Toggle SGML Header (+)


Section 1: 10-Q (CHIMERA INVESTMENT CORPORATION 10-Q)

a50684688.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X]             QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED:  JUNE 30, 2012

OR

[  ]             TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM _______________ TO _________________

COMMISSION FILE NUMBER:  1-33796

CHIMERA INVESTMENT CORPORATION
(Exact name of Registrant as specified in its Charter)

MARYLAND
26-0630461
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
 
1211 AVENUE OF THE AMERICAS, SUITE 2902
NEW YORK, NEW YORK
(Address of principal executive offices)

10036
 (Zip Code)

(646) 454-3759
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all documents and reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
Yes o No þ

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o No þ

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

Class
Outstanding at October 31, 2013
Common Stock, $.01 par value
1,027,527,549
 
 
 

 
 
CHIMERA INVESTMENT CORPORATION
FORM 10-Q
TABLE OF CONTENTS

Part I.     FINANCIAL INFORMATION
 
   
Item 1.  Consolidated Financial Statements:
 
   
1
   
2
   
3
   
4
   
5
   
38
   
60
   
64
   
   
 
   
64
   
65
   
66
   
S-1
 
 
i

 
 
CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands, except share and per share data)
 
             
             
   
June 30, 2012
(Unaudited)
   
December 31, 2011 (1)
 
Assets:
           
Cash and cash equivalents
  $ 116,227     $ 206,299  
Non-Agency RMBS, at fair value
               
  Senior
    665       1,020  
  Senior interest-only
    210,505       188,679  
  Subordinated
    640,425       606,895  
  Subordinated interest-only
    20,612       22,019  
Agency RMBS, at fair value
    2,779,239       3,144,531  
Accrued interest receivable
    23,024       22,709  
Other assets
    15,045       1,403  
  Subtotal
    3,805,742       4,193,555  
Assets of Consolidated VIEs:
               
  Non-Agency RMBS transferred to consolidated variable interest entities ("VIEs"), at fair value
    3,151,807       3,270,332  
  Securitized loans held for investment, net of allowance for loan losses of $11.5 million and $13.9 million, respectively
    1,322,894       256,632  
  Accrued interest receivable
    26,142       26,616  
  Subtotal
    4,500,843       3,553,580  
Total assets
  $ 8,306,585     $ 7,747,135  
                 
Liabilities:
               
Repurchase agreements, Agency RMBS ($2.5 billion and $2.8 billion pledged as collateral, respectively)
  $ 2,362,088     $ 2,672,989  
Payable for investments purchased
    14,863       -  
Accrued interest payable
    2,477       3,294  
Dividends payable
    92,413       112,937  
Accounts payable and other liabilities
    1,608       1,687  
Investment management fees and expenses payable to affiliate
    12,965       12,958  
Interest rate swaps, at fair value
    54,646       44,467  
Subtotal
    2,541,060       2,848,332  
Non-Recourse Liabilities of Consolidated VIEs
               
  Securitized debt, Non-Agency RMBS transferred to consolidated VIEs ($3.2 billion and $3.3 billion pledged as collateral, respectively)
    1,371,736       1,630,276  
  Securitized debt, loans held for investment ($1.3 billion and $238.0 million pledged as collateral, respectively)
    1,203,518       212,778  
  Accrued interest payable
    9,557       8,130  
  Subtotal
    2,584,811       1,851,184  
Total liabilities
  $ 5,125,871     $ 4,699,516  
                 
Commitments and Contingencies (See Note 15)
               
                 
Stockholders' Equity:
               
Common stock: par value $0.01 per share; 1,500,000,000 shares authorized, 1,027,505,245 and 1,027,467,089 shares issued and outstanding, respectively
  $ 10,268     $ 10,267  
Additional paid-in-capital
    3,604,024       3,603,739  
Accumulated other comprehensive income (loss)
    650,607       433,453  
Retained earnings (accumulated deficit)
    (1,084,185 )     (999,840 )
Total stockholders' equity
  $ 3,180,714     $ 3,047,619  
Total liabilities and stockholders' equity
  $ 8,306,585     $ 7,747,135  
(1) Derived from the audited consolidated financial statements.
               
See accompanying notes to consolidated financial statements.
 
 
 
1

 
 
CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands, except share and per share data)
 
(unaudited)
 
                         
    For the Quarter Ended     
For the Six Months Ended
 
   
June 30, 2012
   
June 30, 2011
   
June 30, 2012
   
June 30, 2011
 
Net Interest Income:
                       
Interest income
  $ 52,031     $ 70,856     $ 103,350     $ 128,942  
Interest expense
    (2,473 )     (2,959 )     (4,799 )     (6,011 )
                                 
Interest income, Non-Agency RMBS and securitized loans transferred to consolidated VIEs
    109,493       109,003       207,842       222,960  
Interest expense, Non-Agency RMBS and securitized loans transferred to consolidated VIEs
    (19,480 )     (32,834 )     (53,529 )     (65,359 )
Net interest income (expense)
    139,571       144,066       252,864       280,532  
                                 
Other-than-temporary impairments:
                               
Total other-than-temporary impairment losses
    (12,474 )     (57,926 )     (44,551 )     (82,974 )
Portion of loss recognized in other comprehensive income (loss)
    (53,213 )     (4,244 )     (69,500 )     (12,379 )
Net other-than-temporary credit impairment losses
    (65,687 )     (62,170 )     (114,051 )     (95,353 )
                                 
Other gains (losses):
                               
Net unrealized gains (losses) on interest rate swaps
    (10,992 )     (19,500 )     (10,180 )     (9,669 )
Net realized gains (losses) on interest rate swaps
    (5,194 )     (4,297 )     (9,592 )     (7,144 )
Net gains (losses) on interest rate swaps
    (16,186 )     (23,797 )     (19,772 )     (16,813 )
Net unrealized gains (losses) on interest-only RMBS
    (2,532 )     11,883       15,415       15,989  
Net realized gains (losses) on sales of investments
    -       (913 )     16,010       1,729  
Total other gains (losses)
    (18,718 )     (12,827 )     11,653       905  
Net investment income (loss)
    55,166       69,069       150,466       186,084  
                                 
Other expenses:
                               
Management fees
    12,903       13,152       25,812       25,902  
Provision for loan losses, net
    (1,059 )     -       (892 )     1,442  
General and administrative expenses
    2,541       1,820       4,530       3,307  
Total other expenses
    14,385       14,972       29,450       30,651  
Income (loss) before income taxes
    40,781       54,097       121,016       155,433  
Income taxes
    -       118       2       816  
Net income (loss)
  $ 40,781     $ 53,979     $ 121,014     $ 154,617  
                                 
Net income (loss) per share available to common shareholders:
                               
Basic
  $ 0.04     $ 0.05     $ 0.12     $ 0.15  
Diluted
  $ 0.04     $ 0.05     $ 0.12     $ 0.15  
                                 
Weighted average number of common shares outstanding:
                               
Basic
    1,026,809,700       1,026,308,896       1,026,785,896       1,026,259,300  
Diluted
    1,027,505,247       1,027,130,496       1,027,497,417       1,027,096,962  
                                 
Dividends declared per share of common stock
  $ 0.09     $ 0.13     $ 0.20     $ 0.27  
                                 
Comprehensive income (loss):
                               
Net income (loss)
  $ 40,781     $ 53,979     $ 121,014     $ 154,617  
Other comprehensive income (loss):
                               
Unrealized gains (losses) on available-for-sale securities, net
    (4,021 )     (87,821 )     119,113       (216,390 )
Reclassification adjustment for net losses included in net income (loss) for other-than-
temporary credit impairment losses
    65,687       62,170       114,051       95,353  
Reclassification adjustment for net realized losses (gains) included in net income (loss)
    -       913       (16,010 )     (1,729 )
Other comprehensive income (loss)
    61,666       (24,738 )     217,154       (122,766 )
Comprehensive income (loss)
  $ 102,447     $ 29,241     $ 338,168     $ 31,851  
                                 
See accompanying notes to consolidated financial statements.
                               
