RESI 10Q_3.31.2014

 

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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2014

OR

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

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

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

As of April 25, 2014, 57,115,023 shares of our common stock were outstanding.



Altisource Residential Corporation
March 31, 2014
Table of Contents



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(table of contents)

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

Special note on forward-looking statements

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

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

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

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



ii

(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

Certain information contained herein is presented as of April 25, 2014, which we have concluded is the latest practicable date for financial information prior to the filing of this quarterly report.



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(table of contents)

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

 
March 31, 2014
 
December 31, 2013
Assets:
 
 
 
Real estate assets, net:
 
 
 
Land
$
1,367

 
$
478

Rental residential properties, net
6,488

 
3,092

Real estate owned
121,895

 
32,332

 
129,750

 
35,902

Real estate assets held for sale
4,224

 
1,186

Mortgage loans
1,766,142

 
1,207,163

Cash and cash equivalents
48,022

 
115,988

Restricted cash
7,334

 
5,878

Accounts receivable
681

 
1,428

Related party receivables
10,444

 
9,260

Investment in affiliate
18,000

 
18,000

Deferred leasing and financing costs, net
1,808

 
2,293

Prepaid expenses and other assets
353

 
1,542

Total assets
$
1,986,758

 
$
1,398,640

Liabilities:
 
 
 
Repurchase agreements
$
699,950

 
$
602,382

Accounts payable and accrued liabilities
5,835

 
4,952

Related party payables
12,540

 
5,879

Total liabilities
718,325

 
613,213

Commitments and contingencies (Note 6)


 


Equity:
 
 
 
Common stock, $.01 par value, 200,000,000 authorized shares; 57,114,763 and 42,286,669 shares issued and outstanding, at March 31, 2014 and December 31, 2013, respectively
571

 
423

Additional paid-in capital
1,226,927

 
758,584

Retained earnings
40,935

 
26,420

Total equity
1,268,433

 
785,427

Total liabilities and equity
$
1,986,758

 
$
1,398,640


See accompanying notes to consolidated financial statements.




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(table of contents)

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


Three months ended March 31, 2014
 
Three months ended March 31, 2013
 
 
 
 
Rental revenues and net gain on investments:
 
 
 
Rental revenues
$
69

 
$
—

Net unrealized gain on mortgage loans
65,130

 
1,128

Net realized gain on mortgage loans
9,321

 
387

Total rental revenues and net gain on investments
74,520

 
1,515

Expenses:
 
 
 
Residential property operating expenses
1,050

 
—

Real estate depreciation and amortization
48

 
—

Mortgage loan servicing costs
11,437

 
392

Interest expense
5,708

 
42

Related party general and administrative
12,632

 
987

General and administrative
1,392

 
1,078

Total expenses
32,267

 
2,499

Other income
108

 
—

Income before income taxes
42,361

 
(984
)
Income tax expense
448

 
—

Net income (loss)
$
41,913

 
$
(984
)
 
 
 
 
Earnings (loss) per share of common stock – basic:
 
 
 
Earnings (loss) per basic share
$
0.78

 
$
(0.13
)
Weighted average common stock outstanding – basic
53,436,108

 
7,810,708

Earnings (loss) per share of common stock – diluted:
 
 
 
Earnings (loss) per diluted share
$
0.77

 
$
(0.13
)
Weighted average common stock outstanding – diluted
54,086,959

 
7,810,708

 
 
 
 
Dividends declared per common share
$
0.48

 
$
—


See accompanying notes to consolidated financial statements.



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(table of contents)


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

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

$
423

$
758,584

$
26,420

$
785,427

Issuance of common stock, including stock option exercises
14,828,094

148

483,358

—

483,506

Cost of issuance of common stock
—

—

(15,071
)
—

(15,071
)
Dividends on common stock
—

—

—

(27,398
)
(27,398
)
Share-based compensation
—

—

56

—

56

Net income (loss)
—

—

—

41,913

41,913

March 31, 2014
57,114,763

$
571

$
1,226,927

$
40,935

$
1,268,433


 
Common stock
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Accumulated deficit
Total equity
December 31, 2012
7,810,708

$
78

$
99,922

$
(89
)
$
99,911

Net loss
—

—

—

(984
)
(984
)
March 31, 2013
7,810,708

$
78

$
99,922

$
(1,073
)
$
98,927


See accompanying notes to consolidated financial statements.
 




