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

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
AMTG > SEC Filings for AMTG > Form 10-K on 21-Feb-2014All Recent SEC Filings




Annual Report

ITEM 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion should be read in conjunction with our financial statements and accompanying notes included under ITEM 8 of this annual report on Form 10-K.
All currency amounts are presented in thousands, except per share amounts or as otherwise noted.

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 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. We invest in residential mortgage assets throughout the U.S. At December 31, 2013, our portfolio was comprised of: (i) Agency RMBS (which include pass-through securities whose underlying collateral primarily includes fixed-rate mortgages), Agency IOs and Agency Inverse IOs; (ii) non-Agency RMBS;
(iii) securitized mortgage loans and (iv) other mortgage related assets. Over time, we expect that we may invest in other residential mortgage related assets. (For information about our target assets, see "Investment Strategy" included under ITEM 1 of this annual report on Form 10-K.) At December 31, 2013, our portfolio was comprised of $2,290,537 of Agency RMBS, $1,212,789 of non-Agency RMBS, $110,984 of securitized mortgage loans, and $11,515 of other mortgage related assets. 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 December 31, 2013, our derivatives included Swaps, Swaptions and TBA Short Contracts. We do not enter into derivatives instruments for speculative purposes.
Factors Impacting Our Operating Results
Our results of operations are driven by, among other things, our net interest income, changes in the market value of our investments and derivative instruments and, from time to time, realized gains and losses on the sale of our investments and termination of our derivative instruments. 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 constant prepayment rates (or, CPR) on our RMBS. The CPR measures the amount of unscheduled principal prepayments on 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 investment assets 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 to increase; and
(vi) the value of our TBA Short Contracts, 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 expect that interest rates will decrease 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, other investment securities and securitized mortgage loans, associated with delinquency, default and foreclosure and any resulting losses on disposing of the real estate underlying such assets. 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 substantially all of our non-Agency RMBS at a discount to par value; a portion of 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.
(See "Credit Risk", included under ITEM 7A of this annual report on Form 10-K.)
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 rates, 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 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 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 investments, we also note that such instruments serve as a partial 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 December 31, 2013, the value of and return on such instruments are highly sensitive to changes in interest rates and prepayments.

Market Conditions and Our Strategy
Interest rates, which started 2013 on a relatively stable note, began to increase in the middle of January and continued on an upward trajectory through mid-March primarily based on what was perceived to be a strengthening U.S. economy, and that monetary policy may become less accommodative in the near future. In mid-March and throughout April, as economic data seemed to reflect renewed weakness in the economy, interest rates moved back down and the prices of Agency RMBS and U.S. Treasury securities rallied back to proximate highs for the year. However, the market sentiment changed markedly in early May based on a very strong employment report for the month of April. This coupled with comments from the Federal Reserve Chairman that the Federal Reserve may soon begin to taper securities purchases under its quantitative easing policy caused a significant sell-off in the fixed income markets in the late spring and early summer, resulting in a significant decline in the value of such securities. Strength in job creation and declines in the unemployment rate throughout the summer and early fall pushed interest rates higher, as many financial market participants assumed the tapering announcement was to come at the October 2013 meeting. However, the Federal Reserve's policy actions remained unchanged and mixed signals followed from Federal Reserve board members with respect to when such monetary policy accommodations would begin to be tapered. Adding to this uncertainty were financial headlines about the state of the U.S. economy, speculation regarding the nomination of the next Federal Reserve Chairperson and the impact of political frictions on the budget deficit and debt ceiling. Against this backdrop, and fueled by record outflows of bond mutual funds, the last eight months of 2013 were marked by increased

volatility and generally higher interest rates. On December 18, 2013, the Federal Reserve announced its first tapering action, reducing the size of its quantitative easing program from $85 billion in monthly bond purchases to $75 billion. While the initial reaction in the fixed income market was muted, the combination of the tapering news combined with increasingly strong economic reports drove the yield on the 10-year note over 3.0% by year end 2013. (See Tables 1 and 2 below.)
The table below presents the high and low rates for ten-year U.S. Treasuries relative to ten-year Swap rates for each calendar quarter during the year ended December 31, 2013:

Table 1                Ten-Year Treasury Rate       Ten-Year Swap Rate
Quarter Ended           High            Low          High          Low
March 31, 2013           2.06 %         1.76 %       2.14 %        1.84 %
June 30, 2013            2.61 %         1.63 %       2.83 %        1.81 %
September 30, 2013       2.99 %         2.47 %       3.18 %        2.69 %
December 31, 2013        3.03 %         2.50 %       3.09 %        2.65 %

Late in the second quarter of 2013, we began to rebalance our investment portfolio seeking to reduce our net portfolio duration, increase liquidity and take advantage of market opportunities to invest in non-Agency RMBS. The shift in the portfolio has reduced our exposure to changes in interest rates while increasing our sensitivity to credit. During the last six months of 2013, we generally maintained higher cash balances, which resulted in reduced earnings, as we selectively redeployed proceeds from sales of Agency RMBS into non-Agency RMBS. In addition, during this period, we maintained lower leverage on our Agency RMBS portfolio and increased our use of derivative instruments. Our average debt-to-equity multiple during 2013, was 4.45 times compared to 5.16 times for 2012. A portion of the decrease in our leverage also reflects our shift in equity to non-Agency RMBS from Agency RMBS, as we employ less leverage when we finance non-Agency RMBS. At December 31, 2013 our investments were comprised of 63.1% of Agency RMBS (of which 61.2% were pass-through securities and 1.9% were Agency IOs and Agency Inverse IOs), 33.5% of non-Agency RMBS, 3.1% of securitized mortgage loans and 0.3% of other investments. Agency RMBS Portfolio/Interest Rate Hedges:
For 2013, our Agency RMBS portfolio experienced a fair value weighted CPR of 6.4% comprised of 6.2% CPR on Agency pass-through securities and 17.4% on Agency IO and Agency Inverse IO securities, in the aggregate. During 2013, the maximum average monthly CPR of our Agency RMBS was experienced in May 2013, with an overall Agency CPR of 7.7% comprised of 7.5% on Agency pass-through securities and 21.8% on Agency IO and Agency Inverse IO securities in the aggregate. During 2013, generic fixed-rate Fannie Mae RMBS prepaid at 19.2% CPR in the aggregate, with a high of 27.8% in January 2013.

Beginning in the second quarter of 2013, the market conditions, as discussed above, generally had a significant negative impact on our RMBS valuations. The following table presents the estimated fair value and unrealized gain/(loss) position with respect to our RMBS at the end of each calendar quarter in 2013:

Table 2               December 31, 2013                  September 30, 2013                   June 30, 2013                       March 31, 2013
               Estimated Fair     Unrealized      Estimated Fair     Unrealized      Estimated Fair     Unrealized      Estimated Fair      Unrealized
Collateral         Value          Gain/(Loss)         Value          Gain/(Loss)         Value          Gain/(Loss)         Value           Gain/(Loss)
ARM-RMBS       $     12,339     $         (62 )   $     13,089     $         (75 )   $          -     $           -     $          -     $           -
3.5% Coupon         301,068           (21,883 )        477,308           (22,218 )        805,988           (40,587 )      1,863,750            (5,336 )
4.0% Coupon       1,602,080           (77,499 )      1,587,384           (58,953 )      1,620,521           (67,904 )      2,002,782             6,774
4.5% & 5.0%
Coupons             250,136            (3,257 )         58,624              (105 )         49,419              (429 )        266,438            10,787
                  2,165,623          (102,701 )      2,136,405           (81,351 )      2,475,928          (108,920 )      4,132,970            12,225
15-20 Year
3.0% Coupon          53,711              (401 )         55,478               410                -                 -           23,588               372
3.5% Coupon               -                 -                -                 -                -                 -           77,475               560
                     53,711              (401 )         55,478               410                -                 -          101,063               932
Agency IOs           44,425             2,904           43,272               310           30,184             2,387            7,974                85
Inverse IOs          26,778              (895 )         25,367            (3,036 )         45,944            (6,157 )         57,557                69
Total Agency
RMBS              2,290,537          (101,093 )      2,260,522           (83,667 )      2,552,056          (112,690 )      4,299,564            13,311
RMBS              1,212,789            77,609        1,117,820            62,118          751,024            60,250          595,838            67,059
Total RMBS     $  3,503,326     $     (23,484 )   $  3,378,342     $     (21,549 )   $  3,303,080     $     (52,440 )   $  4,895,402     $      80,370

