RESI 10Q_9.30.2014

 

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 SEPTEMBER 30, 2014

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR TRANSITION PERIOD FROM __________ TO __________

COMMISSION FILE NUMBER: 001-35657
 
Altisource Residential Corporation
(Exact name of registrant as specified in its charter)
MARYLAND
46-0633510
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

c/o Altisource Asset Management Corporation
402 Strand Street
Frederiksted, United States Virgin Islands 00840-3531
(Address of principal executive office)

(340) 692-1055
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all 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 x  No o

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer
o
 
Accelerated Filer
x
Non-Accelerated Filer
o
(Do not check if a smaller reporting company)
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 x

As of October 31, 2014, 57,186,587 shares of our common stock were outstanding.



Altisource Residential Corporation
September 30, 2014
Table of Contents



i

(table of contents)

References in this report to "we," "our," "us," or the "Company" refer to Altisource Residential Corporation and its consolidated subsidiaries, unless otherwise indicated. References in this report to “AAMC” refer to Altisource Asset Management Corporation, unless otherwise indicated. References in this report to “Altisource” refer to Altisource Portfolio Solutions S.A. and its consolidated subsidiaries, unless otherwise indicated. References in this report to “Ocwen” refer to Ocwen Financial Corporation and its consolidated subsidiaries, unless otherwise indicated.

Special note on forward-looking statements

Our disclosure and analysis in this quarterly report on Form 10-Q contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, which we refer to as the “Securities Act,” and Section 21E of the Securities Exchange Act of 1934, as amended, which we refer to as the “Exchange Act.” In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions.

The forward-looking statements contained in this quarterly report reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. Factors that may materially affect such forward-looking statements include, but are not limited to:

•
our ability to implement our business strategy;
•
our ability to make distributions to our stockholders;
•
the impact of changes to the supply of, value of and the returns on sub-performing and non-performing loans;
•
our ability to convert loans to rental properties generating attractive returns;
•
our ability to predict our costs;
•
our ability to effectively compete with our competitors;
•
our ability to apply the proceeds from financing activities to target assets in a timely manner;
•
changes in interest rates and the market value of the collateral underlying our sub-performing and non-performing loan portfolios or acquired properties;
•
our ability to obtain and access financing arrangements on favorable terms, or at all;
•
our ability to retain our exclusive engagement of AAMC;
•
the failure of Altisource to effectively perform its obligations under various agreements with us;
•
the failure of Ocwen to effectively perform its servicing obligations under the Ocwen servicing agreement;
•
our failure to maintain qualification as a REIT;
•
our failure to maintain our exemption from registration under the Investment Company Act;
•
the impact of adverse real estate, mortgage or housing markets;
•
the impact of adverse legislative or regulatory tax changes; and
•
general economic and market conditions.

While forward-looking statements reflect our good faith beliefs, assumptions and expectations, they are not guarantees of future performance. Such forward-looking statements speak only as of their respective dates, and we assume no obligation to update them to reflect changes in underlying assumptions or factors, new information or otherwise. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, please see "Item 1A. Risk factors” in our annual report on Form 10-K for the year ended December 31, 2013 and in our quarterly reports on Form 10-Q for the first and second quarters of 2014.



ii

(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

Certain information contained herein is presented as of October 31, 2014, which we have concluded is the latest practicable date for financial information prior to the filing of this quarterly report.



1

(table of contents)

Altisource Residential Corporation
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
(Unaudited)

 
September 30, 2014
 
December 31, 2013
Assets:
 
 
 
Real estate held for use:
 
 
 
Land
$
9,865

 
$
478

Rental residential properties (net of accumulated depreciation of $482 and $24, respectively)
38,470

 
3,092

Real estate owned
370,733

 
32,332

Total real estate held for use, net
419,068

 
35,902

Real estate assets held for sale
40,985

 
1,186

Mortgage loans
2,071,505

 
1,207,163

Mortgage loans held for sale
143,197

 
—

Cash and cash equivalents
76,027

 
115,988

Restricted cash
12,033

 
5,878

Accounts receivable
874

 
1,428

Related party receivables
19,254

 
9,260

Investment in affiliate
18,000

 
18,000

Deferred leasing and financing costs, net
3,688

 
2,293

Prepaid expenses and other assets
5,305

 
1,542

Total assets
$
2,809,936

 
$
1,398,640

Liabilities:
 
 
 
Repurchase agreements
$
1,258,329

 
$
602,382

Other secured borrowings (including $15,000 repurchase agreement with NewSource)
165,000

 
—

Accounts payable and accrued liabilities
14,577

 
4,952

Related party payables
55,216

 
5,879

Total liabilities
1,493,122

 
613,213

Commitments and contingencies (Note 6)

 

Equity:
 
 
 
Common stock, $.01 par value, 200,000,000 authorized shares; 57,186,587 and 42,286,669 shares issued and outstanding, at September 30, 2014 and December 31, 2013, respectively
572

 
423

Additional paid-in capital
1,227,021

 
758,584

Retained earnings
89,221

 
26,420

Total equity
1,316,814

 
785,427

Total liabilities and equity
$
2,809,936

 
$
1,398,640


See accompanying notes to consolidated financial statements.




2

(table of contents)

Altisource Residential Corporation
Consolidated Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)

Three months ended September 30, 2014
 
Three months ended September 30, 2013
 
Nine months ended September 30, 2014
 
Nine months ended September 30, 2013
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
Rental revenues
$
469

 
$
6

 
$
719

 
$
6

Net unrealized gain on mortgage loans
88,726

 
17,670

 
258,898

 
25,963

Net realized gain on mortgage loans
13,727

 
1,909

 
33,867

 
4,015

Net realized gain on re-performing mortgage loans
302

 
—

 
302

 
—

Net realized gain on real estate
3,310

 
—

 
4,544

 
—

Interest income
2,568

 
156

 
2,757

 
368

Total revenues
109,102

 
19,741

 
301,087

 
30,352

Expenses:
 
 
 
 
 
 
 
Residential property operating expenses
9,247

 
191

 
13,550

 
275

Real estate depreciation and amortization
313

 
4

 
464

 
4

Real estate selling costs and impairment
5,542

 
210

 
8,775

 
210

Mortgage loan servicing costs
21,226

 
2,154

 
49,588

 
3,788

Interest expense
11,699

 
467

 
24,352

 
1,163

General and administrative
1,819

 
980

 
5,665

 
2,480

Related party general and administrative
21,530

 
2,039

 
51,629

 
4,474

Total expenses
71,376

 
6,045

 
154,023

 
12,394

Other income (expense)
—

 
13

 
383

 
(6
)
Income before income taxes
37,726

 
13,709

 
147,447

 
17,952

Income tax expense
50

 
—

 
76

 
—

Net income
$
37,676

 
$
13,709

 
$
147,371

 
$
17,952

 
 
 
 
 
 
 
 
Earnings per share of common stock – basic:
 
 
 
 
 
 
 
Earnings per basic share
$
0.66

 
$
0.55

 
$
2.63

 
$
1.03

Weighted average common stock outstanding – basic
57,174,150

 
25,078,727

 
55,930,010

 
17,484,598

Earnings per share of common stock – diluted:
 
 
 
 
 
 
 
Earnings per diluted share
$
0.66

 
$
0.53

 
$
2.62

 
$
0.98

Weighted average common stock outstanding – diluted
57,406,325

 
25,949,293

 
56,312,104

 
18,373,205

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.55

 
$
0.10

 
$
1.48

 
$
0.10


See accompanying notes to consolidated financial statements.



3

(table of contents)


Altisource Residential Corporation
Consolidated Statements of Stockholders' Equity
(In thousands, except share amounts)
(Unaudited)

 
Common stock
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Retained earnings
Total equity
December 31, 2013
42,286,669

$
423

$
758,584

$
26,420

$
785,427

Issuance of common stock, including stock option exercises
14,899,918

149

483,557

—

483,706

Cost of issuance of common stock
—

—

(15,290
)
—

(15,290
)
Dividends on common stock
—

—

—

(84,570
)
(84,570
)
Share-based compensation
—

—

170

—

170

Net income
—

—

—

147,371

147,371

September 30, 2014
57,186,587

$
572

$
1,227,021

$
89,221

$
1,316,814


 
Common stock
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Retained earnings/(accumulated deficit)
Total equity
December 31, 2012
7,810,708

$
78

$
99,922

$
(89
)
$
99,911

Issuance of common stock, including stock option exercises
17,276,528

173

323,330

—

323,503

Cost of issuance of common stock
—

—

(13,991
)
—

(13,991
)
Dividends on common stock
 
 
 
(2,509
)
(2,509
)
Share-based compensation
—

—

188

—

188

Net income
—

—

—

17,952

17,952

September 30, 2013
25,087,236

$
251

$
409,449

$
15,354

$
425,054


See accompanying notes to consolidated financial statements.
 




