RESI 10Q_6.30.2015
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2015

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
36C Strand Street
Christiansted, United States Virgin Islands 00820
(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
x
 
Accelerated Filer
o
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 July 31, 2015, 57,216,166 shares of our common stock were outstanding.



Altisource Residential Corporation
June 30, 2015
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 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;
•
our ability to acquire assets for our portfolio;
•
the impact of changes to the supply of, value of and the returns on sub-performing and non-performing loans and single-family rental properties;
•
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 maintain adequate liquidity;
•
our ability to retain our engagement of AAMC;
•
the failure of Altisource to effectively perform its obligations under various agreements with us;
•
the failure of our mortgage loan servicers to effectively perform their servicing obligations;
•
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, 2014.



ii

(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

Certain information contained herein is presented as of July 31, 2015, 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)

 
June 30, 2015
 
December 31, 2014
Assets:
 
 
 
Real estate held for use:
 
 
 
Land
$
23,743

 
$
14,424

Rental residential properties (net of accumulated depreciation of $3,351 and $1,062, respectively)
97,533

 
60,908

Real estate owned
548,137

 
457,045

Total real estate held for use, net
669,413

 
532,377

Real estate assets held for sale
134,027

 
92,230

Mortgage loans at fair value
1,716,489

 
1,959,044

Mortgage loans held for sale
5,977

 
12,535

Cash and cash equivalents
70,502

 
66,166

Restricted cash
18,459

 
13,282

Accounts receivable
45,981

 
10,313

Related party receivables
—

 
17,491

Investment in affiliate
18,000

 
18,000

Deferred leasing and financing costs, net
8,605

 
4,251

Prepaid expenses and other assets
6,184

 
373

Total assets
$
2,693,637

 
$
2,726,062

Liabilities:
 
 
 
Repurchase and loan and security agreements
$
810,236

 
$
1,015,000

Other secured borrowings (including $14,991 repurchase agreement with NewSource at June 30, 2015 and December 31, 2014)
538,916

 
339,082

Accounts payable and accrued liabilities
54,247

 
11,678

Related party payables
5,163

 
33,391

Total liabilities
1,408,562

 
1,399,151

Commitments and contingencies (Note 6)

 

Equity:
 
 
 
Common stock, $.01 par value, 200,000,000 authorized shares; 57,216,166 and 57,192,212 shares issued and outstanding, at June 30, 2015 and December 31, 2014, respectively
572

 
572

Additional paid-in capital
1,227,246

 
1,227,091

Retained earnings
57,257

 
99,248

Total equity
1,285,075

 
1,326,911

Total liabilities and equity
$
2,693,637

 
$
2,726,062


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 June 30, 2015
 
Three months ended June 30, 2014
 
Six months ended June 30, 2015
 
Six months ended June 30, 2014
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
Rental revenues
$
2,140

 
$
181

 
$
3,540

 
$
250

Net unrealized gain on mortgage loans
42,209

 
105,042

 
103,343

 
170,172

Net realized gain on mortgage loans
19,272

 
10,819

 
34,654

 
20,140

Net realized gain on re-performing mortgage loans
254

 
—

 
405

 
—

Net realized gain on real estate
12,404

 
1,234

 
23,012

 
1,234

Interest income
240

 
81

 
480

 
189

Total revenues
76,519

 
117,357

 
165,434

 
191,985

Expenses:
 
 
 
 
 
 
 
Residential property operating expenses
16,857

 
3,253

 
29,316

 
4,303

Real estate depreciation and amortization
1,344

 
103

 
2,342

 
151

Real estate selling costs and impairment
8,839

 
2,879

 
23,530

 
3,233

Mortgage loan servicing costs
16,246

 
16,925

 
34,512

 
28,362

Interest expense
13,398

 
6,945

 
25,041

 
12,653

General and administrative
1,569

 
2,808

 
6,350

 
3,846

Related party general and administrative
5,151

 
17,467

 
20,801

 
30,099

Total expenses
63,404

 
50,380

 
141,892

 
82,647

Other income
—

 
383

 
2,000

 
383

Income before income taxes
13,115

 
67,360

 
25,542

 
109,721

Income tax expense (benefit)
23

 
(422
)
 
26

 
26

Net income
$
13,092

 
$
67,782

 
$
25,516

 
$
109,695

 
 
 
 
 
 
 
 
Earnings per share of common stock – basic:
 
 
 
 
 
 
 
Earnings per basic share
$
0.23

 
$
1.19

 
$
0.45

 
$
1.98

Weighted average common stock outstanding – basic
57,208,273

 
57,138,695

 
57,204,602

 
55,297,630

Earnings per share of common stock – diluted:
 
 
 
 
 
 
 
Earnings per diluted share
$
0.23

 
$
1.18

 
$
0.44

 
$
1.97

Weighted average common stock outstanding – diluted
57,407,845

 
57,401,953

 
57,407,253

 
55,754,685

 
 
 
 
 
 
 
 
Dividends declared per common share
$
0.55

 
$
0.45

 
$
1.18

 
$
0.93


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, 2014
57,192,212

$
572

$
1,227,091

$
99,248

$
1,326,911

Issuance of common stock, including stock option exercises
23,954

—

62

—

62

Dividends on common stock ($1.18 per share)
—

—

—

(67,507
)
(67,507
)
Share-based compensation
—

—

93

—

93

Net income
—

—

—

25,516

25,516

June 30, 2015
57,216,166

$
572

$
1,227,246

$
57,257

$
1,285,075


 
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
14,875,402

149

483,457

—

483,606

Cost of issuance of common stock
—

—

(15,215
)
—

(15,215
)
Dividends on common stock ($0.93 per share)
—

—

—

(53,118
)
(53,118
)
Share-based compensation
—

—

113

—

113

Net income
—

—

—

109,695

109,695

June 30, 2014
57,162,071

$
572

$
1,226,939

$
82,997

$
1,310,508


See accompanying notes to consolidated financial statements.
 




4

(table of contents)

Altisource Residential Corporation
Consolidated Statements of Cash Flows
(In thousands)(Unaudited)
 
Six months ended June 30, 2015
 
Six months ended June 30, 2014
Operating activities:
 
 
 
Net income
$
25,516

 
$
109,695

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(103,343
)
 
(170,172
)
Net realized gain on mortgage loans
(34,654
)
 
(20,140
)
Net realized gain on sale of re-performing mortgage loans
(405
)
 
—

Net realized gain on sale of real estate
(23,012
)
 
(1,293
)
Real estate depreciation and amortization
2,342

 
151

Real estate selling costs and impairment
23,530

 
3,233

Accretion of interest on re-performing mortgage loans
(469
)
 
—

Share-based compensation
93

 
113

Amortization of deferred financing costs
2,218

 
1,171

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
4,214

 
797

Related party receivables
—

 
4,952

Prepaid expenses and other assets
(180
)
 
(180
)
Accounts payable and accrued liabilities
7,004

 
1,061

Related party payables
(22,407
)
 
26,068

Net cash used in operating activities
(119,553
)
 
(44,544
)
Investing activities:
 
 
 
Investment in mortgage loans
—

 
(1,056,493
)
Investment in real estate
—

 
(27,569
)
Investment in renovations
(11,001
)
 
(1,700
)
Real estate tax advances
(14,443
)
 
(14,368
)
Mortgage loan dispositions
107,887

 
70,379

Mortgage loan payments
12,447

 
7,951

Disposition of real estate
70,916

 
3,466

Acquisition related deposits
(5,631
)
 
—

Change in restricted cash
(5,177
)
 
(4,391
)
Net cash provided by (used in) investing activities
154,998

 
(1,022,725
)
Financing activities:
 
 
 
Issuance of common stock, including stock option exercises
134

 
487,142

Payment of tax withholdings on exercise of stock options
(72
)
 
(3,536
)
Cost of issuance of common stock
—

 
(15,215
)
Dividends on common stock
(36,038
)
 
(53,118
)
Proceeds from issuance of other secured debt
221,691

 
—

Repayments of secured notes
(21,306
)
 
—

Proceeds from repurchase agreement
109,683

 
749,240

Repayments of repurchase agreement
(298,078
)
 
(80,139
)
Payment of deferred financing costs
(7,123
)
 
(2,335
)
Net cash (used in) provided by financing activities
(31,109
)
 
1,082,039

Net increase in cash and cash equivalents
4,336

 
14,770

Cash and cash equivalents as of beginning of the period
66,166

 
115,988

Cash and cash equivalents as of end of the period
$
70,502

 
$
130,758

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
21,732

 
$
10,496

Transfer of mortgage loans to real estate owned
271,547

 
220,971

Transfer of real estate owned to mortgage loans
2,865

 
3,594

Change in accrued capital expenditures
(1,732
)
 
1,746

Changes in receivables from mortgage loan dispositions, payments and real estate tax advances to borrowers, net
36,359

 
4,796

Changes in receivables from real estate owned dispositions
1,369

 
—

Dividends declared but not paid
31,469

 
—

See accompanying notes to consolidated financial statements.

5

(table of contents)

Altisource Residential Corporation
Notes to Consolidated Financial Statements
June 30, 2015
(Unaudited)

1. Organization and basis of presentation

Altisource Residential Corporation is a Maryland REIT focused on acquiring and managing single-family rental properties throughout the United States. We conduct substantially all of our activities through our wholly owned subsidiary Altisource Residential, L.P. and its subsidiaries. To date, we have acquired 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. Given evolving market conditions, commencing in the second quarter of 2015, we expanded our acquisition strategy to opportunistically acquire portfolios of single-family rental properties as an avenue to more quickly achieve scale in our rental portfolio where we believe the economics make sense. We also commenced a program to begin purchasing REO properties on a one-by-one basis sourcing listed properties from the Multiple Listing Service ("MLS") and alternative listing sources. We expect the first purchases of this program to occur in the third quarter of 2015.

