What changed in this filing

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Item 1. Business

2023-02-24 compared with 2022-02-23 · 64 added, 52 removed, 110 unchanged (51% of the section changed)

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Our targeted investments include principally the following:

• Residential whole loans, including Purchased Performing Loans, Purchased Credit Deteriorated and Purchased Non-performing Loans.

Through certain of our subsidiaries, we also originate and service business purpose loans for real estate investors.

• Residential whole loans, including Purchased Performing Loans, Purchased Credit Deteriorated and Purchased Non-performing Loans, which we acquire and hold through certain trusts that are consolidated on our balance sheet for financial reporting purposes.

Through our wholly-owned subsidiary, Lima One Capital, LLC (or Lima One), a leading nationwide originator and servicer of business purpose loans (or BPLs), which we acquired on July 1, 2021, we also originate and service BPLs for real estate investors.

We also own residential real estate (or REO), which is typically acquired as a result of the foreclosure or other liquidation of delinquent whole loans in connection with our loan investment activities.

• Residential mortgage securities, including CRT securities;

• MSR-related assets, which include term notes backed directly or indirectly by MSRs.

• Residential mortgage securities, including Agency MBS, Non-Agency MBS, CRT securities and MSR-related assets, which include term notes backed directly or indirectly by MSRs.

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.

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We are an internally-managed real estate investment trust (or REIT).

2021 saw a continuation of the unprecedented conditions caused by the COVID-19 global pandemic, causing ongoing volatility and disruption in the United States economy and financial markets.

However, the markets for residential mortgage assets have generally benefited from strong demand for housing and ongoing movement of people away from urban to suburban areas.

In addition, fiscal policies of the federal government and monetary and other economic policies pursued by the U.S.

Federal Reserve (or Federal Reserve) have resulted in continued historically low interest rates that have supported residential mortgage assets and markets.

After the negative market impacts experienced during 2020, particularly during the initial months of the pandemic in the first and second quarters of the year, we significantly reduced the size and composition of our investment portfolio during 2020.

During 2021, market conditions were generally more stable and supportive of our business and we took advantage of these market conditions to implement an asset acquisition strategy that resulted in significant growth of our residential whole loan portfolio.

We also completed our first acquisition of a mortgage origination company, Lima One Capital, LLC (Lima One), a leading originator and servicer of business purpose loans.

We discuss the impact of the COVID-19 pandemic on our business, including our investment and financing strategies, throughout this Annual Report on Form 10-K.

2022 was extremely challenging for fixed income investors, and exceptionally so for mortgage investors, including us, and was characterized by higher interest rates across the yield curve as well as wider mortgage and credit spreads.

We addressed these challenges by prioritizing liquidity and active portfolio management, including increasing our use of interest rate swap agreements (or Swaps) to hedge exposure to higher interest rates and using loan securitizations to generate securitized debt to replace floating rate recourse mark-to-market financing with fixed rate non-recourse, non-mark-to-market financing.

While continued interest rate volatility and generally wider spreads on securitized mortgage assets pressured mortgage loan pricing, we believe that our portfolio and risk management measures partially mitigated the impact of the interest rate environment.

We were incorporated in Maryland on July 24, 1997 and began operations on April 10, 1998.

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INVESTMENT STRATEGY

We primarily invest, through our various subsidiaries, in residential mortgage assets.

During 2021 we successfully executed on our asset acquisition strategy.

Specifically, we acquired more than $4.5 billion of residential whole loans.

We also completed the acquisition of the remaining 57% of the common equity interests of Lima One, the first time that we completed the acquisition of a controlling stake in a third party entity.

We are particularly pleased with the results of the business combination to date, as Lima One has achieved consecutive record quarters for origination volumes since the acquisition closed on July 1, 2021.

The execution of our strategy has resulted in a 49% year-over-year increase in our residential whole loans and 39% year-over-year increase in our overall investment portfolio.