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(table of contents)

Altisource Residential Corporation
Consolidated Statements of Cash Flows
(In thousands)(Unaudited)
 
Nine months ended September 30, 2014
 
Nine months ended September 30, 2013
Operating activities:
 
 
 
Net income
$
147,371

 
$
17,952

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(258,898
)
 
(25,963
)
Net realized gain on mortgage loans
(33,867
)
 
(4,015
)
Net realized gain on sale of re-performing mortgage loans
(302
)
 
—

Net realized gain on sale of real estate
(4,544
)
 
—

Real estate depreciation, amortization and other non-cash charges
9,239

 
4

Accretion of interest on re-performing mortgage loans
(2,475
)
 
—

Share-based compensation
170

 
188

Amortization of deferred financing costs
2,241

 
630

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(518
)
 
—

Related party receivables
6,421

 
(527
)
Prepaid expenses and other assets
(5,225
)
 
(213
)
Accounts payable and accrued liabilities
2,137

 
1,103

Related party payables
49,337

 
1,174

Net cash used in operating activities
(88,913
)
 
(9,667
)
Investing activities:
 
 
 
Investment in mortgage loans
(1,241,083
)
 
(642,645
)
Investment in real estate
(27,463
)
 
(6,198
)
Investment in renovations
(5,957
)
 
(145
)
Real estate tax advances
(20,244
)
 
(547
)
Mortgage loan dispositions
122,023

 
13,783

Mortgage loan payments
14,903

 
2,659

Disposition of real estate
11,771

 
—

Change in restricted cash
(6,155
)
 
(3,092
)
Net cash used in investing activities
(1,152,205
)
 
(636,185
)
Financing activities:
 
 
 
Issuance of common stock, including stock option exercises
491,337

 
323,619

Payment of tax withholdings on exercise of stock options
(7,631
)
 
(116
)
Cost of issuance of common stock
(15,290
)
 
(13,441
)
Dividends on common stock
(84,570
)
 
(2,509
)
Proceeds from issuance of secured borrowings
165,000

 
—

Proceeds from repurchase agreement
952,264

 
418,099

Repayments of repurchase agreement
(296,317
)
 
(79,299
)
Payment of deferred financing costs
(3,636
)
 
(2,254
)
Net cash provided by financing activities
1,201,157

 
644,099

Net decrease in cash and cash equivalents
(39,961
)
 
(1,753
)
Cash and cash equivalents as of beginning of the period
115,988

 
100,005

Cash and cash equivalents as of end of the period
$
76,027

 
$
98,252

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
20,212

 
$
377

Transfer of mortgage loans to real estate owned
410,913

 
10,598

Transfer of real estate owned to mortgage loans
5,367

 
—

Change in accrued capital expenditures
7,712

 
—

Change in accrued equity issuance costs
—

 
1,242

Changes in receivables from mortgage loan dispositions, payments and real estate tax advances to borrowers, net
13,081

 
5,745

Changes in receivables from real estate owned dispositions
3,097

 
—

See accompanying notes to consolidated financial statements.

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(table of contents)

Altisource Residential Corporation
Notes to Consolidated Financial Statements
September 30, 2014
(Unaudited)

1. Organization and basis of presentation

Altisource Residential Corporation is a Maryland REIT focused on acquiring, owning and managing single-family rental properties throughout the United States. We acquire our rental properties primarily through the acquisition of sub-performing and non-performing mortgage loan portfolios, which is a differentiated approach that we believe strategically positions us to take advantage of market opportunities better than market participants that are solely focused on real estate-owned (“REO”) acquisitions. We conduct substantially all of our activities through our wholly owned subsidiary Altisource Residential, L.P.

On December 21, 2012, which we refer to as the “separation date,” we separated from Altisource Portfolio Solutions S.A.
("Altisource") and became a stand-alone publicly traded company through the contribution to us by Altisource of $100 million of equity capital and the distribution of our shares of common stock to the stockholders of Altisource. On the separation date, we entered into long-term service agreements with Ocwen Financial Corporation ("Ocwen"), a leading residential mortgage loan servicer, and with Altisource, a leading provider of real estate and mortgage portfolio management, asset recovery and customer relationship management services. We believe that our access to Ocwen’s servicing expertise and multifaceted resolution methodologies helps us maximize the value of our loan portfolios and provides us with a competitive advantage over other companies with a similar focus. We also believe that our relationship with Altisource and access to its nationwide vendor network enables us to competitively bid on large sub-performing or non-performing residential mortgage loan portfolios with assets dispersed throughout the United States.

We are managed by Altisource Asset Management Corporation ("AAMC"). We rely on AAMC for administering our business and performing certain of our corporate governance functions. AAMC also provides portfolio management services in connection with our acquisition and management of sub-performing and non-performing loans and REO properties. AAMC was formed on March 15, 2012 as a wholly owned subsidiary of Altisource and was spun off from Altisource into a stand-alone publicly traded company concurrently with our separation from Altisource.

Since we commenced operations, we have completed three public equity offerings with aggregate net proceeds of approximately $1.1 billion. On March 22, 2013, September 12, 2013 and September 23, 2013, we entered into three separate repurchase agreements to finance the acquisition and ownership of residential mortgage loans and REO properties. The maximum aggregate funding available under these repurchase agreements initially was $425.0 million. We subsequently increased the aggregate funding capacity under each repurchase agreement as follows:

•
For the repurchase agreement entered into on March 22, 2013, we amended it on April 21, 2014 to initially increase the aggregate maximum borrowing capacity from $100.0 million to $200.0 million. The maturity date of the repurchase agreement was also extended to April 20, 2015, subject to an additional one-year extension with the approval of the lender. On June 11, 2014, we further amended this repurchase agreement to increase the aggregate maximum borrowing capacity from $200.0 million to $375.0 million, subject to certain sublimits, for the period from June 11, 2014 through October 11, 2014, and on October 3, 2014, we extended the increase through December 10, 2014. The aggregate borrowing capacity under the repurchase agreement will revert to $200.0 million after December 10, 2014.

•
The repurchase agreement dated September 12, 2013, as amended on December 18, 2013, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016. This agreement includes a provision that, beginning in the nineteenth month, we will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of the eighteenth month.

•
For the repurchase agreement dated September 23, 2013, we amended it on December 23, 2013 to initially increase the aggregate maximum borrowing capacity from $200.0 million to $400.0 million. On June 25, 2014, we further amended this repurchase agreement to increase the aggregate maximum borrowing capacity from $400.0 million to $1.0 billion, subject to certain sublimits. The maturity date of the repurchase agreement is March 23, 2015. We have the option to extend this agreement for an additional year with no additional funding.
 
Following these increases, the maximum aggregate funding available to us under these repurchase agreements as of September 30, 2014 was $1.7 billion, subject to certain sublimits, eligibility requirements and conditions precedent to each

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funding. As of September 30, 2014, an aggregate of $1.3 billion was outstanding under our repurchase agreements. All obligations under the repurchase agreements are fully guaranteed by us.

On September 25, 2014, we completed a securitization transaction in which ARLP Securitization Trust, Series 2014-1 (“ARLP 2014-1”) issued $150.0 million in Class A Notes (the “Class A Notes”) with a weighted yield of approximately 3.5% and $32.0 million in Class M Notes (the “Class M Notes”) with a weighted yield of 4.25%. The Class A Notes and the Class M Notes are secured solely by the non-performing mortgage loans of ARLP 2014-1 and not by any of our other assets. The assets of ARLP 2014-1 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on September 25, 2044, and we do not guaranty any of the obligations of ARLP 2014-1 under the terms of the Indenture governing the notes or otherwise. As of September 30, 2014, the book value of the underlying securitized assets held by ARLP 2014-1 was $211.3 million.

We retained all of the Class M Notes in our taxable REIT subsidiary (“TRS”). On September 30, 2014, pursuant to a master repurchase agreement, the TRS sold $15.0 million of the Class M Notes to NewSource Reinsurance Company Ltd, ("NewSource"), an entity in which we own 100% of the outstanding preferred stock and in which AAMC owns 100% of the outstanding common stock, for a purchase price of $15.0 million. The master repurchase agreement requires the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, subject to the parties’ option to extend the master repurchase agreement for an additional 89 day period. In no event can the master repurchase agreement be extended beyond September 29, 2015.

We ceased to be a development stage enterprise in the second quarter of 2013.

Basis of presentation and use of estimates

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States which we refer to as "U.S. GAAP." All wholly owned subsidiaries are included and all intercompany accounts and transactions have been eliminated. The preparation of consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ materially from those estimates.

The unaudited consolidated financial statements and accompanying unaudited consolidated financial information, in our opinion, contain all adjustments that are of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods. The interim results are not necessarily indicative of results for a full year. We have omitted certain notes and other information from the interim consolidated financial statements presented in this Quarterly Report as permitted by SEC rules and regulations. These consolidated financial statements should be read in conjunction with our 2013 annual report on Form 10-K.

Loans held for sale

Loans held for sale, which consist of re-performing residential mortgage loans acquired from others, are recorded at the lower of cost or fair value. We do not originate loans. During the third quarter 2014, management decided to sell these re-performing loans and as such they were reclassified as loans held for sale from loans held for investment. See Note 12 - "Subsequent events" for information on our dispositions of re-performing loans subsequent to September 30, 2014.

Recently issued accounting standards

In January 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-04, Troubled Debt Restructurings by Creditors. It provides that a repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendment requires disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The amended guidance may be applied using either a prospective transition method or a modified retrospective transition method and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. We do not expect this

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amendment to have a significant effect on our financial position or results of operations since our accounting policies and disclosures are currently consistent with the requirements set forth in the amendment.

In May 2014, the FASB issued ASU 2014-09 Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. We do not expect this amendment to have a significant effect on our financial position or results of operations since our accounting policies and disclosures are currently consistent with the requirements set forth in the amendment.

2. Mortgage loans

During the nine months ended September 30, 2014, Residential acquired an aggregate of 8,155 mortgage loans and REO properties, consisting of the following:

Acquisitions of non-performing residential mortgage loans

During the nine months ended September 30, 2014, we acquired an aggregate of 7,086 residential mortgage loans, substantially all of which were non-performing, and 190 REO properties having an aggregate UPB of approximately $1.9 billion and an aggregate market value of underlying properties of $1.7 billion. The aggregate purchase price for these acquisitions was $1.1 billion. During the quarter ended September 30, 2014, we agreed to acquire an aggregate of 246 residential mortgage loans, substantially all of which are non-performing, with an aggregate market value of underlying properties of $29.7 million. There can be no assurance that we will complete this pending transaction in whole or in part on a timely basis or at all.

