferred stock dividends
5,665
5,665
—
—
%
Net income attributable to noncontrolling interest
11,012
19,429
(8,417)
(43)
%
Net income attributable to common stockholders
$
66,778
$
85,532
$
(18,754)
(22)
%
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):
Nine Months Ended September 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
$
4,323,098
$
192,860
5.96
%
$
3,257,310
$
180,257
7.40
%
Preferred equity investments
205,706
17,094
11.10
%
181,550
15,614
11.50
%
Mezzanine / junior participation loans
176,889
11,825
8.93
%
173,484
15,213
11.72
%
Other
87,519
3,941
6.01
%
23,580
550
3.12
%
Core interest-earning assets
4,793,212
225,720
6.29
%
3,635,924
211,634
7.78
%
Cash equivalents
387,332
2,523
0.87
%
345,531
4,148
1.61
%
Total interest-earning assets
$
5,180,544
$
228,243
5.89
%
$
3,981,455
$
215,782
7.25
%
Structured Business interest-bearing liabilities:
CLO
$
2,439,365
$
44,722
2.45
%
$
1,742,738
$
59,434
4.56
%
Warehouse lines
979,846
26,215
3.57
%
856,667
32,581
5.08
%
Unsecured debt
853,339
38,175
5.98
%
454,872
23,623
6.94
%
Trust preferred
154,336
4,693
4.06
%
154,336
6,373
5.52
%
Debt fund
29,891
1,585
7.08
%
70,000
4,171
7.97
%
Total interest-bearing liabilities
$
4,456,777
115,390
3.46
%
$
3,278,613
126,182
5.15
%
Net interest income
$
112,853
$
89,600
(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 $12.5 million, or 6%, from our Structured Business and $6.9 million, or 38%, from our Agency Business. The increase from our Structured Business was primarily due to a 32% increase in our average core interest-earning assets, as a result of loan originations exceeding loan runoff, partially offset by a 19% 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 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 decrease in interest expense was due to a decrease of $10.8 million, or 9%, from our Structured Business, partially offset by an increase of $1.8 million, or 15%, from our Agency Business. The decrease in our Structured Business was the result of a 33% 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 36% 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. The increase from our Agency Business was primarily due to a $269.5 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.
Agency Business Revenue
The increase in gain on sales, including fee-based services, net was primarily due to a 19% increase ($656.2 million) in loan sales volume.
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The increase in income from MSRs was primarily due to a 40% increase in the MSR rate from 1.73% to 2.42%, mainly due to an increase in the average servicing fee on loan commitments, along with a 10% increase in loan commitment volume.
Other Revenue
Property operating income and expenses both decreased in 2020 as a result of lower occupancy and closure of the hotel property for most of the second quarter as a result of the COVID-19 pandemic. We sold the hotel in September 2020. See Note 9.
The increase in loss on derivative instruments was primarily due to an increase of $49.6 million from our Agency Business, mostly due to losses recognized on 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 increased headcount in both businesses associated with each business’s portfolio growth, including the full period impact in 2020 of new hires in 2019, as well as an increase in commissions in our Agency Business in connection with the Private Label loan sales.
The decrease in selling and administrative expenses was primarily due to a $2.5 million decline in the Structured Business. Legal and consulting costs were lower as transactions and projects that were terminated or completed in 2019 did not recur in 2020. Administrative expenses were also lower in 2020 as a result of the COVID-19 pandemic due to travel restrictions and fewer events. These decreases were partially offset by the $2.5 million litigation settlement we recorded related to the hotel property that we sold in the third quarter of 2020.
The impairment loss on real estate owned of $1.0 million in 2019 reflects an impairment charge taken on our hotel property in the second quarter. See Note 9.
The increases in 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 partial conversion of our 5.375% and 5.25% Convertible Notes.
Loss on Sale of Real Estate
The loss recorded in 2020 was from the hotel property we sold in September 2020.
Income from Equity Affiliates
Income from equity affiliates in 2020 and 2019 primarily reflects income from our investment in a residential mortgage banking business of $56.1 million and $6.1 million, respectively, and distributions from an equity investment totaling $1.1 million and $3.0 million, respectively.
Provision for Income Taxes
In the nine months ended September 30, 2020, we recorded a tax provision of $15.5 million, which consisted of a current tax provision of $20.7 million and a deferred tax benefit of $5.2 million. In the nine months ended September 30, 2019, we recorded a tax provision of $11.0 million, which consisted of a current tax provision of $12.0 million and a deferred tax benefit of $1.0 million. The tax provision increase is primarily due to an increase in income generated from our residential mortgage banking business joint venture and growth in our agency business.