At the end of 2021, residential whole loan investments comprised approximately 87% of our assets and more than 75% of our allocated net equity.

During 2022, assuming economic conditions continue to support markets for residential mortgage assets, we expect to continue pursuing investment opportunities

primarily focused on residential whole loans as market opportunities arise.

We expect that our investment activities will continue to be financed through a combination of term loan warehouse financing, repurchase agreement financing and securitization transactions.

We primarily invest in and finance, through our various subsidiaries, residential mortgage assets.

During 2022 we acquired more than $3.1 billion of residential whole loans.

This includes $2.0 billion of loans originated by our wholly-owned subsidiary, Lima One, which has funded more than $2.7 billion of loans since July 2021, when we fully acquired Lima One.

At the end of 2022, residential whole loan investments comprised approximately 83% of our assets and 69% of our allocated net equity.

During 2023, assuming economic conditions continue to support markets for residential mortgage assets, we expect to continue pursuing investment opportunities primarily focused on residential whole loans as market opportunities arise.

We expect that our investment activities will continue to be financed primarily through a combination of securitization transactions, term loan warehouse financing and repurchase agreement financing.

At December 31, 2022, our total investment-related assets were comprised of the following:

$7.5 billion, or 92%, of residential whole loans (compared to $7.9 billion, or 93%, at December 31, 2021);

$256.7 million, or 3%, of residential mortgage securities and MSR-related assets (compared to $400.0 million, or 7%, at December 31, 2020);

$333.4 million, or 4%, of residential

mortgage securities (compared to $256.7 million, or 3%, at December 31, 2021);

and $315.0 million, or 4%, of remaining investment-related assets, comprised primarily of REO, capital contributions made to loan origination partners, other interest-earning assets, and loan-related receivables (compared to $369.8 million, or 4% at December 31, 2021).

Residential Whole Loans

During 2021, we continued to increase our residential whole loan portfolio primarily through acquisitions of Purchased Performing Loans and loans originated by Lima One.

During 2022, we continued to acquire residential whole loans, primarily Purchased Performing Loans, with approximately two-thirds of acquisitions reflecting loans originated by Lima One.

Our Purchased Performing Loan portfolio includes:

(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 (“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 (“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 (“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”) (“Agency eligible investor loans”), and (v) previously originated loans secured by residential real estate that is generally owner occupied (“Seasoned performing loans”).

(iii) business purpose loans to finance (or refinance) non-owner occupied one-to-four family residential properties that are rented to one or more tenants (“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”) (“Agency eligible investor loans”);

and (v) previously originated loans secured by residential real estate that is generally owner occupied (“Seasoned performing loans”).

We acquire and hold our non-business purpose loans and certain of our Transitional loans and Single-family rental loans through certain trusts that are consolidated on our balance sheet for financial reporting purposes.

In addition, during 2022, we continued to manage our Purchased Non-performing residential whole loan and Purchased Credit Deteriorated Loan portfolios.

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We also own REO property as a result of managing the resolution of non-performing loans.

A combination of strong loan portfolio performance, continued lower levels of foreclosure activity and the efforts of our asset management team, has resulted in a substantial decline in balances of REO property held during 2021.

A combination of strong loan portfolio performance, and the efforts of our asset management team, has resulted in a continued reduction in the balances of REO property held during 2022.

Securities, at Fair Value

Prior to the onset of the COVID-19 pandemic, we owned significantly higher balances of residential mortgage securities (primarily investments in Agency MBS, Non-Agency MBS and CRT securities).

During 2020, we sold our Agency and Legacy Non-Agency MBS portfolios and significantly reduced our CRT securities, RPL/NPL MBS and MSR-related assets.

Going forward, we may invest selectively in residential mortgage securities and MSR-related assets as market opportunities arise, and we discuss the general features of our currently held portfolio below.

MSR-Related Assets

We have made investments in term notes backed directly or indirectly by MSRs.

