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Interest Rate Risk
−Removed: Interest rates are sensitive to many factors, including governmental, monetary or tax policies, domestic and international economic conditions, and political or regulatory matters beyond our control.
+Added: Interest rates are sensitive to many factors, including governmental, monetary or tax policies, domestic and international economic conditions, including inflation and deflation, and political or regulatory matters beyond our control.
Changes in interest rates affect the value of the assets we manage and hold in our investment portfolio and the variable-rate borrowings we use to finance our portfolio.
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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 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: 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 loans or RMBS.
Moreover, changes in interest rates can directly impact prepayment speeds, thereby affecting our net return on residential loans and RMBS.
−Removed: 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.
−Removed: 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.
+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 loans and RMBS may have a lower yield than those being prepaid.
+Added: Conversely, during an increasing interest rate environment, residential loans and RMBS may prepay more slowly than expected, requiring us to finance a higher amount of residential loans and RMBS than originally forecast and at a time when interest rates may be higher, resulting in a decline in our net return on residential loans and RMBS.
Accordingly, each of these scenarios can negatively impact our net interest income.
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.
−Removed: 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.
+Added: We seek to manage interest rate risk in our portfolio by utilizing interest rate caps, interest rate swaps, swaptions, futures, options on futures and U.S.
Treasury securities with the goal of optimizing the earnings potential while seeking to maintain long term stable portfolio values.
−Removed: Given current market volatility and historically low interest rates, we do not currently have any hedges in place to mitigate the risk of rising interest rates.
+Added: Certain of our consolidated multi-family properties with variable rate mortgages payable have entered into interest rate cap contracts as required by the mortgage loan agreement.
+Added: The Company also has an interest rate cap contract related to a repurchase agreement for residential loans, as required by the counterparty.
+Added: Besides the interest rate cap contracts, we do not have any other interest rate derivatives in place as of December 31, 2022.
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 investment portfolio and derivative hedging instruments, if any.
−Removed: 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):
−Removed: Changes in Net Interest Income
−Removed: Changes in Interest Rates (basis points) Changes in Net Interest Income
+Added: Based on the results of the model, the instantaneous changes in interest rates specified below would have had the following effect on adjusted net interest income for the next 12 months based on our assets and liabilities as of December 31, 2022 (dollar amounts in thousands):
+Added: Changes in Interest Rates (basis points) Changes in Adjusted Net Interest Income (1)
+200 $ (14,638)
+100 $ (7,443)
−Removed: Interest rate changes may also impact our net book value as our assets and related hedge derivatives, if any, are marked-to-market each quarter.
+Added: (1) Represents a non-GAAP financial measure.
+Added: See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations — Non-GAAP Financial Measures" in this Annual Report on Form 10-K for a reconciliation of the Company's non-GAAP financial measures to their most directly comparable GAAP measure.
+Added: Interest rate changes may also impact our GAAP book value and adjusted book value as our assets and related hedge derivatives, if any, are marked-to-market each quarter.
Generally, as interest rates increase, the value of our mortgage assets decreases, and conversely, as interest rates decrease, the value of such investments will increase.
−Removed: In general, we expect that, over time, decreases in the value of our portfolio attributable to interest rate changes will be offset, to the degree we are hedged, by increases in the value of our interest rate swaps or other financial instruments used for hedging purposes, and vice versa.
+Added: In general, we expect that, over time, decreases in the value of our portfolio attributable to interest rate changes may be offset, to the degree we are hedged, by increases in the value of our interest rate swaps or other financial instruments used for hedging purposes, and vice versa.
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, which has been the subject of recent reform.
+Added: The interest rates for certain of our investments and our subordinated debt are either explicitly or indirectly based on LIBOR, which has been the subject of recent reform.
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 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.
−Removed: Our net interest income, the fair value of our assets and our financing activities could be negatively affected by volatility in interest rates.
+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 trustee of our subordinated debt 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, as was the case throughout much of 2022.
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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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 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.
+Added: 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.
We took a number of decisive actions in response to these conditions, including the sale of assets and termination of our interest rate swaps.
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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 also 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 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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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 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.
−Removed: 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.
−Removed: 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.
+Added: Concern surrounding the ongoing COVID-19 pandemic and certain of the actions taken to reduce its spread caused and may in the future, with respect to COVID-19 or other pandemics or global health emergencies, 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.
+Added: Similarly, current inflationary pressures have caused, and a possible economic recession in the U.S.
+Added: in the next 12 months will cause, an increase in the credit risk of our credit sensitive assets.
+Added: Although we did not see an increase in forbearance and delinquency rates in our portfolio during the year ended December 31, 2022, we would expect delinquencies, defaults and requests for forbearance arrangements to rise should savings, incomes and revenues of borrowers, operating partners and other businesses become increasingly constrained from inflation or 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 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 or 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: "Risk Factors" and Item 7.
−Removed: “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.
We purchase certain residential loans at a discount to par, reflecting a perceived higher risk of default.
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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, including joint venture equity investments in multi-family apartment communities.
+Added: In addition, we are exposed to credit risk in our single-family rental property investments and preferred equity, mezzanine loan and equity investments in owners of 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.
−Removed: The Company monitors the performance and credit quality of the underlying assets that serve as collateral for its investments.
+Added: The Company monitors the performance and credit quality of the underlying assets in which it invests or that serve as collateral for its investments.
In connection with these types of investments by us in multi-family properties, the procedures for ongoing monitoring include financial statement analysis and regularly scheduled site inspections of portfolio properties to assess property physical condition, performance of on-site staff and competitive activity in the sub-market.
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For certain of our credit sensitive assets, fair values may only be derived or estimated for these investments using various valuation techniques, such as computing the present value of estimated future cash flows using discount rates commensurate with the risks involved.
−Removed: However, the determination of estimated future cash flows is inherently subjective and imprecise.
−Removed: Moreover, the uncertainty over the ultimate impact that the COVID-19 pandemic will have on the global economy generally, and on our business in particular, makes any estimates and assumptions inherently less certain than they would be absent the current and potential impacts of the COVID-19 pandemic.
−Removed: The uncertainties stemming from the pandemic created unprecedented illiquidity and volatility in the financial markets.
+Added: However, the determination of estimated future cash flows is inherently subjective and imprecise and extremely volatile periods or disruptions in the market, such as during the severe market disruption that occurred in 2020 or the current volatile market environment, make such estimates and assumptions inherently less certain.
As a result, we believe our market value (fair value) risk has significantly increased.
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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 investment portfolio as of December 31, 2021, 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 portfolio as of December 31, 2022, 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, 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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Therefore, actual results are likely to vary from modeled results.
−Removed: Fair Value Changes
−Removed: Changes in Interest Rates Changes in Fair Value Net Duration
+Added: Changes in Interest Rates Changes in Fair Value (1)
+Added: Net Duration (1)
(basis points) (dollar amounts in thousands)
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-100 $95,372 3.4
+Added: (1) Assets analyzed include residential loans, Mezzanine Lending investments, investment securities and derivatives held at fair value.
It should be noted that the model is used as a tool to identify potential risk in a changing interest rate environment but does not include any changes in portfolio composition, financing strategies, market spreads or changes in overall market liquidity.
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We seek to mitigate these risks by monitoring the debt and equity capital markets to inform our decisions on the amount, timing, and terms of capital we raise.
−Removed: The ongoing COVID-19 pandemic has resulted in volatility that has been extreme at times in a variety of global markets, including the U.S.
−Removed: financial, mortgage and real estate markets.
−Removed: 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.
−Removed: 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.
+Added: Based on the currently uncertain market environment, we expect the capital markets 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.