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We seek to manage risks that we believe will impact our business including interest rates, liquidity, prepayments, credit quality and market value.
−Removed: Many of these risks have become particularly heightened due to the COVID-19 pandemic and related economic and market conditions.
When managing these risks we consider the impact on our assets, liabilities and derivative positions.
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As a result, our net interest income is particularly affected by changes in interest rates.
−Removed: For example, we hold RMBS and loans, some of which may have fixed rates or interest rates that adjust on various dates that are not synchronized to the adjustment dates on our repurchase agreements.
+Added: For example, we hold residential loans and RMBS, some of which may have fixed rates or interest rates that adjust on various dates that are not synchronized to the adjustment dates on our repurchase agreements.
In general, the re-pricing of our repurchase agreements occurs more quickly than the re-pricing of our variable-interest rate assets.
−Removed: Thus, it is likely that our floating rate financing, such as our repurchase agreements, may react to interest rates before our RMBS or loans because the weighted average next re-pricing dates on the related financing may have shorter time periods than that of the RMBS or loan.
−Removed: Moreover, changes in interest rates can directly impact prepayment speeds, thereby affecting our net return on RMBS.
−Removed: During a declining interest rate environment, the prepayment of RMBS may accelerate (as borrowers may opt to refinance at a lower interest rate) causing the amount of liabilities that have been extended by the use of interest rate swaps to increase relative to the amount of RMBS, possibly resulting in a decline in our net return on RMBS, as replacement RMBS may have a lower yield than those being prepaid.
+Added: Thus, it is likely that our floating rate financing, such as our repurchase agreements, may react to interest rates before our residential loans or RMBS because the weighted average next re-pricing dates on the related financing may have shorter time periods than that of the residential loan or RMBS.
+Added: Moreover, changes in interest rates can directly impact prepayment speeds, thereby affecting our net return on residential loans and RMBS.
+Added: During a declining interest rate environment, the prepayment of residential loans and RMBS may accelerate (as borrowers may opt to refinance at a lower interest rate) causing the amount of liabilities that have been extended by the use of repurchase agreements to increase relative to the amount of residential loans and RMBS, possibly resulting in a decline in our net return on residential loans and RMBS, as replacement residential loan and RMBS may have a lower yield than those being prepaid.
Conversely, during an increasing interest rate environment, RMBS may prepay more slowly than expected, requiring us to finance a higher amount of RMBS than originally forecast and at a time when interest rates may be higher, resulting in a decline in our net return on RMBS.
Accordingly, each of these scenarios can negatively impact our net interest income.
+Added: In addition, when we purchase residential loans at a discount to par value, and borrowers then prepay at a slower rate than we expected, the decreased prepayments would result in a lower yield than expected on the asset and/or may result in a decline in the fair value of the residential loans.
We seek to manage interest rate risk in our portfolio by utilizing interest rate swaps, swaptions, interest rate caps, futures, options on futures and U.S.
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We utilize a model-based risk analysis system to assist in projecting portfolio performances over a scenario of different interest rates.
−Removed: The model incorporates shifts in interest rates, changes in prepayments and other factors impacting the valuations of our financial securities and derivative hedging instruments.
+Added: The model incorporates shifts in interest rates, changes in prepayments and other factors impacting the valuations of our investment portfolio and derivative hedging instruments, if any.
Based on the results of the model, the instantaneous changes in interest rates specified below would have had the following effect on our net interest income for the next 12 months based on our assets and liabilities as of December 31, 2021 (dollar amounts in thousands):
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However, the relationship between spreads on our assets and spreads on our hedging instruments may vary from time to time, resulting in a net aggregate book value increase or decline.
−Removed: The interest rates for certain of our investments and a majority of our financing transactions are either explicitly or indirectly based on LIBOR.
−Removed: On July 27, 2017, the United Kingdom Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021.
+Added: The interest rates for certain of our investments and a majority of our financing transactions are either explicitly or indirectly based on LIBOR, which has been the subject of recent reform.
+Added: In line with its plans to transition away from LIBOR, the United Kingdom's Financial Conduct Authority ceased publication for the one week and two month LIBOR tenors as of December 31, 2021, and intends to stop publication for all other tenors on June 30, 2023.
