Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 8 of this Annual Report on Form 10-K.
GENERAL
We are a specialty finance company that invests in and finances residential mortgage assets. We invest, on a leveraged basis, in residential whole loans, residential mortgage-backed securities, MSR-related assets and other real estate assets. Through certain of our subsidiaries, we also originate and service business purpose loans for real estate investors. Our principal business objective is to deliver shareholder value through the generation of distributable income and through asset performance linked to residential mortgage credit fundamentals. We selectively invest in residential mortgage assets with a focus on credit analysis, projected prepayment rates, interest rate sensitivity and expected return. We are an internally-managed real estate investment trust.
At December 31, 2021, we had total assets of approximately $9.1 billion, of which $7.9 billion, or 87%, represented residential whole loans acquired through interests in certain trusts established to acquire the loans or originated by Lima One. Our Purchased Performing Loans, which as of December 31, 2021 comprised approximately 80% of our residential whole loans, include: (i) loans to finance (or refinance) one-to-four family residential properties that are not considered to meet the definition of a “Qualified Mortgage” in accordance with guidelines adopted by the Consumer Financial Protection Bureau (or Non-QM loans), (ii) short-term business purpose loans collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit (or Rehabilitation loans or Fix and Flip loans), (iii) loans to finance (or refinance) non-owner occupied one-to-four family residential properties that are rented to one or more tenants (or Single-family rental loans), (iv) loans on investor properties that conform to the standards for purchase by a federally chartered corporation, such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (or Agency eligible investor loans), and (v) previously originated loans secured by residential real estate that is generally owner occupied (or Seasoned performing loans). In addition, at December 31, 2021, we had approximately $256.7 million in investments in Securities, at fair value, which represented approximately 3% of our total assets. At such date, our Securities, at fair value included MSR-related assets and CRT securities. Our MSR-related assets include term notes whose cash flows are considered to be largely dependent on MSR collateral and loan participations to provide financing to mortgage originators that own MSRs. Our remaining investment-related assets, which represent approximately 4% of our total assets at December 31, 2021, were primarily comprised of REO, capital contributions made to loan origination partners, other interest-earning assets, and loan-related receivables.
The results of our business operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income and the market value of our assets, which is driven by numerous factors, including the supply and demand for residential mortgage assets in the marketplace, the terms and availability of adequate financing, general economic and real estate conditions (both on a national and local level), the impact of government actions in the real estate and mortgage sector, and the credit performance of our credit sensitive residential mortgage assets. Changes in these factors, or uncertainty in the market regarding the potential for changes in these factors, can result in significant changes in the value and/or performance of our investment portfolio. Further, our GAAP results may be impacted by market volatility, resulting in changes in market values of certain financial instruments for which changes in fair value are recorded in net income each period, such as certain residential whole loans and CRT securities. Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds, the behavior of which involves various risks and uncertainties. Interest rates and CPRs (which is an annualized measure of the amount of unscheduled principal prepayments on an asset as a percentage of the asset balance), vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. Our financial results are impacted by estimates of credit losses that are required to be recorded when loans that are not accounted for at fair value through net income are acquired or originated, as well as changes in these credit loss estimates that will be required to be made periodically.
With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of certain of our residential mortgage assets and, correspondingly, our stockholders’ equity to decline; (iii) coupons on our adjustable-rate assets to reset, on a delayed basis, to higher interest rates; (iv) prepayments on our assets to decline, thereby slowing the amortization of purchase premiums and the accretion of our purchase discounts, and slowing our ability to redeploy capital to generally higher yielding investments; and (v) the value of our derivative hedging instruments, if any, and, correspondingly, our stockholders’ equity to increase. Conversely, decreases in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to decrease; (ii) the value
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of certain of our residential mortgage assets and, correspondingly, our stockholders’ equity to increase; (iii) coupons on our adjustable-rate assets, on a delayed basis, to lower interest rates; (iv) prepayments on our assets to increase, thereby accelerating the amortization of purchase premiums and the accretion of our purchase discounts, and accelerating the redeployment of our capital to generally lower yielding investments; and (v) the value of our derivative hedging instruments, if any, and, correspondingly, our stockholders’ equity to decrease. In addition, our borrowing costs and credit lines are further affected by the type of collateral we pledge and general conditions in the credit market.
Our investments in residential mortgage assets expose us to credit risk, meaning that we are generally subject to credit losses due to the risk of delinquency, default and foreclosure on the underlying real estate collateral. Our investment process for credit sensitive assets focuses primarily on quantifying and pricing credit risk. With respect to investments in Purchased Performing Loans, we believe that sound underwriting standards, including low LTVs at origination, significantly mitigate our risk of loss. Further, we believe the discounted purchase prices paid on Purchased Non-performing and Purchased Credit Deteriorated Loans mitigate our risk of loss in the event that, as we expect on most such investments, we receive less than 100% of the par value of these investments.
Premiums arise when we acquire an MBS at a price in excess of the aggregate principal balance of the mortgages securing the MBS (i.e., par value) or when we acquire residential whole loans at a price in excess of their aggregate principal balance Conversely, discounts arise when we acquire an MBS at a price below the aggregate principal balance of the mortgages securing the MBS or when we acquire residential whole loans at a price below their aggregate principal balance. Accretable purchase discounts on these investments are accreted to interest income. Premiums paid to purchase loans, primarily on certain of our Non-QM loans, business purpose loans and Agency eligible investor loans, are amortized against interest income over the life of the investment using the effective yield method, adjusted for actual prepayment activity. An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase premiums, thereby reducing the interest income earned on these assets.
CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. In particular, CPR reflects the conditional prepayment rate, which measures voluntary prepayments of a loan, and the conditional default rate (or CDR) measures involuntary prepayments resulting from defaults. CPRs on our residential mortgage securities and whole loans may differ significantly. For the year ended December 31, 2021, the average CPRs on certain of our loan portfolios were: 35.3% for Non-QM loans, 24.2% for Single-family rental loans, 17.4% for Purchased Credit Deteriorated loans, and 16.3% for Purchased Non-Performing loans.
It is generally our business strategy to hold our residential mortgage assets as long-term investments. On at least a quarterly basis, excluding investments for which the fair value option has been elected or for which specialized loan accounting is otherwise applied, we assess our ability and intent to continue to hold each asset and, as part of this process, we monitor our investments in securities that are designated as AFS for impairment. A change in our ability and/or intent to continue to hold any of these securities that are in an unrealized loss position, or a deterioration in the underlying characteristics of these securities, could result in our recognizing future impairment charges or a loss upon the sale of any such security.
Our residential mortgage investments have longer-term contractual maturities than our non-securitization related financing liabilities. Even though the majority of our investments have interest rates that adjust over time based on short-term changes in corresponding interest rate indices (typically following an initial fixed-rate period for our Hybrids), the interest rates we pay on our borrowings will typically change at a faster pace than the interest rates we earn on our investments. In order to reduce this interest rate risk exposure, we may enter into derivative instruments, which currently include Swaps and short positions in to be announced (or TBA) securities.
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Recent Market Conditions and Our Strategy
At December 31, 2021, our residential mortgage asset portfolio, which includes residential whole loans and REO, and Securities, at fair value, was approximately $8.3 billion compared to $6.0 billion at December 31, 2020.
The following table presents the activity for our residential mortgage asset portfolio for the year ended December 31, 2021:
(In Millions) December 31, 2020 Runoff (1)
Acquisitions (2)
Other (3)
December 31, 2021 Change
Residential whole loans and REO $ 5,575 $ (2,167) $ 4,593 $ 68 $ 8,069 $ 2,494
Securities, at fair value 400 (157) — 14 257 (143)
Totals $ 5,975 $ (2,324) $ 4,593 $ 82 $ 8,326 $ 2,351
(1) Primarily includes principal repayments and sales of REO.
(2) Includes draws on previously originated Rehabilitation loans.