On December 21, 2012 we became a stand-alone publicly traded company with an initial capital contribution of $100 million. We have a long-term service agreement with Altisource Portfolio Solutions, SA (“Altisource”), a leading provider of real estate and mortgage portfolio management, asset recovery and customer relationship management services. We also have servicing agreements with three separate mortgage loan servicers.

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. On March 31, 2015, we entered into a new asset management agreement with AAMC (the “New AMA”) with an effective date of April 1, 2015. Prior to the AMA, we were party to a different asset management agreement with AAMC (the “Original AMA”) pursuant to which we paid incentive fees, which we refer to as “incentive management fees,” that gave AAMC a share of cash flow available for distribution to our stockholders as well as reimbursement for certain overhead and operating expenses. The New AMA provides for a new fee structure in which we pay AAMC a base management fee, an incentive management fee and a conversion fee for loans and REOs that become rental properties during each quarter versus the incentive management fee and expense reimbursement structure under the Original AMA. For additional details on the New AMA, please see “Note 7. Related Party Transactions.”

Since we commenced operations, we have completed three public equity offerings with aggregate net proceeds of approximately $1.1 billion. We also entered into three separate repurchase agreements to finance our acquisition and ownership of residential mortgage loans and REO properties. The maximum aggregate funding available under these repurchase agreements at December 31, 2014 was $1.2 billion. On April 10, 2015, we also entered into a loan and security agreement (the “Nomura loan agreement”) with Nomura Corporate Funding Americas, LLC (“Nomura”). The purpose of the Nomura loan agreement is to finance our beneficial ownership of REO properties. The maximum aggregate funding available to us under the repurchase agreements and the Nomura loan agreement as of June 30, 2015 was $1.0 billion, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. As of June 30, 2015, an aggregate of $810.2 million was outstanding under our repurchase agreements and the Nomura loan agreement. All obligations of our subsidiaries under the repurchase agreements and the Nomura loan agreement are fully guaranteed by us.

Each of our repurchase agreements and the Nomura loan agreement is described below:

•
Credit Suisse (“CS”) is the lender on the repurchase agreement entered into on March 22, 2013, (the “CS repurchase agreement”) with an initial aggregate maximum borrowing capacity of $100.0 million. During 2014 the CS repurchase agreement was amended on several occasions, ultimately increasing the aggregate maximum borrowing capacity to $225.0 million on December 31, 2014 with a maturity date of April 20, 2015, subject to an additional one-year extension with the approval of the lender. On April 20, 2015, we entered into an amended and restated repurchase agreement with CS that increased our aggregate borrowing capacity from $225.0 million to $275.0 million, increased the REO sublimit under the facility and extended the maturity date to April 18, 2016.


6
(table of contents)

•
Deutsche Bank (“DB”) is the lender on the repurchase agreement entered into on September 12, 2013 (the “DB repurchase agreement”). The DB repurchase agreement matures on March 11, 2016 and includes a provision that after March 2015, we are not eligible for additional funding under the facility, thereby reducing our aggregate funding capacity under the DB repurchase agreement to $91.8 million, which was the amount outstanding under the facility on June 30, 2015.

•
Wells Fargo (“Wells”) is the lender on the repurchase agreement entered into on September 23, 2013 (the “Wells repurchase agreement”) with an initial aggregate maximum borrowing capacity of $200.0 million. Throughout 2013 and 2014 the Wells repurchase agreement was amended several times increasing the aggregate maximum borrowing capacity to a high of $1.0 billion, and on December 31, 2014 was reduced to $750.0 million, subject to certain sublimits, to reflect the securitization of a significant portion of our non-performing loans that previously had been financed under the Wells repurchase agreement. The maturity date of the Wells repurchase agreement was March 23, 2015. However, on February 20, 2015, we exercised our option to extend the termination date of this facility to March 23, 2016 without any additional funding, thereby reducing our aggregate funding capacity under the Wells repurchase agreement to $471.3 million on June 30, 2015, which was the amount outstanding under the facility at that date. We are in discussions with Wells to further extend the repurchase agreement with an ability to obtain additional funding. No assurance can be provided that we will be able to renew this facility on reasonable terms, on a timely basis or at all.
The agreement calls for the advance rate to be reduced by 10% after the first 90 days of the extension term. The 10% reduction date has been extended for an additional 90 days while the parties are negotiating an amended and restated repurchase agreement.

•
Nomura is the lender on the Nomura loan agreement entered into on April 10, 2015 with an initial aggregate maximum funding capacity of $100.0 million. On May 12, 2015, we amended the terms of the Nomura loan agreement to increase the aggregate maximum funding capacity to $200.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. The Nomura loan agreement terminates on April 8, 2016.

Since September 2014, we have also completed three securitization transactions, each of which is summarized below:

•
On June 29, 2015, we completed a securitization transaction in which ARLP Securitization Trust, Series 2015-1 ("ARLP 2015-1") issued $205.0 million in Class A Notes (the “ARLP 2015-1 Class A Notes”) with a weighted coupon of approximately 4.01% and $60.0 million in Class M Notes (the “ARLP 2015-1 Class M Notes”). We retained $34.0 million of the ARLP 2015-1 Class A Notes and all of the ARLP 2015-1 Class M Notes. No interest will be paid on any ARLP 2015-1 Class M Notes while any ARLP 2015-1 Class A Notes remain outstanding. The ARLP 2015-1 Class A Notes and ARLP 2015-1 Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2015-1 and not by any of our other assets. The assets of ARLP 2015-1 are the only source of repayment and interest on the ARLP 2015-1 Class A Notes and the ARLP 2015-1 Class M Notes. The ARLP 2015-1 Class A Notes and the ARLP 2015-1 Class M Notes mature on May 25, 2055, and we do not guaranty any of the obligations of ARLP 2015-1 under the terms of the Indenture governing the notes or otherwise. As of June 30, 2015, the book value of the underlying securitized assets held by ARLP 2015-1 was $275.7 million.

•
On November 25, 2014, we completed a securitization transaction in which ARLP Securitization Trust, Series 2014-2 ("ARLP 2014-2") issued $270.8 million in Class A Notes (the “ARLP 2014-2 Class A Notes”) with a weighted coupon of approximately 3.85% and $234.0 million in Class M Notes (the “ARLP 2014-2 Class M Notes”). We initially retained $95.8 million of the ARLP 2014-2 Class A Notes and all of the ARLP 2014-2 Class M Notes. On February 9, 2015, we sold $50.7 million of the retained ARLP 2014-2 Class A Notes to an unrelated third party. No interest will be paid on any ARLP 2014-2 Class M Notes while any ARLP 2014-2 Class A Notes remain outstanding. The ARLP 2014-2 Class A Notes and ARLP 2014-2 Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-2 and not by any of our other assets. The assets of ARLP 2014-2 are the only source of repayment and interest on the ARLP 2014-2 Class A Notes and the ARLP 2014-2 Class M Notes. The ARLP 2014-2 Class A Notes and the ARLP 2014-2 Class M Notes mature on January 26, 2054, and we do not guaranty any of the obligations of ARLP 2014-2 under the terms of the Indenture governing the notes or otherwise. As of June 30, 2015, the book value of the underlying securitized assets held by ARLP 2014-2 was $329.0 million.

•
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 “ARLP 2014-1 Class A Notes”) with a weighted coupon of approximately 3.47% and $32.0 million in Class M Notes (the “ARLP 2014-1 Class M Notes”) with a weighted coupon of 4.25%. The ARLP 2014-1 Class A Notes and the ARLP 2014-1 Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-1 and not by any of our other assets. The assets of

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(table of contents)

ARLP 2014-1 are the only source of repayment and interest on the ARLP 2014-1 Class A Notes and the ARLP 2014-1 Class M Notes. The ARLP 2014-1 Class A Notes and the ARLP 2014-1 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 June 30, 2015, the book value of the underlying securitized assets held by ARLP 2014-1 was $208.5 million.

We retained all of the ARLP 2014-1 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 ARLP 2014-1 Class M Notes to NewSource. The master repurchase agreement initially required the TRS to repurchase the ARLP 2014-1 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 additional 89-day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on September 22, 2015.

For a more complete description of our repurchase agreements, loan and security agreement and securitization transactions, please see “Note 5. Borrowings.”

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 2014 annual report on Form 10-K.

Recently issued accounting standards

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("ASU") 2015-03, Interest - Imputation of Interest (Subtopic 835-30) - Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 requires that debt issuance costs are presented on the balance sheet as a deduction from the carrying amount of the related debt liability instead of being presented as an asset. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The standard requires retrospective application and represents a change in accounting principle. The standard is effective for fiscal years beginning after December 15, 2015. Early adoption is permitted. We do not expect the impact of adopting this standard to have a material impact on our financial position, results of operations, or cash flows.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. ASU 2015-02 makes targeted amendments to the current consolidation guidance that change the analysis a reporting entity must perform to determine whether it should consolidate certain types of legal entities. This guidance addresses concerns that current accounting might require a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations. The standard is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. Early application is permitted. We are evaluating the impact of ASU 2015-02 on our consolidated financial statements.

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, 2017. Early adoption is permitted for fiscal years, and interim periods

8

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within those years, beginning after December 15, 2016. We do not expect this amendment to have a significant effect on our financial position or results of operations.

2. Mortgage loans

Acquisitions of non-performing residential mortgage loans

During the six months ended June 30, 2015, we did not acquire any portfolios of non-performing residential mortgage loans. During the six months ended June 30, 2014, we acquired an aggregate of 5,797 residential mortgage loans, substantially all of which were non-performing, and 190 REO properties having an aggregate UPB of approximately $1.6 billion and an aggregate market value of underlying properties of approximately $1.4 billion. The aggregate purchase price for these acquisitions was approximately $940.5 million.

During the three and six months ended June 30, 2015, we recognized $0.3 million and $0.4 million, respectively, for due diligence costs related to a potential purchase of a portfolio we did not ultimately acquire. During the three and six months ended June 30, 2014, we recognized $2.4 million and $2.9 million, respectively, for due diligence costs related to transactions in both general and administrative expense and related party general and administrative expense.