At this time, it is not possible to predict the effect of such change, including the establishment of potential alternative reference rates, on the economy or markets we are active in either currently or in the future, or on any of our assets or liabilities whose interest rates are based on LIBOR.
−Removed: We are in the process of evaluating the potential impact of a discontinuation of LIBOR after 2021 on our portfolio, as well as the related accounting impact.
−Removed: However, we expect that throughout 2021, we will work closely with the entities that are involved in calculating the interest rates for our RMBS, our loan servicers for our floating rate loans, and with the various counterparties to our financing transactions in order to determine what changes, if any, are required to be made to existing agreements for these transactions.
−Removed: Our net interest income, the fair value of our assets and our financing activities could be negatively affected by volatility in interest rates caused by uncertainties stemming from COVID-19.
+Added: We are working closely with the entities that are involved in calculating the interest rates for our RMBS, our loan servicers for our floating rate loans, and with the various counterparties to our financing transactions in order to determine what changes, if any, are required to be made to existing agreements for these transactions.
+Added: Our net interest income, the fair value of our assets and our financing activities could be negatively affected by volatility in interest rates.
A prolonged period of extremely volatile and unstable market conditions would likely increase our funding costs and negatively affect market risk mitigation strategies.
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We plan to meet liquidity through normal operations with the goal of avoiding unplanned sales of assets or emergency borrowing of funds.
−Removed: We are subject to “margin call” risk under nearly all of our repurchase agreements.
+Added: We are subject to “margin call” risk on a portion of our repurchase agreements.
In the event the value of our assets pledged as collateral suddenly decreases, margin calls relating to our repurchase agreements could increase, causing an adverse change in our liquidity position.
Additionally, if one or more of our repurchase agreement counterparties chooses not to provide ongoing funding, we may be unable to replace the financing through other lenders on favorable terms or at all.
−Removed: As discussed throughout this Annual Report on Form 10-K, in March 2020, we observed unprecedented illiquidity in repurchase agreement financing and MBS markets which resulted in our receiving margin calls under our repurchase agreements that were well beyond historical norms.
+Added: As discussed in this Annual Report on Form 10-K, in March 2020, we observed unprecedented illiquidity in repurchase agreement financing and MBS markets which resulted in our receiving margin calls under our repurchase agreements that were well beyond historical norms.
We took a number of decisive actions in response to these conditions, including the sale of assets and termination of our interest rate swaps.
−Removed: Because of this, we intend to place a greater emphasis on procuring longer-termed and/or more committed financing arrangements, such as securitizations and other term financings, which may involve greater expense relative to repurchase agreement funding.
+Added: Since this time, we have placed and expect to continue to place a greater emphasis on procuring longer-termed and/or more committed financing arrangements, such as non-mark-to-market repurchase agreements, securitizations and other term financings, which may involve greater expense relative to repurchase agreement funding.
We provide no assurance that we will be able in the future to access sources of capital that are attractive to us, that we will be able to roll over or replace our repurchase agreements or other financing instruments as they mature from time to time in the future or that we otherwise will not need to resort to unplanned sales of assets to provide liquidity in the future.
−Removed: See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and the other information in this Annual Report on Form 10-K for further information about our liquidity and capital resource management.
+Added: "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" and the other information in this Annual Report on Form 10-K for further information about our liquidity and capital resource management.
Derivative financial instruments are also subject to “margin call” risk.
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Generally, when market interest rates decline, borrowers have a tendency to refinance their mortgages, thereby increasing prepayments.
+Added: Therefore, increased prepayments on our investments may accelerate the redeployment of our capital to generally lower yielding investments.
+Added: Similarly, decreased prepayments are generally associated with increasing market interest rates and may slow our ability to redeploy capital to generally higher-yielding investments.
Our modeled prepayments will help determine the amount of hedging we use to off-set changes in interest rates.
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Conversely, when we have paid a premium, if actual prepayment rates experienced are slower than modeled, we would amortize the premium over a longer time period, resulting in a higher yield to maturity.