(3) Primarily includes changes in fair value and changes in the allowance for credit losses.
At December 31, 2021, our total recorded investment in residential whole loans and REO was $8.1 billion, or 96.9% of our residential mortgage asset portfolio. Of this amount, $6.3 billion are Purchased Performing Loans, $525.0 million are Purchased Credit Deteriorated Loans and $1.1 billion are Purchased Non-performing Loans. Loan acquisition activity of $4.6 billion during 2021 included $2.2 billion of Non-QM loans, $1.3 billion of business purpose loans (including draws on Rehabilitation loans), and $1.1 billion of Agency eligible investor loans. During 2021, we recognized approximately $303.5 million of residential whole loan interest income on our consolidated statements of operations, representing an effective yield of 5.26%, with Purchased Performing Loans generating an effective yield of 4.35%, Purchased Credit Deteriorated Loans generating an effective yield of 6.56% and Purchased Non-performing Loans generating an effective yield of 8.39%. In addition, all of our Purchased Non-performing Loans and certain of our Purchased Performing Loans are measured at fair value as a result of the election of the fair value option at acquisition. Included in earnings in other income, net are net gains on these loans of $16.7 million for the year ended December 31, 2021. At December 31, 2021 and 2020, we had REO with an aggregate carrying value of $156.2 million and $249.7 million, respectively, which is included in Other assets on our consolidated balance sheets.
In response to the financial impact of COVID-19 on borrowers, and in compliance with various federal and state guidelines, starting in the first quarter of 2020, we offered short-term relief to certain borrowers who were contractually current at the time the pandemic started to impact the economy. Under the terms of such plans, for certain borrowers a deferral plan was entered into where missed payments were deferred to the maturity of the related loan, with a corresponding change to the loan’s next payment due date. In addition, certain borrowers were granted up to a seven-month “zero pay” forbearance with payments required to resume at the conclusion of the plan. For these borrowers, delinquent payments were permitted to be placed on specified repayment plans. While the majority of the borrowers granted relief have resumed making payments at the conclusion of such deferral and forbearance periods, certain borrowers, particularly in our Non-QM loan portfolio, continue to be impacted financially by COVID-19 and have not yet resumed payments. When these borrowers became more than 90 days delinquent on payments, any interest income receivable related to the associated loans was reversed in accordance with our non-accrual policies. At December 31, 2021, Non-QM loans with an unpaid principal balance of $94.8 million, or 2.8% of the portfolio, were more than 90 days delinquent. For these and other borrowers that have been impacted by COVID-19, we are continuing to evaluate loss mitigation options with respect to these loans, including forbearance, repayment plans, loan modification and foreclosure. In addition, at December 31, 2021, Rehabilitation Loans with an unpaid principal balance of $103.0 million, or 14.1% of the portfolio, were more than 90 days delinquent. Because rehabilitation loans are shorter term and repayment is usually dependent on completion of the rehabilitation project and sale of the property, the strategy to resolve delinquent rehabilitation loans differs from owner occupied loans. Consequently, forbearance and repayment plans are offered less frequently. However, we seek to work with delinquent rehabilitation loan borrowers whose projects are close to completion or are listed for sale in order to provide the borrower the opportunity to sell the property and repay our loan. In circumstances where the borrower is not able to complete the project or we are not able to work with the borrower to our mutual benefit, we pursue foreclosure or other forms of resolution.
At December 31, 2021, our Securities, at fair value totaled $256.7 million and included $153.8 million of MSR-related assets and $102.9 million of CRT securities. The net yield on our Securities, at fair value was 22.95% for 2021, compared to 6.16% for 2020. The increase in the net yield on our Securities, at fair value portfolio primarily reflects accretion income of approximately $20.5 million recognized during 2021 due to the redemption of MSR-related assets that had been held at amortized cost basis below par due to impairment charges recorded in the first quarter of 2020, and $8.1 million of accretion recognized during 2021 on the redemption of a Non-Agency MBS security that had been previously purchased at a discount.
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We adopted the accounting standard addressing the measurement of credit losses on financial instruments (CECL) on January 1, 2020 for loans on which we do not elect the fair value option at the time of acquisition. CECL requires that reserves for credit losses be estimated at the reporting date based on expected cash flows for the life of the loan or financial asset, including anticipated prepayments and reasonable and supportable forecasts of future economic conditions. For 2021, we recorded a reversal of provision for credit losses on residential whole loans held at carrying value of $44.9 million. The reversal for the period primarily reflects run-off of loans held at carrying value and adjustments to certain macroeconomic and loan prepayment speed assumptions used in our credit loss forecasts. The total allowance for credit losses recorded on residential whole loans held at carrying value at December 31, 2021 was $39.4 million. In addition, as of December 31, 2021, CECL reserves for credit losses totaling approximately $205,000 were recorded related to undrawn commitments on loans held at carrying value.
During 2021, we continued to execute on our strategy of entering into more durable forms of financing by completing eight securitizations consisting of $2.6 billion of residential whole loans.
Our GAAP book value per common share was $4.78 as of December 31, 2021. Book value per common share increased from $4.54 as of December 31, 2020. Economic book value per common share, a non-GAAP financial measure of our financial position that adjusts GAAP book value by the amount of unrealized mark-to-market gains on our residential whole loans and securitized debt held at carrying value, was $5.15 as of December 31, 2021, an increase from $4.91 as of December 31, 2020. Increases in GAAP and Economic book value during 2021 reflect GAAP earnings in excess of dividends declared and fair value increases for our Residential whole loans at carrying value. For additional information regarding the calculation of Economic book value per share, including a reconciliation to GAAP book value per share, refer to page 58 under the heading “Economic Book Value.”
Completion of Lima One Acquisition:
On July 1, 2021, we completed the previously announced acquisition from affiliates of Magnetar Capital of their ownership interests in Lima One. In connection with this transaction, we also acquired from certain members of Lima One management their ownership interests in the company. We now own 100% of Lima One, and the financial results of Lima One are included in our consolidated financial results from the date of the transaction closing.
For more information regarding market factors which impact our portfolio, see Part I, Item 1A. “Risk Factors” and Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” of this Annual Report on Form 10-K.
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Information About Our Assets
The table below presents certain information about our asset allocation at December 31, 2021:
ASSET ALLOCATION
(Dollars in Millions) Purchased Performing Loans (1)
Purchased Credit Deteriorated Loans (2)
Purchased Non-Performing Loans Securities, at fair value Real Estate Owned Other,
net (3)
Total
Fair Value/Carrying Value $ 6,316 $ 525 $ 1,072 $ 257 $ 156 $ 595 $ 8,921
Financing Agreements with Non-mark-to-market Collateral Provisions (589) (126) (214) — (11) — (940)
Financing Agreements with Mark-to-market Collateral Provisions (2,152) (100) (139) (159) (12) — (2,562)
Less Securitized Debt (2,103) (195) (331) — (21) — (2,650)
Less Convertible Senior Notes — — — — — (226) (226)
Net Equity Allocated $ 1,472 $ 104 $ 388 $ 98 $ 112 $ 369 $ 2,543
Debt/Net Equity Ratio (4)
3.3 x 4.0 x 1.8 x 1.6 x 0.4 x 2.5 x
(1) Includes $3.5 billion of Non-QM loans, $728.0 million of Rehabilitation loans, $949.8 million of Single-family rental loans, $102.0 million of Seasoned performing loans, and $1.1 billion of Agency eligible investor loans. At December 31, 2021, the total fair value of these loans is estimated to be approximately $6.4 billion.
(2) At December 31, 2021, the total fair value of these loans is estimated to be approximately $624.0 million.
(3) Includes $304.7 million of cash and cash equivalents, $99.8 million of restricted cash, and $71.7 million of capital contributions made to loan origination partners, as well as other assets and other liabilities.
(4) Total Debt/Net Equity ratio represents the sum of borrowings under our financing agreements noted above as a multiple of net equity allocated.