Acquisition of re-performing residential mortgage loans

On June 27, 2014, we acquired 879 re-performing mortgage loans with an aggregate market value of underlying properties of $271.1 million for an aggregate purchase price of $144.6 million. Under ASC 310-30, acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. These 879 re-performing residential mortgage loans were determined to have common risk characteristics and have been accounted for as a single loan pool. Under ASC 310-30, we estimate cash flows expected to be collected, adjusted for expected prepayments and defaults expected to be incurred over the life of the loan pool. We determine the excess of the loan pool's contractually required principal and interest payments over the expected cash flows as an amount that should not be accreted, the nonaccretable yield. The difference between expected cash flows and the present value of the expected cash flows is referred to as the accretable yield, which represents the amount that is expected to be recorded as interest income over the remaining life of the loan pool. For the three and nine months ended September 30, 2014, we recognized no provision for loan loss and no adjustments to the amount of the accretable yield. For the three and nine months ended September 30, 2014, we accreted $2.5 million into interest income with respect to our re-performing loans. As of September 30, 2014, these re-performing loans, having a UPB of $204.3 million and a carrying value of $143.2 million, were held for sale. During October 2014, we sold an aggregate of 934 re-performing loans to an unrelated third party for an aggregate purchase price of $164 million. See Note 12 - "Subsequent events" for information on our dispositions of re-performing loans subsequent to September 30, 2014.

The following tables present information regarding the estimates of the contractually required payments and the cash flows expected to be collected as of the date of the acquisition and changes in the balance of the accretable yield ($ in thousands):
Contractually required principal and interest
$
325,000

Non-accretable yield
(96,263
)
Expected cash flows to be collected
228,737

Accretable yield
(84,728
)
Fair value at the date of acquisition
$
144,009


8


Accretable Yield
Three months ended September 30, 2014
Balance at the beginning of the period
$
84,728

Accretion
(2,475
)
Balance at the end of the period
$
82,253

Since the commencement of our operations, we have engaged in the acquisition of the following portfolios of non-performing and re-performing residential mortgage loans:
Portfolios We Agreed to Acquire
 
 
Acquisitions Completed in 2014
Acquisitions Completed in 2013
Date of agreement in principle
Number of loans
Fair value of underlying property (in millions)
 
Date acquisition closed
Number of loans acquired
Fair value of underlying property (in millions)
Number of loans acquired
Fair value of underlying property (in millions)
January 23, 2013
460

$
94.2

 
February 14, 2013
 
 
460

$
94.2

February 12, 2013
244

40.1

 
March 21, 2013
 
 
230

38.7

February 14, 2013
762

128.9

 
April 5, 2013
 
 
720

122.1

June 25, 2013
321

73.9

 
August 26, 2013
 
 
292

67.3

June 27, 2013
2,377

296.1

 
August 6, 2013
 
 
1,562

185.2

 
September 19, 2013
 
 
416

56.0

August 12, 2013
2,966

790.2

 
September 30, 2013
 
 
1,547

403.6

 
October 21, 2013
 
 
1,100

298.0

November 12, 2013
993

137.3

 
January 2, 2014
650

$
93.6

 
 
November 22, 2013
6,540

1,542.1

 
December 24, 2013
 
 
2,204

530.1

 
January 31, 2014
3,421

791.7

 
 
December 19, 2013
164

18.3

 
January 28, 2014
66

7.0

 
 
 
February 28, 2014
70

8.2

 
 
March 11, 2014(1)
915

180.0

 
May 1, 2014(2)
664

126.6

 
 
May 2, 2014
78

8.7

 
July 10, 2014
46

5.0

 
 
June 4, 2014
3,191

891.6

 
June 27, 2014
1,116

375.3

 
 
 
July 31, 2014
1,243

315.7

 
 
June 4, 2014(3)
1,105

331.6

 
June 27, 2014(3)
879

271.1

 
 
September 15, 2014
246

29.7

 
pending(4)
 
 
 
 
Totals
20,362

$
4,562.7

 
Totals
8,155

$
1,994.2

8,531

$
1,795.2

_____________
(1)
The remaining portion of this acquisition, consisting of 159 mortgage loans and REO properties, closed in October 2014.
(2)
Includes 190 REOs.
(3)
This acquisition consisted of a portfolio of re-performing loans.
(4)
This acquisition is expected to close in the fourth quarter of 2014.

During the three and nine months ended September 30, 2014, we recognized a nominal amount and $2.9 million respectively, for due diligence costs related to these and other transactions in both general and administrative expense and related party general and administrative expense. During the three and nine months ended September 30, 2013, we expensed $0.9 million and $1.3 million, respectively, for due diligence costs.

Generally, we expect that our residential mortgage loan portfolio may grow at an uneven pace, as opportunities to acquire distressed residential mortgage loans may be irregularly timed and may involve large portfolios of loans, and the timing and extent of our success in acquiring such loans cannot be predicted. In addition, for any given portfolio of loans that we agree to acquire, we typically acquire fewer loans than originally expected, as certain loans may be resolved prior to the closing date or may fail to meet our diligence standards. The number of unacquired loans typically constitutes a relatively small portion of a particular portfolio. In some cases, the number of loans we do not acquire could be significant. In any case where we do not acquire the full portfolio, appropriate adjustments are made to the applicable purchase price.



Throughout this quarterly report, all unpaid principal balance and market value amounts for the portfolios we have acquired are provided as of “cut-off date” for each transaction unless otherwise indicated. The “cut-off date” for each acquisition is a date shortly before the closing used to identify the final loans being purchased and the related unpaid principal balance, market value of underlying properties and other characteristics of the loans.

Transfer of mortgage loans to real estate owned

During the three months ended September 30, 2014 and 2013, we transferred 1,113 and 43 mortgage loans, respectively, to REO at an aggregate fair value based on broker price opinions ("BPOs") of $189.9 million and $6.2 million, respectively. Such transfers occur when the foreclosure sale is complete. In connection with these transfers to REO, we recorded $38.4 million and $1.8 million, respectively, in net unrealized gains on mortgage loans.

During the nine months ended September 30, 2014 and 2013, we transferred 2,657 and 77 mortgage loans, respectively, to REO at an aggregate fair value based on BPOs, of $410.9 million and $10.6 million, respectively. In connection with these transfers to REO, we recorded $90.5 million and $3.0 million, respectively, in net unrealized gains on mortgage loans.

Dispositions

During the three months ended September 30, 2014 and 2013, we disposed of 165 and 54 mortgage loans, respectively, primarily through short sales, refinancing and foreclosure sales. In connection with these dispositions, we recorded $13.7 million and $1.9 million, respectively, of net realized gains on mortgage loans.

During the nine months ended September 30, 2014 and 2013, we disposed of 416 and 92 mortgage loans, respectively, primarily through short sales, refinancing and foreclosure sales. In connection with these dispositions, we recorded $33.9 million and $4.0 million, respectively, of net realized gains on mortgage loans. During October 2014, we sold 934 re-performing loans to an unrelated third party. The sale included 770 loans from the re-performing mortgage loans held for sale, purchased in the second quarter of 2014, and 164 loans that have transitioned to re-performing status from prior non-performing loan acquisitions that have a clean pay history of at least six months. See Note 12 - "Subsequent events" for information on our dispositions of re-performing loans subsequent to September 30, 2014.

3. Real estate assets, net

Acquisitions

During the nine months ended September 30, 2014, we acquired 190 REO properties as part of our portfolio acquisitions. We acquired no REO properties during the three months ended September 30, 2014. During the three and nine months ended September 30, 2013, we acquired 34 and 40 REO properties, respectively. The aggregate purchase price attributable to these acquired REO properties was $27.5 million for the nine months ended September 30, 2014 and was $5.9 million and $6.2 million, respectively, for the three and nine months ended September 30, 2013.

Real estate held for use

As of September 30, 2014, we had 2,660 REO properties held for use. Of these properties, 216 had been rented, 90 were being listed for rent and 270 were in varying stages of renovation. With respect to the remaining 2,084 REO properties, we will make a final determination whether each property meets our rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified, (c) we have recorded the deed for the property, (d) utilities have been activated and (e) we have secured access for interior inspection. A majority of the REO properties are subject to state regulations which require us to await the expiration of a redemption period before a foreclosure can be finalized. We include these redemption periods in our portfolio pricing which generally reduces the price we pay for the mortgage loans. Once the redemption period expires, we immediately proceed to record the new deed, take possession of the property, activate utilities, and start the inspection process in order to make our final determination. As of December 31, 2013, we had 246 REO properties held for use. Of these properties, 14 had been rented, 11 were being listed for rent and 18 were in various stages of renovation. With respect to the remaining 203 REO properties, we were in the process of determining whether these properties would meet our rental profile. As of September 30, 2013, we had 100 REO properties held for use. Of these properties, five had been rented, six were being listed for rent and three were in various stages of renovation. With respect to the remaining 86 REO properties, we were in the process of determining whether these properties would meet our rental profile. If a REO property meets our rental profile, we determine the extent of renovations that are needed to generate an optimal rent and maintain consistency of renovation

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specifications for future branding. If we determine that the REO property will not meet our rental profile, we list the property for sale, in certain instances after renovations are made to optimize the sale proceeds.

Real estate held for sale

As of September 30, 2014, we classified 324 REO properties having an aggregate carrying value of $41.0 million as real estate held for sale as they do not meet our residential rental property investment criteria. As of December 31, 2013, we had 16 REO properties having an aggregate carrying value of $1.2 million held for sale, and as of September 30, 2013, we had 14 REO properties having an aggregate carrying value of $1.1 million held for sale. None of these REO properties have any operations; therefore, we are not presenting discontinued operations related to these properties.

Dispositions

During the three and nine months ended September 30, 2014, we disposed of 78 and 102 residential properties, respectively. We did not dispose of any residential properties during the nine months ended September 30, 2013. In connection with the dispositions for the three and nine months ended September 30, 2014, we recorded $3.3 million and $4.5 million, respectively, of net realized gains on real estate.

