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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

2023-02-24 compared with 2022-02-23 · 38 added, 33 removed, 136 unchanged (34% of the section changed)

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Because these loans are primarily newly or recently originated performing loans, we believe these investments exhibit positive duration.

Given the short duration of our Rehabilitation loans, we believe the fair value of these loans exhibits little sensitivity to changes in interest rates.

Given the short duration of our Transitional loans, we believe the fair value of these loans exhibits little sensitivity to changes in interest rates.

We estimate the duration of these Purchased Performing Loans held at carrying value using management’s assumptions.

The fair value of our non-performing residential whole loans is typically primarily dependent on the value of the underlying real estate collateral and the time required for collateral liquidation.

The fair value of our non-performing residential whole loans is typically dependent on the value of the underlying real estate collateral and the time required for collateral liquidation.

Since neither the value of the collateral nor the liquidation timeline is generally sensitive to interest rates, we believe their fair value exhibits little sensitivity to interest rates.

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Additionally, we have entered into short positions in TBA securities to economically hedge interest rate and other market risks arising from our investments in Agency eligible investor loans.

The interest rates for the vast majority of our investments, financings and certain of our hedging transactions are either explicitly or indirectly based on LIBOR.

The interest rates for certain of our investments and financing agreements are either explicitly or indirectly based on LIBOR.

On March 5, 2021, the United Kingdom Financial Conduct Authority (or FCA) which regulates LIBOR, announced that all LIBOR tenors relevant to us will cease to be published or will no longer be representative after June 30, 2023.

The FCA’s announcement coincides with the March 5, 2021 announcement of LIBOR’s administrator, the ICE Benchmark Administration Limited (or IBA), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023.

At present, it is not possible to predict the effect of such change, including the establishment of potential alternative reference rates, on the economy or markets we are active in either currently or in the future, or on any of our assets or liabilities whose interest rates are based on LIBOR.

We are in the process of evaluating the potential impact of a discontinuation of LIBOR on our portfolio, as well as the related accounting impact.

However, we expect that in the near term, we will work closely with the Trustee companies and/or other entities that are involved in calculating the interest rates for our residential mortgage securities and securitized debt, our loan servicers for our hybrid and floating rate loans, and with the various counterparties to our financing and hedging transactions in order to determine what changes, if any, are required to be made to existing agreements for these transactions.

The information presented in the following “Shock Table” projects the potential impact of sudden parallel changes in interest rates on our net interest income and portfolio value, including the impact of Swaps and short positions in TBA securities (if any), over the next 12 months based on the assets in our investment portfolio at December 31, 2021 and 2020.

The FCA’s announcement coincided with the March 5, 2021 announcement of LIBOR’s administrator, the ICE Benchmark Administration Limited (or IBA), indicating that, as a result of not having access to input data necessary to calculate LIBOR tenors relevant to us on a representative basis after June 30, 2023, IBA would have to cease publication of such LIBOR tenors immediately after the last publication on June 30, 2023.

On March 15, 2022, President Biden signed the Adjustable Interest Rate (LIBOR) Act, which transitions certain contracts that use LIBOR to another benchmark once LIBOR is permanently discontinued after June 30, 2023.

The Act provides, among other things, that an alternative benchmark based on the Secured Overnight Financing Rate (or SOFR) published by the New York Federal Reserve Bank will automatically apply after the LIBOR replacement date for any contract without provisions for selecting a replacement for LIBOR or identifying a person authorized to select a replacement after LIBOR is permanently discontinued.

The Act also provides that if the SOFR-based replacement is selected, the selecting person responsible under the contract is not required to obtain the consent of anyone before implementing that replacement.

The Act further creates a safe harbor by ensuring that the SOFR-based benchmark replacement is by law a commercially reasonable replacement for LIBOR, that the use of that benchmark replacement cannot be deemed a breach of a contract or an impairment of the right of any person to receive payment under that contract, and that no person can be liable for selecting or using that benchmark replacement.

The Act further authorizes the Board of Governors of the Federal Reserve to promulgate regulations under the statute to designate specific SOFR-based rates that incorporate the statutory spread adjustments as replacement rates for covered LIBOR contracts.

The Federal Reserve’s final rules provide for the following SOFR-based replacement rates:

(i) SOFR compounded in arrears for derivatives, using the same methodology as under the International Swaps and Derivatives Association (or ISDA) protocol, (ii) CME Term SOFR for all covered cash products, except FHFA-regulated entity contracts and (iii) a 30-day compounded SOFR average for certain FHFA-regulated entity contracts.