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Residential Whole Loans
The following table presents the contractual maturities of our residential whole loan portfolios at December 31, 2021. Amounts presented do not reflect estimates of prepayments or scheduled amortization.
(In Thousands) Purchased
Performing Loans (1)
Purchased Credit
Deteriorated Loans (2)
Purchased Non-Performing Loans
Amount due:
Within one year $ 431,173 $ 1,109 $ 4,066
After one year:
Over one to five years 331,900 2,861 3,812
Over five years 5,569,332 543,802 1,064,392
Total due after one year $ 5,901,232 $ 546,663 $ 1,068,204
Total residential whole loans $ 6,332,405 $ 547,772 $ 1,072,270
(1) Excludes an allowance for credit losses of $16.7 million at December 31, 2021.
(2) Excludes an allowance for credit losses of $22.8 million at December 31, 2021.
The following table presents, at December 31, 2021, the dollar amount of certain of our residential whole loans, contractually maturing after one year, and indicates whether the loans have fixed interest rates or adjustable interest rates:
(In Thousands) Purchased
Performing Loans (1)(2)
Purchased Credit
Deteriorated Loans (1)(3)
Purchased Non-Performing Loans (1)
Interest rates:
Fixed $ 4,253,384 $ 444,163 $ 835,125
Adjustable 1,647,848 102,500 233,079
Total $ 5,901,232 $ 546,663 $ 1,068,204
(1) Includes loans on which borrowers have defaulted and are not making payments of principal and/or interest as of December 31, 2021.
(2) Excludes an allowance for credit losses of $16.7 million at December 31, 2021.
(3) Excludes an allowance for credit losses of $22.8 million at December 31, 2021.
For additional information regarding our residential whole loan portfolios, see Note 3 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K.
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Securities, at Fair Value
The following table presents information with respect to our Securities, at fair value at December 31, 2021 and December 31, 2020:
(Dollars in Thousands) December 31, 2021 December 31, 2020
MSR-Related Assets
Face/Par $ 154,350 $ 249,769
Fair Value 153,771 238,999
Amortized Cost 121,376 184,908
Weighted average yield (1)
10.30 % 12.30 %
Weighted average time to maturity 1.7 years 8.7 years
CRT Securities
Face/Par $ 99,999 $ 104,031
Fair Value 102,914 104,234
Amortized Cost 86,643 86,214
Weighted average yield 10.52 % 7.37 %
Weighted average time to maturity 18.5 Years 19.7 years
RPL/NPL MBS
Face/Par $ — $ 54,998
Fair Value — 53,946
Amortized Cost — 46,862
Weighted average yield — % 7.55 %
Weighted average time to maturity N/A 28.7 years
(1) Weighted average yield is annualized interest income divided by average amortized cost for MSR-related assets held at December 31, 2021.
Tax Considerations
Current period estimated taxable income
We estimate that for 2021, our REIT taxable income was approximately $72.2 million. We have until the filing of our 2021 tax return (due not later than October 17, 2022) to declare the distribution of any 2021 REIT taxable income not previously distributed.
Key differences between GAAP net income and REIT Taxable Income
Residential Whole Loans and Securities
The determination of taxable income attributable to residential whole loans and securities is dependent on a number of factors, including principal payments, defaults, loss mitigation efforts and loss severities. In estimating taxable income for such investments during the year, management considers estimates of the amount of discount expected to be accreted. Such estimates require significant judgment and actual results may differ from these estimates.
Potential timing differences can arise with respect to the accretion of discount and amortization of premium into income as well as the recognition of gain or loss for tax purposes as compared to GAAP. For example: a) while our REIT uses fair value accounting for GAAP in some instances, it generally is not used for purposes of determining taxable income; b) impairments generally are not recognized by us for income tax purposes until the asset is written-off or sold; c) capital losses may only be recognized by us to the extent of its capital gains; capital losses in excess of capital gains generally are carried over
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by us for potential offset against future capital gains; and d) tax hedge gains and losses resulting from the termination of interest rate swaps by us generally are amortized over the remaining term of the swap.
Securitization
Generally, securitization transactions for GAAP and tax can be characterized as either sales or financings, depending on transaction type, structure and available elections. For GAAP purposes, our securitizations have been treated as on-balance sheet financing transactions. For tax purposes, they have been characterized as both financing and sale transactions.
Where a securitization has been characterized as a sale, gain or loss is recognized for tax purposes. In addition, we own or may in the future acquire interests in securitization and/or re-securitization trusts, in which several of the classes of securities are or will be issued with original issue discount (or OID). As the holder of the retained interests in the trust, for tax purposes we generally will be required to include OID in our current gross interest income over the term of the applicable securities as the OID accrues. The rate at which the OID is recognized into taxable income is calculated using a constant rate of yield to maturity, with realized losses impacting the amount of OID recognized in REIT taxable income once they are actually incurred. REIT taxable income may be recognized in excess of economic income (i.e., OID) or in advance of the corresponding cash flow from these assets, thereby affecting our dividend distribution requirement to stockholders.
For securitization and/or re-securitization transactions that were treated as a sale of the underlying collateral for tax purposes, the unwinding of any such transaction will likely result in taxable income or loss. Given that securitization and re-securitization transactions are typically accounted for as financing transactions for GAAP purposes, such income or loss is not likely to be recognized for GAAP. As a result, the income recognized from securitization and re-securitization transactions may differ for tax and GAAP purposes.
Whether our investments are held by our REIT or one of its Taxable REIT Subsidiaries (TRS)
We estimate that for 2021, our gross TRS taxable income will be $79.8 million and that we will utilize $72.7 million of net operating loss; resulting in net TRS taxable income of $7.1 million Net income generated by our TRS subsidiaries is included in consolidated GAAP net income, but may not be included in REIT taxable income in the same period. REIT taxable income generally does not include taxable income of the TRS unless and until it is distributed to the REIT. For example, because our securitization transactions that are treated as a sale for tax purposes are undertaken by a domestic TRS, any gain or loss recognized on the sale is not included in our REIT taxable income until it is distributed by the TRS. Similarly, the income earned from loans, securities, REO and other investments held by our domestic TRS is excluded from REIT taxable income until it is distributed by the TRS. Net income of our foreign domiciled TRS subsidiaries is included in REIT taxable income as if distributed to the REIT in the taxable year it is earned by the foreign domiciled TRS.
Consequently, our REIT taxable income calculated in a given period may differ significantly from our GAAP net income.
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Results of Operations
In this section, we discuss the results of our operations for the year ended December 31, 2021 compared to the year ended December 31, 2020. For a discussion related to our results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, please refer to Part II, Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the Year Ended December 31, 2020, which was filed with the SEC on February 23, 2021, and is available on the SEC’s website at www.sec.gov and on our website at www.mfafinancial.com.