4. Fair value of financial instruments

The following table sets forth the fair value of financial assets and liabilities by level within the fair value hierarchy as of September 30, 2014 and December 31, 2013 ($ in thousands):
 
Level 1
Level 2
Level 3
 
Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
September 30, 2014
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
2,071,505

Nonrecurring basis (assets)
 
 
 
Real estate assets held for sale
$
—

$
—

$
44,187

Transfer of real estate owned to mortgage loans
$
—

$
—

$
5,367

Transfer of mortgage loans to real estate owned
$
—

$
—

$
410,913

Not recognized on consolidated balance sheets at fair value (assets)
 
 
 
Mortgage loans held for sale
$
—

$
—

$
143,197

Not recognized on consolidated balance sheets at fair value (liabilities)
 
 
 
Repurchase agreements at fair value
$
—

$
1,258,329

$
—

Other secured borrowings
$
—

$
165,000

$
—

 
 
 
 
December 31, 2013
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
1,207,163

Nonrecurring basis (assets)
 
 
 
Real estate assets held for sale
$
—

$
—

$
1,520

Transfer of mortgage loans to real estate owned
$
—

$
—

$
31,014

Not recognized on consolidated balance sheets at fair value (liabilities)
 
 
 
Repurchase agreements at fair value
$
—

$
602,382

$
—


We have not transferred any assets from one level to another level during the nine months ended September 30, 2014. Additionally there were no transfers between levels for the year ended December 31, 2013.

The carrying values of our cash and cash equivalents, restricted cash, related party receivables, accounts payable and accrued liabilities, related party payables and investment in NewSource are equal to or approximate fair value. The fair value of

11
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mortgage loans is estimated using our asset manager's proprietary pricing model. The fair value of transfers of mortgage loans to real estate owned is estimated using BPOs. The fair value of re-performing mortgage loans held for sale is estimated using the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. The fair value of the repurchase agreements is estimated using the income approach based on credit spreads available to us currently in the market for similar floating rate debt. The fair value of other secured borrowings is estimated using observable market data.

The following table sets forth the changes in our level 3 assets that are measured at fair value on a recurring basis ($ in thousands):

Three months ended September 30, 2014
 
Three months ended September 30, 2013
 
Nine months ended September 30, 2014
 
Nine months ended September 30, 2013
Mortgage loans
 
 
 
 
 
 
 
Beginning balance
$
2,024,028

 
$
163,520

 
$
1,207,163

 
$
—

Investment in mortgage loans
184,590

 
475,998

 
1,097,601

 
644,163

Net unrealized gain on mortgage loans
88,726

 
17,670

 
258,898

 
25,963

Net realized gain on mortgage loans
13,727

 
1,909

 
33,867

 
4,015

Mortgage loan dispositions and payments
(60,062
)
 
(11,882
)
 
(143,834
)
 
(22,527
)
Real estate tax advances to borrowers
6,397

 
887

 
19,119

 
887

Reclassification of realized gains on real estate sold from unrealized gains
3,322

 
—

 
4,237

 
—

Transfer of real estate owned to mortgage loans
719

 
—

 
5,367

 
—

Transfer of mortgage loans to real estate owned
(189,942
)
 
(6,199
)
 
(410,913
)
 
(10,598
)
Ending balance at September 30
$
2,071,505

 
$
641,903

 
$
2,071,505

 
$
641,903

 
 
 
 
 
 
 
 
Net unrealized gain on mortgage loans held at the end of the period
$
55,558

 
$
17,670

 
$
164,378

 
$
25,963


The following table sets forth the fair value of our non-performing mortgage loans, the related unpaid principal balance and market value of underlying properties by delinquency status as of September 30, 2014 and December 31, 2013 ($ in thousands):
 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties
September 30, 2014
 
 
 
 
Current
685

$
96,445

$
161,438

$
168,946

30
98

10,080

17,485

19,072

60
46

6,593

9,560

10,208

90
2,608

410,583

663,560

629,706

Foreclosure
8,653

1,547,804

2,362,326

2,086,407

Mortgage loans
12,090

$
2,071,505

$
3,214,369

$
2,914,339

December 31, 2013
 
 
 
 
Current
238

$
31,649

$
60,051

$
52,506

30
26

2,087

4,492

3,763

60
23

3,376

5,683

4,738

90
1,555

245,024

419,836

355,451

Foreclosure
6,212

925,027

1,609,546

1,310,439

Mortgage loans
8,054

$
1,207,163

$
2,099,608

$
1,726,897


The following table sets forth the carrying value of our re-performing mortgage loans held for sale, the related unpaid principal balance and market value of underlying properties by delinquency status as of September 30, 2014.

12
(table of contents)

 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties
September 30, 2014
 
 
 
 
Current
818

$
136,814

$
194,861

$
257,491

30
23

2,587

3,867

4,114

60
7

1,062

1,552

1,703

90
24

2,734

4,066

4,436

Mortgage loans held for sale
872

$
143,197

$
204,346

$
267,744


The significant unobservable inputs used in the fair value measurement of our mortgage loans are discount rates, forecasts of future home prices, alternate loan resolution probabilities, resolution timelines and the value of underlying properties. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. A decline in the discount rate in isolation would increase the fair value. A decrease in the housing pricing index in isolation would decrease the fair value. Individual loan characteristics such as location and value of underlying collateral affect the loan resolution probabilities and timelines. An increase in the loan resolution timeline in isolation would decrease the fair value. A decrease in the value of underlying properties in isolation would decrease the fair value. The following table sets forth quantitative information about the significant unobservable inputs used to measure the fair value of our mortgage loans as of September 30, 2014 and December 31, 2013:
Input
September 30, 2014
December 31, 2013
Equity discount rate
15.0%
15.0%
Debt to asset ratio
65.0%
55.0%
Cost of funds
3.5% over 1 month LIBOR
3.5% over 1 month LIBOR
Annual change in home pricing index  
-0.2% to 7.6%
-0.3% to 7.6%
Loan resolution probabilities — modification
0% to 44.7%
0% to 22.3%
Loan resolution probabilities — rental
0% to 100.0%
0% to 100.0%
Loan resolution probabilities — liquidation
0% to 100.0%
0% to 100.0%
Loan resolution timelines (in years)
0.1 to 5.3
0.1 - 5.8
Value of underlying properties
$3,000 - $6,450,000
$3,000 - $3,550,000

5. Borrowings

Repurchase Agreements

Our operating partnership and certain of its Delaware Statutory Trust subsidiaries, as applicable, have entered into master repurchase agreements with major financial institutions. The purpose of these repurchase agreements is to finance the acquisition and ownership of mortgage loans and REO properties in our portfolio. We have effective control of the assets associated with these agreements and therefore have concluded these are financing arrangements. As of September 30, 2014, the weighted average annualized interest rate on borrowings under our repurchase agreements was 3.05%, excluding amortization of deferred financing costs. The following table sets forth data with respect to our repurchase agreements as of September 30, 2014 and December 31, 2013 ($ in thousands):

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Maximum borrowing capacity
Book value of collateral
Amount outstanding
September 30, 2014
 
 
 
Repurchase agreement due April 20, 2015 (1)
$
375,000

$
655,739

$
374,982

Repurchase agreement due March 23, 2015
1,030,000

1,076,441

669,452

Repurchase agreement due March 11, 2016
250,000

414,889

213,894

 
$
1,655,000

$
2,147,069

$
1,258,328

December 31, 2013
 
 
 
Repurchase agreement due April 21, 2014
$
100,000

$
166,350

$
85,364

Repurchase agreement due March 23, 2015
$
400,000

$
634,234

$
398,602

Repurchase agreement due March 11, 2016
$
250,000

$
205,328

$
118,416

 
$
750,000

$
1,005,912

$
602,382

_____________
(1)
The aggregate borrowing capacity under the repurchase agreement reverts to $200.0 million after December 10, 2014.

Under the terms of each repurchase agreement, as collateral for the funds drawn thereunder, subject to certain conditions, our operating partnership will sell to the applicable lender equity interests in the Delaware statutory trust subsidiary that owns the applicable underlying mortgage assets on our behalf, or the trust will directly sell such underlying mortgage assets. In the event the lender determines the value of the collateral has decreased, the lender has the right to initiate a margin call and require us, or the applicable trust subsidiary, to post additional collateral or to repay a portion of the outstanding borrowings. The price paid by the lender for each mortgage asset we finance under the repurchase agreements is based on a percentage of the market value of the mortgage asset and may depend on its delinquency status. With respect to funds drawn under the repurchase agreements, our applicable subsidiary is required to pay the lender interest based on LIBOR or at the lender’s cost of funds plus a spread calculated based on the type of applicable mortgage assets collateralizing the funding, as well as certain other customary fees, administrative costs and expenses to maintain and administer the repurchase agreements. We do not collateralize any of our repurchase facilities with cash.

The repurchase agreements require us to maintain various financial and other covenants, including maintaining a minimum adjusted tangible net worth, a maximum ratio of indebtedness to adjusted tangible net worth and specified levels of unrestricted cash. In addition, the repurchase agreements contain customary events of default. We are restricted by the terms of our repurchase agreements from paying dividends greater than our REIT taxable income in a calendar year.

We are currently in compliance with the covenants and other requirements with respect to the repurchase agreements. We monitor our banking partners’ ability to perform under the repurchase agreements and have concluded there is currently no reason to doubt that they will continue to perform under the repurchase agreements as contractually obligated.

Other Secured Debt

On September 25, 2014, we completed a securitization transaction in which ARLP 2014-1 issued $150.0 million in Class A Notes with a weighted yield of approximately 3.5% and $32.0 million in Class M Notes with a weighted yield of 4.25%. The Class A Notes and the Class M Notes are secured solely by the non-performing mortgage loans of ARLP 2014-1 and not by any of our other assets. The assets of ARLP 2014-1 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on September 25, 2044, and we do not guaranty any of the obligations of ARLP 2014-1 under the terms of the Indenture governing the notes or otherwise. As of September 30, 2014, the book value of the underlying securitized assets held by ARLP 2014-1 was $211.3 million.

We retained all of the Class M Notes in our TRS. On September 30, 2014, pursuant to a master repurchase agreement, the TRS sold $15.0 million of the Class M Notes to NewSource for a purchase price of $15.0 million. The master repurchase agreement requires the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, with the parties having the option to extend the master repurchase agreement for an additional 89 day period. In no event can the master repurchase agreement be extended beyond September 29, 2015.