We believe the credit risk on these investments is mitigated by structural credit support in the form of over-collateralization as well as a corporate guarantee from the ultimate parent or sponsor of the related special purpose vehicle issuing the note, that is intended to provide for payment of interest and principal to the holders of the term notes should cash flows generated by the underlying MSRs be insufficient.

Residential Mortgage Securities

CRT securities are debt obligations issued by or sponsored by Fannie Mae and Freddie Mac.

The coupon payments on CRT securities are paid by the issuer and the principal payments received are dependent on the performance of loans in either a reference pool or an actual pool of loans.

As an investor in a CRT security, we may incur a principal loss if the performance of the actual or reference pool loans results in either an actual or calculated loss that exceeds the credit enhancement on the security owned by us.

We assess the credit risk associated with our investments in CRT securities by assessing the current and expected future performance of the associated loan pool.

MBS investments held during the year ended December 31, 2020 and in prior periods included Agency MBS and Non-Agency MBS, which included MBS issued prior to 2008.

Until the second quarter of 2021, we also owned RPL/NPL MBS purchased primarily at prices around par and representing the senior and mezzanine tranches of the related securitizations.

Prior to the onset of the COVID-19 pandemic, we owned significantly higher balances of residential mortgage securities (primarily investments in Agency MBS, Non-Agency MBS, CRT securities and MSR-Related assets).

During 2020, we sold our Agency and Legacy Non-Agency MBS portfolios and significantly reduced our other securities holdings.

In late 2022, we opportunistically invested in Agency MBS, bringing our total portfolio of securities to $333.4 million.

Going forward, we may continue to invest selectively in a range of residential mortgage securities as market opportunities arise.

FINANCING STRATEGY

Our financing strategy is designed to increase the size of our investment portfolio by borrowing against a substantial portion of the market value of the assets in our portfolio.

We use term warehouse facilities, loan securitizations and shorter term repurchase agreements to finance our holdings of residential mortgage assets.

We use loan securitizations, term warehouse facilities and shorter term repurchase agreements to finance our holdings of residential mortgage assets.

Our financing strategy shifted significantly during 2020 and 2021.

In particular, in response to the turmoil in the financial markets resulting from the conditions created by the COVID-19 pandemic, we sought to implement more durable forms of borrowing, including warehouse lines with non-mark-to-market collateral terms.

In addition, during the second half of 2020, we executed three securitization transactions for our residential whole loans.

These programmatic securitization transactions continued during 2021 as we executed eight additional transactions involving Non-QM, business purpose, Agency eligible investor, Purchased Credit Deteriorated and Purchased Non-performing loan collateral.

The securitization transactions generally lowered the funding costs and lengthened the term of funding for these assets and generated additional liquidity.

In addition, since the second half of 2020, we have executed numerous programmatic securitization transactions for our residential whole loans, involving Non-QM, business purpose, Agency eligible investor, Purchased Credit Deteriorated, Seasoned performing and Purchased Non-performing loan collateral.

The securitization transactions lengthened the term of funding for these assets, generated additional liquidity and generally replaces floating rate financing with fixed rate financing.

In addition, securitized debt financing is non-recourse and does not include mark-to-market collateral provisions.

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REGULATORY MATTERS

Congress, Federal Reserve, U.S.

Congress, the U.S.

Federal Reserve (or Federal Reserve), U.S.

Treasury, Federal Deposit Insurance Corporation (or FDIC), the Securities and Exchange Commission (or SEC) and other governmental and regulatory bodies have taken actions in response to the 2007-2008 financial crisis.

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Numerous regulations have been issued pursuant to the Dodd-Frank Act, including regulations regarding mortgage loan servicing, underwriting and loan originator compensation, and others could be issued in the future.

