Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
AMTG > SEC Filings for AMTG > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for APOLLO RESIDENTIAL MORTGAGE, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for APOLLO RESIDENTIAL MORTGAGE, INC.


8-Aug-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Dollars in thousands, except share and per share data or as otherwise noted)
FORWARD-LOOKING INFORMATION
We make forward-looking statements in this Quarterly Report on Form 10-Q and will make forward-looking statements in future filings with the SEC, press releases or other written or oral communications within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (or, the Exchange Act). For these statements, we claim the protections of the safe harbor for forward-looking statements contained in such Section. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words "believe," "expect," "anticipate," "estimate," "plan," "continue," "intend," "should," "may," or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking: market trends in our industry, interest rates, real estate values, the debt securities markets, the U.S. housing market or the general economy or the demand for residential mortgage loans; our business and investment strategy; our operating results and potential asset performance; actions and initiatives of the U.S. Government and changes to U.S. Government policies and the execution and impact of these actions, initiatives and policies; the state of the U.S. economy generally or in specific geographic regions; economic trends and economic recoveries; our ability to obtain and maintain financing arrangements, including securitizations; the favorable Agency RMBS return dynamics available; the level of government involvement in the U.S. mortgage market; the anticipated default rates on non-Agency RMBS; the return of the non-Agency RMBS securitization market; general volatility of the securities markets in which we participate; changes in the value of our assets; our expected portfolio of assets; our expected investment and underwriting process; interest rate mismatches between our target assets and any borrowings used to fund such assets; changes in interest rates and the market value of our target assets; prepayment speeds on our target assets; effects of hedging instruments on our target assets; rates of default or decreased recovery rates on our target assets; the degree to which our hedging strategies may or may not protect us from interest rate volatility; the impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters; our ability to maintain our qualification as a REIT for U.S. federal income tax purposes; our ability to maintain our exclusion from registration as an investment company under the 1940 Act; availability of opportunities to acquire Agency RMBS, non-Agency RMBS, residential mortgage loans and other residential mortgage assets; availability of qualified personnel; estimates relating to our ability to make distributions to our stockholders in the future; and our understanding of our competition.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to it. Forward-looking statements are not predictions of future events. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. See Item "1A - Risk Factors" of our annual report on Form 10-K for the year ended December 31, 2012. These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those included in any forward-looking statements we make. All forward-looking statements speak only as of the date they are made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with our consolidated financial statements and the accompanying notes to our consolidated financial statements, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as the information contained in our annual report on Form 10-K filed for the year ended December 31, 2012.
General
We were incorporated in Maryland on March 15, 2011 and began operations on July 27, 2011. We are structured as a holding company and conduct our business primarily through ARM Operating, LLC and our other operating subsidiaries. We have elected and operate to qualify as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2011. We also operate our business in a manner that we believe will allow us to remain excluded from registration as an investment company under the 1940 Act. We are externally managed and advised by our Manager, an indirect subsidiary of Apollo Global Management, LLC.