Generally, we expect that our residential mortgage loan and REO portfolios may grow at an uneven pace, as opportunities to acquire distressed residential mortgage loans and REO portfolios may be irregularly timed and may involve large portfolios of loans or REO, and the timing and extent of our success in acquiring such assets 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 loans excluded from an acquisition 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 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 June 30, 2015 and 2014, we transferred 687 and 894 mortgage loans, respectively, to REO at an aggregate fair value based on broker price opinions ("BPOs") of $133.9 million and $120.8 million, respectively. Such transfers occur when the foreclosure sale is complete. In connection with these transfers to REO, we recorded $14.7 million and $28.5 million, respectively, in net unrealized gains on mortgage loans.

During the six months ended June 30, 2015 and 2014, we transferred 1,411 and 1,530 mortgage loans, respectively, to REO at an aggregate fair value based on BPOs of $268.7 million and $217.4 million, respectively. Such transfers occur when the foreclosure sale is complete. In connection with these transfers to REO, we recorded $33.1 million and $52.1 million, respectively, in net unrealized gains on mortgage loans. At June 30, 2015, we had 6,316 loans with a carrying value of $1.3 billion that were in the foreclosure process compared to 7,841 loans with a carrying value of $1.5 billion at December 31, 2014.

Dispositions of non-performing residential mortgage loans

During the three months ended June 30, 2015 and 2014, we disposed of 270 and 135 mortgage loans, respectively, primarily through short sales, refinancing, foreclosure sales, and sale of loans that had transitioned to re-performing loans from prior non-performing loan acquisitions. In connection with these dispositions, we recorded $19.3 million and $10.8 million, respectively, of net realized gains on mortgage loans.

During the six months ended June 30, 2015 and 2014, we disposed of 420 and 251 mortgage loans, respectively, primarily through short sales, refinancing, foreclosure sales, and sale of loans that had transitioned to re-performing loans from prior non-performing loan acquisitions. In connection with these dispositions, we recorded $34.7 million and $20.1 million, respectively, of net realized gains on mortgage loans.


9


Acquisition and dispositions 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.

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. The sale included 770 loans from the re-performing mortgage loans purchased in June 2014, and 164 loans that had transitioned to re-performing status from prior non-performing loan acquisitions. During June 2015, we sold an aggregate of 189 re-performing loans to an unrelated third party for an aggregate purchase price of $34.6 million. The sale included 52 loans from the re-performing mortgage loans purchased in June 2014, and 137 loans that had transitioned to re-performing status from prior non-performing loan acquisitions. Approximately $2.0 million of the proceeds from the June 2015 re-performing loan sale were used to purchase the loans out of our ARLP 2014-1 and ARLP 2014-2 securitizations and approximately $16.4 million of the proceeds were used to purchase the loans out of our Wells repurchase facility. Therefore, our net proceeds from the June 2015 re-performing loan sale were approximately $16.2 million.

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 six months ended June 30, 2015, we recognized no provision for loan loss and no adjustments to the amount of the accretable yield. For the three and six months ended June 30, 2015, we accreted $0.2 million and $0.5 million, respectively, into interest income with respect to our re-performing loans. As of June 30, 2015, these re-performing loans, having a UPB of $8.8 million and a carrying value of $6.0 million, were held for sale.

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):
 
Six months ended June 30, 2015
 
Accretable Yield
Carrying Amount of Loans
Balance at the beginning of the period
$
7,640

$
12,535

Additions
—

37

Payments and other reductions, net
(3,285
)
(7,064
)
Accretion
(469
)
469

Balance at the end of the period
$
3,886

$
5,977


3. Real estate assets, net

Acquisitions


During the six months ended June 30, 2015, we acquired no REO properties. During three and six months ended June 30, 2014, we acquired 190 REO properties as part of our portfolio acquisitions for an aggregate purchase price of $27.6 million.

On June 28, 2015, we entered into an agreement (the “IH Purchase Agreement”) to purchase an aggregate of 1,325 REO properties, the substantial majority of which were rented and occupied, from certain subsidiaries of Invitation Homes (“Invitation Homes”) for an aggregate purchase price of approximately $112.6 million (the “IH Transaction”). The IH Purchase Agreement provided for a 30-day contingency period after signing in which we were entitled to complete due diligence on the REO properties, with each of Invitation Homes and us having the ability to terminate the IH Purchase Agreement based on the due diligence results. On July 28, 2015, the contingency period expired, and Invitation Homes and we determined to move forward with the closing of the IH Transaction. We currently expect to complete the IH Transaction in the third quarter of 2015. There can be no assurance that we will be able to complete the IH Transaction on a timely basis or at all.

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Real estate held for use

As of June 30, 2015, we had 3,977 REO properties held for use. Of these properties, 777 had been rented, 96 were being listed for rent and 111 were in varying stages of renovation. With respect to the remaining 2,993 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, 2014, we had 3,349 REO properties held for use. Of these properties, 336 had been rented, 197 were being listed for rent and 254 were in various stages of renovation. With respect to the remaining 2,562 REO properties, we were in the process of determining whether these properties would meet our rental profile. As of June 30, 2014, we had 1,766 REO properties held for use. Of these properties, 102 had been rented, 40 were being listed for rent and 140 were in various stages of renovation. With respect to the remaining 1,484 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 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 June 30, 2015, we classified 819 REO properties having an aggregate carrying value of $134.0 million as real estate held for sale as they do not meet our residential rental property investment criteria. As of December 31, 2014, we had 611 REO properties having an aggregate carrying value of $92.2 million held for sale, and as of June 30, 2014, we had 192 REO properties having an aggregate carrying value of $27.6 million held for sale. None of these REO properties have any operations; therefore, we are not presenting discontinued operations related to these properties.

We record residential properties held for sale at the lower of either the carrying amount of REO or its estimated fair value less estimated selling costs. If the carrying amount exceeds the estimated fair value, as adjusted, we record impairment equal to the amount of such excess. If an increase in fair value is noted at a subsequent measurement date, a gain is recognized to the extent of any previous impairment recognized. As of June 30, 2015 we had $7.8 million of impairment on the 819 REO properties having a fair value of $153.9 million. As of December 31, 2014 we had $4.9 million of impairment on the 611 REO properties having a fair value of $96.0 million. There was no impairment on the 192 REO properties held at June 30, 2014.

Dispositions

During the three and six months ended June 30, 2015, we disposed of 321 and 575 REO properties, respectively, and recorded $12.4 million and $23.0 million of net realized gains on real estate, respectively. During the three and six months ended June 30, 2014, we disposed of 22 and 24 REO properties, respectively, and recorded $1.2 million of net realized gains for the three and six months ended June 30, 2014.


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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 June 30, 2015 and December 31, 2014 ($ in thousands):
 
Level 1
Level 2
Level 3
 
Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
June 30, 2015
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
1,716,489

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

$
—

$
153,868

Transfer of real estate owned to mortgage loans
$
—

$
—

$
2,865

Transfer of mortgage loans to real estate owned
$
—

$
—

$
271,547

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

$
—

$
5,977

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

$
810,236

$
—

Other secured borrowings
$
—

$
536,491

$
—

 
 
 
 
December 31, 2014
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
1,959,044

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

$
—

$
96,041

Transfer of real estate owned to mortgage loans
$
—

$
—

$
8,400

Transfer of mortgage loans to real estate owned
$
—

$
—

$
595,668

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

$
—

$
12,535

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

$
1,015,000

$
—

Other secured borrowings
$
—

$
336,409

$
—


We have not transferred any assets from one level to another level during the six months ended June 30, 2015 or during the year ended December 31, 2014.

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 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.


12
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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 June 30, 2015
 
Three months ended June 30, 2014
 
Six months ended June 30, 2015
 
Six months ended June 30, 2014
Mortgage loans
 
 
 
 
 
 
 
Beginning balance
$
1,853,495

 
$
1,766,142

 
$
1,959,044

 
$
1,207,163

Investment in mortgage loans
—

 
300,503

 
—

 
913,011

Net unrealized gain on mortgage loans
42,209

 
105,042

 
103,343

 
170,172

Net realized gain on mortgage loans
19,272

 
10,819

 
34,654

 
20,140

Mortgage loan dispositions and payments
(82,070
)
 
(44,314
)
 
(147,238
)
 
(83,772
)
Real estate tax advances to borrowers
4,264

 
4,716

 
11,391

 
12,722

Reclassification of realized gains on real estate sold from unrealized gains
13,175

 
—

 
23,977

 
—

Transfer of real estate owned to mortgage loans
1,509

 
5,563

 
2,865

 
5,563

Transfer of mortgage loans to real estate owned
(135,365
)
 
(124,443
)
 
(271,547
)
 
(220,971
)
Ending balance at June 30
$
1,716,489

 
$
2,024,028

 
$
1,716,489

 
$
2,024,028

 
 
 
 
 
 
 
 
Net unrealized gain on mortgage loans held at the end of the period
$
29,784

 
$
70,623

 
$
80,852

 
$
108,820


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 June 30, 2015 and December 31, 2014 ($ in thousands):
 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties(1)
June 30, 2015
 
 
 
 
Current
727

$
117,544

$
165,532

$
169,272

30
102

16,148

22,309

24,784

60
59

7,128

10,398

11,972

90
1,930

316,877

493,893

477,131

Foreclosure
6,316

1,258,792

1,767,873

1,654,676

Mortgage loans
9,134

$
1,716,489

$
2,460,005

$
2,337,835

December 31, 2014
 
 
 
 
Current
670

$
107,467

$
159,731

$
160,654

30
109

15,424

22,629

24,046

60
57

7,921

11,624

12,510

90
2,286

361,434

569,930

544,709

Foreclosure
7,841

1,466,798

2,172,047

1,951,606

Mortgage loans
10,963

$
1,959,044

$
2,935,961

$
2,693,525

_____________
(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.

The following table sets forth the carrying value of our remaining re-performing mortgage loans from the re-performing loan portfolio we bought in June 2014, which are held for sale, the related unpaid principal balance and market value of underlying properties by delinquency status as of June 30, 2015 and December 31, 2014 ($ in thousands):