We have made substantial progress, and continue to work, with the Trustee companies and/or other entities that are involved in calculating the interest rates for our residential mortgage securities and securitized debt, our loan servicers for our hybrid and floating rate loans, and with the various counterparties to our financing transactions in order to implement the changes required to be made to existing agreements for these transactions in response to the impending termination of the use of LIBOR and to evaluate the impact of the federal legislation, and the Federal Reserve’s rules on our transition away from LIBOR.

Furthermore, our transaction processing systems are already processing, or have been tested and are capable of processing, SOFR-based instruments.

The information presented in the following “Shock Table” projects the potential impact of sudden parallel changes in interest rates on our net interest income and portfolio value, including the impact of Swaps and securitized debt and other fixed rate debt, based on the assets in our investment portfolio at December 31, 2022 and 2021.

All changes in income and value are measured as the percentage change from the projected net interest income and portfolio value under the base interest rate scenario at December 31, 2022 and 2021.

December 31, 2022

Change in Interest Rates Estimated

of Assets (1)

Value of Securitized and Other Fixed Rate Debt Estimated

Instruments Change in

Value Percentage

Change in Interest Rates Change in

Estimated Net Portfolio

Change in Net

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December 31, 2021

Change in Interest Rates Estimated

of Assets (1)

Value of Securitized and Other Fixed Rate Debt Estimated

Instruments Change in

Value Percentage

Change in Interest Rates Change in

Estimated Net Portfolio

Change in Net

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-100 Basis Point Decrease $ 76,848 (3.49) % 0.86 %

(1) Such assets include residential whole loans and REO, MBS and CRT securities, MSR-related assets, cash and cash equivalents and restricted cash.

(1) Assets in our portfolio include residential whole loans and REO, securities, other portfolio investments, goodwill, intangibles, receivables, and cash and cash equivalents and restricted cash.

(2) Change in estimated net portfolio value includes the effect of our interest rate swaps, securitized debt, and other fixed rate debt.

Certain assumptions have been made in connection with the calculation of the information set forth in the Shock Table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes.

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Actual results could differ significantly from those estimated in the Shock Table above.

The Shock Table quantifies the potential changes in net interest income and portfolio value, which includes the value of our derivative and other hedging transactions (if any) and securitized and other fixed rate debt (which are carried at fair value), should interest rates immediately change (i.e., are shocked).

The Shock Table quantifies the potential changes in net interest income and portfolio value, which includes the value of our derivative and other hedging transactions (if any) and securitized and other fixed rate debt, should interest rates immediately change (i.e., are shocked).

The Shock Table presents the estimated impact of interest rates instantaneously rising 50 and 100 basis points, and falling 50 and 100 basis points.

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Due to this floor, it is anticipated that any hypothetical interest rate shock decrease would have a limited positive impact on our funding costs;

however, because prepayments speeds are unaffected by this floor, it is expected that any increase in our prepayment speeds (occurring as a result of any interest rate shock decrease or otherwise) could result in an acceleration of premium amortization on assets purchased at a premium and discount accretion on

assets purchased at a discount and in the reinvestment of principal repayments in lower yielding assets.

As a result, because the presence of this floor limits the positive impact of interest rate decrease on our funding costs, hypothetical interest rate shock decreases could cause a decline in the fair value of our financial instruments and our net interest income.

As a result, because the presence of this floor limits the positive

impact of interest rate decrease on our funding costs, hypothetical interest rate shock decreases could cause a decline in the fair value of our financial instruments and our net interest income.

At December 31, 2022, the impact on portfolio value was approximated using estimated net effective duration (i.e., the price sensitivity to changes in interest rates), including the effect of securitized and other fixed rate debt, of 0.99, which is the weighted average of 3.69 for our Residential whole loans, 1.94 for our Securities investments, (2.85) for our derivative and other hedging transactions and securitized and other fixed rate debt, and 0.01 for our Other assets and cash and cash equivalents.

Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.92), which is the weighted average of (1.09) for our Residential whole loans, 0.14 for our derivative and other hedging transactions and securitized and other fixed rate debt, zero for our Securities, and zero for our Other assets and cash and cash equivalents.

At December 31, 2020, the impact on portfolio value was approximated using estimated net effective duration (i.e., the price sensitivity to changes in interest rates), including the effect of securitized and other fixed rate debt, of 1.43, which is the weighted average of 2.42 for our Residential whole loans, 0.75 for our Non-Agency investments, (2.11) for our securitized debt and other fixed rate debt, and 0.06 for our Other assets and cash and cash equivalents.

Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.67), which is the weighted average of (0.85) for our Residential whole loans, zero for our securitized and other fixed rate debt, zero for our Non-Agency MBS, and zero for our Other assets and cash and cash equivalents.

Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.53), which is the weighted average of (0.61) for our Residential whole loans, zero for our derivative and other hedging transactions and securitized and other fixed rate debt, (0.37) for our Securities, and zero for our Other assets and cash and cash equivalents.

At December 31, 2021, the impact on portfolio value was approximated using estimated net effective duration (i.e., the price sensitivity to changes in interest rates), including the effect of securitized and other fixed rate debt, of 1.32, which is the weighted average of 3.06 for our Residential whole loans, 0.13 for our Securities investments, (3.22) for our derivative and other hedging transactions and securitized and other fixed rate debt, and 0.06 for our Other assets and cash and cash equivalents.

Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.92), which is the weighted average of (1.09) for our Residential whole loans, 0.14 for our derivative and other hedging transactions and securitized and other fixed rate debt, zero for our Securities investments, and zero for our Other assets and cash and cash equivalents.

The impact on our net interest income is driven mainly by the difference between portfolio yield and cost of funding of our repurchase agreements.

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To the extent that delinquencies and defaults on these loans are higher than our expectation at the time the loans were purchased, the discounted purchase price at which the asset is acquired is intended to provide a level of protection against financial loss.

Credit risk on Purchased Performing Loans is mitigated through our process to underwrite the loan before it is acquired and/or originated and includes an assessment of the borrower’s financial condition and ability to repay the loan, nature of the collateral and relatively low LTV, including after-repair LTV for the majority of our Rehabilitation loans.

Credit risk on Purchased Performing Loans is mitigated through our process to underwrite the loan before it is acquired and/or originated and includes an assessment of the borrower’s financial condition and ability to repay the loan, nature of the collateral and LTV, including after repaired LTV for the majority of our Transitional loans.

Given the extent of home price appreciation that has occurred since the majority of our Purchased Performing Loans were acquired or originated, we estimate that current LTV’s have decreased significantly, further mitigating the risk of material credit losses on this portfolio.

The following table presents certain information about our Residential whole loans at December 31, 2022:

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(2) LTV represents the ratio of the total unpaid principal balance of the loan to the estimated value of the collateral securing the related loan as of the most recent date available, which may be the origination date.

For Rehabilitation loans, the LTV presented is the ratio of the maximum unpaid principal balance of the loan, including unfunded commitments, to the estimated “after repaired” value of the collateral securing the related loan, where available.

For certain Rehabilitation loans, totaling $137.3 million, an after repaired valuation was not obtained and the loan was underwritten based on an “as is” valuation.

For Transitional loans, the LTV presented is the ratio of the maximum unpaid principal balance of the loan, including unfunded commitments, to the estimated “after repaired” value of the collateral securing the related loan, where available.

For certain Transitional loans, totaling $223.2 million, an after repaired valuation was not obtained and the loan was underwritten based on an “as is” valuation.

The LTV of these loans based on the current unpaid principal balance and the valuation obtained during underwriting, is 70%.

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New York 4.9 %

New Jersey 4.4 %

Georgia 4.9 %

MSR-Related Assets

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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.

The payment of principal and/or interest we receive on our Agency MBS, which depend directly upon payments on the mortgages underlying such securities, are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae.

Fannie Mae and Freddie Mac are GSEs, and while their guarantees are not explicitly backed by the full faith and credit of the United States, we do not consider that we are exposed to significant credit risk.

Ginnie Mae is part of a U.S.

Government agency and its guarantees are explicitly backed by the full faith and credit of the United States.

Overall, investments in Agency MBS are not considered to be subject to significant credit risk.

Credit Spread Risk

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In addition, at December 31, 2022, we had $38.2 million of unencumbered residential whole loans.

Further, we believe that we have unused capacity of approximately $350 million 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 events that asset prices do not decline by more than a specified amount.

PREPAYMENT RISK

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Premiums paid are amortized against interest income and accretable purchase discounts on these investments are accreted to interest income.

Purchase premiums, which are primarily carried on our Purchased Performing Loans (excluding Rehabilitation loans that are typically purchased at par), are amortized against interest income over the life of the investment using the effective yield method, adjusted for actual prepayment activity.

Purchase premiums, which are primarily carried on our Purchased Performing Loans (excluding Transitional loans that are typically purchased at par), 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.

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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 7A. Quantitative and Qualitative Disclosures About Market Risk