4

(table of contents)

Altisource Residential Corporation
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Three months ended March 31, 2014
 
Three months ended March 31, 2013
Operating activities:
 
 
 
Net income (loss)
$
41,913

 
(984
)
Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(65,130
)
 
(1,128
)
Net realized gain on mortgage loans
(9,321
)
 
(387
)
Net realized gain on real estate
(55
)
 
—

Real estate depreciation, amortization and other non-cash charges
403

 
—

Share-based compensation
56

 
—

Amortization of deferred financing costs
608

 
30

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
747

 
—

Related party receivables
63

 
231

Prepaid expenses and other assets
(145
)
 
(186
)
Accounts payable and accrued liabilities
633

 
475

Related party payables
6,661

 
585

Net cash used in operating activities
(23,567
)
 
(1,364
)
Investing activities:
 
 
 
Investment in mortgage loans
(611,357
)
 
(88,257
)
Investment in real estate
—

 
(278
)
Investment in renovations
(447
)
 
—

Real estate tax advances to borrowers
(6,259
)
 
—

Mortgage loan dispositions
32,775

 
88

Mortgage loan payments
3,129

 
—

Disposition of real estate
734

 
—

Change in restricted cash
(1,456
)
 
—

Net cash used in investing activities
(582,881
)
 
(88,447
)
Financing activities:
 
 
 
Issuance of common stock, including stock option exercises
487,041

 
—

Cost of issuance of common stock
(15,071
)
 
(73
)
Dividends on common stock
(27,398
)
 
—

Payment of tax withholdings on exercise of stock options
(3,535
)
 
—

Proceeds from repurchase agreement
127,664

 
12,926

Repayments of repurchase agreement
(30,096
)
 
—

Payment of deferred financing costs
(123
)
 
(1,100
)
Net cash provided by financing activities
538,482

 
11,753

Net increase/(decrease) in cash and cash equivalents
(67,966
)
 
(78,058
)
Cash and cash equivalents as of beginning of the period
115,988

 
100,005

Cash and cash equivalents as of end of the period
$
48,022

 
$
21,947



 
 
Supplemental disclosure of cash flow information:

 
 
Cash paid for interest
$
4,736

 
$
12

Transfer of mortgage loans to real estate owned
$
96,528

 
$
156

Changes in accrued equity issuance costs
$
183

 
$
370

Changes in receivables from mortgage loan dispositions, payments and real estate tax advances to borrowers, net
$
1,247

 
$
1,858


See accompanying notes to consolidated financial statements.

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(table of contents)

Altisource Residential Corporation
Notes to Consolidated Financial Statements
March 31, 2014
(Unaudited)

1. Organization and basis of presentation

Altisource Residential Corporation is a Maryland REIT formed in 2012. We are focused on acquiring, owning and managing single-family rental properties throughout the United States. We acquire our rental properties primarily through the acquisition of sub-performing and non-performing mortgage loan portfolios, which is a differentiated approach that we believe strategically positions us to take advantage of market opportunities better than market participants that are solely focused on real estate-owned (“REO”) acquisitions. We conduct substantially all of our activities through our wholly owned subsidiary Altisource Residential, L.P.

Our principal objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation. 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 also created a large supply of distressed mortgage loans for sale in the market. We believe we have an opportunity to acquire single-family properties through the acquisition of sub-performing and non-performing loan portfolios at attractive valuations. We expect our integrated approach of acquiring sub-performing and non-performing residential mortgage loans and converting them to rental properties will enable us to compete more effectively for attractive investment opportunities.

On December 21, 2012, which we refer to as the “separation date,” we separated from Altisource Portfolio Solutions S.A.
("Altisource") and became a stand-alone publicly traded company through the contribution to us by Altisource of $100.0 million of equity capital and the distribution of our shares of common stock to the stockholders of Altisource. On the separation date, we entered into long-term service agreements with Ocwen Financial Corporation ("Ocwen"), a leading residential mortgage loan servicer, and with Altisource, a leading provider of real estate and mortgage portfolio management, asset recovery and customer relationship management services. We believe that our access to Ocwen’s servicing expertise and multifaceted resolution methodologies helps us maximize the value of our loan portfolios and provides us with a competitive advantage over other companies with a similar focus. We also believe that our relationship with Altisource and access to its nationwide vendor network enables us to competitively bid on large sub-performing or non-performing residential mortgage loan portfolios with assets dispersed throughout the United States.