As a result, we are unable to fully predict at this time how the Dodd-Frank Act, as well as other laws or regulations that may be adopted in the future, will affect our business, results of operations and financial condition, or the environment for repurchase financing and other forms of borrowing, the investing environment for Agency MBS, Non-Agency MBS and/or residential mortgage loans, the securitization industry, interest rate swap agreements (or Swaps) and other derivatives.

We believe that the Dodd-Frank Act and the regulations promulgated thereunder are likely to continue to increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.

On October 19, 2022, a three-judge panel of the Fifth Circuit Court of Appeals issued an opinion in Community Financial Services Association of America, Ltd., et al.

Consumer Financial Protection Bureau, et al., concluding that the CFPB’s funding structure violates the Appropriations Clause of the U.S.

Constitution.

As a result, the Court vacated the payday lending rule that was the subject of challenge.

The CFPB may seek a rehearing en banc and/or appeal to the U.S.

Supreme Court.

Although the Fifth Circuit’s decision applies only to the disputed regulation in that case, it may call into question the CFPB’s authority and other rules promulgated during CFPB’s self-funding structure.

It is unclear yet what impact the Fifth Circuit’s ruling may have on the mortgage lending markets but it may give rise to uncertainty, particularly in those markets in the Fifth Circuit.

Any such uncertainty could adversely impact the cash flow on mortgage loans.

In addition to the regulatory actions being implemented under the Dodd-Frank Act, on August 31, 2011, the SEC issued a concept release under which it is reviewing interpretive issues related to Section 3(c)(5)(C) of the Investment Company Act.

Section 3(c)(5)(C) excludes from the definition of “investment company” entities that are primarily engaged in, among other things, “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” Many companies that engage in the business of acquiring mortgages and mortgage-related instruments seek to rely on existing interpretations of the SEC Staff with respect to Section 3(c)(5)(C) so as not to be deemed an investment company for the purpose of regulation under the Investment Company Act.

engage in the business of acquiring mortgages and mortgage-related instruments seek to rely on existing interpretations of the SEC Staff with respect to Section 3(c)(5)(C) so as not to be deemed an investment company for the purpose of regulation under the Investment Company Act.

In connection with the concept release, the SEC requested comments on, among other things, whether it should reconsider its existing interpretation of Section 3(c)(5)(C).

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In addition, any decline in the value of securities issued by Fannie Mae and Freddie Mac may affect the value of MBS in general.

The recent change of FHFA Leadership and the fact that a permanent Director has yet to be confirmed raise further uncertainties about whether, and if so on what timeline, the Biden administration will address the conservatorships of the GSEs and any such comprehensive housing reform.

The recent change of FHFA Leadership raises further uncertainties about whether, and if so on what timeline, the Biden administration will address the conservatorships of the GSEs and any such comprehensive housing reform.

On October 27, 2021, FHFA announced that it is seeking comment on a proposed rulemaking that would introduce additional public disclosure requirements for the Enterprise Regulatory Capital Framework (or ERCF) for Fannie Mae and Freddie Mac.

As proposed, the rule would implement quarterly quantitative and qualitative disclosure requirements for Fannie Mae and Freddie Mac related to regulatory capital instruments, risk-weighted assets calculated under the ERCF’s standardized approach, and risk management policies and procedures.

This notice of proposed rulemaking suggests the potential for

enhanced regulation and reporting obligations in the mortgage and securitization industries, which in turn may further increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.

This notice of proposed rulemaking suggests the potential for enhanced regulation and reporting obligations in the mortgage and securitization industries, which in turn may further increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.

On February 25, 2022, FHFA announced its final rule amending the ERCF by refining the prescribed leverage buffer amount (leverage buffer) and risk-based capital treatment of retained CRT exposures for Fannie Mae and Freddie Mac.

The final rule largely tracks the proposed rule.