We invest on a leveraged basis in residential mortgage and related assets in the United States. At June 30, 2013, our portfolio was comprised of: (i) Agency RMBS, which include pass-through securities (whose underlying collateral includes fixed-rate mortgages), Agency IOs and Agency Inverse IOs,
(ii) non-Agency RMBS and (iii) securitized mortgage loans. Over time, we expect that we may invest in other residential mortgage related assets included in our target assets. (See "Target Assets," below.) At June 30, 2013, we had $2,552,056 of Agency RMBS, $751,024 of non-Agency RMBS and $110,278 of securitized mortgage loans. We use leverage as part of our business strategy in order to increase potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon our Manager's assessment of a variety of factors, which include the availability of particular types of financing and our Manager's assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We use derivatives to hedge a portion of our interest rate risk. As of June 30, 2013, our derivatives included Swaps, Swaptions and TBA Shorts. We do not enter into derivative instruments for speculative purposes. Factors Impacting Our Operating Results
Our results of operations are primarily driven by, among other things, our net interest income, changes in the market value of our investments and interest rate derivatives and realized gains and losses on the sale of our investments and, from time to time termination of our interest rate derivative contracts. The supply and demand for RMBS in the market place, the terms and availability of financing for our RMBS, general economic and real estate conditions, the impact of U.S Government actions that impact the real estate and mortgage sector and the credit performance of our non-Agency RMBS impact our overall performance. Our net interest income varies primarily as a result of changes in market interest rates and the slope of the yield curve (i.e., the differential between long-term and short-term interest rates) and the constant prepayment speeds (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on an RMBS as a percentage of the principal balance, and includes the conditional repayment rate (or, CRR), which measures voluntary prepayments of mortgages collateralizing a particular RMBS and conditional default rates (or, CDR), which measures involuntary prepayments resulting from defaults of the underlying mortgage loans. CPRs vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. In addition, our borrowing costs and available credit are further affected by the collateral pledged and general conditions in the credit market.
With respect to our results of operations and financial condition, increases in interest rates are generally expected to cause: (i) the interest expense associated with our borrowings to increase; (ii) the value of our pass-through Agency RMBS and Agency Inverse IO securities to decline; (iii) coupons on our variable rate non-Agency RMBS to reset to higher interest rates;
(iv) prepayments on our RMBS to decline, thereby slowing the amortization of our Agency RMBS purchase premiums and the accretion of purchase discounts on our non-Agency RMBS; (v) the value of our Agency IO securities and TBA Shorts to increase; and (vi) the performance of our Swaps and Swaptions to improve. Conversely, decreases in interest rates are generally expected to have the opposite impact as those stated above. The timing and extent to which interest rates change, the specific terms of the mortgage loans underlying our RMBS, such as periodic and life-time caps and floors on ARMs as well as other conditions in the market place will further impact our results of operations and financial condition. In addition, in periods with low interest rates, such as the current environment, the impact of decreases in interest rates may be limited, given that we do not foresee interest rates decreasing to zero. Premiums arise when we purchase a security at a price in excess of the security's par value and discounts arise when we purchase a security at a price below the security's par value. Premiums on our RMBS are amortized against interest income over the life of the security, while discounts (excluding credit discounts, as discussed below) are accreted to income over the life of the security. The speeds at which premiums are amortized and discounts are accreted are significantly impacted by the CPR for each security. CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. CPRs on Agency RMBS and non-Agency RMBS may differ significantly. We are exposed to credit risk with respect to our non-Agency RMBS portfolio, associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such securities. (See Quantitative and Qualitative Disclosures about Market Risk - Credit Risk, included under Item 3 of Part I of this Quarterly Report on Form 10-Q.) The credit risk on our non-Agency RMBS is generally mitigated by the credit support built into non-Agency RMBS structures and the purchase discounts on such securities, which provides a level of credit protection in the event that we receive less than 100% of the par value of these securities. To date we purchased all of our non-Agency RMBS at a discount to par value; a portion such discount may be viewed as a credit discount, which is not expected to be amortized into interest income. The


amount designated as credit discount on a security may change over time based on the security's performance and its anticipated future performance. Our non-Agency RMBS investment process involves analysis focused primarily on quantifying and pricing credit risk. Interest income on our non-Agency RMBS is recorded at an effective yield, which reflects an estimate of expected cash flows for each security. In forecasting cash flows on our non-Agency RMBS, our Manager makes certain assumptions about the underlying mortgage loans which assumptions include, but are not limited to, future interest rates, voluntary prepayment speeds, default rates, modifications and loss severities. As part of our non-Agency RMBS surveillance, we review, on at least a quarterly basis, each security's performance. To the extent that actual performance and our current assessment of future performance differs from our prior assessment, such changes are reflected in the yield/income recognized on such securities prospectively. Credit losses greater than those anticipated or in excess of purchase discount on a given security could occur, which could materially adversely impact our operating results.
We receive interest payments only with respect to the notional amount of Agency IOs and Agency Inverse IOs. Therefore, the performance of such instruments is extremely sensitive to prepayments on the underlying pool of mortgages. Unlike Agency pass-through RMBS, the market prices of Agency IOs generally have a positive correlation to increases in interest rates. Generally, as market interest rates increase, prepayments on the mortgages underlying an Agency IO are generally expected to decrease, which in turn is expected to extend/increase the cash flow and the value of such securities; we expect the inverse to occur with respect to decreases in market interest rates. In addition to viewing Agency IOs as attractive investments, we also consider such instruments as an economic hedge against the impact that an increase in market interest rates would have on the value of our Agency RMBS in the marketplace. While Agency IOs and Agency Inverse IOs comprised a relatively small portion of our investments at June 30, 2013, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments. Target Assets
As of June 30, 2013, we held investments in Agency RMBS, including Agency IOs and Agency Inverse IOs, non-Agency RMBS and securitized mortgage loans. In the future we may invest in assets other than our target assets listed below, in each case subject to maintaining our qualification as a REIT for U.S. federal income tax purposes and our exclusion from registration as an investment company under the 1940 Act. The following is a summary of our target assets:

Asset Classes                                 Principal Assets

Agency RMBS                 Agency RMBS, primarily comprised of whole pool RMBS,
                            collateralized mortgage obligations, Agency IO,
                            Agency Inverse IO and Agency principal-only (or,
                            Agency PO) securities.

Non-Agency RMBS             Non-Agency RMBS, including highly rated, as well as
                            non-investment grade and unrated, tranches backed by
                            Alt-A mortgage loans, Option ARMs, subprime mortgage
                            loans and prime mortgage loans.

Residential Mortgage        Prime mortgage loans, jumbo mortgage loans, Alt-A
Loans                       mortgage loans, Option ARMs and subprime mortgage
                            loans. These mortgages may be performing,
                            sub-performing or non-performing.

Other Residential           Non-Agency RMBS comprised of interest-only (or,
Mortgage Assets             non-Agency IO), principal-only (or, non-Agency PO),
                            floating rate inverse interest-only (or, non-Agency
                            Inverse IO), and floating rate securities, and other
                            Agency and non-Agency RMBS derivative securities, as
                            well as other financial assets, including, but not
                            limited to, common stock, preferred stock and debt of
                            other real estate-related entities, mortgage
                            servicing rights (or, MSRs), and excess MSRs.


Financing Strategy
We use leverage primarily for the purpose of financing our investment portfolio and increasing potential returns to our stockholders and not for speculative purposes. The amount of leverage we choose to employ for particular assets will depend upon a variety of factors, which include the availability of particular types of financing and our Manager's assessment of the credit, liquidity, price volatility and other risks inherent in those assets and the creditworthiness of our financing counterparties. We had aggregate debt-to-equity of 5.2 times at June 30, 2013, which included net repurchase agreement borrowings of $990,973 on unsettled sales of RMBS. Had such sales and purchases settled at June 30, 2013, our debt-to-equity multiple would have been 3.9 times, reflecting the net reduction in our repurchase borrowings upon settlement. Our debt-to-equity multiple reflects the aggregate of our borrowings under repurchase agreements and securitized debt to our total stockholders' equity.
We continue to have available capacity under our master repurchase agreements. However, such agreements are generally uncommitted and are renewable at the discretion of our lenders. During the six months ended June 30, 2013, we financed our Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity ratio of approximately eight-to-one leverage and financed our non-Agency RMBS with repurchase agreements generally targeting, in the aggregate, a debt-to-equity ratio of approximately three-to-one leverage. The terms of our repurchase agreements are typically one to six months at inception, but in some cases may have initial terms that are shorter or longer. Beginning in late April, we were able to extend certain of our repurchase borrowings collateralized by non-Agency RMBS with terms up to 18 months. At June 30, 2013, we had master repurchase agreements with 23 counterparties and, as a matter of routine business may have discussions with additional financial institutions with respect to expanding our repurchase agreement capacity. As of June 30, 2013, we had $3,945,097 of borrowings outstanding under our repurchase agreements with 19 counterparties collateralized by $3,339,925 of Agency RMBS, and $780,578 of non-Agency RMBS, which includes $44,834 of non-Agency RMBS that are eliminated from our balance sheet in consolidation with a VIE. (See Notes 8 and 9 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.)
In February 2013, in connection with our purchase of a pool of performing and re-performing mortgage loans, we engaged in a securitization transaction. One objective of this transaction, as well as potential future securitization transactions, is to obtain permanent non-recourse financing on the underlying securitized assets with more favorable terms than those available on whole loans. For financial statement reporting purposes, the sale of the senior security created in the securitization is presented on our consolidated balance sheet as non-recourse securitized debt, which is in effect collateralized by the securitized mortgage loans. (See Notes 5 and 13 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.) In addition to repurchase borrowings and securitized debt, subject to market conditions, we may utilize other sources of leverage in the future, including, but not limited to, securitized debt associated with resecuritizations, warehouse facilities, bank credit facilities (including term loans and revolving facilities), and public and private equity and debt issuances, in addition to transaction or asset-specific funding arrangements. Our future use of these alternative forms of financing is subject to market conditions. Hedging Strategy