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

On the separation date, we entered into long-term service agreements with Ocwen, a leading mortgage loan servicer, and Altisource, a leading provider of real estate and mortgage portfolio management, asset recovery and customer relationship management services.

Since December 21, 2012, we have completed three public equity offerings with aggregate net proceeds of approximately $1.1 billion. On May 1, 2013, we completed a public offering of 17,250,000 shares of common stock at $18.75 per share and received net proceeds of approximately $309.5 million. On October 1, 2013, we completed our second public offering of 17,187,000 shares of common stock at $21.00 per share and received net proceeds of $349.4 million. On January 22, 2014, we completed our third public offering of 14,200,000 shares of common stock at $34.00 per share and received net proceeds of approximately $467.6 million.

On March 22, 2013, September 12, 2013 and September 23, 2013, we entered into three separate repurchase agreements to finance the acquisition and ownership of residential mortgage loans and REO properties. In December 2013, we increased the maximum aggregate funding available under our repurchase agreements by an additional $325.0 million. The maximum aggregate funding available to us under these repurchase agreements as of March 31, 2013 was $750.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. On April 21, 2014, we increased the aggregate maximum borrowing capacity under the repurchase agreement dated as of March 22, 2013 from $100.0 million to $200.0 million, subject to certain sublimits. The maturity date of the repurchase agreement was also extended to April 20, 2015 subject to an additional one-year extension at the option of the lender. The repurchase agreement dated September 12, 2013, as

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(table of contents)

amended, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016 and includes a provision that, beginning in the nineteenth month, we will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of the eighteenth month. The repurchase agreement dated September 23, 2013, as amended, has an aggregate funding capacity of $400.0 million and matures on March 23, 2015. All obligations under the repurchase agreements are fully guaranteed by us. As of March 31, 2014, an aggregate of $700.0 million was outstanding under our repurchase agreements.

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

Basis of presentation and use of estimates

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

The unaudited consolidated financial statements and accompanying unaudited consolidated financial information, in our opinion, contain all adjustments (including normal recurring accruals) necessary for a fair presentation of our financial position, results of operations and cash flows. We have omitted certain notes and other information from the interim consolidated financial statements presented in this Quarterly Report as permitted by SEC rules and regulations. These consolidated financial statements should be read in conjunction with our 2013 annual report on Form 10-K.

Recently issued accounting standards

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

Acquisitions

During the three months ended March 31, 2014, we completed the acquisition of the following portfolios of non-performing residential mortgage loans:

•On January 2, 2014, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value of underlying properties of $94 million.
•On January 28, 2014, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value of underlying properties of $7 million.
•On January 31, 2014, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value of underlying properties of $792 million.
•On February 28, 2014, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value of underlying properties of $8 million

During the three months ended March 31, 2013, we completed the acquisition of the following portfolios of non-performing residential mortgage loans:


7


•On February 14, 2013, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value of underlying properties of $94 million.
•On March 21, 2013, a portfolio of first lien residential mortgage loans, substantially all of which were non-performing, having aggregate market value underlying properties of $39 million.

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

During the three months ended March 31, 2014 and 2013, we expensed $0.5 million and $0.4 million, respectively, for due diligence costs related to these and other transactions.

Transfer of mortgage loans to real estate owned

During the three months ended March 31, 2014 and 2013, we transferred 637 mortgage loans and one mortgage loan, respectively, at an aggregate fair value based on broker price opinions ("BPOs") of $96.5 million and $0.2 million, respectively, to real estate owned. Such transfers occur when title to the real estate has been received by us.

Dispositions

During the three months ended March 31, 2014 and 2013, we disposed of 116 and 10 mortgage loans, respectively, primarily through short sales and foreclosure sales. In connection with these dispositions, we generated $9.3 million and $0.4 million, respectively, of net realized gains on mortgage loans.


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3. Real estate assets, net

Acquisitions

During the three months ended March 31, 2014, we did not acquire any REO properties as part of our portfolio acquisitions. During the three months ended March 31, 2013, we acquired six residential properties. These REO properties were acquired as part of the loan portfolio acquisitions described in Note 2. The aggregate purchase price attributable to these acquired REO properties was $0.3 million.