 
 
2

 

CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands, except per share data)
 
(unaudited)
 
                               
                               
   
Common Stock
Par Value
   
Additional Paid-in Capital
   
Accumulated
Other
Comprehensive Income (Loss)
   
Retained
Earnings (Accumulated
Deficit)
   
Total
 
Balance, December 31, 2010
  $ 10,261     $ 3,601,890     $ 680,123     $ (613,688 )   $ 3,678,586  
Net income
    -       -       -       154,617       154,617  
Unrealized gains (losses) on available-for-sale securities, net
    -       -       (216,390 )     -       (216,390 )
Reclassification adjustment for net losses included in net
  income (loss) for other-than-temporary credit impairment
  losses
    -       -       95,353       -       95,353  
Reclassification adjustment for net realized losses (gains)
  included in net income (loss)
    -       -       (1,729 )     -       (1,729 )
Proceeds from direct purchase and dividend reinvestment
    2       540       -       -       542  
Proceeds from common stock offerings
    -       (8 )     -       -       (8 )
Proceeds from restricted stock grants
    -       249       -       -       249  
Common dividends declared, $0.27 per share
    -       -       -       (277,101 )     (277,101 )
Balance, June 30, 2011
  $ 10,263     $ 3,602,671     $ 557,357     $ (736,172 )   $ 3,434,119  
                                         
Balance, December 31, 2011
  $ 10,267     $ 3,603,739     $ 433,453     $ (999,840 )   $ 3,047,619  
Net income
    -       -       -       121,014       121,014  
Unrealized gains (losses) on available-for-sale securities, net
    -       -       119,113       -       119,113  
Reclassification adjustment for net losses included in net
  income (loss) for other-than-temporary credit impairment
  losses
    -       -       114,051       -       114,051  
Reclassification adjustment for net realized losses (gains)
  included in net income (loss)
    -       -       (16,010 )     -       (16,010 )
Proceeds from direct purchase and dividend reinvestment
    1       116       -       -       117  
Proceeds from restricted stock grants
    -       169       -       -       169  
Common dividends declared, $0.20 per share
    -       -       -       (205,359 )     (205,359 )
Balance, June 30, 2012
  $ 10,268     $ 3,604,024     $ 650,607     $ (1,084,185 )   $ 3,180,714  
                                         
See accompanying notes to consolidated financial statements.
                         
 
 
3

 

CHIMERA INVESTMENT CORPORATION
 
 
(dollars in thousands)
 
   
For the Six Months Ended
 
   
June 30, 2012
   
June 30, 2011
 
Cash Flows From Operating Activities:
           
Net income (loss)
  $ 121,014     $ 154,617  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
(Accretion) amortization of investment discounts/premiums, net
    (28,340 )     (21,049 )
Amortization of deferred financing costs
    5,265       908  
Amortization of debt issue costs of securitized debt
    (883     6,503  
Net unrealized losses (gains) on interest rate swaps
    10,180       9,669  
Net unrealized losses (gains) on interest-only RMBS
    (15,415 )     (15,989 )
Net realized losses (gains) on sales of investments
    (16,010 )     (1,729 )
Net other-than-temporary credit impairment losses
    114,051       95,353  
Provision for loan losses, net
    (892 )     1,442  
Equity-based compensation expense
    169       249  
Changes in operating assets:
               
   Decrease (increase) in accrued interest receivable, net
    (725 )     (8,998 )
   Decrease (increase) in other assets
    447       365  
Changes in operating liabilities:
               
   Increase (decrease) in accounts payable and other liabilities
    (79 )     962  
   Increase (decrease) in investment management fees and expenses payable to affiliate
    7        774  
   Increase (decrease) in accrued interest payable, net
    610       (112 )
Net cash provided by (used in) operating activities
    189,399       222,965  
Cash Flows From Investing Activities:
               
RMBS portfolio:
               
   Purchases
    (101,764 )     (3,653,583 )
   Sales
    79,059       668,529  
   Principal payments
    362,625       244,221  
RMBS transferred to consolidated VIEs:
               
   Principal payments
    263,772       385,168  
Securitized loans:
               
   Purchases
    (1,185,664 )     -  
   Principal payments
    114,148       48,402  
Net cash provided by (used in) investing activities
    (467,824 )     (2,307,263 )
Cash Flows From Financing Activities:
               
   Proceeds from repurchase agreements
    3,918,315       9,335,704  
   Payments on repurchase agreements
    (4,229,216 )     (6,824,014 )
   Net proceeds from common stock offerings
    -       (8 )
   Payment of deferred financing costs
    (8,073 )     -  
   Proceeds from securitized debt borrowings, loans held for investment
    1,101,526       -  
   Payments on securitized debt borrowings, loans held for investment
    (110,495 )     (45,159 )
   Proceeds from securitized debt borrowings, RMBS transferred to consolidated VIEs
     -       311,012  
   Payments on securitized debt borrowings, RMBS transferred to consolidated VIEs
     (257,938      (366,751
   Net proceeds from direct purchase and dividend reinvestment
    117       542  
   Common dividends paid
    (225,883 )     (318,121 )
Net cash provided by (used in) financing activities
    188,353       2,093,205  
Net increase (decrease) in cash and cash equivalents
    (90,072 )     8,907  
Cash and cash equivalents at beginning of period
    206,299       7,173  
Cash and cash equivalents at end of period
  $ 116,227     $ 16,080  
                 
Supplemental disclosure of cash flow information:
               
   Interest received
  $ 283,015     $ 321,000  
   Interest paid
  $ 58,601     $ 64,979  
   Taxes paid
  $ -     $ 3  
   Management fees and expenses paid to affiliate
  $ 25,805     $ 24,979  
                 
Non-cash investing activities:
               
   Payable for investments purchased
  $ 14,863     $ -  
   Net change in unrealized gain (loss) on available-for sale securities
  $ 217,154     $ (122,766 )
                 
Non-cash financing activities:
               
   Common dividends declared, not yet paid
  $ 92,413     $ 133,425  
                 
See accompanying notes to consolidated financial statements.
               

 
4

 
 
CHIMERA INVESTMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   Organization

Chimera Investment Corporation (the “Company”) was organized in Maryland on June 1, 2007.  The Company commenced operations on November 21, 2007 when it completed its initial public offering.  The Company elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended.  The Company formed the following wholly-owned qualified REIT subsidiaries:  Chimera Securities Holdings, LLC in July 2008; Chimera Asset Holding LLC and Chimera Holding LLC in June 2009; and Chimera Special Holding LLC in January 2010 which is a wholly-owned subsidiary of Chimera Asset Holding LLC.  In July 2010, the Company formed CIM Trading Company LLC, a wholly-owned taxable REIT subsidiary (“TRS”).

Annaly Capital Management, Inc. (“Annaly”) owns approximately 4.38% of the Company’s common shares.  The Company is managed by Fixed Income Discount Advisory Company (“FIDAC”), an investment advisor registered with the Securities and Exchange Commission (“SEC”).  FIDAC is a wholly-owned subsidiary of Annaly.