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Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties(1)
June 30, 2015
 
 
 
 
Current
13

$
1,908

$
2,531

$
3,760

30
6

1,045

1,440

1,909

60
5

466

1,254

1,253

90
17

2,457

3,126

3,847

Foreclosure
3

101

422

348

Mortgage loans held for sale
44

$
5,977

$
8,773

$
11,117

December 31, 2014
 
 
 
 
Current
68

$
8,317

$
11,938

$
15,154

30
6

$
1,118

$
1,667

$
2,004

60
4

$
359

$
644

$
670

90
24

$
2,741

$
4,149

$
4,624

Mortgage loans held for sale
102

$
12,535

$
18,398

$
22,452

_____________
(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.

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 June 30, 2015 and December 31, 2014:
Input
June 30, 2015
December 31, 2014
Equity discount rate
15.0%
15.0%
Debt to asset ratio
65.0%
65.0%
Cost of funds
3.5% over 1 month LIBOR
3.5% over 1 month LIBOR
Annual change in home pricing index  
0% to 7.5%
-0.1% to 7.6%
Loan resolution probabilities — modification
0% to 44.7%
0% to 44.7%
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 to 5.3
Value of underlying properties
$500 - $5,500,000
$3,000 - $5,300,000

5. Borrowings

Repurchase agreements and the Nomura loan agreement

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, rental properties and REO properties in our portfolio. On April 10, 2015, we also entered into the Nomura loan agreement for the purpose of financing our beneficial ownership of REO properties. We have effective control of the assets associated with these agreements and therefore have concluded these are financing arrangements. As of June 30, 2015, the weighted average annualized interest rate on borrowings under our repurchase agreements and the Nomura loan agreement was 3.30%, excluding amortization of deferred financing costs.


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The following table sets forth data with respect to our repurchase agreements and the Nomura loan agreement as of June 30, 2015 and December 31, 2014 ($ in thousands):
 
Maximum borrowing capacity
Book value of collateral
Amount outstanding
June 30, 2015
 
 
 
CS repurchase agreement due April 18, 2016
$
275,000

$
367,114

$
202,855

Wells repurchase agreement due March 23, 2016
471,303

949,984

471,303

DB repurchase agreement due March 11, 2016
91,750

208,958

91,750

Nomura loan agreement due April 8, 2016
200,000

69,831

44,328

 
$
1,038,053

$
1,595,887

$
810,236

December 31, 2014
 
 
 
CS repurchase agreement due April 20, 2015
$
225,000

$
332,618

$
222,044

Wells repurchase agreement due March 23, 2015
750,000

1,036,409

569,509

DB repurchase agreement due March 11, 2016
250,000

450,532

223,447

 
$
1,225,000

$
1,819,559

$
1,015,000


Under the terms of each of our repurchase agreements, 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. Pursuant to the CS repurchase agreement, we are entitled to collateralize a portion of the facility with securities. As of June 30, 2015, approximately $10.6 million of the amounts outstanding under the CS repurchase agreement was collateralized by $17.0 million of the Class M Notes issued and retained by us in connection with the securitization completed in September 2014 by ARLP 2014-1, and approximately $29.4 million of the amounts outstanding under the CS repurchase agreement was collateralized by $45.1 million of the Class A-2 Notes issued and retained by us in connection with the securitization completed in November 2014 by ARLP 2014-2.

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. For additional information on the repurchase agreements, please see Note 1, "Organization and basis of presentation."

Under the terms of the Nomura loan agreement, subject to certain conditions, Nomura may advance funds to us from time to time, with such advances collateralized by REO properties. The advances paid under the Nomura loan agreement with respect to the REO properties from time to time will be based on a percentage of the market value of the applicable REO properties. Under the terms of the Nomura loan agreement, we are required to pay interest based on the one-month LIBOR plus a spread and certain other customary fees, administrative costs and expenses in connection with Nomura's structuring, management and ongoing administration of the facility.

The Nomura loan agreement requires us to maintain various financial and other covenants, including 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 Nomura loan agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, certain material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The

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remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the Nomura loan agreement and the liquidation by Nomura of the REO properties then subject thereto.

Other Secured Debt - Securitizations

On June 29, 2015, we completed a securitization transaction in which ARLP 2015-1 issued $205.0 million in ARLP 2015-1 Class A Notes with a weighted coupon of approximately 4.01% and $60.0 million in ARLP 2015-1 Class M Notes. ARLP 2015-1 is a Delaware statutory trust that is wholly-owned by our operating partnership with a federally-chartered bank as its trustee. We retained $34.0 million of the ARLP 2015-1 Class A Notes and all of the ARLP 2015-1 Class M Notes. No interest will be paid on any ARLP 2015-1 Class M Notes while any ARLP 2015-1 Class A Notes remain outstanding. The ARLP 2015-1 Class A Notes and ARLP 2015-1 Class M Notes are non-recourse to us and are secured solely by the non-performing mortgage loans and REO properties of ARLP 2015-1 but not by any of our other assets. The assets of ARLP 2015-1 are the only source of repayment and interest on the ARLP 2015-1 Class A Notes and the ARLP 2015-1 Class M Notes, thereby making the cash proceeds received by ARLP 2015-1 of loan payments, loan liquidations, loan sales and sales of converted REO properties the sole sources of the payment of interest and principal by ARLP 2015-1 to the bond holders. The ARLP 2015-1 Class A Notes and the ARLP 2015-1 Class M Notes mature on May 25, 2055, and we do not guaranty any of the obligations of ARLP 2015-1 under the terms of the Indenture governing the notes or otherwise. As of June 30, 2015, the book value of the underlying securitized assets held by ARLP 2015-1 was $275.7 million.

On November 25, 2014, we completed a securitization transaction in which ARLP 2014-2 issued $270.8 million in ARLP 2014-2 Class A Notes with a weighted coupon of approximately 3.85% and $234.0 million in ARLP 2014-2 Class M Notes. ARLP 2014-2 is a Delaware statutory trust that is wholly-owned by our operating partnership with a federally-chartered bank as its trustee. We initially retained $95.8 million of the ARLP 2014-2 Class A Notes and all of the ARLP 2014-2 Class M Notes. On February 9, 2015, we sold $50.7 million of the retained ARLP 2014-2 Class A Notes to an unrelated third party. No interest will be paid on any ARLP 2014-2 Class M Notes while any ARLP 2014-2 Class A Notes remain outstanding. The ARLP 2014-2 Class A Notes and ARLP 2014-2 Class M Notes are non-recourse to us and are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-2 but not by any of our other assets. The assets of ARLP 2014-2 are the only source of repayment and interest on the ARLP 2014-2 Class A Notes and the ARLP 2014-2 Class M Notes, thereby making the cash proceeds received by ARLP 2014-2 of loan payments, loan liquidations, loan sales and sales of converted REO properties the sole sources of the payment of interest and principal by ARLP 2014-2 to the bond holders. The ARLP 2014-2 Class A Notes and the ARLP 2014-2 Class M Notes mature on January 26, 2054, and we do not guaranty any of the obligations of ARLP 2014-2 under the terms of the Indenture governing the notes or otherwise. As of June 30, 2015, the book value of the underlying securitized assets held by ARLP 2014-2 was $329.0 million.

On September 25, 2014, we completed a securitization transaction in which ARLP 2014-1 issued $150.0 million in ARLP 2014-1 Class A Notes with a weighted coupon of approximately 3.47% and $32.0 million in ARLP 2014-1 Class M Notes with a weighted coupon of 4.25%. ARLP 2014-1 is a Delaware statutory trust that is wholly-owned by our operating partnership with a federally-chartered bank as its trustee. The ARLP 2014-1 Class A Notes and the ARLP 2014-1 Class M Notes are non-recourse to us and are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-1 but not by any of our other assets. The assets of ARLP 2014-1 are the only source of repayment and interest on the ARLP 2014-1 Class A Notes and the ARLP 2014-1 Class M Notes, thereby making the cash proceeds received by ARLP 2014-1 of loan payments, loan liquidations, loan sales and sales of converted REO properties the sole sources of the payment of interest and principal by ARLP 2014-1 to the bond holders. The ARLP 2014-1 Class A Notes and the ARLP 2014-1 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 June 30, 2015, the book value of the underlying securitized assets held by ARLP 2014-1 was $208.5 million.

We retained all of the ARLP 2014-1 Class M Notes in our TRS. On September 30, 2014, pursuant to a master repurchase agreement, the TRS sold $15.0 million of the ARLP 2014-1 Class M Notes to NewSource. The master repurchase agreement initially required the TRS to repurchase the ARLP 2014-1 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 additional 89-day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on September 22, 2015.


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The following table sets forth data with respect to these notes as of June 30, 2015 and December 31, 2014 ($ in thousands):
 
Interest Rate
Amount outstanding
June 30, 2015
 
 
ARLP Securitization Trust, Series 2015-1
 
 
ARLP 2015-1 Class A Notes due May 25, 2055(1)
4.01
%
$
205,000

ARLP 2015-1 Class M Notes due May 25, 2044
—
%
60,000

ARLP Securitization Trust, Series 2014-2
 
 
ARLP 2014-2 Class A Notes due January 26, 2054(2)
3.87
%
255,144

ARLP 2014-2 Class M Notes due January 26, 2054
—
%
234,010

ARLP Securitization Trust, Series 2014-1
 
 
ARLP 2014-1 Class A Notes due September 25, 2044(3)
3.47
%
142,919

ARLP 2014-1 Class M Notes due September 25, 2044(4)
4.25
%
32,000

ARNS, Inc.
 
 
Securities sold under agreement to repurchase due September 22, 2015
5.00
%
14,991

Intercompany eliminations
 
 
Elimination of ARLP 2015-1 Class A Notes due to ARNS, Inc.
 