The following table sets forth data with respect to these notes as of September 30, 2014 ($ in thousands):

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Interest Rate
September 30, 2014
ARLP Securitization Trust, Series 2014-1
 
 
ARLP 2014-1 Class A Notes due September 25, 2044(1)
3.4747
%
$
150,000

ARLP 2014-1 Class M Notes due September 25, 2044(2)
4.25
%
32,000

ARNS, Inc.
 
 
Securities sold under agreement to repurchase due December 28, 2014
5.00
%
15,000

Elimination of Class M Notes due to ARNS, Inc.
 
(32,000
)
Total

$
165,000

_____________
(1)
The expected redemption date for the Class A Notes is September 25, 2017.
(2)
The expected redemption date for the Class M Notes is September 25, 2018.

6. Commitments and contingencies
 
Litigation, claims and assessments

From time to time, we may be involved in various claims and legal actions arising in the ordinary course of business. As of September 30, 2014, we were not a party to, and our properties were not subject to, any pending or threatened legal proceedings that individually or in the aggregate, are expected to have a material impact on our financial condition, results of operations or cash flows.

7. Related party transactions

Our Consolidated Statements of Operations included the following significant related party transactions ($ in thousands):

 
Three months ended September 30, 2014
Nine months ended September 30, 2014
Counter-party
Consolidated Statements of Operations location
2014
 
 
 
 
Residential property operating expenses
$
7,038

$
11,238

Ocwen/Altisource
Residential property operating expenses
Mortgage loan servicing costs
22,173

47,605

Ocwen
Mortgage loan servicing costs
Due diligence and unsuccessful deal costs
4

1,770

Altisource
Related party general and administrative expenses
Expense reimbursements
1,591

4,849

AAMC
Related party general and administrative expenses
Management incentive fee
19,503

44,129

AAMC
Related party general and administrative expenses
 
Three months ended September 30, 2013
Nine months ended September 30, 2013
Counter-party
Consolidated Statements of Operations location
2013
 
 
 
 
Residential property operating expenses
$
138

$
246

Ocwen/Altisource
Residential property operating expenses
Mortgage loan servicing costs
2,134

3,335

Ocwen
Mortgage loan servicing costs
Due diligence and unsuccessful deal costs
651

1,004

Altisource
Related party general and administrative expenses
Expense reimbursements
1,307

3,371

AAMC
Related party general and administrative expenses
Management incentive fee
51

51

AAMC
Related party general and administrative expenses

On September 30, 2014, pursuant to a master repurchase agreement, our TRS sold $15.0 million of the Class M Notes to NewSource for a purchase price of $15.0 million. The master repurchase agreement requires the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, with the parties having the option to extend the master repurchase agreement for an additional 89 day period. In no event can the master repurchase agreement be extended beyond September 29, 2015.

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During the nine months ended September 30, 2013, we acquired a portfolio from Ocwen of non-performing first lien residential mortgage loans having aggregate market value of underlying properties of $94 million. The aggregate purchase price for this portfolio was $64 million.

8. Share-based payments

On December 21, 2012, as part of our separation transaction from Altisource, we issued stock options under the 2012 Conversion Option Plan and 2012 Special Conversion Option Plan to holders of Altisource stock options to purchase shares of our common stock in a ratio of one share of our common stock to every three shares of Altisource common stock. The options were granted as part of our separation to employees of Altisource and/or Ocwen solely to give effect to the exchange ratio in the separation, and we do not include share-based compensation expense related to these options in our consolidated statements of operations because they are not related to our incentive compensation.

Our directors each receive annual grants of restricted stock equal to $45,000 based on the market value of our common stock at the time of the annual stockholders meeting. This restricted stock vests and is issued after a one-year service period subject to each director attending at least 75% of the Board and committee meetings. No dividends are paid on the shares until the award is issued. During the nine months ended September 30, 2014 and 2013, we granted 8,245 and 16,355 shares of stock, respectively, pursuant to our 2013 Director Equity Plan with weighted average grant date fair value per share of $27.28 and $18.47, respectively.

We recorded $0.1 million and $0.2 million of compensation expense related to these grants for the three and nine months ended September 30, 2014, respectively, and recorded $0.1 million and $0.2 million for the three and nine months ended September 30, 2013, respectively. As of September 30, 2014 and 2013, we had $0.2 million and $0.1 million, respectively, of unrecognized share-based compensation cost remaining with respect to the director grants to be recognized over a weighted average remaining estimated term of 0.7 years and 0.7 years.

9. Income taxes

As a REIT, we must meet certain organizational and operational requirements including the requirement to distribute at least 90% of our annual REIT taxable income to our stockholders. As a REIT, we generally will not be subject to federal income tax to the extent we distribute our REIT taxable income to our stockholders and provided we satisfy the REIT requirements including certain asset, income, distribution and stock ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, we will be subject to U.S. 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 we lost our REIT qualification.

Based on our 2013 taxable income of $17.7 million, the aggregate minimum distribution to stockholders required to maintain our REIT status was $16.0 million in 2013. Dividends declared and paid per share of common stock aggregated $0.35 for the year ended December 31, 2013, or $13.1 million. On February 20, 2014, our Board of Directors declared a cash dividend of $0.08 per share of common stock, which was paid on March 10, 2014 to all stockholders of record as of the close of business on March 3, 2014. This additional dividend, an aggregate of $4.5 million, was intended to satisfy the requirement that a REIT must distribute at least 90% of its annual REIT taxable income to its stockholders and will be treated as a 2013 distribution for REIT qualification purposes. On March 6, 2014, our Board of Directors declared a quarterly cash dividend of $0.40 per share of common stock, which was paid on March 24, 2014 to all stockholders of record as of the close of business on March 17, 2014.
On May 29, 2014, our Board of Directors declared a quarterly cash dividend of $0.45 per share of common stock, which was paid on June 23, 2014 to all stockholders of record as of the close of business on June 9, 2014. On September 5, 2014, our Board of Directors declared a quarterly cash dividend of $0.55 per share of common stock which was paid on September 30, 2014 to all stockholders of record as of the close of business on September 15, 2014.

Our consolidated financial statements include the operations of our taxable REIT subsidiary ("TRS"), which is subject to federal, state and local income taxes on its taxable income. Through December 31, 2013, the TRS operated at a cumulative taxable loss, which resulted in our recording a deferred tax asset with a corresponding valuation allowance. The TRS has continued to operate at a cumulative taxable loss through September 30, 2014 which resulted in our recording additional deferred tax assets and a corresponding valuation allowance. As of September 30, 2014, we are forecasting that the TRS will break even for the 2014 fiscal year.

We recorded state income tax expense on our consolidated operations for the nine months ended September 30, 2014. As a REIT, we may also be subject to federal taxes if we engage in certain types of transactions.

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As of September 30, 2014 and 2013, we did not accrue interest or penalties associated with any unrecognized tax benefits, nor was any interest expense or penalty recognized during the nine months ended September 30, 2014 and 2013. We recorded nominal state and local tax expense on income and property for the nine months ended September 30, 2014. Our subsidiaries and we remain subject to tax examination for the period from inception to December 31, 2013.

10. Earnings per share

The following table sets forth the components of diluted earnings per share (in thousands, except share and per share amounts):
 
Three months ended September 30, 2014
 
Three months ended September 30, 2013
 
Nine months ended September 30, 2014
 
Nine months ended September 30, 2013
Numerator
 
 
 
 
 
 
 
Net income
$
37,676

 
$
13,709

 
$
147,371

 
$
17,952

 
 
 
 
 
 
 
 
Denominator
 
 
 
 
 
 
 
Weighted average common stock outstanding – basic
57,174,150

 
25,078,727

 
55,930,010

 
17,484,598

Stock options using the treasury method
231,101

 
870,566

 
375,657

 
888,607

Restricted stock
1,074

 
—

 
6,437

 
—

Weighted average common stock outstanding – diluted
57,406,325

 
25,949,293

 
56,312,104

 
18,373,205

 
 
 
 
 
 
 
 
Earnings per basic share
$
0.66

 
$
0.55

 
$
2.63

 
$
1.03

Earnings per diluted share
$
0.66

 
$
0.53

 
$
2.62

 
$
0.98


11. Segment information

Our primary business is the acquisition and ownership of single-family rental assets. Our primary sourcing strategy is to acquire these assets by purchasing sub-performing and non-performing mortgage loans. As a result, we operate in a single segment focused on the resolution of sub-performing and non-performing mortgages and ownership of rental residential properties.

12. Subsequent events

Sale of Re-performing Mortgage Loans

In October 2014, we sold an aggregate of 934 re-performing loans for an aggregate purchase price of $164 million. Of the 934 loans sold in this transaction, 770 were from the re-performing loan pool we purchased in the second quarter of 2014 and 164 were from prior NPL acquisitions that had transitioned to re-performing status and had a clean pay history of at least six months. Our gain on purchase price for the 770 loans we purchased in the second quarter of 2014 was 2%, and our gain on purchase price for the remaining 164 re-performing loans was 28%. We used a portion of the proceeds from this transaction to pay down our repurchase facilities. Following such payment, the total outstanding borrowings under our repurchase agreements was reduced from $1.3 billion to $1.1 billion.

Completed Portfolio Acquisition

On October 24, 2014, we acquired a portfolio of 159 first lien residential mortgage loans, substantially all of which were non-performing, and REO properties, having an aggregate UPB of $42.8 million and an aggregate market value of properties of $31.6 million for an aggregate purchase price of $21.0 million. This transaction represented the second closing of the portfolio of 915 non-performing mortgage loans and REO properties that we had agreed to purchase in the second quarter of 2014.