Year Ended December 31, 2021 Compared to the Year Ended December 31, 2020
General
For 2021, we had a net income available to our common stock and participating securities of $296.0 million, or $0.67 per basic common share and $0.66 diluted common share, compared to a net loss available to common stock and participating securities for 2020 of $709.2 million, or $1.57 per basic and diluted common share. The prior period results were significantly impacted by the unprecedented disruption in residential mortgage markets due to concerns related to COVID-19 that required management to take actions to bolster and stabilize our balance sheet, improve our liquidity position and renegotiate the financing associated with our remaining investments. The actions included disposing our Agency and Legacy Non-Agency MBS portfolios, substantially reducing our investments in MSR-related assets and CRT securities, and sales of certain residential whole loans. In addition, as we had entered into forbearance agreements with the majority of our remaining lenders that were in place for most of the second quarter of 2020, our financing costs were dramatically increased during this period. Asset disposals resulted in net realized losses for the year ended December 31, 2020 totaling $188.8 million. Further, during the year ended December 31, 2020, we recorded impairment losses on certain residential mortgage securities and other assets of $425.1 million, recorded losses totaling $57.0 million on terminated Swaps that had previously been designated as hedges for accounting purposes, expenses totaling $25.3 million on the early payment of a senior secured credit agreement and $10.5 million of net unrealized losses on residential mortgage securities measured at fair value through earnings. These losses were partially offset by $20.8 million in net gains on residential whole loans measured at fair value through earnings. During the year ended December 31, 2020, we also recorded a provision for credit losses on residential whole loans and other financial assets of $22.4 million and incurred $44.4 million of professional services and other costs in connection with negotiating and exiting forbearance arrangements with our lenders. Accordingly, the increase in net income available to common stock and participating securities in 2021 over 2020 primarily reflects higher Other income, which in 2021 includes $38.9 million of gains recorded in connection with Lima One purchase accounting and a gain of $34.0 million from the reversal of prior period impairments, while the prior period was characterized by the significant losses discussed above. In addition, Net Interest Income was also significantly higher in 2021, as funding costs significantly decreased in the period after we exited forbearance and due to the increased use of securitization funding. Further, the current period results include a net reversal of provision for credit losses on residential whole loans held at carrying value, compared to a net provision in the prior year and lower operating and other expenses as the prior year period included significant professional services costs associated with restructuring and our forbearance agreements.
Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned or paid. Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our investments. Interest rates and CPRs (which measure the amount of unscheduled principal prepayment on a bond or loan as a percentage of its unpaid balance) vary according to the type of investment, conditions in the financial markets and other factors, none of which can be predicted with any certainty.
The changes in average interest-earning assets and average interest-bearing liabilities and their related yields and costs are discussed in greater detail below under “Interest Income” and “Interest Expense.”
For 2021, our net interest spread and margin were 2.81% and 3.58%, respectively, compared to a net interest spread and margin of 0.87% and 1.94%, respectively, for 2020. Our net interest income increased by $77.8 million, or 47.4%, to $241.9 million from $164.1 million for 2020. For 2021, net interest income includes higher net interest income from our residential whole loan portfolio of approximately $57.2 million compared to 2020, primarily due to lower financing costs and higher yields, partially offset by lower average balances invested in these assets. In addition, interest expense for 2021 included $6.0 million of interest expense related to 8.00% Senior Notes due 2042 (or Senior Notes) that were redeemed in January of 2021
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but were outstanding during all of 2020. Net interest income for our Securities, at fair value portfolio increased by approximately $1.9 million compared to 2020, primarily due to a higher yield earned on these assets due to the early redemption at par of several securities during the current year period and lower financing costs, offset by lower average amounts invested in these securities due to portfolio sales in the first and second quarters of 2020.
Analysis of Net Interest Income
The following table sets forth certain information about the average balances of our assets and liabilities and their related yields and costs for the years ended December 31, 2021 and 2020 . Average yields are derived by dividing interest income by the average amortized cost of the related assets, and average costs are derived by dividing interest expense by the daily average balance of the related liabilities, for the periods shown. The yields and costs include premium amortization and purchase discount accretion which are considered adjustments to interest rates.
For the Year Ended December 31,
2021 2020
Average Balance Interest Average Yield/Cost Average Balance Interest Average Yield/Cost
(Dollars in Thousands)
Assets:
Interest-earning assets:
Residential whole loans $ 5,767,655 $ 303,468 5.26 % $ 6,395,581 $ 332,212 5.19 %
Securities, at fair value (1)(2)
246,978 56,690 22.95 1,461,819 90,094 6.16
Cash and cash equivalents (3)
715,529 344 0.05 502,598 676 0.13
Other interest-earning assets 20,100 1,800 8.96 102,447 9,850 9.61
Total interest-earning assets 6,750,262 362,302 5.37 8,462,445 432,832 5.11
Total non-interest-earning assets 669,455 657,551
Total assets $ 7,419,717 $ 9,119,996
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Collateralized financing agreements (4)(5)
$ 2,565,064 $ 67,766 2.64 % $ 5,067,511 $ 202,049 3.99 %
Securitized debt (6)
1,902,913 36,831 1.94 725,200 23,749 3.27
Convertible Senior Notes 225,768 15,668 6.94 224,462 15,581 6.94
Senior Notes (7)
1,096 120 8.31 96,894 11,138 8.31
Senior secured credit agreement — — — 147,643 16,241 11.00
Total interest-bearing liabilities 4,694,841 120,385 2.56 6,261,710 268,758 4.24
Total non-interest-bearing liabilities 169,399 127,349
Total liabilities 4,864,240 6,389,059
Stockholders’ equity 2,555,477 2,730,937
Total liabilities and stockholders’ equity $ 7,419,717 $ 9,119,996
Net interest income/net interest rate spread (8)
$ 241,917 2.81 % $ 164,074 0.87 %
Net interest-earning assets/net interest margin (9)
$ 2,055,421 3.58 % $ 2,200,735 1.94 %
(1) Yields presented throughout this Annual Report on Form 10-K are calculated using average amortized cost data for securities which excludes unrealized gains and losses and includes principal payments receivable on securities. For GAAP reporting purposes, purchases and sales are reported on the trade date. Average amortized cost data used to determine yields is calculated based on the settlement date of the associated purchase or sale as interest income is not earned on purchased assets and continues to be earned on sold assets until settlement date.
(2) The net yield of 22.95% includes $20.5 million of accretion income recognized in 2021, due to the redemption of MSR-related assets that had been held at amortized cost basis below par due to impairment charges recorded in the first quarter of 2020; and $8.1 million of accretion recognized during 2021 on the redemption of a Non-Agency MBS security that was purchased at a discount. Excluding this accretion, the yield reported would have been 11.38%.
(3) Includes average interest-earning cash, cash equivalents and restricted cash.
(4) Collateralized financing agreements include the following: Secured term notes, Non-mark-to-market term-asset based financing, and repurchase agreements. For additional information, see Note 6, included under Item 8 of this Annual Report on Form 10-K.
(5) Average cost of repurchase agreements in the prior year period includes the cost of Swaps allocated based on the proportionate share of the overall estimated weighted average portfolio duration.
(6) Includes both Securitized debt, at carrying value and Securitized debt, at fair value.
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(7) Interest expense for 2020 includes a non-cash charge of $3.1 million recorded in the connection with the redemption of these notes that was completed early in 2021. The yield presented for the period excludes the impact of that charge.
(8) Net interest rate spread reflects the difference between the yield on average interest-earning assets and average cost of funds.
(9) Net interest margin reflects net interest income divided by average interest-earning assets.
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates (yield/cost) and changes in the volume (average balance) of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) the changes attributable to changes in volume (changes in average balance multiplied by prior rate); (ii) the changes attributable to changes in rate (changes in rate multiplied by prior average balance); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately, based on absolute values, to the changes due to rate and volume.
Year Ended December 31, 2021
Compared to
Year Ended December 31, 2020
Increase/(Decrease) due to Total Net Change in Interest Income/Expense
(In Thousands) Volume Rate
Interest-earning assets:
Residential whole loans $ (33,145) $ 4,401 $ (28,744)
Securities, at fair value (122,502) 89,098 (33,404)
Cash and cash equivalents 193 (525) (332)
Other interest-earning assets (7,425) (625) (8,050)
Total net change in income from interest-earning assets $ (162,879) $ 92,349 $ (70,530)
Interest-bearing liabilities:
Residential whole loan financing agreements $ (49,043) $ (49,240) $ (98,283)
Securities, at fair value repurchase agreements (23,786) (11,471) (35,257)
REO financing agreements 471 — 471
Other repurchase agreements (607) (607) (1,214)
Securitized debt 25,888 (12,806) 13,082
Convertible Senior Notes and Senior Notes (9,201) (1,730) (10,931)
Senior secured credit agreement (8,121) (8,120) (16,241)
Total net change in expense of interest-bearing liabilities $ (64,399) $ (83,974) $ (148,373)
Net change in net interest income $ (98,480) $ 176,323 $ 77,843
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The following table presents certain quarterly information regarding our net interest spread and net interest margin for the quarterly periods presented:
Total Interest-Earning Assets and Interest-
Bearing Liabilities
Quarter Ended Net Interest Spread (1)
Net Interest Margin (2)
December 31, 2021 2.98 % 3.60 %
September 30, 2021 2.98 3.70
June 30, 2021 3.02 3.86
March 31, 2021 2.31 3.29
December 31, 2020 1.51 2.41
September 30, 2020 0.27 1.59
June 30, 2020 (0.88) 0.81
March 31, 2020 2.05 2.70
(1) Reflects the difference between the yield on average interest-earning assets and average cost of funds.