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Net Income Attributable to Noncontrolling Interest
The noncontrolling interest relates to the outstanding OP Units issued as part of the Acquisition. There were 17,632,371 OP Units and 20,484,094 OP Units outstanding as of September 30, 2020 and 2019, respectively, which represented 13.2% and 17.8% of our outstanding stock at September 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 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 $4.52 billion in total structured debt outstanding at September 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 $885.9 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 $500 million in cash and available liquidity as well as other liquidity sources, including our $22.56 billion agency servicing portfolio, which is mostly prepayment protected and generates approximately $100 million a year in recurring cash flow.
At September 30, 2020, we had $100.9 million of securities financed with $42.2 million of debt that was subject to margin calls related to changes in interest spreads. During the nine months ended September 30, 2020, we significantly reduced the UPB of this debt by $175.0 million to $42.2 million through a debt restructuring and the use of proceeds from our senior notes issued in the second quarter of 2020.
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 and liquidity requirements.
Cash Flows. Cash flows provided by operating activities totaled $303.7 million during the nine months ended September 30, 2020 and consisted primarily of net cash inflows of $229.1 million as a result of loan sales exceeding loan originations in our Agency Business.
Cash flows used in investing activities totaled $811.7 million during the nine months ended September 30, 2020. Loan and investment activity (originations and payoffs/paydowns) comprise the bulk of our investing activities. Loan originations from our Structured Business totaling $1.43 billion, net of payoffs and paydowns of $674.9 million, resulted in net cash outflows of $750.1 million. Cash outflows also included $37.9 million to purchase APL certificates in connection with out Private Label securitization in the second quarter of 2020.
Cash flows provided by financing activities totaled $299.9 million during the nine months ended September 30, 2020 and consisted primarily of net proceeds of $385.1 million from CLO activity, $345.8 million received from the issuances of senior unsecured notes and $78.6 million received from common stock issuances, partially offset by net cash outflows of $226.7 million from debt facility
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activities (facility paydowns were greater than funded loan originations), $126.1 million of distributions to our stockholders and OP Unit holders, $70.0 million for the unwind of the Debt Fund and $31.3 million for the redemption of OP units.
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 September 30, 2020. Our restricted liquidity and purchase and loss obligations were satisfied with letters of credit totaling $50.0 million and $6.9 million of cash collateral. See Note 14 for details about our performance regarding these requirements.
We also enter into contractual commitments with borrowers providing rate lock commitments while simultaneously entering into forward sale commitments with investors. These commitments are outstanding for short periods of time (generally less than 60 days) and are described in Note 12.
Debt Instruments. We maintain various forms of short-term and long-term financing arrangements. Borrowings underlying these arrangements are primarily secured by a significant amount of our loans and investments and substantially all of our loans held-for-sale. The following is a summary of our debt facilities ($ in thousands):
September 30, 2020
Maturity
Debt Instruments
Commitment (1)
UPB (2)
Available
Dates (3)
Structured Business
Credit facilities and repurchase agreements
$
1,722,361
$
885,930
$
836,431
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
—
2021 - 2022
Junior subordinated notes
154,336
154,336
—
2034 - 2037
Structured Business total
5,358,530
4,522,099
836,431
Agency Business
Credit facilities (5)
2,050,000
568,489
1,481,511
2020 - 2021
Consolidated total
$
7,408,530
$
5,090,588
$
2,317,942
(1) Includes temporary increases to committed amounts which have not expired as of September 30, 2020.
(2) Excludes the impact of deferred financing costs.
(3) See Note 14 for a breakdown of debt maturities by year.
(4) Maturity dates represent the weighted average remaining maturity based on the underlying collateral as of September 30, 2020.
(5) 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 nine months ended September 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 September 30, 2020.
Off-Balance Sheet Arrangements. At September 30, 2020, we had no off-balance sheet arrangements.
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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 nine months ended September 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.
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, CECL provisions for credit losses (excluding specifically reserved provisions for loss-sharing) 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 September 30,
Nine Months Ended September 30,
2020
2019
2020
2019
Net income attributable to common stockholders
$
81,997
$
33,965
$
66,778
$
85,532
Adjustments:
Net income attributable to noncontrolling interest
13,836
7,363
11,012
19,429
Income from mortgage servicing rights
(42,357)
(29,911)
(96,708)
(62,852)
Deferred tax provision (benefit)
3,853
2,223
(5,172)
(1,026)
Amortization and write-offs of MSRs
15,456
18,904
48,739
52,558
Depreciation and amortization
2,867
2,789
8,731
8,504
Loss on extinguishment of debt
—
—
3,546
128
Provision for credit losses, net
(11,137)
431
79,144
1,021
Loss on derivative instruments, net
753
5,003
44,113
6,726
Stock-based compensation
1,854
2,316
7,286
7,574
Core Earnings (1)
$
67,122
$
43,083
$
167,469
$
117,594
Diluted core earnings per share (1)
$
0.50
$
0.37
$
1.26
$
1.04
Diluted weighted average shares outstanding (1)
133,997,087
117,468,044
132,401,315
113,033,968
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(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.
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.