2.  Summary of the Significant Accounting Policies

Restatement

The Company restated its previously issued (i) consolidated statement of financial condition included in its Annual Report on Form 10-K as of December 31, 2010 and (ii) consolidated statements of operations and comprehensive income, consolidated statements of changes in stockholders’ equity, and consolidated statements of cash flows for the years ended December 31, 2010 and 2009, including the cumulative effect of the restatement on retained earnings (accumulated deficit) as of the earliest period presented (the “Restatement”) as part of its Form 10-K for the year ended December 31, 2011.  The Restatement also impacted each of the quarters for the periods beginning with the Company’s inception in November 2007 through the quarter ended September 30, 2011.   The historical interim periods included in this Form 10-Q reflect the Restatement.

(a) Basis of Presentation and Consolidation

The accompanying consolidated financial statements and related notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). In the opinion of management, all adjustments considered necessary for a fair presentation of the Company's financial position, results of operations and cash flows have been included.  The accompanying unaudited consolidated interim financial statements should be read in conjunction with the consolidated financial statements and the related management’s discussion and analysis of financial condition and results of operations filed with our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

The consolidated financial statements include, on a consolidated basis, the Company’s accounts, the accounts of its wholly-owned subsidiaries, and variable interest entities (“VIEs”) in which the Company is the primary beneficiary. All significant intercompany balances and transactions have been eliminated in consolidation.

VIEs are defined as entities in which equity investors (i) do not have the characteristics of a controlling financial interest, and/or (ii) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The entity that consolidates a VIE is known as its primary beneficiary, and is generally the entity with (i) the power to direct the activities that most significantly impact the VIE’s economic performance, and (ii) the right to receive benefits from the VIE or the obligation to absorb losses of the VIE that could be significant to the VIE.  For VIEs that do not have substantial on going activities, the power to direct the activities that most significantly impact the VIEs’ economic performance may be determined by an entity’s involvement with the design and structure of the VIE.

The Company uses securitization trusts considered to be VIEs in its securitization and re-securitization transactions.  Prior to January 1, 2010, these VIEs met the definition of Qualified Special Purpose Entities (“QSPE”) and, as such, were not subject to consolidation by the Company.  Effective January 1, 2010, all such VIEs were considered for consolidation based on the criteria in ASC 810, Consolidation, resulting in the consolidation of certain VIEs that were not previously consolidated. Non-Agency RMBS transferred to consolidated VIEs are composed entirely of senior certificates.
 
 
 
5

 
 
(b) Statement of Financial Condition Presentation

The Company’s consolidated statements of financial condition separately present: (i) the Company’s direct assets and liabilities, and (ii) the assets and liabilities of consolidated securitization vehicles. Assets of each consolidated VIE can only be used to satisfy the obligations of that VIE, and the liabilities of consolidated VIEs are non-recourse to the Company.

The Company has aggregated all the assets and liabilities of the consolidated securitization vehicles due to the determination that these entities are substantively similar and therefore a further disaggregated presentation would not be more meaningful. The notes to the consolidated financial statements describe the Company’s direct assets and liabilities and the assets and liabilities of consolidated securitization vehicles.  See Note 8 for additional information related to the Company’s investments in consolidated securitization vehicles.

(c) Cash and Cash Equivalents

Cash and cash equivalents include cash on hand and cash deposited overnight in money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation. There were no restrictions on cash and cash equivalents at June 30, 2012 and December 31, 2011.

(d) Agency and Non-Agency Residential Mortgage-Backed Securities

The Company invests in residential mortgage-backed securities (“RMBS”) representing interests in obligations backed by pools of mortgage loans.  The Company delineates between (1) Agency RMBS and (2) Non-Agency RMBS as follows: Agency RMBS are mortgage pass-through certificates, collateralized mortgage obligations (“CMOs”), and other RMBS representing interests in or obligations backed by pools of mortgage loans issued or guaranteed by agencies of the U.S. Government, such as Ginnie Mae, or federally chartered corporations such as Freddie Mac or Fannie Mae where principal and interest repayments are guaranteed by the respective agency of the U.S. Government or federally chartered corporation. Non-Agency RMBS are not issued or guaranteed by a U.S. Government Agency or other institution and are subject to credit risk.  Repayment of principal and interest on Non-Agency RMBS is subject to the performance of the mortgage loans or RMBS collateralizing the obligation.

The Company classifies its RMBS as available-for-sale, records investments at estimated fair value as described in Note 5 of these consolidated financial statements, and includes unrealized gains and losses considered to be temporary on all RMBS, excluding interest-only strips, in other comprehensive income (loss) in the Consolidated Statements of Operations and Comprehensive Income.  Interest-only strips are recorded at estimated fair value and all unrealized gains and losses are included in earnings in the Consolidated Statements of Operations and Comprehensive Income.  From time to time, as part of the overall management of its portfolio, the Company may sell any of its RMBS investments and recognize a realized gain or loss as a component of earnings in the Consolidated Statements of Operations and Comprehensive Income utilizing the average cost method.

The Company’s accounting policy for interest income and impairment related to its RMBS is as follows:

Interest Income Recognition

The recognition of interest income on RMBS securities varies depending on the characteristics of the security as follows:

Agency RMBS and Non-Agency RMBS of High Credit Quality

ASC 310-20, Nonrefundable Fees and Other Costs (“ASC 310-20”) is applied to the recognition of interest income for the following securities:

   
Agency RMBS
   
Non-Agency RMBS that meet all of the following conditions at the acquisition date (referred to hereafter as “Non-Agency RMBS of High Credit Quality”):
 
 
6

 
 
1.   
Rated AA or higher by a nationally recognized credit rating agency.  The Company uses the lowest rating available.
2.   
The Company expects to collect all of the security’s contractual cash flows.
3.   
The security cannot be contractually prepaid such that the Company would not recover substantially all of its recorded investment.

Under ASC 310-20, interest income, including premiums and discounts associated with the acquisition of these securities, is recognized over the life of such securities using the interest method based on the contractual cash flows of the security.   In applying the interest method, the Company considers estimates of future principal prepayments in the calculation of the constant effective yield. Differences that arise between previously anticipated prepayments and actual prepayments received, as well as changes in future prepayment assumptions, result in a recalculation of the effective yield on the security on a quarterly basis. This recalculation results in the recognition of an adjustment to the carrying amount of the security based on the revised prepayment assumptions and a corresponding increase or decrease in reported interest income.

Non-Agency RMBS Not of High Credit Quality

Non-Agency RMBS that are purchased at a discount and that are not of high credit quality at the time of purchase are accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”) or ASC 325-40, Beneficial Interests in Securitized Financial Assets (“ASC 325-40”) (referred to hereafter as “Non-Agency RMBS Not of High Credit Quality”).

Non-Agency RMBS are accounted for under ASC 310-30 if the following conditions are met as of the acquisition date:

1.   
There is evidence of deterioration in credit quality of the security from its inception.
2.   
It is probable that the Company will be unable to collect substantially all contractual cash flows of the security.

Non-Agency RMBS that are not within the scope of ASC 310-30 are accounted for under ASC 325-40 if at the acquisition date:
 
1.   
The security is not of high credit quality (defined as rated below AA or is unrated), or
2.   
The security can contractually be prepaid or otherwise settled in such a way that the Company would not recover substantially all of its recorded investment.