(2) Reflects annualized net interest income divided by average interest-earning assets.
The following table presents the components of the net interest spread earned on our Residential whole loans for the quarterly periods presented:
Quarter Ended
December 31, 2021 September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020 June 30, 2020 March 31, 2020
Purchased Performing Loans
Net Yield (1)
4.12 % 4.56 % 4.45 % 4.41 % 4.57 % 4.58 % 5.17 % 5.10 %
Cost of Funding (2)
2.19 % 2.14 % 2.09 % 2.46 % 2.77 % 3.42 % 6.34 % 3.59 %
Net Interest Spread (3)
1.93 % 2.42 % 2.36 % 1.95 % 1.80 % 1.16 % (1.17) % 1.51 %
Purchased Credit Deteriorated Loans
Net Yield (1)
7.15 % 7.08 % 7.17 % 5.00 % 5.16 % 4.89 % 5.07 % 4.84 %
Cost of Funding (2)
2.23 % 2.18 % 2.39 % 2.86 % 3.02 % 3.22 % 6.03 % 3.39 %
Net Interest Spread (3)
4.92 % 4.90 % 4.78 % 2.14 % 2.14 % 1.67 % (0.96) % 1.45 %
Purchased Non-Performing Loans
Net Yield (1)
9.83 % 8.81 % 7.98 % 7.13 % 7.06 % 5.99 % 5.42 % 7.54 %
Cost of Funding (2)
2.51 % 2.43 % 2.71 % 3.41 % 3.57 % 3.78 % 5.55 % 3.60 %
Net Interest Spread (3)
7.32 % 6.38 % 5.27 % 3.72 % 3.49 % 2.21 % (0.13) % 3.94 %
Total Residential Whole Loans
Net Yield (1)
5.08 % 5.52 % 5.48 % 5.03 % 5.13 % 4.89 % 5.20 % 5.45 %
Cost of Funding (2)
2.23 % 2.20 % 2.25 % 2.70 % 2.97 % 3.47 % 6.15 % 3.58 %
Net Interest Spread (3)
2.85 % 3.32 % 3.23 % 2.33 % 2.16 % 1.42 % (0.95) % 1.87 %
(1) Reflects annualized interest income on Residential whole loans divided by average amortized cost of Residential whole loans. Excludes servicing costs.
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(2) Reflects annualized interest expense divided by average balance of repurchase agreements, agreements with non-mark-to-market collateral provisions, and securitized debt. Total Residential whole loans cost of funding includes six basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarter ended March 31, 2020. Cost of funding for the quarter ended June 30, 2020 includes the impact of amortization of $12.5 million of losses previously recorded in OCI related to Swaps unwound during the quarter ended March 31, 2020 that had been previously designated as hedges for accounting purposes. The amortization of these losses increased the funding cost by 116 basis points for Purchased Performing Loans, 107 basis points for Purchased Credit Deteriorated Loans, 77 basis points for Purchased Non-performing Loans, and 108 basis points for total Residential whole loans during the quarter ended June 30, 2020. At June 30, 2020, following the closing of certain financing transactions and our exit from forbearance arrangements, and an evaluation of our anticipated future financing transactions, $49.9 million of unamortized losses on Swaps previously designated as hedges for accounting purposes was transferred from OCI to earnings, as it was determined that certain financing transactions that were previously expected to be hedged by these Swaps were no longer probable of occurring. In addition, cost of funding for the quarter ended June 30, 2020 was significantly higher than for prior periods as it reflects default interest and/or higher rates charged by lenders while we were under a forbearance agreement. During the quarter ended September 30, 2020, we transferred from AOCI to earnings approximately $7.2 million of losses on Swaps that had been previously designated as hedges for accounting purposes as we had assessed that the underlying transactions were no longer probable of occurring.
(3) Reflects the difference between the net yield on average Residential whole loans and average cost of funds on Residential whole loans.
The following table presents the components of the net interest spread earned on our residential mortgage securities and MSR-related assets for the quarterly periods presented:
Securities, at fair value
Quarter Ended Net
Yield (1)(2)
Cost of
Funding (3)
Net Interest
Rate
Spread (4)
December 31, 2021 26.28 % 1.50 % 24.78 %
September 30, 2021 18.78 1.61 17.17
June 30, 2021 24.57 1.81 22.76
March 31, 2021 22.25 2.02 20.23
December 31, 2020 10.15 2.69 7.46
September 30, 2020 9.80 3.49 6.31
June 30, 2020 8.20 5.81 2.39
March 31, 2020 5.22 2.53 2.69
(1) Reflects annualized interest income divided by average amortized cost. Impairment charges recorded on MSR-related assets resulted in a lower amortized cost basis which impacted the calculation of net yields in subsequent periods.
(2) For the quarter ended December 31, 2021, the net yield of 26.28% includes $8.1 million of accretion income recognized on the redemption at par of an MSR-related asset that had been held at amortized cost basis below par due to an impairment charge during the first quarter of 2020. Excluding this accretion, the yield reported would have been 11.37%. For the quarter ended September 30, 2021, the net yield of 18.78% includes $4.0 million of accretion income recognized on the redemption at par of an MSR-related asset that had been held at amortized cost basis below par due to an impairment charge during the first quarter of 2020. Excluding this accretion, the yield reported would have been 11.63%. For the quarter ended June 30, 2021, the net yield of 24.57% includes $8.4 million of accretion income recognized on the redemption at par of an MSR-related asset that had been held at amortized cost basis below par due to an impairment charge recorded in the first quarter of 2020. Excluding this accretion, the yield reported would have been 11.13%. For the quarter ended March 31, 2021, the net yield of 22.25% includes $8.1 million of accretion income recognized on the redemption of an RPL/NPL MBS security that was previously purchased at a discount. Excluding this accretion, the yield reported would have been 11.26%.
(3) Reflects annualized interest expense divided by average balance of repurchase agreements. Securities, at fair value cost of funding includes 26 basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarter ended March 31, 2020. Cost of funding for the quarter ended June 30, 2020 includes the impact of amortization of $1.7 million of losses previously recorded in OCI related to Swaps unwound during the quarter ended March 31, 2020 that had been previously designated as hedges for accounting purposes. The amortization of these losses increased the funding cost by 109 basis points for total Securities, at fair value during the quarter ended June 30, 2020. At June 30, 2020, following the closing of certain financing transactions and our exit from forbearance arrangements, and an evaluation of our anticipated future financing transactions, $49.9 million of unamortized losses on Swaps previously designated as hedges for accounting purposes was transferred from OCI to earnings, as it was determined that certain financing transactions that were previously expected to be hedged by these Swaps were no longer probable of occurring. In addition, during the quarter ended September 30, 2020, we transferred from AOCI to earnings approximately $7.2 million of losses on Swaps that had been previously designated as hedges for accounting purposes as we had assessed that the underlying transactions were no longer probable of occurring.
(4) Reflects the difference between the net yield on average Securities, at fair value, and average cost of funds on Securities, at fair value.
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Interest Income
Interest income on our residential whole loans decreased by $28.7 million, or 8.7%, for 2021, to $303.5 million compared to $332.2 million for 2020. This decrease primarily reflects a $627.9 million decrease in the average balance of this portfolio to $5.8 billion for 2021 from $6.4 billion for 2020, partially offset by an increase in the yield to 5.26% for 2021 from 5.19% for 2020.