17
(table of contents)

Item 2. Management's discussion and analysis of financial condition and results of operations

Overview

We are a Maryland REIT focused on acquiring and managing single-family rental properties primarily by acquiring portfolios of sub-performing and non-performing residential mortgage loans throughout the United States. We believe that the events affecting the housing and mortgage market in recent years have created a significant rental demand for single-family properties. These events have created a large supply of distressed mortgage loans for sale in the market. We therefore believe we have an opportunity to acquire single-family properties through the acquisition of sub-performing and non-performing loan portfolios at attractive valuations. We expect our integrated approach of acquiring sub-performing and non-performing residential mortgage loans and converting them to rental properties will enable us to compete more effectively for attractive investment opportunities. While we focus on acquiring our rental properties through the acquisition of distressed mortgage loans, we also may consider purchasing rental properties through other avenues, including, without limitation, though the purchase of REO, residential mortgage-backed securities, clean-up calls and other distressed assets.

During the nine months ended September 30, 2014, we completed the acquisition of an aggregate of 7,086 residential mortgage loans, substantially all of which were non-performing, and 190 REO properties having an aggregate unpaid principal balance (“UPB”) of approximately $1.9 billion and an aggregate market value of underlying properties of $1.7 billion. The aggregate purchase price for these acquisitions was $1.1 billion. During the quarter ended September 30, 2014, we agreed to acquire an aggregate of 246 residential mortgage loans, substantially all of which are non-performing, with an aggregate market value of underlying properties of $29.7 million. There can be no assurance that we will complete this transaction in whole or in part on a timely basis or at all.

On June 27, 2014, we acquired 879 re-performing mortgage loans with an aggregate market value of underlying properties of $271.1 million for an aggregate purchase price of $144.6 million. During October 2014, we sold 770 of these re-performing mortgage loans. See Note 12 - "Subsequent events" for information on our dispositions of re-performing loans subsequent to September 30, 2014.

In 2013, we acquired portfolios consisting of an aggregate of 8,491 residential mortgage loans and 40 REO properties, substantially all of which were non-performing, having an aggregate UPB of approximately $2.2 billion and an aggregate market value of underlying properties of $1.8 billion. The aggregate purchase price for these portfolios was $1.2 billion.

During 2013 and the nine months ended September 30, 2014, we modified an aggregate of 451 mortgage loans, converted an aggregate of 2,860 mortgage loans into REO properties and disposed of an aggregate of 627 mortgage loans through short sale, refinancing or other liquidation events.

Following the above-referenced transactions, as of September 30, 2014, our portfolio consisted of 12,090 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $3.2 billion and an aggregate market value of underlying properties of $2.9 billion. We also owned 2,984 REO properties with an aggregate carrying value of $460.1 million, of which 2,660 were held for use and 324 were held for sale. Of the 2,660 REO properties held for use, 216 properties had been rented and were occupied by tenants, 90 were being listed for rent and 270 were in varying stages of renovation. With respect to the remaining 2,084 REO properties held for use, we will make a final determination whether each property meets our rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified, (c) we have recorded the deed for the property, (d) utilities have been activated and (e) we have secured access for interior inspection. We also owned 872 re-performing mortgage loans held for sale having an aggregate UPB of approximately $204.3 million and an aggregate market value of underlying properties of approximately $267.7 million as of September 30, 2014.

To date, we have acquired our non-performing and re-performing mortgage loans through direct acquisitions from institutions such as banks, HUD and private equity funds.

We are externally managed by AAMC, an asset management company that provides portfolio management and corporate governance services to investment vehicles that own real estate related assets. We conduct substantially all of our operations, and make substantially all of our investments, through our operating partnership and its subsidiaries. One of our subsidiaries is the sole general partner of the operating partnership, and we are the sole limited partner.


18

(table of contents)

Observations on Current Market Opportunities

We believe there is currently a significant market opportunity to acquire single-family rental properties through the distressed loan channel and expect the supply of non-performing loans, sub-performing loans, properties in foreclosure and REO to remain steady over the next several years as banks and other mortgage lenders seek to dispose of their distressed inventories. We continue to see substantial volumes of distressed residential mortgage loan portfolios offered for sale by banks, HUD and private equity funds, among others. We believe that the distressed loan channel gives us a cost advantage over other acquisition channels such as foreclosure auctions and REO acquisitions, involves less competition and positions us to be selected as the buyer of diverse portfolios of such loans since we are not geographically constrained. Our preferred resolution methodology is to modify the sub-performing and non-performing loans. We believe modification followed by refinancing generates near-term cash flows, provides the highest possible economic outcome for us and is a socially responsible business strategy because it keeps more families in their homes.

Metrics Affecting Our Results

Revenues

Our revenues primarily consist of the following:

i.
Net realized gain on mortgage loans. We record net realized gains, including the reclassification of previously accumulated net unrealized gains, upon the liquidation of a loan which may consist of short sale, third party sale of the underlying property, refinancing or full debt pay-off of the loan. We expect the timeline to liquidate loans will vary significantly by loan, which could result in fluctuations in revenue recognition and operating performance from period to period. Additionally, the proceeds from loan liquidations may vary significantly depending on the resolution methodology. We generally expect to collect proceeds of loan liquidations in cash and, thereafter, have no continuing involvement with the asset.

ii.
Net unrealized gains from the conversion of loans to REO. Upon conversion of loans to REO, we mark the properties to the most recent market value (less estimated selling costs in the case of REO properties held for sale). The difference between the carrying value of the asset at the time of conversion and the most recent market value, based on BPOs, is recorded in our statement of operations as net unrealized gain on mortgage loans. We expect the timeline to convert acquired loans into REO will vary significantly by loan, which could result in fluctuations in our revenue recognition and our operating performance from period to period. The factors that may affect the timelines to foreclose upon a residential mortgage loan include, without limitation, state foreclosure timelines and deferrals associated therewith; unauthorized parties occupying the property; federal, state or local legislative action or initiatives designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures and continued declines in real estate values and/or sustained high levels of unemployment that increase the number of foreclosures and which place additional pressure and/or delays on the already overburdened judicial and administrative proceedings.

iii.
Net unrealized gains from the change in fair value of loans. After our sub-performing and non-performing mortgage loans are acquired, the fair value of each loan is adjusted in each subsequent reporting period as the loan proceeds to a particular resolution (i.e., modification, or conversion to real estate owned). As a loan approaches resolution, the resolution timeline for that loan decreases and costs embedded in the discounted cash flow model for loan servicing, foreclosure costs and property insurance are incurred and removed from future expenses. The shorter resolution timelines and reduced future expenses each increase the fair value of the loan. The increase in the value of the loan is recognized in net unrealized gain on mortgage loans in our consolidated statements of operations. The exact nature of resolution will be dependent on a number of factors that are beyond our control, including borrower willingness to pay, property value, availability of refinancing, interest rates, conditions in the financial markets, the regulatory environment and other factors.

As a greater number of our REO properties are renovated and deemed suitable for rental, we expect a greater portion of our revenues will be rental revenues. We believe the key variables that will affect our rental revenues over the long term will be average occupancy and rental rates. We anticipate that a majority of our leases of single-family rental properties to tenants will be for a term of two years or less. As these leases permit the residents to leave at the end of the lease term without penalty, we anticipate our rental revenues will be affected by declines in market rents more quickly than if our leases were for longer terms. Short-term leases may result in high turnover, which involves expenses such as renovation costs and leasing expenses, or reduced rental revenues.


19

(table of contents)

Although we seek to lease the majority of REO properties we acquire on foreclosure, we also sell the properties that do not meet our rental investment criteria. The real estate market and home prices will determine proceeds from any sale of real estate. In addition, while we seek to track real estate price trends and estimate the effects of those trends on the valuations of our portfolios of residential mortgage loans, future real estate values are subject to influences beyond our control.

Expenses

Our expenses primarily consist of loan servicing fees and advances, rental property operating expenses, depreciation and amortization, general and administrative expenses, expense reimbursement, incentive management fees and interest expense. From time to time, expenses also may include impairments of assets. Mortgage loan servicing costs are primarily for servicing fees, foreclosure fee and advances of residential property insurance and HOA dues. Rental property operating expenses are expenses associated with our ownership and operation of rental properties including expenses such as Altisource's inspection, property preservation and renovation fees, property management fees, utility expenses on vacant properties, turnover costs, property taxes, insurance and HOA dues. Depreciation and amortization is a non-cash expense associated with the ownership of real estate and generally remains relatively consistent each year in relation to our asset levels since we depreciate our properties on a straight-line basis over a fixed life. Interest expense consists of the costs to borrow money in connection with our debt financing of our portfolios. General and administrative expenses consist of the costs related to the general operation and overall administration of our business. Expense reimbursement consists primarily of employee salaries of AAMC in direct correlation to the services they provide on our behalf and other personnel costs and corporate overhead. The incentive management fees consist of compensation due to AAMC, based on the amount of cash available for distribution to our stockholders for each period.

Other factors affecting our consolidated results

We expect our results of operations to be affected by various factors, many of which are beyond our control, including the following:

Acquisitions

Our operating results will depend on our ability to source sub-performing and non-performing loans, as well as other residential mortgage loans and REO property assets. We believe that there is currently a large supply of sub-performing and non-performing mortgage loans available to us for acquisition. We believe the available supply provides for a steady acquisition pipeline of assets since we plan on targeting just a small percentage of the population.

Generally, we expect that our residential mortgage loan portfolio may grow at an uneven pace, as opportunities to acquire distressed residential mortgage loans may be irregularly timed and may at times involve large portfolios of loans, and the timing and extent of our success in acquiring such loans cannot be predicted. In addition, for any given portfolio of loans that we agree to acquire, we typically acquire fewer loans than originally expected, as certain loans may be resolved prior to the closing date or may fail to meet our diligence standards. The number of unacquired loans typically constitutes a relatively small portion of a particular portfolio. In some cases, the number of loans we do not acquire could be significant. In any case where we do not acquire the full portfolio, appropriate adjustments are made to the applicable purchase price.

Financing

Our ability to grow our business is dependent on the availability of adequate financing including additional equity financing, debt financing or both in order to meet our objectives. We intend to leverage our investments with debt, the level of which may vary based upon the particular characteristics of our portfolio and on market conditions. To the extent available at the relevant time, our financing sources may include bank credit facilities, warehouse lines of credit, structured financing arrangements and repurchase agreements, among others. We may also seek to raise additional capital through public or private offerings of debt or equity securities, depending upon market conditions. To qualify as a REIT under the Code, we will need to distribute at least 90% of our taxable income each year to our stockholders. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities.