Subject to maintaining our qualification as a REIT for U.S. federal income purposes, we pursue various hedging strategies with the objective of reducing our exposure to increases in interest rates. The U.S. federal income tax rules applicable to REITs may necessitate that we implement certain of these techniques through a domestic TRS that is fully subject to federal and state income taxation. Our hedging activity may vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions.
We use interest rate derivatives, primarily comprised of Swaps and Swaptions, to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings and decreases in the value of our Agency RMBS portfolio. As of June 30, 2013, we had Swaps with a notional of $2,032,000 with a weighted average fixed pay rate of 1.48% and a weighted average term to maturity of 6.4 years. Our Swaps have the economic effect of modifying the repricing characteristics on repurchase borrowings equal to the aggregate notional balance of the Swaps. Pursuant to our Swaps, we pay a fixed rate of interest and receive a variable rate of interest, generally based on three-month LIBOR, on the notional amount of the Swap. Our Swaptions provide that at the expiration of the option period, we: (i) may enter into a Swap under which we would pay a fixed interest rate and receive a variable rate of interest on the notional amount or
(ii) cash settle if the Swaption is in-the-money. The method of settlement at expiration of the option period is prescribed in each Swaption confirmation. At June 30, 2013, we held Swaptions with an aggregate notional of $775,000. In June 2013, we entered into TBA Shorts, with an aggregate notional balance of $325,000, which provide that we settle such contracts at their maturity date of August 12, 2013 by either delivering the Agency RMBS as specified in the contract or net settle such contracts, whereby we would either pay or receive an amount equal to the fair value of the contract. TBA Shorts serve as an economic hedge against decreases in the value of


Agency RMBS held in our portfolio, in an amount equivalent to the TBA Contract notional, with the same characteristics as those stipulated in the TBA Contract. (See Note 10 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q.) For U.S. federal income tax purposes, although the law is not clear with respect to such transactions, we intend to take the position that settling such TBA Shorts will be treated as resulting in a gain or loss on the disposition of the securities delivered for purpose of the REIT 75% and 95% gross income tests. In addition, we may also engage in TBA Shorts or other TBA transactions that we identify as a hedge of indebtedness incurred or to be incurred to acquire real estate assets in which case any gain recognized in connection with net settling such a contract would not constitute gross income for purposes of the REIT 75% and 95% gross income tests. To date, we have not elected to apply hedge accounting for our derivatives and, as a result, we record changes in the estimated fair value of such instruments along with the associated net Swap interest in earnings, as a component of the net gain/(loss) on derivatives instruments in our consolidated statement of operations.
Beginning June 10, 2013, certain Swap trades were required to be cleared through a clearinghouse, in accordance with the new Commodities Futures Trading Commission (or, CFTC) Swap clearing rules. Swaps cleared through the CFTC generally require that higher initial margin collateral be posted relative to Swaps cleared with individual counterparties. Through June 30, 2013, we did not enter into Swaps that were subject to CFTC clearing. The change in Swap margin collateral requirement may, in effect, increase the inherent cost of future Swaps, as we will be required to pledge higher amounts of cash to meet the initial margin requirement on such instruments. We cannot predict with any certainty the amount of our future Swap additions and, accordingly, the amount of collateral we will be required to pledge.
The following table presents information about our Swaps as of June 30, 2013:

Table 1
                                                                                 Average
                                                          Average Fixed  Pay    Maturity
Remaining Interest Rate Swap Term    Notional Amount             Rate            (Years)
> Three to five years               $       1,159,000               1.06 %           4.1
> Five to ten years                           873,000               2.04 %           9.5
Total                               $       2,032,000               1.48 %           6.4

Critical Accounting Policies and Use of Estimates Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 1 in this Quarterly Report on Form 10-Q. A summary of our critical accounting policies is set forth in our annual report on Form 10-K for the year ended December 31, 2012 under Part II, Item 7 - Management Discussion and Analysis - Critical Accounting Policies.
Recent Market Conditions and Our Strategy during the Quarter Ended June 30, 2013 General:
The second quarter of 2013 began with a continuation of the decrease in interest rates that started in mid-March 2013. A weak non-farm payroll report for March 2013, that was announced in early April 2013, served as a catalyst for interest rates to retrace their first quarter rise, and by the end of April 2013 the ten-year U.S. Treasury (or, Treasury) note was yielding 1.70%. However, in early May 2013 a much stronger than consensus estimate for the April 2013 non-farm payroll report caused market interest rates to start increasing.
The increase in interest rates gathered momentum over the course of May 2013 as market participants became increasingly concerned about the Federal Open Markets Committee (or, FOMC) potentially tapering purchases of Treasuries and Agency RMBS, a component of the FOMC's third round of quantitative easing known as "QE3". FOMC Chairman Bernanke's testimony to Congress at the end of May 2013, rather than stabilizing markets as many participants hoped, resulted in additional volatility as his testimony was generally viewed as reflecting a belief that there was underlying strength in the economy, thereby implying support for tapering of bond purchases earlier than previously expected. The negative tone in the fixed-income market continued following another stronger than consensus non-farm payroll report released in June 2013, which caused Treasury bonds to sell off further. Interest rates continued their upward climb during the second quarter of 2013 following both the release of the FOMC statement from its June 2013 meeting and comments made by FOMC Chairman Bernanke, regarding the potential timing of tapering for bond purchases. From the near-term low in rates on May 2, 2013 to the peak on June 25, 2013, the ten-year Treasury note rate increased 94 basis points from 1.66% to


2.60%. The ten-year Treasury note rate ended the June 30, 2013 quarter slightly lower at 2.52%, as a result of follow up commentary by several FOMC Governors stating that the market had severely misunderstood Chairman Bernanke's testimony.
During the second quarter of 2013, the fixed income market sold off heavily, negatively impacting the value of Agency RMBS. While market yields on Treasury notes and Swaps increased during the second quarter of 2013, the magnitude of changes in market yields on Agency RMBS increased to an even greater extent. This caused our Agency RMBS prices to decline considerably more than our Swap valuations increased, negatively impacting the value of our portfolio, as reflected in the net loss for the three and six months ended June 30, 2013. Amid this backdrop of extreme and rapid changes in the fixed income market during the second quarter of 2013, we rebalanced our investment portfolio aimed at reducing our net portfolio duration (or, the price sensitivity to changes in RMBS yields relative to other benchmark interest rates, such as Swaps and Swaptions), increasing liquidity in light of market volatility and taking advantage of market opportunities to invest in non-Agency RMBS. To achieve these objectives, we sold certain of our Agency RMBS, increased our aggregate . . .

  Add AMTG to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for AMTG - All Recent SEC Filings
Sign Up for a Free Trial to the NEW EDGAR Online Pro
Detailed SEC, Financial, Ownership and Offering Data on over 12,000 U.S. Public Companies.
Actionable and easy-to-use with searching, alerting, downloading and more.
Request a Trial      Sign Up Now


Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.