(34,000
)
Elimination of ARLP 2015-1 Class M Notes due to ARLP
 
(60,000
)
Elimination of ARLP 2014-2 Class A Notes due to ARNS, Inc.
 
(45,138
)
Elimination of ARLP 2014-2 Class M Notes due to ARLP
 
(234,010
)
Elimination of ARLP 2014-1 Class M Notes due to ARNS, Inc.
 
(32,000
)
 
 
$
538,916

December 31, 2014
 
 
ARLP Securitization Trust, Series 2014-2
 
 
ARLP 2014-2 Class A Notes due January 26, 2054(2)
3.85
%
$
269,820

ARLP 2014-2 Class M Notes due January 26, 2054
—
%
234,010

ARLP Securitization Trust, Series 2014-1
 
 
ARLP 2014-1 Class A Notes due September 25, 2044(3)
3.47
%
150,000

ARLP 2014-1 Class M Notes due September 25, 2044(4)
4.25
%
32,000

ARNS, Inc.
 
 
Securities sold under agreement to repurchase due March 27, 2015
5.00
%
14,991

Intercompany eliminations
 
 
Elimination of ARLP 2014-2 Class A Notes due to ARNS, Inc.
 
(95,729
)
Elimination of ARLP 2014-2 Class M Notes due to ARNS, Inc.
 
(234,010
)
Elimination of ARLP 2014-1 Class M Notes due to ARLP
 
(32,000
)
 
 
$
339,082

_____________
(1)
The expected redemption date for the Class A Notes ranges from June 25, 2018 to June 25, 2019.
(2)
The expected redemption date for the Class A Notes ranges from November 27, 2017 to November 27, 2018.
(3)
The expected redemption date for the Class A Notes ranges from September 25, 2017 to September 25, 2018.
(4)
The expected redemption date for the Class M Notes is September 25, 2018.



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6. Commitments and contingencies
 
Litigation, claims and assessments

Set forth below are developments in our legal proceedings since the March 2, 2015 filing of our annual report on Form 10-K for the year ended December 31, 2014 and the May 7, 2015 filing of our quarterly report on Form 10-Q for the three months ended March 31, 2015:

The Police Retirement System of Saint Louis v. Erbey, et al. On June 30, 2015, The Police Retirement System of Saint Louis and the defendants entered into a Stipulation and Agreement of Compromise, Settlement and Release (the “Settlement Stipulation”) for the settlement of this derivative action (the “Settlement”), and the parties filed the Settlement Stipulation with the Circuit Court for Baltimore City, Maryland (the “Court") on the same day. By Order dated August 3, 2015, the Court preliminarily approved the Settlement, scheduled a hearing on November 9, 2015 to consider final approval of the Settlement, and authorized us to provide notice of the proposed Settlement to stockholders.  If the Settlement is finally approved by the Court and, ultimately, no shareholders successfully object to the Settlement, it will resolve and release all claims in the action that were, or could have been, brought by or on behalf of our company challenging the Original AMA among us, Altisource Residential L.P. and AAMC, or the negotiation of, the terms and provisions of, or the approval of the New AMA. In addition, pursuant to the Settlement Stipulation, the parties agreed that the defendants will pay the attorneys’ fees and expenses of plaintiff’s counsel, in an amount not to exceed $6.0 million. We have been informed by our insurers that the Settlement will be a covered claim under our insurance policy.

Martin v. Altisource Residential Corporation, et al.  In May 2015, two of our purported shareholders filed competing motions with the court to be appointed lead plaintiff and for selection of lead counsel in the action.  Subsequently, opposition and reply briefs were filed by the purported shareholders with respect to these motions.  The court has not made any decisions with respect to the lead plaintiff motions.

Sokolowski v. Erbey, et al.  On July 16, 2015, we filed a motion to dismiss all claims against us in the action, based upon, among other arguments, lack of personal jurisdiction and failure to state a claim. Co-defendant AAMC has filed a similar motion to dismiss the complaint as to all claims asserted against it.  Briefing on the motions to dismiss the complaint is ongoing. 
 
Hulstrom v. William C. Erbey, et al. On April 23, 2015, a shareholder derivative action was filed in the Superior Court of the Virgin Islands, Division of St. Croix by a purported shareholder under the caption Kirk Hulstrom v. William Erbey et al. SX-15-CV-158.  The action names as defendants William C. Erbey, each of the current and former members of our Board of Directors, certain officers of the Company, AAMC and Ocwen.  In the complaint, plaintiff asserts claims against the individual defendants for breach of fiduciary duty, abuse of control and gross mismanagement in connection with the asset management agreement between AAMC and us.  As to AAMC and Ocwen, plaintiff alleges that these two companies aided and abetted the purported breaches of fiduciary duty and have been unjustly enriched by the asset management agreement.  The complaint also names RESI as a nominal defendant.  At this time, we are not able to predict the ultimate outcome of this matter, nor can we estimate the range of possible loss, if any.

Moncavage v. Faris, et al.  In March, 2015, a shareholder derivative action was filed in the Circuit Court for the Fifteenth Judicial Circuit in and for Palm Beach County, Florida by a purported shareholder of Ocwen under the caption Moncavage v. Ronald Faris, et al., Case No. 2015-CA-03244 (MB-AD).  The action named certain officers and directors of Ocwen as defendants and alleged, among other things, various breaches of fiduciary duties by these individual defendants.  The action also named Altisource, Home Loan Servicing Solutions and us as alleged aiders and abettors of the purported breaches of fiduciary duties.  The allegations of wrongdoing contained in the Moncavage action are similar to the allegations in the Sokolowski action updated above.  On July 13, 2015, the plaintiff and we jointly filed a stipulation of an extension of time to respond to the pending motions to stay the action that had been filed by Ocwen and the individual defendants. We believe the claims against us in the matter are without merit.  At this time, we are not able to predict the ultimate outcome of this matter, nor can we estimate the range of possible loss, if any.

In connection with the Police Retirement System case described above, management had previously established a litigation accrual in the amount of $1.5 million. Given the notice received by us from our insurers that the Police Retirement System case is a covered claim, we have reversed the $1.5 million litigation accrual.

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Management does not believe that we have incurred an estimable, probable or material loss by reason of any of the above new or updated actions.

7. Related party transactions

New Asset Management Agreement with AAMC

On March 31, 2015, we entered into a new Asset Management Agreement (the "New AMA") with AAMC. The New AMA, which became effective on April 1, 2015, provides for a new management fee structure which replaces the incentive fee structure under the original asset management agreement (the “Original AMA”) as follows:

•
Base Management Fee. AAMC is entitled to a quarterly base management fee equal to 1.5% of the product of (i) our average invested capital for the quarter multiplied by (ii) 0.25, while we have fewer than 2,500 single family rental properties actually rented (“Rental Properties”). The base management fee percentage increases to 1.75% of invested capital while we have between 2,500 and 4,499 Rental Properties and increases to 2.0% of invested capital while we have 4,500 or more Rental Properties; 

•
Incentive Management Fee. AAMC is entitled to a quarterly incentive management fee equal to 20% of the amount by which our return on invested capital (based on AFFO as defined in the New AMA) exceeds a hurdle return rate of between 7.0% and 8.25% (depending on the 10-year treasury rate). The incentive management fee increases to 22.5% while we have between 2,500 and 4,499 Rental Properties and increases to 25% while we have 4,500 or more Rental Properties; and
 
•
Conversion Fee. AAMC is entitled to a quarterly conversion fee equal to 1.5% of the market value of the single-family homes leased by us for the first time during the quarter.
 
We have the flexibility to pay up to 25% of the incentive management fee to AAMC in shares of our common stock.

Under the New AMA, AAMC will continue to be the exclusive asset manager for us for an initial term of 15 years from April 1, 2015, with two potential five-year extensions, subject to our achieving an average annual return on invested capital of at least 7.0%. Under the New AMA, we will not be required to reimburse AAMC for the allocable compensation and routine overhead expenses of its employees and staff, all of which will now be covered by the base management fee described above.

Neither party is entitled to terminate the New AMA prior to the end of the initial term, or each renewal term, other than termination by (a) us and/or AAMC “for cause” for certain events such as a material breach of the New AMA and failure to cure such breach, (b) Residential for certain other reasons such as our failure to achieve a return on invested capital of at least 7.0% for two consecutive fiscal years after the third anniversary of the New AMA, and (c) Residential in connection with certain change of control events.

Under the amended fee structure of the New AMA, the fees payable to AAMC reduced from $15.5 million in the second quarter of 2014 to $5.2 million in the second quarter of 2015. The $5.2 million fees payable to AAMC in the second quarter of 2015 consists of a $4.8 million Base Management Fee and a $0.4 million Conversion Fee. No Incentive Management Fee was payable to AAMC for the second quarter of 2015 because return on invested capital (as defined in the New AMA) was below the required hurdle rate.  The amount by which return on invested capital was below the required hurdle rate in the second quarter of 2015 is a deficit which is carried forward for up to seven future quarters or until the deficit is reduced by our future performance above the hurdle rate.  In future quarters, return on invested capital must exceed the required hurdle rate for the current quarter plus any carried forward cumulative deficit from the prior seven quarters before any Incentive Management Fee is payable to AAMC.

Summary of Related Party Transaction Expenses

Through January 16, 2015, William C. Erbey served as our Chairman as well as the Executive Chairman of Ocwen, Chairman of Altisource, and Chairman of AAMC. Effective January 16, 2015, Mr. Erbey stepped down as the Executive Chairman of Ocwen and Chairman of each of Altisource, Residential and AAMC and is no longer a member of the Board of Directors for any of these companies. Accordingly, at that point, Ocwen and Altisource are no longer considered related parties of Residential and AAMC as defined by FASB Accounting Standards Codification (“ASC”) Topic 850, Related Party Disclosures.

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Transactions under our agreements with Ocwen and Altisource for the current year through January 16, 2015 were not material to our consolidated results of operations.