Real estate held for use

As of March 31, 2014, we had 852 REO properties held for use. Of these properties, 35 had been rented, 17 were being listed for rent and 48 were in various stages of renovation. With respect to the remaining 752 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 and title transferred to us. 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 March 31, 2013, we had seven REO properties held for use, all of which were in the process of our 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 many instances after renovations are made to optimize the sale proceeds.

Real estate held for sale

As of March 31, 2014, we classified 44 REO properties having an aggregate carrying value of $4.2 million as real estate held for sale as they do not meet our residential rental property investment criteria. As of March 31, 2013, we had no real estate held for sale. None of these REO properties have any operations; therefore, we are not presenting discontinued operations related to these properties.

Dispositions

During the three months ended March 31, 2014, we disposed of two residential properties. We did not dispose of any residential properties during the three months ended March 31, 2013.


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4. Fair value of financial instruments

The following table sets forth the financial assets and liabilities that we measure at fair value by level within the fair value hierarchy as of March 31, 2014 and December 31, 2013 ($ in thousands):

Level 1
Level 2
Level 3

Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
March 31, 2014
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
1,766,142

Nonrecurring basis (assets)
 
 
 
Real estate assets held for sale
 
 
$
4,928

Transfer of mortgage loans to real estate owned
$
—

$
—

$
96,528

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

$
699,950

$
—

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

$
—

$
1,207,163

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

$
—

$
1,520

Transfer of mortgage loans to real estate owned
$
—

$
—

$
31,014

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

$
602,382

$
—


We have not transferred any assets from one level to another level during the three months ended March 31, 2014 or December 31, 2013.

The carrying values of our cash and cash equivalents, restricted cash, related party receivables, accounts payable and accrued liabilities, related party payables and investment in NewSource are equal to or approximate fair value. The fair value of 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 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 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 March 31, 2014
 
Three months ended March 31, 2013
Mortgage loans
 
 
 
Beginning balance at December 31
$
1,207,163

 
$
—

Investment in mortgage loans
612,508

 
88,257

Net unrealized gain on mortgage loans
65,130

 
1,128

Net realized gain on mortgage loans
9,321

 
387

Mortgage loan dispositions and payments
(39,458
)
 
(1,946
)
Real estate tax advances to borrowers
8,006

 
—

Transfer of mortgage loans to real estate owned
(96,528
)
 
(156
)
Ending balance at March 31
$
1,766,142

 
$
87,670

 
 
 
 
Net unrealized gain on mortgage loans held
$
38,197

 
$
1,128



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The following table sets forth the fair value of our mortgage loans, the related unpaid principal balance and market value of underlying properties by delinquency status as of March 31, 2014 and December 31, 2013 ($ in thousands):
 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties
March 31, 2014
 
 
 
 
Current
329

$
44,280

$
86,860

$
76,452

30
25

2,838

5,238

4,995

60
20

2,446

4,046

4,068

90
2,120

326,308

566,858

483,245

Foreclosure
9,015

1,390,270

2,386,927

1,945,606

Mortgage loans
11,509

$
1,766,142

$
3,049,929

$
2,514,366

December 31, 2013
 
 
 
 
Current
238

$
31,649

$
60,051

$
52,506

30
26

2,087

4,492

3,763

60
23

3,376

5,683

4,738

90
1,555

245,024

419,836

355,451

Foreclosure
6,212

925,027

1,609,546

1,310,439

Mortgage Loans
8,054

$
1,207,163

$
2,099,608

$
1,726,897


The 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 March 31, 2014 and December 31, 2013:

Input
March 31, 2014
December 31, 2013
Discount rate
15.0%
15.0%
Annual change in home pricing index  
-0.3% to 7.6%
-0.3% to 7.6%
Loan resolution probabilities — modification
0% to 22.3%
0% to 22.3%
Loan resolution probabilities — rental
0% to 100.0%
0% to 100.0%
Loan resolution probabilities — liquidation
0% to 100.0%
0% to 100.0%
Loan resolution timelines (in years)
0.1 to 5.3
0.1 - 5.8
Value of underlying properties
$3,000 - $6,343,000
$3,000 - $3,550,000


5. Repurchase agreements

Our operating partnership and certain of its Delaware Statutory Trust subsidiaries, as applicable, have entered into master repurchase agreements with major financial institutions. The purpose of these repurchase agreements is to finance the acquisition and ownership of mortgage loans and REO properties in our portfolio. We have effective control of the assets associated with these agreements and therefore have concluded these are financing arrangements. As of March 31, 2014, the weighted average annualized interest rate on borrowings under our repurchase agreements was 3.08%, excluding amortization of deferred financing costs. The following table sets forth data with respect to our repurchase agreements as of March 31, 2014 and December 31, 2013 ($ in thousands):