Interest income on Non-Agency RMBS Not of High Credit Quality is recognized using the interest method based on management’s estimates of cash flows expected to be collected. The effective interest rate on these securities is based on management’s estimate for each security of the projected cash flows, which are estimated based on observation of current market information and include assumptions related to fluctuations in prepayment speeds and the timing and amount of credit losses. Quarterly, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on inputs and analyses received from external sources, internal models, and the Company’s judgments about prepayment rates, the timing and amount of credit losses, and other factors. Changes in the amount and/or timing of cash flows from those originally projected, or from those estimated at the last evaluation date, are considered to be either positive changes or adverse changes. For securities accounted for under ASC 325-40, any positive or adverse change in cash flows that does not result in the recognition of an other-than-temporary impairment results in a prospective increase or decrease in the effective interest rate used to recognize interest income. For securities accounted for under ASC 310-30, only significant positive changes are reflected prospectively in the effective interest rate used to recognize interest income.  Adverse changes in cash flows expected to be collected are generally treated consistently for RMBS accounted for under ASC 325-40 and ASC 310-30, and generally result in recognition of an other-than-temporary impairment with no change in the effective interest rate used to recognize interest income.
 
 
7

 

Impairment

Considerations Applicable to all RMBS

When the fair value of an available-for-sale RMBS is less than its amortized cost the security is considered impaired.  On at least a quarterly basis the Company evaluates its securities for other-than-temporary impairment (“OTTI”).  If the Company intends to sell an impaired security, or it is more-likely-than-not that the Company will be required to sell an impaired security before its anticipated recovery, then the Company must recognize an OTTI through a charge to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the measurement date.  If the Company does not intend to sell an impaired security and it is not more-likely-than-not that it would be required to sell an impaired security before recovery, the Company must further evaluate the security for impairment due to credit losses. The credit component of OTTI is recognized in earnings and the remaining or non-credit component is recorded as a component of OCI. Following the recognition of an OTTI through earnings, a new amortized cost basis is established for the security and subsequent recoveries in fair value may not be adjusted through earnings.

When evaluating whether the Company intends to sell an impaired security or will more-likely-than-not be required to sell an impaired security before recovery, the Company makes judgments that consider among other things, its liquidity, leverage, contractual obligations, and targeted investment strategy to determine its intent and ability to hold the investments that are deemed impaired.  The determination as to whether an OTTI exists is subjective as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of future conditions.  As a result, the determination of OTTI, its timing and amount, is based on estimates that may change materially over time.

The Company’s estimate of the amount and timing of cash flows for its RMBS is based on its review of the underlying securities or mortgage loans securing the RMBS.  The Company considers historical information available and expected future performance of the underlying securities or mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, extent of credit support available, Fair Isaac Corporation (“FICO”) scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as reports by credit rating agencies, such as Moody’s Investors Service, Inc., Standard & Poor’s Rating Services or Fitch Ratings, Inc., general market assessments and dialogue with market participants.  As a result, substantial judgment is used in the Company’s analysis to determine the expected cash flows for its RMBS.

Considerations Applicable to Non-Agency RMBS of High Credit Quality

The impairment assessment for Non-Agency RMBS of High Credit Quality involves comparing the present value of the remaining cash flows expected to be collected to the amortized cost of the security at the assessment date.  The discount rate used to calculate the present value of the expected future cash flows is based on the security’s effective interest rate as calculated under ASC 310-20 (i.e., the  discount rate implicit in the security as of the last measurement date).   If the present value of the remaining cash flows expected to be collected is less than the amortized cost basis, an OTTI is recognized in earnings for the difference. This amount is considered to be the credit loss component; the remaining difference between amortized cost and the fair value of the security is considered to be the non-credit component of the OTTI, which is recognized in other comprehensive income (loss).

Following the recognition of an OTTI through earnings for the credit loss component, a new amortized cost basis is established for the security and subsequent recoveries in fair value may not be adjusted through earnings.

Considerations Applicable to Non-Agency RMBS Not of High Credit Quality

Non-Agency RMBS within the scope of ASC 325-40 or ASC 310-30 are considered other-than-temporarily impaired when the following two conditions exist: (1) the fair value is less than the amortized cost basis, and (2) there has been an adverse change in cash flows expected to be collected from the last measurement date (i.e., adverse changes in either the amount or timing of cash flows from those previously expected).

The other-than-temporary impairment is separated into a credit loss component that is recognized in earnings and a non-credit component that is recorded in other comprehensive income (loss). The credit component is comprised of the impact of the fair value decline due to changes in assumptions related to default (collection) risk and prepayments. The non-credit component comprises the change in fair value of the security due to all other factors, including changes in benchmark interest rates and market liquidity.  In determining the OTTI related to credit losses for securities, the Company compares the present value of the remaining cash flows expected to be collected at the current financial reporting date to the present value of the remaining cash flows expected to be collected at the original purchase date (or the last date those estimates were revised for accounting purposes).  The discount rate used to calculate the present value of expected future cash flows is the effective interest rate used for income recognition purposes as determined under ASC 325-40 or ASC 310-30.
 
 
8

 

Following the recognition of an OTTI through earnings for the credit component, a new amortized cost basis is established for the security and subsequent recoveries in fair value may not be adjusted through earnings. However, to the extent that there are subsequent increases in cash flows expected to be collected, the OTTI previously recorded through earnings may be accreted into interest income following the guidance in ASC 325-40 or ASC 310-30.

The determination of whether an OTTI exists and, if so, the extent of the credit component is subject to significant judgment and management’s estimates of both historical information available at the time of assessment, the current market environment, as well as the Company’s estimates of the future performance and projected amount and timing of cash flows expected to be collected on the security. As a result, the timing and amount of OTTI constitutes an accounting estimate that may change materially over time.

(e) Interest-Only RMBS

The Company invests in interest-only (“IO”) Agency and Non-Agency RMBS. These IO RMBS represent the Company’s right to receive a specified proportion of the contractual interest flows of the collateral. The Company has accounted for IO RMBS at fair value with changes in fair value recognized in the Company’s Consolidated Statements of Operations and Comprehensive Income.  The Company has elected the fair value option to account for IO RMBS to simplify the reporting of changes in fair value.  The IO RMBS are included in RMBS, at fair value, on the accompanying Consolidated Statements of Financial Condition.  Coupon income on IO RMBS is accrued based on the outstanding notional balance and the security’s contractual terms, and amortization is computed in accordance with ASC 325-40.  Changes in fair value are presented in Net unrealized gains (losses) on interest-only RMBS on the Consolidated Statement of Operations and Comprehensive Income.  Interest income reported on IO securities was $7.7 million and $6.6 million for the quarters ended June 30, 2012 and June 30, 2011, respectively.  Interest income reported on IO securities was $13.7 million and $14.2 million for the six months ended June 30, 2012 and June 30, 2011, respectively.

(f) Securitized Loans Held for Investment and Related Allowance for Loan Losses

The Company’s securitized residential mortgage loans are comprised of fixed-rate and variable-rate loans.  Mortgage loans are designated as held for investment, and are carried at their principal balance outstanding, plus any premiums, less discounts and allowances for loan losses.  Interest income on loans held for investment is recognized over the life of the investment using the interest method.  Income recognition is suspended for loans when, based on information from the servicer, a full recovery of income and principal becomes doubtful.  Income recognition is resumed when the loan becomes contractually current and performance is demonstrated to be resumed.  The Company estimates the fair value of securitized loans for disclosure purposes only as described in Note 5 of these consolidated financial statements.

(g) Allowance for Loan Losses – Securitized Loans Held for Investment

The securitized loan portfolio is comprised primarily of non-conforming, single family, owner occupied, jumbo, prime loans that are not guaranteed as to repayment of principal or interest.  Securitized loans are serviced and modified by a third-party servicer.  The Company is not involved in the loan modification process, except as it relates to the CSMC 2012-CIM1 and CSMC 2012-CIM2 securitization vehicles consolidated by the Company that are collateralized by residential mortgage loans.  As it relates solely to CSMC 2012-CIM1 and CSMC 2012-CIM2, the Company has the ability to approve certain loan modifications and determine the course of action to be taken as it relates to loans in technical default, including whether or not to proceed with foreclosure.
 