The following table presents information with respect to our Swaps and Swaptions at the end of each calendar quarter in 2013:

Table 3                      December 31, 2013     September 30, 2013     June 30, 2013      March 31, 2013
Notional amount             $       1,587,000     $        1,867,000     $    2,302,000     $     2,207,000
Estimated fair value        $          35,525     $           32,735     $       47,609     $       (24,101 )
Weighted average fixed
pay rate                                 1.34 %                 1.42 %             1.48 %              1.39 %
Weighted average term to
maturity (years)                          5.1                    5.8                6.4                 6.2

Notional amount             $       1,375,000     $        1,175,000     $      775,000     $       225,000
Estimated fair value        $          12,430     $           13,757     $       18,447     $         1,641
Weighted average term to
expiration (months)                         5                      8                 11                  10
Weighted average
underlying Swap term
(years)                                  10.0                   10.0               10.0                10.0
Weighted average
underlying Swap fixed pay
rate                                     3.64 %                 3.65 %             3.37 %              2.99 %

Credit Investments:
Yields available on non-Agency RMBS in the market place generally trended lower during 2013, as market valuations for such bonds generally continued to trend upward over the course of 2013. We believe non-Agency valuations continue to be driven by technicals, such as the continued lack of supply of newly issued non-Agency securities, as well as fundamentals, such as the recovering housing market, which should lead to better performance with respect to borrower defaults and loss severities in the future. During 2013, we continued to shift our investment allocation to credit sensitive assets, investing $748,032 in non-Agency RMBS with a weighted average unlevered yield of 5.34% and we purchased a pool of 755 residential mortgage loans, with an unpaid principal balance of approximately $155,001, and simultaneously completed a securitization transaction collateralized by these mortgage loans. At December 31, 2013, approximately 53.3% of our non-Agency portfolio was comprised of securities on which we receive both principal and interest on a monthly basis and approximately 46.7% were securities on which we currently receive only interest payments and will receive principal after the more senior securities in the capital structure are paid off. (See Tables 25 and 26 below.)

New Business Development:
We are exploring several new credit initiatives. In late December 2013, we entered into an agreement with a third party to assist us in sourcing seller-financing agreements and mortgage loans secured by properties purchased by such third party. No assurance can be provided that we will be able to successfully grow this business platform, or that such investments will be profitable.
Borrowings under repurchase agreements remained readily available from an increasing number of counterparties for repurchase agreements collateralized by Agency and non-Agency RMBS. Over time, as market conditions change, in addition to repurchase borrowings we may use other forms of leverage, including, but not limited to, warehouse facilities, additional securitizations, resecuritizations, 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.
Regulatory Updates:
As broadly publicized, Fannie Mae and Freddie Mac are presently under federal conservatorship as the U.S. Government continues to evaluate the future of these entities and what role the U.S. Government should continue to play in the housing markets. On June 25, 2013, a bipartisan group of Senators introduced a draft bill titled the "Housing Finance Reform and Taxpayer Protection Act of 2013" to the U.S. Senate, which would wind down Fannie Mae and Freddie Mac over a period of five years and replace the public securitization market used by the government-sponsored enterprises with a public-private alternative market, where a new Federal Mortgage Insurance Corporation would provide a financial guarantee that can only be tapped after private capital has already stepped in. On July 11, 2013, members of the U.S. House Committee on Financial Services introduced a similar draft bill titled "Protecting American Taxpayers and Homeowners Act" to the U.S. House of Representatives. It also calls for the winding down of Fannie Mae and Freddie Mac, but would replace them with a National Mortgage Market Utility that facilitates private market mortgage securitization and does not provide a government guarantee.
Currently, it remains unclear whether these or any other proposals will become law and how these or other proposals to reform Fannie Mae and Freddie Mac would impact housing finance and our business. While both bills contemplate a diminished level of Agency participation in the mortgage market and changes in the nature and terms of Agency RMBS, they also seek to increase opportunities for private capital in the mortgage market, which could provide new opportunities for our business. We believe that our Manager's deep understanding of RMBS market fundamentals, as well as its ability to analyze, model and set parameters around valuing individual mortgages will enable us to take advantage of regulatory changes and new financing opportunities that may emerge as a result of these changes in the mortgage market.