11
(table of contents)

 
Maximum borrowing capacity
Book value of collateral
Amount outstanding
March 31, 2014
 
 
 
Repurchase agreement due April 21, 2014(1)
$
100,000

$
158,576

$
76,800

Repurchase agreement due March 23, 2015
400,000

678,779

400,000

Repurchase agreement due March 11, 2016
250,000

396,916

223,150

 
$
750,000

$
1,234,271

$
699,950

December 31, 2013
 
 
 
Repurchase agreement due April 21, 2014(1)
$
100,000

$
166,350

$
85,364

Repurchase agreement due March 23, 2015
$
400,000

$
634,234

$
398,602

Repurchase agreement due March 11, 2016
$
250,000

$
205,328

$
118,416

 
$
750,000

$
1,005,912

$
602,382

________________
(1) This repurchase agreement was amended to increase the maximum borrowing capacity and extend the term to April 20, 2015. See Note 12 - Subsequent events.

Under the terms of each repurchase agreement, as collateral for the funds drawn thereunder, subject to certain conditions, our operating partnership will sell to the applicable lender equity interests in the Delaware statutory trust subsidiary that owns the applicable underlying mortgage assets on our behalf, or the trust will sell directly such underlying mortgage assets. In the event the lender determines the value of the collateral has decreased, it 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 its repurchase facilities with cash.

The repurchase agreements require us to maintain various financial and other covenants, including maintaining positive earnings, a minimum adjusted tangible net worth, a maximum ratio of indebtedness to adjusted tangible net worth and specified levels of unrestricted cash as well as restrictions on net losses in excess of specified amounts. 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.

6. Commitments and contingencies
 
Litigation, claims and assessments

We are not currently the subject of any material legal or regulatory proceedings, and no material legal or regulatory proceedings have been threatened against us.


12
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7. Related party transactions

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

 
Three months ended March 31, 2014
Three months ended March 31, 2013
Counter-party
Consolidated Statements of Operations location
Residential property operating expenses
$
1,050

$
—

Altisource
Residential property operating expenses
Mortgage loan servicing costs
10,490

392

Ocwen
Mortgage loan servicing costs
Due diligence and unsuccessful deal costs
111

183

Altisource
Related party general and administrative expenses
Expense reimbursements
1,469

895

AAMC
Related party general and administrative expenses
Management incentive fee
10,911

—

AAMC
Related party general and administrative expenses

During the three months ended March 31, 2013, we acquired a portfolio from Ocwen of non-performing first lien residential mortgage loans having aggregate market value of underlying properties of $94 million. The aggregate purchase price for this portfolio was $64 million.



13
(table of contents)

8. Share-based payments

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

Our directors each receive annual grants of restricted stock equal to $45,000 based on the market value of our common stock at the time of the annual stockholders meeting. This restricted stock vests and is issued after a one-year service period subject to each director attending at least 75% of the Board and committee meetings. No dividends are paid on the shares until the award is issued. We recorded $0.1 million and $0.1 million of compensation expense related to these grants for the three months ended March 31, 2014 and 2013. As of March 31, 2014, we had a nominal amount of unrecognized share-based compensation cost remaining with respect to the director grants. During the three months ended March 31, 2014 and 2013, we granted no shares to directors and, therefore, had no share-based payments.

9. Income taxes

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

Based on our 2013 taxable income of $17.7 million, the aggregate minimum distribution to stockholders required to maintain our REIT status was $16.0 million in 2013. On February 20, 2014, our Board of Directors declared a cash dividend of $0.08 per share of common stock, which was paid on March 10, 2014 to all stockholders of record as of the close of business on March 3, 2014. This additional dividend, an aggregate of $4.5 million, was intended to satisfy the requirement that a REIT must distribute at least 90% of its annual REIT taxable income to its stockholders and will be treated as a 2013 distribution for REIT qualification purposes. Dividends declared and paid per share of common stock aggregated $0.35 for the year ended December 31, 2013, or $13.1 million. On March 6, 2014, our Board of Directors declared its quarterly cash dividend of $0.40 per share of common stock, which was paid on March 24, 2014 to all stockholders of record as of the close of business on March 17, 2014. We did not declare or pay any dividends during the three months ended March 31, 2013.