 
9

 

The Company has established an allowance for loan losses related to securitized loans that is composed of a general and specific reserve. The general reserve relates to loans that have not been individually evaluated for impairment and is accounted for under ASC 450, Contingencies.  The general reserve is based on historical loss rates for pools of loans with similar credit characteristics, adjusted for current trends and conditions.
 
Certain loans are individually evaluated for impairment, including securitized loans modified by the servicer and loans more than 60 days delinquent under ASC 310, Receivables.  Loan modifications made by the servicer are evaluated to determine if they constitute troubled debt restructurings (“TDRs”).  A restructuring of a loan constitutes a TDR if the servicer, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that it would not otherwise consider. Impairment of modified loans considered to be TDRs is measured based on the present value of expected cash flows discounted at the loan’s effective interest rate at inception. If the present value of expected cash flows is less than the recorded investment in the loan, a provision for loan losses is recognized through an allowance with a corresponding charge to provision for loan losses. Impairment of all other loans individually evaluated is measured as the difference between the unpaid principal balance and the estimated fair value of the collateral, less estimated costs to sell.  The Company charges off the corresponding loan allowance and related principal balance when the servicer reports a realized loss. A complete discussion of securitized loans held for investment is included in Note 4 to these financial statements.

(h) Repurchase Agreements

The Company finances the acquisition of a significant portion of its Agency mortgage-backed securities with repurchase agreements. The Company examines each of the specified criteria in ASC 860, Transfers and Servicing (“ASC 860”), at the inception of each transaction and has determined that each of the Company’s repurchase agreements meet the specified criteria in this guidance to be accounted for as secured borrowings. None of the Company’s repurchase agreements are accounted for as components of linked transactions. As a result, the Company separately accounts for the financial assets posted as collateral and related repurchase agreements in the accompanying consolidated financial statements.

(i) Securitized Debt, Non-Agency RMBS Transferred to Consolidated VIEs, and Securitized Debt, Loans Held for Investment

The Company has issued securitized debt to finance a portion of its residential mortgage loan and RMBS portfolios.  Certain transactions involving residential mortgage loans are accounted for as secured borrowings, and are recorded as “Securitized loans held for investment” and the corresponding debt as “Securitized debt, loans held for investment” in the Consolidated Statements of Financial Condition.  These securitizations are collateralized by residential adjustable or fixed rate mortgage loans that have been placed in a trust and pay interest and principal to the debt holders of that securitization.  Re-securitization transactions classified as “Securitized debt, Non-Agency RMBS transferred to consolidated VIEs” reflect the transfer to a trust of fixed or adjustable rate RMBS which are classified as “Non-Agency RMBS transferred to consolidated VIEs” that pay interest and principal to the debt holders of that re-securitization.  Re-securitization transactions completed by the Company that did not qualify as a sale are accounted for as secured borrowings pursuant to ASC 860. For the six months ended June 30, 2012, the Company did not have any continuing involvement with any loans or securities previously sold, except as it relates to the loans in the CSMC 2012-CIM1 and CSMC 2012-CIM2 securitizations as further described above.  The holders of securitized debt have no recourse to the Company and the Company does not receive any interest or principal paid on such debt.  As of June 30, 2012 and December 31, 2011 the Company recorded $2.6 billion and $1.9 billion in principal on securitized debt and accrued interest payable, respectively.  The associated securitized debt is carried at amortized cost. The Company estimates the fair value of its securitized debt for disclosure purposes as described in Note 5 to these consolidated financial statements.

(j) Fair Value Disclosure

A complete discussion of the methodology utilized by the Company to estimate the fair value of its financial instruments is included in Note 5 to these consolidated financial statements.

(k) Derivative Financial Instruments

The Company’s policies permit it to enter into derivative contracts, including interest rate swaps and interest rate caps, as a means of managing its interest rate risk. The Company intends to use interest rate derivative instruments to manage interest rate risk rather than to enhance returns.  Interest rate swaps are recorded as either assets or liabilities in the Consolidated Statements of Financial Condition and measured at fair value.  Net payments on interest rate swaps are included in the Consolidated Statements of Cash Flows as a component of net income (loss).  Unrealized gains (losses) on interest rate swaps are removed from net income (loss) to arrive at cash flows from operating activities. The Company estimates the fair value of interest rate swaps as described in Note 5 of these consolidated financial statements.
 
 
10

 

The Company elects to net by counterparty the fair value of interest rate swap contracts.  These contracts contain legally enforceable provisions that allow for netting or setting off of all individual swaps receivable and payable with each counterparty and, therefore, the fair value of those swap contracts are reported net by counterparty.  The credit support annex provisions of the Company’s interest rate swap contracts allow the parties to mitigate their credit risk by requiring the party which is in a net payable position to post collateral. As the Company elects to net by counterparty the fair value of interest rate swap contracts, it also nets by counterparty any collateral exchanged as part of the interest rate swap contracts.

(l) Sales, Securitizations, and Re-Securitizations

The Company periodically enters into transactions in which it sells financial assets, such as RMBS, and mortgage loans.  Gains and losses on sales of assets are computed on the average cost method whereby the Company records a gain or loss on the difference between the average value of the asset and the proceeds from the sale.  In addition, the Company from time to time securitizes or re-securitizes assets and sells tranches in the newly securitized assets.  These transactions may be recorded as either a sale and the assets contributed to the securitization are removed from the Consolidated Statements of Financial Condition and a gain or loss is recognized, or as a secured borrowing whereby the assets contributed to the securitization are not derecognized but rather the debt issued by the securitization are recorded to reflect the term financing of the assets.  In these securitizations and re-securitizations, the Company may retain senior or subordinated interests in the securitized and/or re-securitized assets.

(m) Income Taxes
 
The Company elected to be taxed as a REIT, and therefore it generally will not be subject to corporate federal or state income tax to the extent that qualifying distributions are made to stockholders and the REIT requirements, including certain asset, income, distribution and stock ownership tests are met. If the Company failed to qualify as a REIT and did not qualify for certain statutory relief provisions, the Company would be subject to federal, state and local income taxes and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year in which the REIT qualification was lost. The Company and CIM Trading made a joint election to treat CIM Trading as a TRS. As such, CIM Trading is taxable as a domestic C corporation and subject to federal, state, and local income taxes based upon its taxable income.
 
The provisions of ASC 740, Income Taxes (“ASC 740”), clarify the accounting for uncertainty in income taxes recognized in financial statements and prescribe a recognition threshold and measurement attribute for tax positions taken or expected to be taken on a tax return.  The Company does not have any unrecognized tax benefits that would affect its financial position. The Company has not taken any tax positions that would require disclosure under ASC 740.  No accruals for penalties and interest were necessary as of June 30, 2012 or December 31, 2011.

(n) Net Income per Share

The Company calculates basic net income per share by dividing net income for the period by the basic weighted-average shares of its common stock outstanding for that period.  Diluted net income per share takes into account the effect of dilutive instruments, such as unvested restricted stock, but uses the average share price for the period in determining the number of incremental shares that are to be added to the diluted weighted average number of shares outstanding.