Our taxable income is triggered primarily by material changes in the economic status of loans, such as a sale of the loan, modification of the loan from a non-performing status to a performing status or conversion of the loan to REO. We expect to convert our taxable gains on REO dispositions and loan modifications within a short period of time to cash gains, which can be used to fund the distribution requirements from the corresponding taxable gains. Distribution requirements from our taxable

20

(table of contents)

gains on the remaining loans that we expect to convert to rental properties can be funded through a higher advance rate on the increased value when a property becomes rented.

Resolution Activities
 
First quarter 2013
Second quarter 2013
Third quarter 2013
Nine months ended September 30, 2013
 
First quarter 2014
Second quarter 2014
Third quarter 2014
Nine months ended September 30, 2014
Mortgage Loans (1)
 
 
 
 
 
 
 
 
 
Beginning balance
—

673

1,332

—

 
8,054

11,509

12,070

8,054

Acquisitions
684

720

3,783

5,187

 
4,207

1,590

1,289

7,086

Dispositions
(10
)
(28
)
(54
)
(92
)
 
(116
)
(135
)
(165
)
(416
)
Mortgage loan conversions to REO
(1
)
(33
)
(43
)
(77
)
 
(637
)
(907
)
(1,113
)
(2,657
)
Reversions to mortgage loans (2)
—

—

2

2

 
1

13

9

23

Ending balance
673

1,332

5,020

5,020

 
11,509

12,070

12,090

12,090

 
 
 
 
 
 
 
 
 
 
Modifications
—

18

29

47

 
81

90

179

350

Loan reinstatements
4

10

6

20

 
19

30

64

113

 
 
 
 
 
 
 
 
 
 
Real Estate Owned
 
 
 
 
 
 
 
 
 
Beginning balance
—

7

40

—

 
262

896

1,958

262

Acquisitions
6

—

34

40

 
—

190

—

190

Dispositions
—

—

(1
)
(1
)
 
(2
)
(22
)
(78
)
(102
)
Mortgage loan conversions to REO
1

33

43

77

 
637

907

1,113

2,657

Reversions to mortgage loans
—

—

(2
)
(2
)
 
(1
)
(13
)
(9
)
(23
)
Ending balance
7

40

114

114

 
896

1,958

2,984

2,984

 
 
 
 
 
 
 
 
 
 
Leased
—

1

5

5

 
35

102

216

216

Renovations complete
—

—

6

6

 
17

40

90

90

Renovations in process
—

5

3

3

 
48

140

270

270

Evaluating strategy/held for sale
7

34

100

100

 
796

1,676

2,408

2,408

 
7

40

114

114

 
896

1,958

2,984

2,984

_____________
(1)
Excludes mortgage loans held for sale.
(2)
Subsequent to the foreclosure sale, we may be notified that the foreclosure sale was invalidated for certain reasons.

In addition, as of September 30, 2014, 197 of our mortgage loans were on trial modification plans, compared to 291 mortgage loans on trial modification plans as of June 30, 2014.

Portfolio size

The size of our investment portfolio will also be a key revenue driver. Generally, as the size of our investment portfolio grows, the amount of revenue we expect to generate will increase. A growing investment portfolio, however, will drive increased expenses including possibly higher servicing fees to Ocwen, property management fees to Altisource and fees payable to AAMC. We may also incur additional interest expense if we incur debt to finance the purchase of our assets.

Existing Portfolio

In 2013, we acquired portfolios consisting of an aggregate of 8,491 residential mortgage loans and 40 REO properties, substantially all of which were non-performing, having an aggregate UPB of approximately $2.2 billion and an aggregate market value of underlying properties of $1.8 billion. The aggregate purchase price for these portfolios was $1.2 billion.


21

(table of contents)

During the nine months ended September 30, 2014, we completed the acquisition of an aggregate of an additional 7,086 residential mortgage loans, substantially all of which were non-performing, and 190 REO properties having an aggregate UPB of approximately $1.9 billion and an aggregate market value of underlying properties of $1.7 billion. The aggregate purchase price for these acquisitions was $1.1 billion. During the quarter ended September 30, 2014, we agreed to acquire an aggregate of 246 residential mortgage loans, substantially all of which are non-performing, with an aggregate market value of underlying properties of $29.7 million.

During the nine months ended September 30, 2014 and the year ended December 31, 2013, we completed the acquisition of the following portfolios of non-performing residential mortgage loans.
 
Portfolios Acquired
Date acquired
Number of loans acquired
 
Fair value of underlying property (in millions)
UPB
Twelve months ended December 31, 2013
8,531

 
$
1,795.2

$
2,219.3

January 2, 2014
650

 
$
93.6

120.8

January 28, 2014
66

 
7.0

7.3

January 31, 2014
3,421

 
791.7

987.8

February 28, 2014
70

 
8.2

8.0

May 1, 2014
664

 
126.6

153.0

June 27, 2014
1,116

 
375.3

328.2

July 10, 2014
46

 
5.0

6.9

July 31, 2014
1,243

 
315.7

260.3

Totals
15,807

(1) 
$
3,518.3

$
4,091.6

_____________
(1)
Includes 40 REOs purchased in 2013 and 190 REOs purchased in May 2014. Excludes the portfolio of 879 re-performing loans acquired in June 2014.

Throughout this quarterly report, all unpaid principal balance and market value amounts for the portfolios we have acquired are provided as of the applicable “cut-off” date for each transaction unless otherwise indicated. We refer to the assets underlying our completed acquisitions of nonperforming loans through September 30, 2014 as our “Existing Portfolio.” As defined in this quarterly report, our “Existing Portfolio” does not include the 872 re-performing mortgage loans having an aggregate UPB of approximately $204.3 million and an aggregate market value of underlying properties of approximately $267.7 million as of September 30, 2014, which are considered “Mortgage loans held for sale.”

Our sub-performing and non-performing mortgage loans become REO properties when we have obtained legal title to the property upon completion of the foreclosure. Additionally, some of the portfolios we purchase may, from time to time, contain a small number of residential mortgage loans that have already been converted to REO.

As of September 30, 2014, we had 2,984 REO properties, consisting of 2,660 REO properties held for use and 324 held for sale. Of the 2,660 REO properties held for use, 216 properties had been rented and were occupied by tenants, 90 were being listed for rent and 270 were in varying stages of renovation. With respect to the remaining 2,084 REO properties held for use, we will make a final determination whether each property meets our rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified, (c) we have recorded the deed for the property, (d) utilities have been activated and (e) we have secured access for interior inspection. A majority of the REO properties are subject to state regulations which require us to await the expiration of a redemption period before a foreclosure can be finalized. We include these redemption periods in our portfolio pricing which generally reduces the price we pay for the mortgage loans. Once the redemption period expires, we immediately proceed to record the new deed, take possession of the property, activate utilities, and start the inspection process in order to make our final determination. If an REO property meets our rental investment criteria, we determine the extent of renovations that are needed to generate an optimal rent and maintain consistency of renovation specifications for future branding. If we determine that the REO property will not meet our rental investment criteria, we list the property for sale, in some instances after renovations are made to optimize the sale proceeds. As of September 30, 2013, we had 100 REO properties held for use. Of these properties, five had been rented, six were being listed for rent and three were in various stages of renovation. With respect to the remaining 86 REO properties at September 30, 2013, we were in the process of determining whether these properties would meet our rental profile. Additionally, 14 REO properties owned as of September 30, 2013 were held for sale.

22

(table of contents)

The following table sets forth a summary of our REO properties as of September 30, 2014 ($ in thousands):
State / District
Number of properties
Carrying value (1)
Weighted average age (2)
Alabama
21

3,737

20

Alaska
1

185

28

Arizona
55

8,799

22

Arkansas
27

2,785

28

California
324

96,700

34

Colorado
21

3,932

30

Connecticut
14

2,547

48

Delaware
9

1,711

24

District of Columbia
1

244

103

Florida
509

77,710

23

Georgia
133

15,815

21

Hawaii
2

339

20

Idaho
5

508

31

Illinois
286

41,967

43

Indiana
134

14,287

34

Iowa
5

319

61

Kansas
26

2,277

44

Kentucky
42

5,043

32

Louisiana
19

1,991

28

Maine
8

1,207

120

Maryland
47

8,523

32

Massachusetts
27

5,458

84

Michigan
81

10,033

44

Minnesota
52

8,275

38

Mississippi
5

465

31

Missouri
63

5,895

43

Montana
2

255

35

Nebraska
4

937

33

Nevada
18

2,910

19

New Hampshire
7

1,085

34

New Jersey
38

6,629

64

New Mexico
28

3,232

24

New York
28

4,604

67

North Carolina
242

29,552

18

Ohio
112

11,879

45

Oklahoma
20

2,199

27

Oregon
5

868

37

Pennsylvania
125

16,431

51

Rhode Island
35

4,533

68

South Carolina
58

6,482

21

South Dakota
2

295

52

Tennessee
67

8,451

24

Texas
58

7,127

24

Utah
37

5,876

32

Vermont
3

561

140

Virginia
25

6,023

32

Washington
15

3,106

36

West Virginia
3

660

26

Wisconsin
134

15,331

49

Wyoming
1

$
275

21

Total
2,984

$
460,053

34


23

(table of contents)

_____________
(1)
The carrying value of an asset is based on historical cost which generally consists of the market value at the time of foreclosure sale plus renovation costs, net of any accumulated depreciation.
(2)
Weighted average age is based on the age weighted by carrying value for each state.

The remainder of our Existing Portfolio consists of a diversified pool of sub-performing and non-performing residential mortgage loans with the underlying properties located across the United States. The aggregate purchase price of our Existing Portfolio for acquisitions completed through September 30, 2014 was 67% of the aggregate market value, as determined by the most recent BPO provided by the applicable seller for each property in the respective portfolio as of its cut-off date. We cannot assure you that the BPOs accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.