Due to the previously discussed asset sales and impairment charges that primarily occurred late in the first quarter of 2020 to early in the second quarter of 2020, as well as further asset disposals and redemptions that have occurred later in 2020 and throughout 2021, the average amortized cost of our Securities, at fair value portfolio decreased $1.2 billion to $247.0 million for 2021 from $1.5 billion for 2020, and interest income on our Securities, at fair value portfolio decreased $33.4 million to $56.7 million for 2021 from $90.1 million for 2020. The net yield on our Securities, at fair value was 22.95% for 2021, compared to 6.16% for 2020. The increase in the net yield on our Securities, at fair value portfolio primarily reflects approximately $20.5 million of accretion income recognized in 2021 due to the redemption of MSR-related assets that had been held at amortized cost basis below par due to impairment charges recorded in the first quarter of 2020; and $8.1 million of accretion recognized in 2021 due to the redemption of a Non-Agency MBS that had been previously purchased at a discount.
Interest Expense
Our interest expense for 2021 decreased by $148.4 million, or 55.2%, to $120.4 million, from $268.8 million for 2020. This decrease primarily reflects a decrease in our average collateralized financing agreement borrowings to finance our residential mortgage asset portfolio and a decrease in financing rates on our financing agreements. In addition, in the prior year period we incurred interest expense of approximately $16.2 million related to the senior secured credit agreement we entered into during the second quarter of 2020. Further, 2020 included $11.1 million of interest expense related to our Senior Notes, which were redeemed in the first quarter of 2021. The effective interest rate paid on our borrowings decreased to 2.56% for 2021, from 4.24% for 2020.
Provision for Credit Losses on Residential Whole Loans Held at Carrying Value
For 2021, we recorded a reversal of provision for credit losses on residential whole loans held at carrying value of $44.9 million (which includes a reversal of provision for credit losses on undrawn commitments of $969,000) compared to a provision of $22.4 million for 2020. The reversal for the period primarily reflects run-off of loans held at carrying value and adjustments to certain macroeconomic and loan prepayment speed assumptions used in our credit loss forecasts. With respect to our residential whole loans held at carrying value, CECL requires that reserves for credit losses are estimated at the reporting date based on expected cash flows over the life of the loan or financial instrument, including anticipated prepayments and reasonable and supportable forecasts of future economic conditions.
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Other Income, net
For 2021, Other Income/(Loss), net increased by $844.7 million, to $165.1 million compared to a $679.6 million loss for 2020. The components of Other Income/(Loss), net for 2021 and 2020 are summarized in the table below:
For the Year Ended December 31,
(In Thousands) 2021 2020
Net gain on residential whole loans measured at fair value through earnings $ 16,736 $ 20,765
Gain on investment in Lima One common equity (Note 15) 38,933 —
Impairment and other gains and losses on securities available-for-sale and other assets 33,956 (425,082)
Lima One - origination, servicing and other fee income 22,600 —
Net gain on real estate owned 22,838 5,391
Net realized loss on sales of securities and residential whole loans — (188,847)
Loss on terminated swaps previously designated as hedges for accounting purposes — (57,034)
Other residential whole loan related income 4,472 4,268
Net unrealized gain/(loss) on securities, at fair value measured at fair value through earnings 1,605 (10,486)
Other 23,963 (28,544)
Total Other Income/(Loss), net $ 165,103 $ (679,569)
Operating and Other Expense
During 2021, we had compensation and benefits and other general and administrative expenses of $85.5 million, compared to $56.7 million for 2020. Compensation and benefits expense increased $22.8 million to $53.8 million for 2021, compared to $31.0 million for 2020 primarily reflecting the impact of including Lima One compensation expense in our financial results and an increase in annual bonus compensation for the current year period. The prior year period also included a provision for estimated severance costs in connection with a reduction in workforce that occurred in the third quarter of 2020. Our other general and administrative expenses increased by $6.1 million to $31.7 million for 2021 compared to $25.7 million for 2020, primarily reflecting the impact of including Lima One expenses in our financial results, increased information technology costs and higher costs associated with deferred compensation to Directors in the current year period, which were impacted by changes in our stock price. In addition, during 2020, we also incurred professional service and other costs of $44.4 million related to negotiating and exiting forbearance arrangements with our lenders.
Operating and Other Expense during 2021 also includes $30.9 million of loan servicing and other related operating expenses related to our residential whole loan activities. These expenses decreased compared to 2020 by approximately $9.5 million, or 23.5%, primarily due to lower servicing fees and non-recoverable advances on our REO portfolio and lower expenses recognized related to loan securitization activities.
In addition, Other expenses for 2021 also includes $6.6 million of amortization related to intangible assets recognized as part of the purchase accounting for the Lima One acquisition.
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Selected Financial Ratios
The following table presents information regarding certain of our financial ratios at or for the dates presented:
At or for the Quarter Ended Return on
Average Total
Assets (1)
Return on
Average Total
Stockholders’
Equity (2)(3)
Total Average
Stockholders’
Equity to Total
Average Assets (4)
Dividend
Payout
Ratio (5) Leverage Multiple (6)
Book Value
per Share
of Common
Stock (7)
Economic Book Value per Share of Common Stock (8)
December 31, 2021 1.67 % 6.84 % 30.00 % 1.38 2.5 $ 4.78 $ 5.15
September 30, 2021 6.64 20.48 34.55 0.36 2.2 4.82 5.25
June 30, 2021 3.46 10.57 37.28 0.77 1.8 4.65 5.10
March 31, 2021 4.55 13.54 37.21 0.44 1.6 4.63 5.08
December 31, 2020 2.12 7.24 35.72 0.94 1.7 4.54 4.91
September 30, 2020 4.17 13.85 33.23 0.29 1.9 4.61 4.92
June 30, 2020 4.33 15.70 30.08 — 2.0 4.51 4.50
March 31, 2020 (26.72) (26.58) 24.90 — 3.4 4.34 4.20
(1) Reflects annualized net income available to common stock and participating securities divided by average total assets.
(2) Reflects annualized net income divided by average total stockholders’ equity.
(3) For the quarter ended March 31, 2020, the amount calculated reflects the quarterly net income divided by average total stockholders’ equity.
(4) Reflects total average stockholders’ equity divided by total average assets.
(5) Reflects dividends declared per share of common stock divided by earnings per share.
(6) Represents the sum of our borrowings under financing agreements and payable for unsettled purchases divided by stockholders’ equity.
(7) Reflects total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.
(8) “Economic book value” is a non-GAAP financial measure of our financial position. To calculate our Economic book value, our portfolios of Residential whole loans and securitized debt held at carrying value are adjusted to their fair value, rather than the carrying value that is required to be reported under the GAAP accounting model applied to these loans. For additional information please refer to page 58 under the heading “Economic Book Value”.
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Economic Book Value
“Economic book value” is a non-GAAP financial measure of our financial position. To calculate our Economic book value, our portfolios of Residential whole loans and securitized debt held at carrying value are adjusted to their fair value, rather than the carrying value that is required to be reported under the GAAP accounting model applied to these financial instruments. These adjustments are also reflected in the table below in our end of period stockholders’ equity. Management considers that Economic book value provides investors with a useful supplemental measure to evaluate our financial position as it reflects the impact of fair value changes for all of our residential mortgage investments and certain associated financing arrangements, irrespective of the accounting model applied for GAAP reporting purposes. Economic book value does not represent and should not be considered as a substitute for Stockholders’ Equity, as determined in accordance with GAAP, and our calculation of this measure may not be comparable to similarly titled measures reported by other companies.