(o) Stock-Based Compensation

The Company accounts for stock-based compensation awards granted to the employees of FIDAC and FIDAC’s affiliates in accordance with ASC 505-50, Equity-Based Payments to Non-Employees (“ASC 505-50”). Pursuant to ASC 505-50 the Company measures the fair value of the equity instrument using the stock prices and other measurement assumptions as of the earlier of either the date at which a performance commitment by the recipient is reached or the date at which the recipient’s performance is complete. Compensation expense related to the grants of stock is recognized over the vesting period of such grants based on the fair value of the stock on each quarterly vesting date, at which the recipient’s performance is complete.
 
 
11

 

The Company accounts for stock-based compensation awards granted to the Company’s independent directors in accordance with ASC 718, Compensation – Stock Compensation (“ASC 718”). Compensation expense for equity based awards granted to the Company’s independent directors is recognized pro-rata over the vesting period of such awards, based upon the fair value of such awards at the grant date.

(p) Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could be materially different than anticipated in those estimates, which could have a material adverse impact on the Company’s results of operations and its financial condition. Management has made significant estimates in accounting for income recognition and OTTI on Agency and Non-Agency RMBS and IO RMBS (Note 3), valuation of Agency and Non-Agency RMBS (Notes 3 and 5), and interest rate swaps (Notes 5 and 9).  Actual results could differ materially from those estimates.

(q) Recent Accounting Pronouncements

Presentation

Balance Sheet (Topic 210)

On December 23, 2011, the FASB released Accounting Standards Update (“ASU”) 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.  Under this update, the Company will be required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and transactions subject to an agreement similar to a master netting arrangement.  The scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements and securities borrowing and securities lending arrangements.   This disclosure is intended to enable financial statement users to understand the effect of such arrangements on the Company’s financial position.  The objective of this update is to support further convergence between U.S. GAAP and International Financial Reporting Standards (“IFRS”).  This update is effective for annual reporting periods beginning on or after January 1, 2013.  This update is expected to result in additional disclosure.

Comprehensive Income (Topic 220)

In June 2011, the FASB released ASU 2011-05, Comprehensive Income: Presentation of Comprehensive Income, which attempts to improve the comparability, consistency, and transparency of financial reporting and increase the prominence of items reported in Other Comprehensive Income (“OCI”).  ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of net income and comprehensive income or two separate consecutive statements.  Either presentation requires the presentation on the face of the financial statements any reclassification adjustments for items that are reclassified from OCI to net income in the statements.  There is no change in what must be reported in OCI or when an item of OCI must be reclassified to net income.  This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  The Company adopted the provisions of ASU 2011-05 effective January 1, 2012.  Adoption of ASU 2011-05 did not have a significant impact on the Company’s consolidated financial statements.

On December 23, 2011, the FASB issued ASU 2011-12, Comprehensive Income: Deferral of Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income In ASU No. 2011-05, which defers those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments out of accumulated OCI. This was done to allow the FASB time to re-deliberate the presentation, on the face of the financial statements, of the effects of reclassifications out of accumulated OCI on the components of net income and OCI.  No other requirements under ASU 2011-05 are affected by ASU 2011-12.  FASB tentatively decided not to require presentation of reclassification adjustments out of accumulated other comprehensive income on the face of the financial statements and to propose new disclosures instead.
 
 
12

 

In February 2013, the FASB issued ASU 2013-02 Comprehensive Income: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  This update addresses the disclosure issue left open at the deferral under ASU 2011-12.  This update requires the provision of information about the amounts reclassified out of accumulated OCI by component. In addition, it requires presentation, either on the face of the statement where net income is presented or in the Notes, significant amounts reclassified out of accumulated OCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, a cross-reference must be provided to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This update is effective for reporting periods beginning after December 15, 2012. Adoption of ASU 2013-02 is not expected to have a significant impact on the consolidated financial statements.

Broad Transactions

Fair Value Measurements and Disclosures (Topic 820)

In May 2011, the FASB released ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, further converging U.S. GAAP and IFRS by providing common fair value measurement and disclosure requirements.  FASB made changes to the fair value measurement guidance, which include: 1) prohibiting the inclusion of block discounts in all fair value measurements, not just Level 1 measurements, 2) adding guidance on when to include other premiums and discounts in fair value measurements,  3) clarifying that the concepts of “highest and best use” and “valuation premise” apply only when measuring the fair value of non-financial assets and 4) adding an exception that allows the measurement of a group of financial assets and liabilities with offsetting risks (e.g., a portfolio of derivative contracts) at their net exposure to a particular risk if certain criteria are met.  ASU 2011-04 also requires additional disclosure related to items categorized as Level 3 in the fair value hierarchy, including a description of the processes for valuing these assets, providing quantitative information about the significant unobservable inputs used to measure fair value and, in certain cases, explaining the sensitivity of the fair value measurements to changes in unobservable inputs.   This update is effective for reporting periods beginning after December 15, 2011. Adoption of ASU 2011-04 increased the footnote disclosure in these consolidated financial statements.

Transfers and Servicing (Topic 860)

In April 2011, the FASB issued ASU 2011-03, Transfers and Servicing: Reconsideration of Effective Control for Repurchase Agreements.  In a typical repurchase agreement transaction, an entity transfers financial assets to the counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future.  Prior to this update, one of the factors in determining whether sale treatment could be used was whether the transferor maintained effective control of the transferred assets and, in order to do so, the transferor must have the ability to repurchase such assets. In connection with the issuance of ASU 2011-03, the FASB concluded that the assessment of effective control should focus on a transferor’s contractual rights and obligations with respect to transferred financial assets, rather than whether the transferor has the practical ability to perform in accordance with those rights or obligations.  ASU 2011-03 removes the transferor’s ability criterion from consideration of effective control.  This update is effective for the first interim or annual period beginning on or after December 15, 2011.  As the Company records repurchase agreements as secured borrowings and not sales, this update has no significant effect on the Company’s consolidated financial statements.

Financial Services – Investment Companies (Topic 946)
 
In June 2013, the FASB finalized ASU 2013-08 amending the scope, measurement and disclosure requirements under Topic 946 – Financial Services-Investment Companies.  The Board decided not to address issues related to the applicability of investment company accounting for real estate entities and the measurement of real estate investments at this time.  Further, as stated in ASC 946-10-15-3, the guidance in Topic 946 does not apply to real estate investment trusts, and thus has no effect on the Company’s consolidated financial statements.
 
 
13

 

3.  Residential Mortgage-Backed Securities

The Company classifies its Non-Agency RMBS as senior, senior interest-only, subordinated, subordinated interest-only, and Non-Agency RMBS transferred to consolidated VIEs.  The Company also invests in Agency RMBS.  Senior interests in Non-Agency RMBS are considered to be entitled to the first principal repayments in their pro-rata ownership interests at the reporting date.  The total fair value of the Non-Agency RMBS that are held by the re-securitization trusts consolidated pursuant to ASC 810 was $3.2 billion and $3.3 billion at June 30, 2012 and December 31, 2011, respectively.  See Note 8 of these consolidated financial statements for further discussion of consolidated VIEs.

The following tables present the principal or notional value, total premium, total discount, amortized cost, fair value, gross unrealized gains, gross unrealized losses, and net unrealized gain (loss) related to the Company’s available-for-sale RMBS portfolio as of June 30, 2012 and December 31, 2011, by asset class.