Our Consolidated Statements of Operations included the following significant related party transactions ($ in thousands):
 
Three months ended June 30, 2015
Six months ended June 30, 2015
Counter-party
Consolidated Statements of Operations location
2015
 
 
 
 
Expense reimbursements
$
—

$
750

AAMC
Related party general and administrative expenses
Conversion fee
399

399

AAMC
Related party general and administrative expenses
Base management fee
4,752

4,752

AAMC
Related party general and administrative expenses
Management incentive fee
—

14,900

AAMC
Related party general and administrative expenses
Interest expense
161

321

NewSource
Interest expense
Professional fee sharing for negotiation of AMA
—

2,000

AAMC
Other income
 
Three months ended June 30, 2014
Six months ended June 30, 2014
Counter-party
Consolidated Statements of Operations location
2014
 
 
 
 
Residential property operating expenses
$
3,150

$
4,200

Ocwen/Altisource
Residential property operating expenses
Mortgage loan servicing costs
14,942

25,432

Ocwen
Mortgage loan servicing costs
Due diligence and unsuccessful deal costs
1,655

1,766

Altisource
Related party general and administrative expenses
Expense reimbursements
1,789

3,258

AAMC
Related party general and administrative expenses
Management incentive fee
13,715

24,626

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 ARLP 2014-1 Class M Notes to NewSource for a purchase price of $15.0 million. The master repurchase agreement initially required the TRS to repurchase the ARLP 2014-1 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 additional 89 day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on September 22, 2015.

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 thousand 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 six months ended June 30, 2015 and 2014, we granted 9,924 and 8,245 shares of stock, respectively, pursuant to our 2013 Director Equity Plan with weighted average grant date fair value per share of $18.25 and $27.28, respectively.

We recorded $36 thousand and $93 thousand of compensation expense related to these grants for the three and six months ended June 30, 2015, respectively, and recorded $57 thousand and $113 thousand of compensation expense for the three and six months ended June 30, 2014, respectively. As of both June 30, 2015 and 2014, we had $0.2 million of unrecognized share-

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based compensation cost remaining with respect to the director grants to be recognized over a weighted average remaining estimated term of 0.9 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.

On March 31, 2015, our Board of Directors declared a quarterly cash dividend of $0.55 per share of common stock, which was paid on April 23, 2015 to all stockholders of record as of the close of business on April 13, 2015. On June 18, 2015, our Board of Directors declared a quarterly cash dividend of $0.55 per share of common stock, which was paid on July 15, 2015 to all stockholders of record as of the close of business on June 30, 2015.

Based on our 2014 taxable income of $115.8 million, which includes net capital gains of $54.4 million, the aggregate minimum distribution to stockholders required to maintain our REIT status was $55.3 million in 2014. Dividends declared and paid per share of common stock aggregated $2.03 for the year ended December 31, 2014, or $116.0 million. These distributions included a cash dividend of $0.08 per share of common stock, or $4.5 million, which was treated as a 2013 distribution for REIT qualification purposes. On March 12, 2015 our Board of Directors declared a cash dividend of $0.08 per share of common stock, which was paid on March 30, 2015 to all stockholders of record as of the close of business on March 23, 2015. This additional dividend, an aggregate of $4.6 million, was treated as a 2014 distribution for REIT qualification purposes.

Our consolidated financial statements include the operations of our TRS, which is subject to federal, state and local income taxes on its taxable income. Through December 31, 2014, 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 June 30, 2015 which resulted in our recording additional deferred tax assets and a corresponding valuation allowance. As of June 30, 2015, we are forecasting that the TRS will not be profitable for the 2015 fiscal year.

We recorded state income tax expense on our consolidated operations for the six months ended June 30, 2015. As a REIT, we may also be subject to federal taxes if we engage in certain types of transactions.

As of June 30, 2015 and 2014, we did not accrue interest or penalties associated with any unrecognized tax benefits, nor was any interest expense or penalty recognized during the six months ended June 30, 2015 and 2014. We recorded nominal state and local tax expense on income and property for the six months ended June 30, 2015. Our subsidiaries and we remain subject to tax examination for the period from inception to December 31, 2014.


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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 June 30, 2015
 
Three months ended June 30, 2014
 
Six months ended June 30, 2015
 
Six months ended June 30, 2014
Numerator
 
 
 
 
 
 
 
Net income
$
13,092

 
$
67,782

 
$
25,516

 
$
109,695

 
 
 
 
 
 
 
 
Denominator
 
 
 
 
 
 
 
Weighted average common stock outstanding – basic
57,208,273

 
57,138,695

 
57,204,602

 
55,297,630

Stock options using the treasury method
195,420

 
257,110

 
198,066

 
447,936

Restricted stock
4,152

 
6,148

 
4,585

 
9,119

Weighted average common stock outstanding – diluted
57,407,845

 
57,401,953

 
57,407,253

 
55,754,685

 
 
 
 
 
 
 
 
Earnings per basic share
$
0.23

 
$
1.19

 
$
0.45

 
$
1.98

Earnings per diluted share
$
0.23

 
$
1.18

 
$
0.44

 
$
1.97


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. While we focus on acquiring our rental properties through the acquisition of distressed mortgage loans, we have also always considered purchasing rental properties through other avenues, including, without limitation, though the purchase of portfolios of single-family rental properties, REO properties, residential mortgage-backed securities, clean-up calls and other distressed assets. 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.


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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 throughout the United States. We conduct substantially all of our activities through our wholly owned subsidiary Altisource Residential, L.P. and its subsidiaries.
To date, we have acquired 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 REO acquisitions. Given evolving market conditions, commencing in the second quarter of 2015, we expanded our acquisition strategy to opportunistically acquire portfolios of single-family rental properties as an avenue to more quickly achieve scale in our rental portfolio where we believe the economics make sense. We also commenced a program to begin purchasing REO properties on a one-by one basis sourcing listed properties from the Multiple Listing Service ("MLS") and alternative listing sources. We expect the first purchases of this program to occur in the third quarter of 2015.

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. Therefore, we historically have had opportunities 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 have also always considered purchasing rental properties through other avenues, including, without limitation, though the purchase of portfolios of single-family rental properties, REO properties, residential mortgage-backed securities, clean-up calls and other distressed assets.

Observations on Current Market Opportunities

In the first two and one-half years of our operations, although we had considered the alternative approaches to acquiring single-family rental homes described above, our most opportunistic acquisition strategy involved acquiring portfolios of non-performing loans. However, as market conditions have continued to evolve, and non-performing mortgage loan pools became relatively higher priced, opportunities in these alternative acquisition strategies have increased and become more prevalent in the marketplace. Although we have been and are continuing to review, assess and bid on portfolios of non-performing mortgage loans, entities are seeking to sell portfolios of REO properties and rental properties. We have been exploring and reviewing these other sources of single-family rental assets, including the acquisition of portfolios of single-family rental properties and the purchase of certain REO properties on a one-by-one basis, as we believe they may also provide alternative attractive avenues to grow our rental portfolio.

As a result of these activities, on June 28, 2015, we entered into the IH Purchase Agreement to acquire an aggregate of 1,325 REO properties, the substantial majority of which were rented and occupied, from certain subsidiaries of Invitation Homes for an aggregate purchase price of approximately $112.6 million. The IH Purchase Agreement provided for a 30-day contingency period after signing in which we were entitled to complete due diligence on the REO properties, with each of Invitation Homes and us having the ability to terminate the IH Purchase Agreement based on the due diligence results. On July 28, 2015, the contingency period expired, and Invitation Homes and we determined to move forward with the closing of the IH Transaction. We currently expect to complete the IH Transaction in the third quarter of 2015. There can be no assurance that we will be able to complete the IH Transaction on a timely basis or at all.

Prior to the second quarter of 2015, we had acquired our non-performing and re-performing mortgage loans through direct acquisitions from institutions such as banks, HUD and private equity funds. We expect to continue to review and acquire portfolios of non-performing loan portfolios at attractive prices, but we expect to be disciplined in doing so, rather than acquiring non-performing loans at inflated prices that do not fit our investment criteria.

Historical Purchases of Non-Performing Mortgage Loans

During 2014 and 2013 we acquired portfolios consisting of an aggregate of 15,817 residential mortgage loans, substantially all of which were non-performing, and 277 REO properties having an aggregate unpaid principal balance (“UPB”) of approximately $4.2 billion and an aggregate market value of underlying properties of approximately $3.6 billion. The aggregate purchase price for these acquisitions was approximately $2.4 billion. We did not complete any acquisitions of non-performing residential loan portfolios in the six months ended June 30, 2015.

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Additionally, in June 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 and June 2015, we sold 770 and 52 of these re-performing mortgage loans, respectively. During June 2015, we sold an aggregate of 189 re-performing loans to an unrelated third party for an aggregate purchase price of $34.6 million. The sale included 52 loans from the re-performing mortgage loans purchased in June 2014, and 137 loans that had transitioned to re-performing status from prior non-performing loan acquisitions. Approximately $2.0 million of the proceeds from the June 2015 re-performing loan sale were used to purchase the loans out of our ARLP 2014-1 and ARLP 2014-2 securitizations and approximately $16.4 million of the proceeds were used to purchase the loans out of our Wells repurchase facility. Therefore, our net proceeds from the June 2015 re-performing loan sale were approximately $16.2 million.

From inception through June 30, 2015, we modified an aggregate of 876 mortgage loans, converted an aggregate of 5,317 non-performing and 2 re-performing mortgage loans into REO properties and disposed of an aggregate of 1,366 non-performing and 11 re-performing mortgage loans through short sale, refinancing or other liquidation events. Our preferred resolution methodology with respect to distressed loans 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. We also sold 800 REO properties from inception through June 30, 2015.
As of June 30, 2015, our portfolio consisted of 9,134 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $2.5 billion and an aggregate market value of underlying properties of $2.3 billion. We also owned 4,796 REO properties with an aggregate carrying value of $803.4 million, of which 3,977 were held for use and 819 were held for sale. Of the 3,977 REO properties held for use, 777 properties had been rented and were occupied by tenants, 96 were being listed for rent and 111 were in varying stages of renovation. With respect to the remaining 2,993 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 44 re-performing mortgage loans held for sale having an aggregate UPB of approximately $8.8 million and an aggregate market value of underlying properties of approximately $11.1 million as of June 30, 2015.