As of September 30, 2014 the aggregate carrying value of our Existing Portfolio was $2.1 billion. The carrying value of an asset is based on our fair value model. The significant unobservable inputs used in the fair value measurement of our mortgage loans are discount rates, forecasts of future home prices, alternate resolution probabilities and timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. For a more complete description of the fair value measurements and the factors that may significantly affect the carrying value of our assets, please see Note 4 to our consolidated financial statements.

The table below provides a summary of the sub-performing and non-performing residential mortgage loans in our Existing Portfolio based on the respective UPB and respective market values of underlying properties as of September 30, 2014 ($ in thousands):
Location
Loan count
UPB
Market value of underlying properties (1)
Weighted average market LTV (2)
Alabama
62

$
8,899

$
7,776

176.3
%
Alaska
3

672

1,108

62.3
%
Arizona
209

54,554

47,899

125.8
%
Arkansas
74

6,448

6,900

116.3
%
California
1605

734,017

743,737

111.9
%
Colorado
68

19,395

19,098

109.0
%
Connecticut
150

45,389

41,551

141.9
%
Delaware
58

11,297

9,769

129.9
%
Dist. of Columbia
67

17,687

20,089

110.6
%
Florida
2306

553,973

441,677

147.6
%
Georgia
306

55,424

46,915

142.7
%
Hawaii
55

29,067

29,402

107.4
%
Idaho
37

8,434

7,861

128.1
%
Illinois
457

111,801

85,165

199.4
%
Indiana
280

34,620

33,120

122.5
%
Iowa
27

2,348

2,479

105.5
%
Kansas
27

2,807

3,172

115.6
%
Kentucky
62

7,301

6,572

122.3
%
Louisiana
31

5,093

5,342

110.7
%
Maine
38

6,808

6,419

119.9
%
Maryland
664

178,918

145,040

146.7
%
Massachusetts
292

79,317

78,266

118.5
%
Michigan
109

15,693

14,233

182.2
%
Minnesota
64

14,119

12,529

129.7
%
Mississippi
31

3,673

3,378

128.1
%
Missouri
98

10,182

8,582

166.7
%
Montana
6

1,337

1,436

101.2
%

24

(table of contents)

Nebraska
8

812

717

117.4
%
Nevada
239

74,476

57,634

148.0
%
New Hampshire
20

4,623

4,705

108.6
%
New Jersey
1079

323,214

254,047

158.7
%
New Mexico
127

18,406

18,494

109.5
%
New York
749

255,877

257,824

130.4
%
North Carolina
269

38,092

34,614

125.1
%
North Dakota
1

123

140

87.9
%
Ohio
135

20,032

17,396

146.5
%
Oklahoma
34

4,160

4,376

135.6
%
Oregon
107

30,803

28,386

116.8
%
Pennsylvania
337

59,848

50,357

139.7
%
Puerto Rico
2

219

293

76.3
%
Rhode Island
71

16,656

8,879

212.4
%
South Carolina
247

45,917

38,860

131.1
%
South Dakota
4

534

448

132.1
%
Tennessee
96

14,062

13,994

120.6
%
Texas
531

63,032

80,242

91.0
%
Utah
97

21,418

21,739

105.2
%
Vermont
11

1,826

1,780

122.9
%
Virginia
161

52,261

50,685

115.8
%
Washington
493

136,302

130,094

117.9
%
West Virginia
8

949

830

131.9
%
Wisconsin
78

11,454

8,290

173.3
%
Total mortgage loans
12,090

$
3,214,369

$
2,914,339

134.3
%
_____________

(1)
Market value is based on the most recent BPO provided to us by the applicable seller for each property in the respective portfolio as of its cut-off date or an updated BPO received since the acquisition was completed. Although we performed diligence on a representative sample of the properties to confirm the accuracy of the BPOs provided to us by the sellers, we cannot assure you that the BPOs set forth in this table accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.
(2)
Weighted average loan to value (LTV) is based on the loan to value weighted by unpaid principal balance for each state.

Results of operations

Three and nine months ended September 30, 2014 versus three and nine months ended September 30, 2013

Rental revenues

Rental revenues increased to $0.5 million and $0.7 million for the three and nine months ended September 30, 2014, respectively. The number of leased properties increased to 216 leased properties at September 30, 2014 from five at September 30, 2013. We had nominal rental revenues for the three and nine months ended September 30, 2013. We expect to generate increasing rental revenues for the remainder of 2014 upon renovating, listing and renting additional residential rental properties. Our rental revenues will be dependent primarily on occupancy levels and rental rates for our residential rental properties. Because our lease terms generally are expected to be two or fewer years, our occupancy levels and rental rates will be highly dependent on localized residential rental markets and our renters’ desire to remain in our properties.

Net unrealized gain on mortgage loans

Our net unrealized gains on mortgage loans increased to $88.7 million for the three months ended September 30, 2014 from $17.7 million for the three months ended September 30, 2013. Additionally, our net unrealized gains on mortgage loans increased to $258.9 million for the nine months ended September 30, 2014 from $26.0 million for the nine months ended September 30, 2013. These increases were primarily related to an increase in the number of loans for which unrealized gains

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were estimated. The net unrealized gains for the three and nine months ended September 30, 2014 and 2013 can be broken down into the following two components:


•
First, we recognized unrealized gains driven by a material change in loan status of $38.4 million and $90.5 million for the three and nine months ended September 30, 2014, respectively, compared to $1.8 million and $3.0 million for the three and nine months ended September 30, 2013, respectively. During the three and nine months ended September 30, 2014, we converted 1,113 and 2,657 mortgage loans to REO status, respectively. During the three and nine months ended September 30, 2013, we converted 43 and 77 mortgage loans to REO status, respectively. Upon conversion of these mortgage loans to REO, we marked these properties to the most recent market value, less estimated selling costs in the case of REO properties held for sale; and

•
Second, we recognized $50.3 million and $168.4 million in unrealized gains for the three and nine months ended September 30, 2014, respectively, from the net increase in the fair value of loans during the period. During the three and nine months ended September 30, 2013, we recognized $15.9 million and $23.0 million, respectively, in unrealized gains from the net increase in the fair value of loans during the period. Adjustments to the fair value of loans after acquisition represent, among other factors, a reduction in the time remaining to complete the foreclosure process due to the passage of time since acquisition and a reduction in future foreclosure expenses to the extent we have already incurred them. The reduction in time remaining to complete the foreclosure is driven by the completion of activities in the foreclosure process after we acquired the loans. This reduction in timeline results in reduced carrying costs and reduced future expenses for the loans, each of which increases the fair value of the loans. The increase in the value of the loans is recognized in net unrealized gain on mortgage loans in our consolidated statements of operations.

Through our acquisitions, the number of sub-performing and non-performing loans in our Existing Portfolio has grown from 8,054 loans at December 31, 2013 to 12,090 loans at September 30, 2014. The fair value of mortgage loans is based on a number of factors which are difficult to predict and may be subject to adverse changes in value depending on the financial condition of borrowers, as well as geographic, economic, market and other conditions. Therefore, we may experience unrealized losses on our mortgage loans in the future.

Net realized gain on mortgage loans

Net realized gains on mortgage loans increased to $13.7 million for the three months ended September 30, 2014 from $1.9 million for the three months ended September 30, 2013. We disposed of 165 mortgage loans in the three months ended September 30, 2014 and 54 mortgage loans in the three months ended September 30, 2013, primarily from short sales and foreclosure sales.

Net realized gains on mortgage loans increased to $33.9 million for the nine months ended September 30, 2014 from $4.0 million for the nine months ended September 30, 2013. We disposed of 416 mortgage loans in the nine months ended September 30, 2014 and 92 mortgage loans in the nine months ended September 30, 2013, primarily from short sales and foreclosure sales.

Net realized gain on real estate

Net realized gains on real estate were $3.3 million and $4.5 million for the three and nine months ended September 30, 2014, during which we disposed of of 78 and 102 residential properties, respectively. We did not dispose of any residential properties during the nine months ended September 30, 2013.

Interest Income

Interest income increased to $2.6 million and $2.8 million or the three and nine months ended September 30, 2014, respectively, as we accreted $2.5 million into interest income with respect to our re-performing loans. Interest income was $0.2 million and $0.4 million for the three and nine months ended September 30, 2013.

Residential property operating expenses

We incurred $9.2 million and $13.6 million of residential property operating expenses for the three and nine months ended September 30, 2014, respectively, compared to $0.2 million and $0.3 million for the three and nine months ended

26

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September 30, 2013, respectively. We expect to incur increasing residential property operating expenses in the remainder of 2014 upon converting our mortgage loans to, and owning, residential properties. Our residential property operating expenses will be dependent primarily on residential property taxes and insurance, property management fees and repair and maintenance expenditures.

Real estate depreciation and amortization

We incurred $0.3 million and $0.5 million of real estate depreciation and amortization for the three and nine months ended September 30, 2014, respectively, compared to a nominal amount of real estate depreciation and amortization for both the three and nine months ended September 30, 2013. We expect to incur increasing real estate depreciation and amortization in 2014 upon converting our mortgage loans to, and owning, residential rental properties. Real estate depreciation and amortization are non-cash expenditures which generally are not expected to be indicative of the market value or condition of our residential rental properties.

Real estate selling costs and impairment

Real estate selling costs and impairment, including estimated selling costs of REO held for sale and impairment, were $5.5 million and $8.8 million for the three and nine months ended September 30, 2014, respectively, compared to $0.2 million for both the three and nine months ended September 30, 2013. We record residential properties held for sale at the lower of the carrying amount or estimated fair value. Fair value of assets held for sale is equal to the estimated or contracted sales price with a potential buyer less costs to sell. The amount by which the carrying amount exceeds the estimated fair value is an impairment loss.

Mortgage loan servicing costs

We incurred $21.2 million of mortgage loan servicing costs, primarily for servicing fees, foreclosure fees and advances of residential property insurance and HOA dues, for the three months ended September 30, 2014 compared to