Among other things, the final rule will replace the fixed leverage buffer equal to 1.5% of each of Fannie Mae’s and Freddie Mac’s adjusted total assets with a dynamic leverage buffer equal to 50% of each enterprise’s stability capital buffer;

replace the prudential floor of 10% on the risk weight assigned to any retained CRT exposure with a prudential floor of 5% on the risk weight assigned to any retained CRT exposure;

and remove the requirement that each of Fannie Mae and Freddie Mac must apply an overall effectiveness adjustment to its retained CRT exposures.

The final rule went into effect on May 16, 2022.

On June 1, 2022, FHFA published a Final Rule that supplements the ERCF by requiring Fannie Mae and Freddie Mac to submit annual capital plans to the Agency and provide prior notice for certain capital actions.

The final rule also incorporates

the stress capital buffer determination from the ERCF into the capital planning process.

Among other things, the final rule mandates that the each of Fannie Mae’s and Freddie Mac’s capital plans must include:

• An assessment of the expected sources and uses of capital over the planning horizon;

• Estimates of projected revenues, expenses, losses, reserves, and pro forma capital levels under a range of the enterprise's internal scenarios, as well as under FHFA's scenarios;

• A description of all planned capital actions over the planning horizon;

• A discussion of how the enterprise will, under expected and stressful conditions, maintain capital commensurate with the business risks and continue to serve the housing market;

• A discussion of any expected changes to the enterprise's business plan that are likely to have a material impact on the enterprise's capital adequacy or liquidity.

This final rule was effective August 2, 2022, and the first capital plan for each of Fannie Mae and Freddie Mac must be submitted by them not later than May 20, 2023.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (or CARES Act) was signed into law.

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However, the foreclosure moratorium was extended several times to July 31, 2021 and the forbearance enrollment window was extended through September 30, 2021 by Department of Housing and Urban Development, Department of Veterans Affairs, the Department of Agriculture and FHFA, which includes mortgages backed by Fannie Mae and Freddie Mac.

Although the federal foreclosure moratorium expired on July 31, 2021, various states and local jurisdictions also imposed foreclosure moratoriums, some of which may continue to be in effect after the federal moratorium expires.

Although the federal foreclosure moratorium expired on July 31, 2021, various states and local jurisdictions also imposed foreclosure moratoriums, some of which continued to be in effect after the federal moratorium expired.

In February 2022, FHA issued a mortgagee letter clarifying the extension of deadlines for the first legal action and reasonable diligence time frame for FHA-insured single family mortgages and home equity conversion mortgages (or HECM) as the later of (i) 180 days from expiration of the foreclosure moratorium for FHA-insured Single Family Mortgages and (ii) the expiration of the borrower’s COVID-19 forbearance of the HECM COVID-19 extension period.

Some of those extended deadlines may adversely affect cash flow on mortgage loans.

In December 2020, the Consolidated Appropriations Act, 2021 was signed into law, which is an omnibus spending bill that included a second COVID-19 stimulus bill (or Second Stimulus).

In addition to providing stimulus checks for individuals and families, the Second Stimulus provides for, among other things, (i) an extension of federal unemployment insurance benefits, (ii) funding to help individuals connect remotely during the pandemic, (iii) tax credits for companies offering paid sick leave and (iv) funding for vaccine distribution and development.

As further described below, the Second Stimulus provided an additional $25 billion in tax-free rental assistance and an executive order by President Biden extended the temporary eviction moratorium promulgated by the CDC (described below) through March 31, 2021.

On September 1, 2020, the Centers for Disease Control and Prevention (or CDC) issued an order effective September 4, 2020 through December 31, 2020 temporarily halting residential evictions to prevent the further spread of COVID-19.

On September 1, 2020, the CDC issued an order effective September 4, 2020 through December 31, 2020 temporarily halting residential evictions to prevent the further spread of COVID-19.

The Second Stimulus extended the order to January 31, 2021 and on January 20, 2021, Present Joseph Biden signed an executive order that, among other things, further extended the temporary eviction moratorium promulgated by the CDC through March 31, 2021.

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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.

What changed 10-K

Item 1. Business