−Removed: In an environment of increasing prepayment speeds, the timing difference between the actual cash receipt of principal paydowns and the announcement of the principal paydowns may result in additional margin requirements from our repurchase agreement counterparties.
+Added: In an environment of increasing prepayment speeds, the timing difference between the actual cash receipt of principal paydowns and the announcement of the principal paydowns may also result in additional margin requirements from our repurchase agreement counterparties.
We mitigate prepayment risk by constantly evaluating our residential mortgage assets relative to prepayment speeds observed for assets with similar structures, quantities and characteristics.
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Historically, we have not hedged 100% of our liability costs due to prepayment risk.
−Removed: Given the combination of low interest rates, government stimulus, high unemployment and other disruptions related to COVID-19, it has become more difficult to predict prepayment levels for the securities in our portfolio.
Credit risk is the risk that we will not fully collect the principal we have invested in our credit sensitive assets, including residential loans, non-Agency RMBS, ABS, multi-family CMBS, preferred equity and mezzanine loan and joint venture equity investments, due to borrower defaults or defaults by our operating partners in their payment obligations to us.
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Nevertheless, these procedures provide no assurance that we will not experience unanticipated credit losses which would materially affect our operating results.
−Removed: Concern surrounding the ongoing COVID-19 pandemic and certain of the actions taken to reduce its spread has caused and may continue to cause business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and multi-family property vacancy and lease default rates, reduced profitability and ability for property owners to make loan, mortgage and other payments, and overall economic and financial market instability, all of which may cause an increase in the credit risk of our credit sensitive assets.
−Removed: Although we did not see a significant increase in forbearance and delinquency rates in our portfolio during the year ended December 31, 2020, we expect delinquencies, defaults and requests for forbearance arrangements to rise as savings, incomes and revenues of borrowers, operating partners and other businesses become increasingly constrained from the resulting slow-down in economic activity and/or the reduction or elimination of current unemployment benefits or other policies intended to help keep borrowers and renters in their residences.
−Removed: Any future period of payment deferrals, forbearance, delinquencies, defaults, foreclosures or losses will likely adversely affect our net interest income from preferred equity investments, residential loans, mezzanine loans and our RMBS, CMBS and ABS investments, the fair value of these assets, our ability to liquidate the collateral that may underlie these investments and obtain additional financing and the future profitability of our investments.
+Added: Concern surrounding the ongoing COVID-19 pandemic and certain of the actions taken to reduce its spread has caused and may continue to cause or cause in the future business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and property vacancy and lease default rates, reduced profitability and ability for property owners or renters to make loan, mortgage, rental and other payments, and overall economic and financial market instability, all of which may cause an increase in the credit risk of our credit sensitive assets.
+Added: Although we did not see a significant increase in forbearance and delinquency rates in our portfolio during the year ended December 31, 2021, we expect delinquencies, defaults and requests for forbearance arrangements to rise should savings, incomes and revenues of borrowers, operating partners, renters and other businesses become increasingly constrained from a slow-down in economic activity and/or the reduction or elimination of policies intended to help keep borrowers and renters in their residences.
+Added: Any future period of increased payment deferrals, forbearance, delinquencies, defaults, foreclosures or losses will likely adversely affect our net interest income from preferred equity investments, residential loans, mezzanine loans and our RMBS, CMBS and ABS investments and reduce the distributions we receive from our joint venture equity investments in multi-family apartment communities, the fair value of these assets, our ability to liquidate the collateral that may underlie these investments and obtain additional financing and the future profitability of our investments.
Further, in the event of delinquencies, defaults and foreclosure, regulatory changes and policies designed to protect borrowers and renters may slow or prevent us from taking remediation actions.
−Removed: See Item 1A, "Risk Factors" and Item 7,“Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in this Annual Report on Form 10-K and for more information on how COVID-19 may impact the credit quality of our credit sensitive assets and the credit quality of the underlying borrowers or operating partners.
−Removed: With respect to our residential loans, we purchased the majority of these mortgage loans at a discount to par reflecting their distressed state or perceived higher risk of default.
+Added: "Risk Factors" and Item 7.