June 30, 2012
 
(dollars in thousands)
 
     
Principal or Notional Value
   
Total
Premium
   
Total Discount
   
Amortized
Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Net Unrealized Gain/(Loss)
 
Non-Agency RMBS
                                               
 
  Senior
  $ 718     $ -     $ (55 )   $ 663     $ 665     $ 2     $ -     $ 2  
 
  Senior interest-only
    4,082,598       207,957       -       207,957       210,505       19,178       (16,630 )     2,548  
 
  Subordinated
    1,344,612       -       (702,237 )     642,375       640,425       50,957       (52,907 )     (1,950 )
 
  Subordinated interest-only
  271,413       18,773       -       18,773       20,612       1,839       -       1,839  
 
  RMBS transferred to
  consolidated variable interest
  entities ("VIEs")
  4,991,190       9,790       (2,286,576 )     2,613,469       3,151,807       547,811       (9,473 )     538,338  
Agency RMBS
    2,652,079       79,102       (149 )     2,659,667       2,779,239       120,063       (491 )     119,572  
Total
  $ 13,342,610     $ 315,622     $ (2,989,017 )   $ 6,142,904     $ 6,803,253     $ 739,850     $ (79,501 )   $ 660,349  
 
December 31, 2011
 
(dollars in thousands)
 
     
Principal or Notional Value
   
Total
Premium
   
Total Discount
   
Amortized
Cost
   
Fair Value
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Net Unrealized Gain/(Loss)
 
Non-Agency RMBS
                                               
 
  Senior
  $ 1,115     $ -     $ (56 )   $ 1,059     $ 1,020     $ 2     $ (41 )   $ (39 )
 
  Senior interest-only
    3,734,452       199,288       -       199,288       188,679       11,308       (21,917 )     (10,609 )
 
  Subordinated
    1,378,891       -       (724,739 )     654,152       606,895       30,997       (78,254 )     (47,257 )
 
  Subordinated interest-only
  277,560       21,910       -       21,910       22,019       1,663       (1,554 )     109  
 
  RMBS transferred to
  consolidated variable interest
  entities ("VIEs")
  5,265,128       19,869       (2,382,995 )     2,902,002       3,270,332       420,505       (52,175 )     368,330  
Agency RMBS
    3,018,347       90,403       (159 )     3,027,285       3,144,531       117,601       (355 )     117,246  
Total
  $ 13,675,493     $ 331,470     $ (3,107,949 )   $ 6,805,696     $ 7,233,476     $ 582,076     $ (154,296 )   $ 427,780  
 
The table below presents changes in Accretable Yield, or the excess of the security’s cash flows expected to be collected over the Company’s investment, solely as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.
 
   
For the Quarter Ended
   
For the Six Months Ended
 
   
June 30, 2012
   
June 30, 2011
   
June 30, 2012
   
June 30, 2011
 
   
(dollars in thousands)
   
(dollars in thousands)
 
Balance at beginning of period
  $ 2,300,876     $ 2,398,721     $ 2,342,462     $ 2,521,723  
Purchases
    -       28,447       86,847       91,680  
Accretion
    (92,332 )     (94,785 )     (187,440 )     (191,210 )
Reclassification (to) from non-accretable difference
    26,247       253,105       14,585       210,675  
Sales
    -       -       (21,663 )     (47,380 )
Balance at end of period
  $ 2,234,791     $ 2,585,488     $ 2,234,791     $ 2,585,488  
 
The table below presents the outstanding principal balance and related carrying amount at the beginning and ending of the quarterly periods ending June 30, 2012 and December 31, 2011 as it pertains to the Company’s Non-Agency RMBS portfolio accounted for according to the provisions of ASC 310-30.

   
For the Quarter Ended
 
   
June 30, 2012
   
December 31, 2011
 
   
(dollars in thousands)
 
Outstanding principal balance:
           
Beginning of period
  $ 5,065,387     $ 5,264,486  
End of period
  $ 4,878,479     $ 5,245,184  
                 
Carrying value:
               
Beginning of period
  $ 2,553,219     $ 2,761,672  
End of period
  $ 2,420,502     $ 2,649,303  

 
14

 

The following tables present the gross unrealized losses and estimated fair value of the Company’s RMBS by length of time that such securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011.  All securities in an unrealized loss position have been evaluated by the Company for OTTI as discussed in Note 2(d).

June 30, 2012
 
(dollars in thousands)
 
                                                       
                                                       
   
Unrealized Loss Position for Less than 12 Months
 
Unrealized Loss Position for 12 Months or More
 
Total
 
   
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Non-Agency RMBS
                                                     
Senior
  $ -     $ -       -     $ -     $ -       -     $ -     $ -       -  
Senior interest-only
    17,853       (5,432 )     8       48,352       (11,198 )     18       66,205       (16,630 )     26  
Subordinated
    7,796       (1,350 )     1       249,181       (51,557 )     23       256,977       (52,907 )     24  
Subordinated interest-only
    -       -       -       -       -       -       -       -       -  
RMBS transferred to consolidated VIEs
    -       -       -       139,895       (9,473 )     6       139,895       (9,473 )     6  
Agency RMBS
    3,470       (491 )     2       -       -       -       3,470       (491 )     2  
Total
  $ 29,119     $ (7,273 )     11     $ 437,428     $ (72,228 )     47     $ 466,547     $ (79,501 )     58  
                                                                         
                                                                         
December 31, 2011
 
(dollars in thousands)
 
                                                                         
                                                                         
   
Unrealized Loss Position for Less than 12 Months
 
Unrealized Loss Position for 12 Months or More
 
Total
 
   
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Estimated
Fair Value
   
Unrealized Losses
   
Number of Securities
 
Non-Agency RMBS
                                                                       
Senior
  $ -     $ -       -     $ 127     $ (41 )     1     $ 127     $ (41 )     1  
Senior interest-only
    99,351       (18,756 )     26       17,647       (3,161 )     12       116,998       (21,917 )     38  
Subordinated
    321,416       (52,824 )     33       111,167       (25,430 )     17       432,583       (78,254 )     50  
Subordinated interest-only
    16,300       (1,554 )     2       -       -       -       16,300       (1,554 )     2  
RMBS transferred to consolidated VIEs
    -       -       -       594,369       (52,175 )     18       594,369       (52,175 )     18  
Agency RMBS
    3,888       (355 )     2       -       -       -       3,888       (355 )     2  
Total
  $ 440,955     $ (73,489 )     63     $ 723,310     $ (80,807 )     48     $ 1,164,265     $ (154,296 )     111  

At June 30, 2012, the Company did not intend to sell any of its RMBS that were in an unrealized loss position, and it was not more likely than not that the Company would be required to sell these RMBS before recovery of their amortized cost basis, which may be at their maturity. With respect to RMBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these RMBS is either expressly prohibited, not probable, or is limited to specified events of default, none of which have occurred to date.

Gross unrealized losses on the Company’s Agency RMBS were $491 thousand and $355 thousand at June 30, 2012 and December 31, 2011, respectively. Given the credit quality inherent in Agency RMBS, the Company does not consider any of the current impairments on its Agency RMBS to be credit related.  In evaluating whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at June 30, 2012 and December 31, 2011 unrealized losses on its Agency RMBS were temporary.

Gross unrealized losses on the Company’s Non-Agency RMBS (including Non-Agency RMBS held by consolidated VIEs) were $79.0 million and $153.9 million at June 30, 2012 and December 31, 2011, respectively. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but rather are due to non-credit related factors. The Company has reviewed its Non-Agency RMBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in cash flows expected to be collected for such RMBS, which considers recent bond performance and expected future performance of the underlying collateral.

A summary of the OTTI included in earnings for the quarters and six months ended June 30, 2012 and 2011 is presented below.
 