Transition to New Servicers

As previously disclosed, during the first quarter of 2015, we appointed two new servicers, Fay Servicing (“Fay”) and BSI Financial Services (“BSI”). By the end of April 2015, we had transferred the servicing on mortgage loans of approximately $1.1 billion of UPB from Ocwen to Fay and BSI. We believe that these servicing transfers were the right thing to do for our long term prospects, but the transfer of a large portion of our loans during the first quarter hampered our resolution efforts on those loans, which negatively impacted our results for the first quarter. We also had previously disclosed that we expected to continue to transfer servicing away from Ocwen. As such, in June 2015, we transferred servicing on mortgage loans of approximately $680 million of UPB to Fay and BSI. Although these transfers have continued to hamper our ability to covert loans to REO during the second quarter, and may continue to hamper our resolution efforts in the short term, we believe these transfers will be beneficial to us in the long term.

The New AMA with AAMC

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.

On March 31, 2015, we entered into a new Asset Management Agreement (the "New AMA") with AAMC. The New AMA, which became effective on April 1, 2015, provides for a new management fee structure which replaces the incentive fee structure under the original asset management agreement with AAMC (the “Original AMA”) as follows:

•
Base Management Fee. AAMC is entitled to a quarterly base management fee equal to 1.5% of the product of (i) our average invested capital for the quarter multiplied by (ii) 0.25, while we have fewer than 2,500 single family rental properties actually rented (“Rental Properties”). The base management fee percentage increases to 1.75% of invested capital while we have between 2,500 and 4,499 Rental Properties and increases to 2.0% of invested capital while we have 4,500 or more Rental Properties; 


24

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•
Incentive Management Fee. AAMC is entitled to a quarterly incentive management fee equal to 20% of the amount by which our return on invested capital (based on AFFO as defined in the New AMA) exceeds a hurdle return rate of between 7.0% and 8.25% (depending on the 10-year treasury rate). The incentive management fee increases to 22.5% while we have between 2,500 and 4,499 Rental Properties and increases to 25% while we have 4,500 or more Rental Properties; and 

•
Conversion Fee. AAMC is entitled to a quarterly conversion fee equal to 1.5% of the market value of the single-family homes leased by us for the first time during the quarter.
 
We have the flexibility to pay up to 25% of the incentive management fee to AAMC in shares of our common stock.

Under the New AMA, AAMC will continue to be the exclusive asset manager for us for an initial term of 15 years from April 1, 2015, with two potential five-year extensions, subject to our achieving an average annual return on invested capital of at least 7.0%.

Neither party is entitled to terminate the New AMA prior to the end of the initial term, or each renewal term, other than termination by (a) us and/or AAMC “for cause” for certain events such as a material breach of the New AMA and failure to cure such breach, (b) Residential for certain other reasons such as our failure to achieve a return on invested capital of at least 7.0% for two consecutive fiscal years after the third anniversary of the New AMA, and (c) Residential in connection with certain change of control events.

Under the amended fee structure of the New AMA, the fees payable to AAMC reduced from $15.5 million in the second quarter of 2014 to $5.2 million in the second quarter of 2015. The $5.2 million fees payable to AAMC in the second quarter of 2015 consists of a $4.8 million Base Management Fee and a $0.4 million Conversion Fee. No Incentive Management Fee was payable to AAMC for the second quarter of 2015 because return on invested capital (as defined in the New AMA) was below the required hurdle rate.  The amount by which return on invested capital was below the required hurdle rate in the second quarter of 2015 is a deficit which is carried forward for up to seven future quarters or until the deficit is reduced by our future performance above the hurdle rate.  In future quarters, return on invested capital must exceed the required hurdle rate for the current quarter plus any carried forward cumulative deficit from the prior seven quarters before any Incentive Management Fee is payable to AAMC.

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. 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; inadequacy of documents necessary to foreclose; bankruptcy proceedings initiated by borrowers; 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 judicial and administrative proceedings.


25

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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.

iv.
Net realized gain on real estate. REO properties that do not meet our investment criteria are sold out of our taxable REIT subsidiary. The realized gain or loss recognized in financial statements reflects the net amount of realized and unrealized gains on sold REOs from the time of acquisition to sale completion.

As a greater number of our REO properties are renovated and deemed suitable for rental and as a greater number of our acquired assets are REO properties to be held for rent, we expect a greater portion of our revenues will be rental revenues. For the non-performing loans we have acquired to date, the average number of days to determine whether a property met our rental profile was 181 days for 200 properties for which renovations began during 2015. The average renovation expense was $22,630 per property for 433 renovations completed during 2015, the average number of days between commencement of renovation and listing of the property for rent was 40 days for 178 properties for which renovation began during 2015, and the average number of days from listing to leasing a property was 27 days for 354 properties listed in 2015. 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 additional renovation costs and leasing expenses, or reduced rental revenues. Our physical occupancy rate at June 30, 2015 was 83%. For properties in lease-up without stabilized occupancy rates, management believes the physical occupancy rate is the appropriate performance metric. In the lease-up phase, we may utilize rent concessions and other incentives, and thus financial occupancy which is based on contractual revenue is not considered the best metric to quantify occupancy. Our rental properties had an average annual rental rate of $14,375 per home for 777 properties rented at June 30, 2015.

Although we seek to lease the majority of REO properties we acquire, we also sell the properties that do not meet our rental investment criteria and generate cash for reinvestment in other acquisitions. 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.

Our investment strategy is to develop a portfolio of single-family rental properties in the United States which provide attractive risk-adjusted returns on invested capital.  In determining which REO properties we will retain for our rental portfolio, we consider various objective and subjective factors, including but not limited to gross and net rental yields, property values, renovation costs, location in relation to our coverage area, property type, HOA covenants, potential future appreciation and neighborhood amenities.

Expenses

Our expenses have primarily consisted of rental property operating expenses, depreciation and amortization, real estate selling cost and impairment, mortgage loan servicing, interest expense, general and administrative expenses, and expense reimbursement and incentive management fees under the Original AMA. Rental property operating expenses are expenses associated with our ownership and operation of rental properties including expenses such as property management fees, expenses towards repairs, 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. Real estate selling cost and impairment represents our estimate for the costs to be incurred to sell a property and an amount that represents the carrying amount over the estimated fair value less costs to sell. Mortgage loan servicing costs are primarily for servicing fees, foreclosure fees and advances of residential property insurance. Interest expense consists of the costs to borrow money in connection with our debt financing of our portfolios. General and administrative expenses consist of

26

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the costs related to the general operation and overall administration of our business. Historically, expense reimbursement consisted primarily of employee salaries of AAMC in direct correlation to the services they provided on our behalf and other personnel costs and corporate overhead. Under the New AMA, there are no general expense reimbursements. The incentive management fees consist of compensation due to AAMC. Historically, this was based on the amount of cash available for distribution to our stockholders for each period. Under the new agreement the management fees are based on our invested capital and leased properties.

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, other residential mortgage loans and REO properties. We believe that there is currently a large supply of sub-performing and non-performing mortgage loans as well as REO properties and single family rental properties available to us for acquisition.

Generally, we expect that our residential mortgage loan and single-family rental and REO portfolios may grow at an uneven pace, as opportunities to acquire distressed residential mortgage loans and REO properties may be irregularly timed and may at times involve large portfolios, and the timing and extent of our success in acquiring such assets cannot be predicted.

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.

Resolution Activities

Our business model is dependent on the success of our loan modification and other resolution efforts and the conversion of a significant portion of those loans to REO. 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 and provides the highest possible economic outcome for us. Upon 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 record net realized gains, including the reclassification of previously accumulated net unrealized gains. 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.

Upon conversion of loans to REO, we mark the properties to the most recent market value and recognize net unrealized gains for the difference between the carrying value of the asset at the time of conversion and the most recent market value, based on BPOs. The timeline to convert acquired loans into REO can vary significantly by loan, which can 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.


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The size and composition of our sub-performing and non-performing mortgage loan portfolio is, and has been, a key factor affecting our overall operating results. The following table summarizes, by quarter and for the six month periods, the key metrics reflecting the operating performance of our loan portfolio.
 
First quarter 2014
Second quarter 2014
Six months ended June 30, 2014
 
First quarter 2015
Second quarter 2015
Six months ended June 30, 2015
Mortgage Loans (1)
 
 
 
 
 
 
 
Beginning balance
8,054

11,509

8,054

 
10,963

10,089

10,963

Acquisitions
4,207

1,590

5,797

 
—

—

—

Dispositions
(116
)
(135
)
(251
)
 
(150
)
(270
)
(420
)
Mortgage loan conversions to REO
(637
)
(907
)
(1,544
)
 
(728
)
(692
)
(1,420
)
Reversions to mortgage loans (2)
1

13

14

 
4

7

11

Ending balance
11,509

12,070

12,070

 
10,089

9,134

9,134

 
 
 
 
 
 
 
 
Modifications
81

90

171

 
126

131

257

Loan reinstatements
19

30

49

 
67

38

105

 
 
 
 
 
 
 
 
Real Estate Owned
 
 
 
 
 
 
 
Beginning balance
262

896

262

 
3,960

4,430

3,960

Acquisitions
—

190

190

 
—

—

—

Dispositions
(2
)
(22
)
(24
)
 
(254
)
(321
)
(575
)
Mortgage loan conversions to REO (3)
637

907

1,544

 
728

694

1,422

Reversions to mortgage loans (2)
(1
)
(13
)
(14
)
 
(4
)
(7
)
(11
)
Ending balance
896

1,958

1,958

 
4,430

4,796

4,796

 
 
 
 
 
 
 
 
Leased
35

102

102

 
587

777

777

Renovations complete
17

40

40

 
151

96

96

Renovations in process
48

140

140

 
116

111

111

Evaluating strategy/held for sale
796

1,676

1,676

 
3,576

3,812

3,812

 
896

1,958

1,958

 
4,430

4,796

4,796

_____________
(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.
(3)
Second quarter 2015 conversions to REO included 2 properties that were previously in our re-performing mortgage loans held for sale.