+Added: “Management's Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in this Annual Report on Form 10-K and for more information on how COVID-19 may impact the credit quality of our credit sensitive assets and the credit quality of the underlying borrowers, operating partners or renters.
+Added: We purchase certain residential loans at a discount to par, reflecting a perceived higher risk of default.
In connection with our loan acquisitions, we or a third-party due diligence firm perform an independent review of the mortgage file to assess the state of mortgage loan files, the servicing of the mortgage loan, compliance with existing guidelines, as well as our ability to enforce the contractual rights in the mortgage.
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This involves, among other things, performing due diligence on the servicer prior to their engagement, assigning the appropriate servicer on each loan based on certain characteristics and monitoring each servicer's performance on an ongoing basis.
−Removed: We are exposed to credit risk in our investments in CMBS, non-Agency RMBS and ABS.
+Added: We are exposed to credit risk in our investments in non-Agency RMBS, CMBS and ABS.
These investments typically consist of either the senior, mezzanine or subordinate tranches in securitizations.
The underlying collateral of these securitizations may be exposed to various macroeconomic and asset-specific credit risks.
−Removed: These securities have varying levels of credit enhancement which provide some structural protection from losses within the portfolio.
+Added: These securities have varying levels of credit enhancement which provide some structural protection from losses within the securitization.
We undertake an in-depth assessment of the underlying collateral and securitization structure when investing in these assets, which may include modeling defaults, prepayments and loss across different scenarios.
−Removed: In addition, we are exposed to credit risk in our preferred equity, mezzanine loan and equity investments in owners of residential and multi-family properties.
+Added: In addition, we are exposed to credit risk in our preferred equity, mezzanine loan and equity investments in owners of residential and multi-family properties, including joint venture equity investments in multi-family apartment communities.
The performance and value of these investments depend upon the applicable operating partner’s or borrower’s ability to effectively operate the multi-family and residential properties, that serve as the underlying collateral, to produce cash flows adequate to pay distributions, interest or principal due to us.
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The uncertainties stemming from the pandemic created unprecedented illiquidity and volatility in the financial markets.
−Removed: As a result, our market value (fair value) risk has significantly increased.
+Added: As a result, we believe our market value (fair value) risk has significantly increased.
Minor changes in assumptions or estimation methodologies can have a material effect on these derived or estimated fair values.
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Also, because of differences in methodologies and assumptions used to estimate fair values, the fair values used by us should not be compared to those of other companies.
−Removed: The table below presents the sensitivity of the fair value and net duration changes of our portfolio as of December 31, 2020, using a discounted cash flow simulation model assuming an instantaneous interest rate shift.
+Added: The table below presents the sensitivity of the fair value and net duration changes of our investment portfolio as of December 31, 2021, using a discounted cash flow simulation model assuming an instantaneous interest rate shift.
Application of this method results in an estimation of the fair market value change of our assets, liabilities and hedging instruments per 100 basis point shift in interest rates.
−Removed: The use of hedging instruments has historically been a critical part of our interest rate risk management strategies.
+Added: The use of hedging instruments has historically been a critical part of our interest rate risk management strategies, although at this time, we currently have no hedging instruments in place.
This analysis also takes into consideration the value of options embedded in our mortgage assets including constraints on the re-pricing of the interest rate of assets resulting from periodic and lifetime cap features, as well as prepayment options.
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financial, mortgage and real estate markets.
−Removed: In reaction to these tumultuous market conditions, various banks and other financing participants restricted or limited lending activity and requested margin posting or repayments where applicable.
−Removed: Although these conditions have subsided somewhat during the year ended December 31, 2020, we expect these conditions to remain volatile and uncertain at varying levels for the near future and this may adversely affect our ability to access capital to fund our operations, meet our obligations and make distributions to our stockholders.
+Added: In reaction to the tumultuous market conditions in March 2020 associated with the pandemic, various banks and other financing participants restricted or limited lending activity and requested margin posting or repayments where applicable.
+Added: Although these conditions have largely subsided as of December 31, 2021, we expect these conditions to remain volatile and uncertain at varying levels for the near future and this may adversely affect our ability to access capital to fund our operations, meet our obligations and make distributions to our stockholders.
Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.