 
15

 
 
    For the Quarter Ended   
   
June 30, 2012
   
June 30, 2011
 
    (dollars in thousands)   
Total other-than-temporary impairment losses
  $ (12,474 )   $ (57,926 )
Portion of loss recognized in other comprehensive income (loss)
    (53,213 )     (4,244 )
Net other-than-temporary credit impairment losses
  $ (65,687 )   $ (62,170 )
                 
                 
    For the Six Months Ended   
   
June 30, 2012
   
June 30, 2011
 
    (dollars in thousands)   
Total other-than-temporary impairment losses
  $ (44,551 )   $ (82,974 )
Portion of loss recognized in other comprehensive income (loss)
    (69,500 )     (12,379 )
Net other-than-temporary credit impairment losses
  $ (114,051 )   $ (95,353 )
 
The following table presents a roll forward of the credit loss component of OTTI on the Company’s Non-Agency RMBS for which a non-credit component of OTTI was previously recognized in other comprehensive income.  The table delineates between those securities that are recognizing OTTI for the first time as opposed to those that have previously recognized OTTI.
 
    For the Quarter Ended  
   
June 30, 2012
   
June 30, 2011
 
    (dollars in thousands)  
Cumulative credit loss beginning balance
  $ 493,900     $ 266,909  
Additions:
               
  Other-than-temporary impairments not previously recognized
    58,101       55,826  
  Reductions for securities sold during the period
    -       (85 )
  Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
    7,586       6,344  
  Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security
    (18,928 )     (86,345 )
Cumulative credit loss ending balance
  $ 540,659     $ 242,649  
                 
    For the Six Months Ended  
   
June 30, 2012
   
June 30, 2011
 
    (dollars in thousands)  
Cumulative credit loss beginning balance
  $ 452,060     $ 237,746  
Additions:
               
  Other-than-temporary impairments not previously recognized
    89,928       77,822  
  Reductions for securities sold during the period
    (290 )     (1,262 )
  Increases related to other-than-temporary impairments on securities with previously recognized other-than-temporary impairments
     24,123        17,531  
  Reductions for increases in cash flows expected to be collected over the remaining life of the securities
     (25,162      (89,188
Cumulative credit impairment loss ending balance
  $ 540,659     $ 242,649  

Cash flows generated to determine net other-than-temporary credit impairment losses recognized in earnings are estimated using significant unobservable inputs.  The significant inputs used to measure the component of OTTI recognized in earnings for the Company’s Non-Agency RMBS are summarized as follows:
 
 
16

 

   
For the Quarter Ended
 
   
June 30, 2012
   
June 30, 2011
 
             
Loss Severity
           
Weighted Average
    58%       52%  
Range
    45% - 86%       40% - 78%  
                 
60+ days delinquent
               
Weighted Average
    28%       23%  
Range
    9% - 53%       0% - 55%  
                 
Credit Enhancement (1)
               
Weighted Average
    10%       23%  
Range
    0% - 75%       0% - 88%  
                 
3 Month CPR
               
Weighted Average
    16%       16%  
Range
    3% - 30%       4% - 56%  
                 
12 Month CPR
               
Weighted Average
    16%       17%  
Range
    8% - 25%       7% - 31%  
                 
(1) Calculated as the combined credit enhancement to the Re-REMIC and underlying from each of their respective capital structures.
 
 
The following tables present a summary of unrealized gains and losses at June 30, 2012 and December 31, 2011.  Interest-only RMBS included in the tables below represent the right to receive a specified proportion of the contractual interest cash flows of the underlying principal balance of specific securities.  At June 30, 2012, interest-only RMBS had a net unrealized gain of $9.7 million and had an amortized cost of $241.8 million. At December 31, 2011, interest-only RMBS had a net unrealized loss of $5.7 million and had an amortized cost of $237.8 million.  The fair value of IOs at June 30, 2012 and December 31, 2011 was $251.6 million, and $232.1 million, respectively.

June 30, 2012
 
(dollars in thousands)
 
                                       
     
Gross Unrealized Gain Included in Accumulated
Other Comprehensive
Income
   
Gross Unrealized Gain Included in Accumulated
Deficit
   
Total Gross Unrealized
Gain
   
Gross Unrealized Loss Included in Accumulated
Other Comprehensive
Income
   
Gross Unrealized Loss Included in Accumulated
Deficit
   
Total Gross Unrealized
Loss
 
Non-Agency RMBS
                                   
 
   Senior
  $ 2     $ -     $ 2     $ -     $ -     $ -  
 
   Senior interest-only
    -       19,178       19,178       -       (16,630 )     (16,630 )
 
   Subordinated
    50,957       -       50,957       (52,907 )     -       (52,907 )
 
   Subordinated interest-
   only
    -       1,839       1,839       -       -       -  
 
   RMBS transferred to
   consolidated VIEs
    541,992       5,819       547,811       (9,473 )     -       (9,473 )
Agency RMBS
    120,036       27       120,063       -       (491 )     (491 )
Total
    $ 712,987     $ 26,863     $ 739,850     $ (62,380 )   $ (17,121 )   $ (79,501 )
                                                   
December 31, 2011
 
(dollars in thousands)
 
                                                   
     
Gross Unrealized Gain Included in Accumulated
Other Comprehensive
Income
   
Gross Unrealized Gain Included in Accumulated
Deficit
   
Total Gross Unrealized
Gain
   
Gross Unrealized Loss Included in Accumulated
Other Comprehensive
Income
   
Gross Unrealized Loss Included in Accumulated
Deficit
   
Total Gross Unrealized
Loss
 
Non-Agency RMBS
                                               
 
   Senior
  $ 2     $ -     $ 2     $ (41 )   $ -     $ (41 )
 
   Senior interest-only
    -       11,308       11,308       -       (21,917 )     (21,917 )
 
   Subordinated
    30,997       -       30,997       (78,254 )     -       (78,254 )
 
   Subordinated interest-
   only
    -       1,663       1,663       -       (1,554 )     (1,554 )
 
   RMBS transferred to
   consolidated VIEs
    415,688       4,817       420,505       (52,175 )     -       (52,175 )
Agency RMBS
    117,236       365       117,601       -       (355 )     (355 )
Total
    $ 563,923     $ 18,153     $ 582,076     $ (130,470 )   $ (23,826 )   $ (154,296 )
 
Changes in prepayments, actual cash flows, and cash flows expected to be collected, among other items, are affected by the collateral characteristics of each asset class.  The portfolio is most heavily weighted to contain Non-Agency RMBS with credit risk.  The Company chooses assets for the portfolio after carefully evaluating each investment’s risk profile.
 
 
17

 

The following tables provide a summary of the Company’s RMBS portfolio at June 30, 2012 and December 31, 2011.

   
June 30, 2012
 
   
Principal or
Notional Value at Period-End
(dollars in
thousands)
   
Weighted
Average
Amortized
Cost Basis
   
Weighted
Average Fair
Value
   
Weighted
Average
Coupon
   
Weighted Average Yield at
Period-End
(1)
 
Non-Agency Mortgage-Backed Securities
                             
Senior
  $ 718     $ 92.39     $ 92.70       1.01 %     4.19 %
Senior, interest only
  $ 4,082,598     $ 5.09     $ 5.16       1.97 %     13.28 %
Subordinated
  $ 1,344,612     $ 47.77     $ 47.63       3.24 %     10.66 %
Subordinated, interest only
  $ 271,413     $ 6.92     $ 7.59       2.66 %     6.13 %
RMBS transferred to consolidated variable interest entities
  $ 4,991,190     $ 53.44     $ 64.45       5.10 %     15.19 %
Agency Mortgage-Backed Securities
  $ 2,652,079     $ 103.06     $ 107.69       4.65 %     3.76 %
                                         
(1) Bond Equivalent Yield at period end.