The following table provides a reconciliation of our GAAP book value per common share to our non-GAAP Economic book value per common share as of the quarterly periods below:
Quarter Ended:
(In Millions, Except Per Share Amounts) December 31, 2021 September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020 June 30, 2020 March 31, 2020
GAAP Total Stockholders’ Equity $ 2,542.8 $ 2,601.1 $ 2,526.5 $ 2,542.3 $ 2,524.8 $ 2,565.7 $ 2,521.1 $ 2,440.7
Preferred Stock, liquidation preference (475.0) (475.0) (475.0) (475.0) (475.0) (475.0) (475.0) (475.0)
GAAP Stockholders’ Equity for book value per common share 2,067.8 2,126.1 2,051.5 2,067.3 2,049.8 2,090.7 2,046.1 1,965.7
Adjustments:
Fair value adjustment to Residential whole loans, at carrying value 153.5 198.8 206.2 203.0 173.9 141.1 (25.3) (113.5)
Fair value adjustment to Securitized debt, at carrying value (1)
4.3 (8.0) (8.9) (3.6) (5.1) (3.5) 18.0 51.9
Stockholders’ Equity including fair value adjustments to Residential whole loans and Securitized debt held at carrying value (Economic book value ) (1)
$ 2,225.6 $ 2,316.9 $ 2,248.8 $ 2,266.7 $ 2,218.6 $ 2,228.3 $ 2,038.8 $ 1,904.1
GAAP book value per common share $ 4.78 $ 4.82 $ 4.65 $ 4.63 $ 4.54 $ 4.61 $ 4.51 $ 4.34
Economic book value per common share (1)
$ 5.15 $ 5.25 $ 5.10 $ 5.08 $ 4.91 $ 4.92 $ 4.50 $ 4.20
Number of shares of common stock outstanding 432.6 440.9 440.8 446.1 451.7 453.3 453.2 453.1
(1) Economic book value per common share for periods prior to December 31, 2021 have been restated to include the impact of fair value changes in securitized debt held at carrying value.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements include the accounts of all of our subsidiaries. The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions that affect the amounts reported in the consolidated financial statements, giving due consideration to materiality. Actual results could differ from these estimates.
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K. Management believes the policies which more significantly rely on estimates and judgments to be as follows:
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Allowance for Credit Losses on Residential Whole Loans
An allowance for credit losses is recorded at acquisition, and maintained on an ongoing basis, for all losses expected over the life of the respective loan. Any required credit loss allowance would reduce the net carrying value of the loan with a corresponding charge to earnings, and may increase or decrease over time. Significant judgments are required in determining any allowance for credit loss, including assumptions regarding the loan cash flows expected to be collected, including related economic forecasts, the value of the underlying collateral and our ability to collect on any other forms of security, such as a personal guaranty provided either by the borrower or an affiliate of the borrower.
Fair Value Measurements - Residential Whole Loans
GAAP requires the categorization of fair value measurements into three broad levels that form a hierarchy. The following describes the valuation methodologies used for our financial instrument investments categorized as level 3 in the valuation hierarchy, which require the most significant estimates and judgments to be made.
We determine the fair value of our residential whole loans after considering valuations obtained from a third-party who specializes in providing valuations of residential mortgage loans. The valuation approach applied generally depends on whether the loan is considered performing or non-performing at the date the valuation is performed. For performing loans, estimates of fair value are derived using a discounted cash flow approach, where estimates of cash flows are determined from the scheduled payments, adjusted using forecasted prepayment, default and loss given default rates. For non-performing loans, asset liquidation cash flows are derived based on the estimated time to liquidate the loan, the estimated value of the collateral, expected costs and estimated home price levels. Estimated cash flows for both performing and non-performing loans are discounted at yields considered appropriate to arrive at a reasonable exit price for the asset. Indications of loan value such as actual trades, bids, offers and generic market color may be used in determining the appropriate discount yield. The estimation of cash flows used in pricing models is inherently subjective and imprecise. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in fair value.
Residential whole loans, at fair value are recorded on our consolidated balance sheets at fair value and changes in their fair value are recorded through earnings. With respect to Residential whole loans, at carrying value, the fair value for these loans is disclosed in the footnotes to the consolidated financial statements and changes in their fair value do not impact earnings.
Recent Accounting Standards to Be Adopted in Future Periods
We are not aware of any recent accounting standards to be adopted in future periods that we expect would materially impact us.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of cash generally consist of borrowings under repurchase agreements and other collateralized financings, payments of principal and interest we receive on our investment portfolio, cash generated from our operating results and, to the extent such transactions are entered into, proceeds from capital market and structured financing transactions. Our most significant uses of cash are generally to pay principal and interest on our financing transactions, to purchase and originate residential mortgage assets, to make dividend payments on our capital stock, to fund our operations, to meet margin calls and to make other investments that we consider appropriate.
We seek to employ a diverse capital raising strategy under which we may issue capital stock and other types of securities. To the extent we raise additional funds through capital market transactions, we currently anticipate using the net proceeds from such transactions to acquire additional residential mortgage-related assets, consistent with our investment policy, and for working capital, which may include, among other things, the repayment of our financing transactions. There can be no assurance, however, that we will be able to access the capital markets at any particular time or on any particular terms. We have available for issuance an unlimited amount (subject to the terms and limitations of our charter) of common stock, preferred stock, depository shares representing preferred stock, warrants, debt securities, rights and/or units pursuant to our automatic shelf registration statement and, at December 31, 2021, we had approximately 8.3 million shares of common stock available for issuance pursuant to our DRSPP shelf registration statement. During 2021, we issued 431,699 shares of common stock through our DRSPP, raising net proceeds of approximately $1.9 million. During 2021, we did not sell any shares of common stock through our at-the-market equity offering program.
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During 2021, we repurchased 20,101,494 shares of our common stock through the stock repurchase program at an average cost of $4.26 per share and a total cost of approximately $85.6 million, net of fees and commissions paid to the sales agents of approximately $201,000. At December 31, 2021, approximately $80.3 million remained outstanding for future repurchases under the repurchase program.
Financing agreements
Our borrowings under financing agreements include a combination of shorter term and longer arrangements. Certain of these arrangements are collateralized directly by our residential mortgage investments or otherwise have recourse to us, while securitized debt financing is non-recourse financing. Further, certain of our financing agreements contain terms that allow the lender to make margin calls on us based on changes in the value of the underlying collateral securing the borrowing. As of December 31, 2021, we had $2.6 billion of total unpaid principal balance related to asset-backed financing agreements with mark-to-market collateral provisions and $3.6 billion of total unpaid principal balance related to asset-backed financing agreements that do not include mark-to-market collateral provisions. Repurchase agreements and other forms of collateralized financing are renewable at the discretion of our lenders and, as such, our lenders could determine to reduce or terminate our access to future borrowings at virtually any time. The terms of the repurchase transaction borrowings under our master repurchase agreements, as such terms relate to repayment, margin requirements and the segregation of all securities that are the subject of repurchase transactions, generally conform to the terms contained in the standard master repurchase agreement published by the Securities Industry and Financial Markets Association (or SIFMA) or the global master repurchase agreement published by SIFMA and the International Capital Market Association. In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts (or the percentage amount by which the collateral value is contractually required to exceed the loan amount), purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default and setoff provisions. Other non-repurchase agreement financing arrangements also contain provisions governing collateral maintenance.
With respect to margin maintenance requirements for agreements secured by harder to value assets, such as residential whole loans, Non-Agency MBS and MSR-related assets, margin calls are typically determined by our counterparties based on their assessment of changes in the fair value of the underlying collateral and in accordance with the agreed upon haircuts specified in the transaction confirmation with the counterparty. We address margin call requests in accordance with the required terms specified in the applicable agreement and such requests are typically satisfied by posting additional cash or collateral on the same business day. We review margin calls made by counterparties and assess them for reasonableness by comparing the counterparty valuation against our valuation determination. When we believe that a margin call is unnecessary because our assessment of collateral value differs from the counterparty valuation, we typically hold discussions with the counterparty and are able to resolve the matter. If this is not successful, we will look to resolve the dispute based on the remedies available to us under the terms of the repurchase agreement, which in some instances may include the engagement of a third-party to review collateral valuations. For certain other agreements that do not include such provisions, we could resolve the matter by substituting collateral as permitted in accordance with the agreement or otherwise request the counterparty to return the collateral in exchange for cash to unwind the financing. For additional information regarding our various types of financing arrangements, including those with non-mark-to-market terms and the haircuts for those agreements with mark-to-market collateral provisions, see Note 6 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K.