In addition, as of June 30, 2015, 107 of our mortgage loans were on trial modification plans, compared to 207 mortgage loans on trial modification plans as of December 31, 2014.


28

(table of contents)

Portfolio size

The size of our investment portfolio will also impact operating results. 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, property management fees and, potentially, depending on our performance, fees payable to AAMC. We may also incur additional interest expense if we incur additional debt to finance the purchase of our assets.

Existing Portfolio

During 2014 and 2013 we acquired portfolios consisting of an aggregate of 15,817 residential mortgage loans, substantially all of which were non-performing, and 277 REO properties having an aggregate UPB of approximately $4.2 billion and an aggregate market value of underlying properties of approximately $3.6 billion. The aggregate purchase price for these acquisitions was approximately $2.4 billion. We did not complete any portfolio acquisitions in the six months ended June 30, 2015.

Throughout this 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 as our “Existing Portfolio.” The Existing Portfolio does not include assets acquired as REO. As defined in this quarterly report, our “Existing Portfolio” does not include the 44 re-performing mortgage loans having an aggregate UPB of approximately $8.8 million and an aggregate market value of underlying properties of approximately $11.1 million as of June 30, 2015, which are considered “Mortgage loans held for sale.”

Our sub-performing and non-performing mortgage loans become REO properties when we obtain legal title to the property upon completion of 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. If and as we acquire more REO properties directly, rather than converting loans to REO, our portfolios may rely less on acquiring and resolving loans.

As of June 30, 2015, we had 4,796 REO properties, consisting of 3,977 REO properties held for use and 819 held for sale. Of the 3,977 REO properties held for use, 777 properties had been rented and were occupied by tenants, 96 were being listed for rent and 111 were in varying stages of renovation. With respect to the remaining 2,993 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 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 a final determination on whether to rent or liquidate the property. 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 it is determined that the REO property will not meet our rental investment criteria, the property is listed for sale, in some instances after renovations are made to optimize the sale proceeds. As of June 30, 2014, we had 1,766 REO properties held for use. Of these properties, 102 had been rented, 40 were being listed for rent and 140 were in various stages of renovation. With respect to the remaining 1,484 REO properties at June 30, 2014, we were in the process of determining whether these properties would meet our rental profile. Additionally, 192 REO properties owned as of June 30, 2014 were held for sale.

The following table sets forth a summary of our REO properties as of June 30, 2015 ($ in thousands):

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State / District
Number of properties
Carrying value (1) (2)
Weighted average age in years (3)
Alabama
34

$
4,791

25

Alaska
1

185

30

Arizona
116

21,765

22

Arkansas
49

4,275

32

California
662

203,928

35

Colorado
36

8,213

28

Connecticut
32

6,343

55

Delaware
17

2,498

36

District of Columbia
1

218

105

Florida
888

135,024

25

Georgia
180

24,024

23

Hawaii
2

339

22

Idaho
13

1,734

32

Illinois
409

63,206

44

Indiana
160

17,315

33

Iowa
9

652

57

Kansas
25

1,979

50

Kentucky
61

6,506

34

Louisiana
26

2,551

28

Maine
13

1,484

124

Maryland
192

36,811

37

Massachusetts
48

9,538

79

Michigan
96

11,888

43

Minnesota
75

12,318

43

Mississippi
11

1,045

29

Missouri
67

6,509

45

Montana
3

790

29

Nebraska
7

921

54

Nevada
15

1,972

21

New Hampshire
15

2,324

68

New Jersey
65

10,353

68

New Mexico
32

4,063

21

New York
66

11,989

72

North Carolina
236

28,541

19

Ohio
133

16,021

42

Oklahoma
24

2,387

32

Oregon
11

1,877

38

Pennsylvania
253

32,941

54

Rhode Island
55

7,044

79

South Carolina
111

12,853

23

South Dakota
2

295

54

Tennessee
74

9,251

24

Texas
168

21,438

26

Utah
77

13,906

31

Vermont
4

630

140

Virginia
67

18,193

29

Washington
31

6,550

34

West Virginia
2

597

22

Wisconsin
121

13,117

51

Wyoming
1

248

23

Total
4,796

$
803,440

36



30

(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 and impairment.
(2)
Portions of the Existing Portfolio are used to collateralize our secured financing obligations, including our securitization transactions.
(3)
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 of mortgage loans for acquisitions completed through June 30, 2015 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.

As of June 30, 2015, the aggregate carrying value of our Existing Portfolio of mortgage loans was $1.7 billion (which does not include the carrying value of our REO properties of an additional $803.4 million). The carrying value of mortgage loans is based on our asset manager's proprietary pricing 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 foreclosure 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 June 30, 2015 ($ in thousands):
Location
Loan count
UPB
Market value of underlying properties (1)
Weighted average market LTV (2)
Alabama
47

$
7,099

$
5,546

228.5
%
Alaska
3

672

1,055

65.9
%
Arizona
95

26,249

24,554

118.6
%
Arkansas
45

3,677

4,393

100.1
%
California
909

448,941

498,948

102.2
%
Colorado
35

9,328

9,988

103.8
%
Connecticut
128

39,588

36,506

136.6
%
Delaware
49

9,669

8,998

123.1
%
Dist. of Columbia
65

17,156

20,543

104.4
%
Florida
1,807

444,750

381,214

136.4
%
Georgia
203

35,425

32,789

129.1
%
Hawaii
52

27,508

29,063

100.7
%
Idaho
28

7,000

6,488

134.3
%
Illinois
282

68,337

56,038

174.5
%
Indiana
222

28,431

27,224

115.2
%
Iowa
23

1,942

1,981

107.7
%
Kansas
19

2,184

2,635

97.4
%
Kentucky
40

5,052

4,623

118.6
%
Louisiana
30

4,836

4,726

115.9
%
Maine
37

6,698

6,204

117.7
%
Maryland
507

135,376

113,650

138.7
%
Massachusetts
258

70,481

71,635

115.3
%
Michigan
62

8,509

8,649

174.7
%
Minnesota
32

7,046

7,137

123.7
%
Mississippi
23

2,706

2,637

118.2
%
Missouri
64

5,907

4,986

175.6
%

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Montana
2

459

564

82.9
%
Nebraska
4

465

432

110.4
%
Nevada
227

72,165

56,493

141.0
%
New Hampshire
10

2,782

2,598

120.5
%
New Jersey
1,034

310,973

247,509

154.7
%
New Mexico
120

17,170

17,302

108.7
%
New York
701

243,001

255,210

112.0
%
North Carolina
185

24,889

23,791

119.6
%
North Dakota
1

123

140

87.9
%
Ohio
96

13,347

11,638

318.4
%
Oklahoma
28

3,769

3,728

126.4
%
Oregon
100

29,468

27,626

114.5
%
Pennsylvania
211

39,253

33,877

132.4
%
Puerto Rico
2

218

285

77.2
%
Rhode Island
47

10,799

6,093

231.1
%
South Carolina
178

31,441

29,833

116.7
%
South Dakota
3

395

305

145.0
%
Tennessee
65

9,410

9,059

123.4
%
Texas
386

45,149

63,793

82.6
%
Utah
36

8,201

8,660

99.5
%
Vermont
7

1,266

1,259

111.5
%
Virginia
117

38,959

37,571

116.8
%
Washington
451

123,536

121,181

113.5
%
West Virginia
8

1,009

842

128.9
%
Wisconsin
50

7,191

5,836

144.1
%
Total mortgage loans
9,134

$
2,460,005

$
2,337,835

127.4
%
_____________
(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.
(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 six months ended June 30, 2015 versus three and six months ended June 30, 2014

Rental revenues

Rental revenues increased to $2.1 million and $3.5 million for the three and six months ended June 30, 2015, respectively, compared to $0.2 million and $0.3 million for the three and six months ended June 30, 2014, respectively. The number of leased properties increased to 777 at June 30, 2015 from 102 at June 30, 2014. We also had an additional 96 properties listed for rent at June 30, 2015. We expect to generate increasing rental revenues as we continue to renovate, list and rent additional residential rental properties. Our rental revenues will depend 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, our ability to manage maintenance and repair costs and our renters’ desire to remain in our properties.

Net unrealized gain on mortgage loans

Our net unrealized gains on mortgage loans decreased to $42.2 million and $103.3 million for the three and six months ended June 30, 2015, respectively, from $105.0 million and $170.2 million for the three and six months ended June 30, 2014, respectively. This decrease was primarily related to lower unrealized gains on loans converted to REO status and friction cost due to our servicing transfers during 2015. The net unrealized gains for the three and six months ended June 30, 2015 and 2014 can be broken down into the following two components:


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(table of contents)

•
First, we recognized unrealized gains driven by a material change in loan status of $14.7 million and $33.1 million for the three and six months ended June 30, 2015, respectively, compared to $28.5 million and $52.1 million for the three and six months ended June 30, 2014, respectively. During the three and six months ended June 30, 2015, we converted 687 and 1,411 mortgage loans to REO status, respectively, compared to 894 and 1,530 mortgage loans converted to REO status during the three and six months ended June 30, 2014, 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 $27.5 million and $70.2 million in unrealized gains for the three and six months ended June 30, 2015, respectively, from the net increase in the fair value of loans during the period compared to $76.5 million and $118.1 million in unrealized gains during the three and six months ended June 30, 2014, respectively. 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 the resolution of non-performing loans, our Existing Portfolio has decreased from 10,963 loans at December 31, 2014 to 9,134 loans at June 30, 2015. 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 $19.3 million for the three months ended June 30, 2015 from $10.8 million for the three months ended June 30, 2014. We disposed of </