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

We recorded federal and state income tax expense on the consolidated operations for the three months ended March 31, 2014. As a REIT, we may also be subject to federal excise taxes if we engage in certain types of transactions.

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


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(table of contents)

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 March 31, 2014
 
Three months ended March 31, 2013
Numerator
 
 
 
Net income (loss)
$
41,913

 
$
(984
)
 
 
 
 
Denominator
 
 
 
Weighted average common stock outstanding – basic
53,436,108

 
7,810,708

Stock options using the treasury method
638,761

 
—

Restricted stock
12,090

 
—

Weighted average common stock outstanding – diluted
54,086,959

 
7,810,708

 
 
 
 
Earnings (loss) per basic share
$
0.78

 
$
(0.13
)
Earnings (loss) per diluted share
$
0.77

 
$
(0.13
)
 
 
 
 
Stock options excluded from the calculation of diluted earnings per share because inclusion would have been anti-dilutive
—

 
1,019,424


11. Segment information

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

12. Subsequent events

On April 21, 2014, we increased the aggregate maximum borrowing capacity under the repurchase agreement, dated as of March 22, 2013 with Credit Suisse First Boston Mortgage Capital LLC from $100.0 million to $200.0 million subject to certain sublimits. The maturity date of the repurchase agreement was also extended to April 20, 2015 subject to an additional one-year extension at the option of the lender. All other terms and conditions of the repurchase agreement remain the same in all material respects. The obligations under the repurchase agreement continue to be fully guaranteed by us.


15

(table of contents)

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

Overview

We are a Maryland REIT focused on acquiring and managing single-family rental properties by acquiring portfolios of sub-performing and non-performing residential mortgage loans throughout the United States. We believe that the events affecting the housing and mortgage market in recent years have created a significant rental demand for single-family properties. These events have also created a large supply of distressed mortgage loans for sale in the market. We therefore believe we have an opportunity to acquire single-family properties through the acquisition of sub-performing and non-performing loan portfolios at attractive valuations. We expect our integrated approach of acquiring sub-performing and non-performing residential mortgage loans and converting them to rental properties will enable us to compete more effectively for attractive investment opportunities.

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

During first quarter 2014, we acquired portfolios consisting of an aggregate of 4,207 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $1.1 billion and an aggregate market value of underlying properties of $901 million. The aggregate purchase price for these portfolios was $612.8 million.

During 2013 and the first quarter of 2014, we modified an aggregate of 182 mortgage loans, converted an aggregate of 862 mortgage loans into REO properties, disposed of an aggregate of 327 mortgage loans through short sale, refinancing or other liquidation events.

Following the above-referenced transactions, as of March 31, 2014, our portfolio consisted of 11,509 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $3.0 billion and an aggregate market value of underlying properties of $2.5 billion. We also had 896 REO properties with an aggregate carrying value of $134.0 million, of which 35 REO properties were rented and 65 were being listed for rent or prepared for rental.

In March 2014, we agreed to acquire a portfolio consisting of 915 residential mortgage loans and REO properties with an aggregate UPB of approximately $221.2 million and aggregate property values of $180.0 million. The UPB for the REO properties is based on the last UPB of each mortgage loan prior to its conversion to REO. Subject to satisfactory due diligence results and final agreement on terms, we anticipate consummating this transaction in the second quarter of 2014. There can be no assurance that we will acquire this portfolio in whole or in part on a timely basis or at all.

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

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

Observations on Current Market Opportunities

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


16

(table of contents)


Metrics Affecting Our Results

Revenues

Our revenues primarily consist of the following:

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

ii.
Net unrealized gains from the change in fair value of loans. On a monthly basis we adjust our loans to fair value by evaluating the fair value of the underlying property, the expected timeline and probabilities of loan resolution and expected market yield. The change in fair value of loans is recorded in our statement of operations as net unrealized gain on mortgage loans. We employ various loan resolution methodologies with respect to our residential mortgage loans including loan modification, collateral resolution and collateral disposition. The manner in which a sub-performing or non-performing loan is resolved will impact the amount and timing of these net unrealized gains. We expect the timelines for each of the different processes to vary significantly, and final resolution could take up to 24 months or longer from the loan acquisition date. The exact nature of resolution will be dependent on a number of factors that are beyond our control, including borrower willingness, property value, availability of refinancing, interest rates, conditions in the financial markets, the regulatory environment and other factors.

iii.
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.