We expect that we will continue to pledge residential mortgage assets as part of certain of our ongoing financing arrangements. When the value of our residential mortgage assets pledged as collateral experiences rapid decreases, margin calls under our financing arrangements could materially increase, causing an adverse change in our liquidity position. Additionally, if one or more of our financing counterparties choose not to provide ongoing funding, our ability to finance our long-maturity assets would decline or otherwise become available on possibly less advantageous terms. Further, when liquidity tightens, our counterparties to our short term arrangements with mark-to-market collateral provisions may increase their required collateral cushion (or margin) requirements on new financings, including financings that we roll with the same counterparty, thereby reducing our ability to use leverage. Access to financing may also be negatively impacted by ongoing volatility in financial markets, thereby potentially adversely impacting our current or future lenders’ ability or willingness to provide us with financing. In addition, there is no assurance that favorable market conditions will exist to permit us to consummate additional securitization transactions if we determine to seek that form of financing.
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Our ability to meet future margin calls will be affected by our ability to use cash or obtain financing from unpledged collateral, the amount of which can vary based on the market value of such collateral, our cash position and margin requirements. Our cash position fluctuates based on the timing of our operating, investing and financing activities and is managed based on our anticipated cash needs. (See “Interest Rate Risk” included under Item 7A. of this Annual Report on Form 10-K and our Consolidated Statements of Cash Flows, included under Item 8 of this Annual Report on Form 10-K.)
At December 31, 2021, we had a total of $4.9 billion of residential whole loans and securities and $10.2 million of restricted cash pledged to our financing counterparties. At December 31, 2021, we had access to various sources of liquidity, including $304.7 million of cash and cash equivalents. Our sources of liquidity do not include restricted cash. In addition, at December 31, 2021, we had $280.2 million of unencumbered residential whole loans. Further, we believe that we have unused capacity in certain borrowing lines, given that the amount currently borrowed is less than the maximum advance rate permitted by the facility. This unused capacity serves to act as a buffer against potential margin calls on certain pledged assets in the event that asset prices do not decline by more than a specified amount.
The table below presents certain information about our borrowings under asset-backed financing agreements and securitized debt:
Asset-backed Financing Agreements Securitized Debt
Quarter Ended (1)
Quarterly
Average
Balance End of Period
Balance Maximum
Balance at Any
Month-End Quarterly
Average
Balance End of Period
Balance Maximum
Balance at Any
Month-End
(In Thousands)
December 31, 2021 $ 3,313,641 $ 3,501,839 $ 3,501,839 $ 2,302,990 $ 2,650,473 $ 2,650,473
September 30, 2021 2,516,940 3,278,941 3,278,941 2,008,639 2,045,729 2,137,773
June 30, 2021 2,063,852 2,156,598 2,156,598 1,778,909 2,046,381 2,046,381
March 31, 2021 2,362,791 2,221,570 2,443,149 1,535,995 1,548,920 1,602,148
December 31, 2020 2,833,649 2,497,290 2,823,306 1,202,292 1,514,509 1,514,509
September 30, 2020 3,511,453 3,217,678 3,613,968 610,120 837,683 837,683
June 30, 2020 4,736,610 3,692,845 5,024,926 538,245 516,102 541,698
March 31, 2020 9,233,808 7,768,180 9,486,555 558,007 533,733 594,458
December 31, 2019 8,781,646 9,139,821 9,139,821 590,813 570,952 594,458
September 30, 2019 8,654,350 8,571,422 8,833,159 617,689 605,712 621,071
June 30, 2019 8,621,895 8,630,642 8,639,311 645,972 627,487 649,405
March 31, 2019 8,282,621 8,509,713 8,509,713 675,678 659,184 679,269
(1) The information presented in the table above excludes $230.0 million of Convertible Senior Notes issued in June 2019 and $100.0 million of Senior Notes issued in April 2012. The outstanding balance of the Convertible Senior Notes have been unchanged since issuance. Subsequent to the end of the third quarter of 2020, we repaid in full the outstanding principal balance of the senior secured term loan facility. During the first quarter of 2021, we redeemed all of our outstanding Senior Notes.
Cash Flows and Liquidity for the Year Ended December 31, 2021
Our cash, cash equivalents and restricted cash decreased by $417.1 million during 2021, reflecting: $2.2 billion used in our investing activities, $1.6 billion provided by our financing activities and $120.3 million provided by our operating activities.
At December 31, 2021, our debt-to-equity multiple was 2.5 times compared to 1.7 times at December 31, 2020. At December 31, 2021, we had borrowings under asset-backed financing agreements of $3.5 billion, of which $3.3 billion were secured by residential whole loans, $159.1 million were secured by securities and $23.0 million were secured by REO. In addition, at December 31, 2021, we had securitized debt of $2.7 billion in connection with our loan securitization transactions. At December 31, 2020, we had borrowings under asset-backed financing agreements of $2.5 billion, of which $2.3 billion were secured by residential whole loans, $213.9 million were secured by securities and $13.7 million were secured by REO. In addition, at December 31, 2020, we had securitized debt of $1.5 billion in connection with our loan securitization transactions.
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During 2021, $2.2 billion was used in our investing activities. We utilized $4.5 billion for acquisitions of residential whole loans, loan related investments and capitalized advances. During 2021, we received $2.0 billion of principal payments on residential whole loans and loan related investments and $187.0 million of proceeds on sales of REO. In addition, during 2021, we received cash of $157.3 million from prepayments and scheduled amortization on our securities.
In connection with our repurchase agreement financings and Swaps, we routinely receive margin calls/reverse margin calls from our counterparties and make margin calls to our counterparties. Margin calls and reverse margin calls, which requirements vary over time, may occur daily between us and any of our counterparties when the value of collateral pledged changes from the amount contractually required. The value of securities pledged as collateral fluctuates reflecting changes in: (i) the face (or par) value of our assets; (ii) market interest rates and/or other market conditions; and (iii) the market value of our Swaps. Margin calls/reverse margin calls are satisfied when we pledge/receive additional collateral in the form of additional assets and/or cash.
The table below summarizes our margin activity with respect to our repurchase agreement financings and derivative hedging instruments for the quarterly periods presented:
Collateral Pledged to Meet Margin Calls Cash and Securities Received for Reverse
Margin Calls Net Assets Received/(Pledged) for Margin Activity
For the Quarter Ended (1)
Fair Value of Securities Pledged Cash Pledged Aggregate Assets Pledged For Margin Calls
(In Thousands)
December 31, 2021 $ — $ 14,446 $ 14,446 $ 2,000 $ (12,446)
September 30, 2021 — — — 2,500 2,500
June 30, 2021 — 3,433 3,433 — (3,433)
March 31, 2021 — — — — —
(1) Excludes variation margin payments on our cleared Swaps which are treated as a legal settlement of the exposure under the Swap contract.
We are subject to various financial covenants under our financing agreements, which include minimum liquidity and net worth requirements, net worth decline limitations and maximum debt-to-equity ratios. We were in compliance with all financial covenants as of December 31, 2021.
During 2021, we paid $156.1 million for cash dividends on our common stock and dividend equivalents and paid cash dividends of $32.9 million on our preferred stock. On December 14, 2021, we declared our fourth quarter 2021 dividend on our common stock of $0.11 per share; on January 31, 2022, we paid this dividend, which totaled approximately $47.8 million, including dividend equivalents of approximately $170,000.