Results of Operations
Year Ended December 31, 2013 compared to the Year Ended December 31, 2012 General
For the year ended December 31, 2013, we had a net loss allocable to common stock and participating securities of $(61,011) or $(2.02) per basic and diluted weighted average common share, compared to net income allocable to common and participating securities of $167,734 and $8.36 per basic and diluted common share for the year ended December 31, 2012. Our results of operations for the year ended December 31, 2013 were significantly impacted by steep declines in the value of our Agency RMBS portfolio, some of which were realized through sales, which were partially offset by increases in the realized and unrealized gains on our derivative instruments and non-Agency RMBS. (See "Market Conditions and Our Strategy," above.) Our results for the year ended December 31, 2012 were positively impacted by significant increases in the value of our Agency RMBS, some of which were realized through sales, which income was partially offset by decreases in the value of our derivatives. Net Interest Income
For the year ended December 31, 2013 and December 31, 2012, we earned interest income of $154,713 and $94,369, respectively, and incurred interest expense, which was primarily related to our borrowings under repurchase agreements, of approximately $27,602 and $14,631, respectively. The increase in our interest income and interest expense was primarily driven by the significant growth in our investments and borrowings reflecting our investment, on a levered basis, of incremental capital raised since the second quarter of 2012. Our cost of funds increased to 0.79% for 2013, from 0.61% for 2012, reflecting higher borrowing costs associated with our portfolio shift toward credit sensitive investments, which borrowings bear higher interest rates compared to borrowing rates on Agency RMBS. In connection with our February 2013 securitization transaction, we had securitized debt with a contractual balance of $42,400 at December 31, 2013 which had a

fixed stated interest rate of 4.00%. Costs associated with our securitization transaction are amortized as a component of interest expense; as a result, our securitized debt had a cost of 4.27% for the year ended December 31, 2013. The yield on our Agency RMBS increased to 2.92% for 2013 from 2.64% for 2012, primarily reflecting our migration to higher coupon bonds during 2013. Actual prepayments and changes in expectations about prepayment rates, which reflect market fundamentals at the time of assessment, may cause future premium amortization on our Agency RMBS to vary significantly over time. Investments in non-Agency RMBS made during 2013 generally generate lower yields than the yields on non-Agency RMBS previously purchased, reflecting the general increase in valuations in the non-Agency RMBS market during 2013. Changes in the performance, or performance expectations, with respect to our non-Agency RMBS may significantly impact the amount of income recognized in future periods on such investments.
We had an interest rate spread and net interest margin of 3.02% and 3.13% for the year ended December 31, 2013, respectively, compared to 2.83% to 2.96%, respectively, for the year ended December 31, 2012. (Interest rate spread measures the difference between the yield on interest-earning assets and the cost of interest-bearing liabilities, while net interest margin reflects net interest income divided by average interest-earning assets.) Over the course of 2013, our interest rate spread and net interest margin increased, generally reflecting our shift in investment allocation from Agency RMBS to non-Agency RMBS. The net interest rate spread and net interest margin do not reflect the total return on equity allocated to investment types, which is significantly impacted by the amount of leverage we use to finance our investments. We are generally able to utilize greater leverage on Agency RMBS than on non-Agency RMBS. Therefore, when making investment decisions we consider, among other things, the relative return on equity for each investment opportunity. Returns on investments will vary overtime based on market conditions at the time of purchase and changes in such conditions thereafter. The impact of our Swaps is not reflected in our net interest rate spread and net interest margin, as we have not elected hedge accounting for our derivative instruments. However, when making investment decisions, we consider our "effective cost of borrowings", which non-GAAP measure includes the net interest component of our Swaps. (See Tables 4, 5, 6, 9, 19, 21, 22 and 23 below.)

The following table presents certain information regarding our interest-earning assets, interest bearing liabilities and the components of our net interest income for the years ended December 31, 2013 and December 31, 2012:

Table 4                                                                  For the Year Ended
                                                 December 31, 2013                                                December 31, 2012
. . .
  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
Copyright © 2015 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.