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

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

Expenses

Our expenses primarily consist of loan servicing fees and advances, rental property operating expenses, depreciation and amortization, general and administrative expenses, expense reimbursement, incentive management fees and interest expense. From time to time, expenses also may include impairments of assets. Loan servicing fees and advances are expenses paid to Ocwen to service our acquired loans and for real estate insurance and other corporate advances. Rental property operating expenses are expenses associated with our ownership and operation of rental properties including expenses such as Altisource's inspection, property preservation and renovation fees, property management fees, turnover costs, property taxes, insurance and

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(table of contents)

HOA dues. Depreciation and amortization is a non-cash expense associated with the ownership of real estate and generally remains relatively consistent each year in relation to our asset levels since we depreciate our properties on a straight-line basis over a fixed life. Interest expense consists of the costs to borrow money in connection with our debt financing of our portfolios. General and administrative expenses consist of the costs related to the general operation and overall administration of our business. Expense reimbursement consists primarily of employee salaries of AAMC in direct correlation to the services they provide on our behalf and other personnel costs and corporate overhead. The incentive management fees consist of compensation due to AAMC, based on the amount of cash available for distribution to our stockholders for each period.

Other factors affecting our consolidated results

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

Acquisitions

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

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

Financing

Our ability to grow our business by acquiring sub-performing and non-performing loans 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 generally will need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our stockholders. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities.

Our taxable income is triggered primarily by material changes in the economic status of loans, such as a sale of the loan, modification of the loan from a non-performing status to a performing status or conversion of the loan to REO. We expect to convert our taxable gains on REO dispositions and loan modifications within a short period of time to cash gains. Our taxable gains on the remaining loans that we expect to convert to rental properties can be funded through a higher advance rate on the increased value when a property becomes rented.

Resolution Activities


18

(table of contents)

 
First quarter 2013
 
First quarter 2014
Mortgage Loans
 
 
 
Beginning balance
—

 
8,054

Acquisitions
684

 
4,207

Dispositions
(10
)
 
(116
)
Conversions to REO
(1
)
 
(637
)
Reversions to mortgage loans (1)
—

 
1

Ending balance
673

 
11,509

 
 
 
 
Modifications
—

 
81

 
 
 
 
Real Estate Owned
 
 
 
Beginning balance
—

 
262

Acquisitions
6

 
—

Dispositions
—

 
(2
)
Conversions to REO
1

 
637

Reversions to mortgage loans
—

 
(1
)
Ending balance
7

 
896

 
 
 
 
Leased
—

 
35

Renovations complete
—

 
17

Renovations in process
—

 
48

Evaluating strategy/held for sale
7

 
796

 
7

 
896

(1) Subsequent to the foreclosure sale, we may be notified that the foreclosure sale was invalidated for certain reasons including bankruptcy.

Portfolio size

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

Current Portfolio
 
During 2013, we acquired portfolios of residential mortgage loans, substantially all of which were non-performing, consisting of an aggregate of 8,491 mortgage loans and 40 REOs with approximately $2.2 billion of UPB and approximately $1.8 billion in aggregate market value of underlying properties.


19

(table of contents)

On January 2, 2014, we acquired a portfolio of residential mortgage loans, substantially all of which were non-performing, consisting of an aggregate of 650 loans with approximately $121 million of UPB and approximately $94 million in aggregate market value of underlying properties.

On January 28, 2014, we acquired a portfolio of residential mortgage loans, substantially all of which were non-performing, consisting of an aggregate of 66 loans with approximately $7 million of UPB and approximately $7 million in aggregate market value of underlying properties.

On January 31, 2014, we acquired a portfolio of residential mortgage loans, substantially all of which were non-performing, consisting of an aggregate of 3,421 loans with approximately $988 million of UPB and approximately $792 million in aggregate market value of underlying properties.

On February 28, 2014, we acquired a portfolio of residential mortgage loans, substantially all of which were non-performing, consisting of an aggregate of 70 loans with approximately $8 million of UPB and approximately $8 million in aggregate market value of underlying properties.

Throughout this quarterly report, all unpaid principal balance and market value amounts for the portfolios we have acquired are provided as of the applicable “cut-off” date for each transaction unless otherwise indicated. We refer to the assets underlying our completed acquisitions through March 31, 2014 as our “Current Portfolio.”

Our mortgage loans become REO properties when we have obtained title to the property through completion of the foreclosure process. Additionally, some of the portfolios we purchase may, from time to time, contain a small number of residential mortgage loans that have already been converted to REO. As of March 31, 2014, we had 896 REO properties. The aggregate fair value of these 896 REO properties as of March 31, 2014 was approximately $134.0 million, or approximately 7% of the total fair value of our Current Portfolio.

As of March 31, 2014, 35 of our 896 REO properties had been rented and were occupied by tenants, 17 were being listed for rent, 48 were in varying stages of renovation and 44 were being held for sale. With respect to the remaining 752 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 and title transferred to us. 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 March 31, 2013, we had seven REO properties held for use and 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 some instances after renovations are made to optimize the sale proceeds.


20

(table of contents)

The following table sets forth a summary of our REO properties as of March 31, 2014 ($ in thousands):
State
Number of properties
Carrying value (1)
Weighted average age (2)
Alabama
3

$
775

15

Arizona
34

6,010

19

Arkansas
3

369

42

California
106

27,791

40

Colorado
9

1,561

22

Connecticut
5

935

49

Delaware
3

485

29

Florida
193

27,204

23

Georgia
12

1,670

26

Hawaii
1

67

24

Idaho
1

175

30

Illinois
101

14,802

40

Indiana
30

3,327

38

Kansas
11

942

49

Kentucky
8

802

39

Louisiana
6

587

41

Maine
5

587

68

Maryland
12

1,901

47

Massachusetts
6

856

93

Michigan
30

3,457

43

Minnesota
23

4,085

37

Missouri
4

525

17

Nebraska
2

212

103

Nevada
9

1,497

20

New Hampshire
1

158

33

New Jersey
13

1,623

84

New Mexico
17

1,729

22

New York
7

1,318

56

North Carolina
75

8,189

26

Ohio
34

3,808

42

Oklahoma
7

772

23

Oregon
2

458

25

Pennsylvania
18

2,506

50

South Carolina
8

762

20

Tennessee
6

573

33

Texas
15

1,916

23

Utah
9

1,488

34

Vermont
1

185

113

Virginia
4

973

30

Washington
2

256

38

West Virginia
2

416

41

Wisconsin
58

6,222

54

Total
896

$
133,974

35

_____________

21

(table of contents)

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

The remainder of our Current Portfolio consists of a diversified pool of residential mortgage loans with the underlying properties located across the United States. The aggregate purchase price of our Current Portfolio for acquisitions completed through March 31, 2014 was 68.0% of the aggregate market value, as determined by the most recent BPO provided by the applicable seller for each property in the respective portfolio as of its cut-off date. We cannot assure you that the BPOs accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.

The table below provides a summary of the residential mortgage loans in our Current Portfolio based on the respective UPB and respective values as of March 31, 2014 ($ in thousands):

Location
Loan count
Carrying value (1)
UPB
Market value of underlying properties (2)
Weighted average market LTV (3)

Alabama
66

$
6,462

$
10,449

$
8,691

200.3
%
Alaska
3

678

687

963

76.2
%
Arizona
220

37,823

59,479

48,286

135.6
%
Arkansas
62

4,068

7,221

5,891

141.0
%
California
1679

517,391

755,931

686,525

123.6
%
Colorado
70

12,118

16,289

15,594

114.3
%
Connecticut
117

15,066

30,907

24,981

149.2
%
Delaware
58

6,918

11,494

9,801

132.4
%
Dist. of Columbia
39

9,291

12,001

13,049

104.9
%
Florida
2176

282,668

528,190

381,094

157.6
%
Georgia
344

32,241

59,391

43,529

154.2
%
Hawaii
47

11,502

20,890

20,210

110.8
%
Idaho
29

3,719

5,973

4,898

135.1
%
Illinois
516

56,715

122,137

85,683

205.2
%
Indiana
369

28,489

44,432

40,775

120.6
%
Iowa
11

693

1,262

986

134.6
%
Kansas
28

2,329

3,374

3,138

122.0
%
Kentucky
92

7,420

11,256

10,254

119.5
%
Louisiana
22

2,249

3,454

3,578

106.7
%
Maine
27

3,532

5,885

5,421

119.1
%
Maryland
538

72,926

147,248

111,326

151.2
%
Massachusetts
257

40,483

73,061

65,146

126.2
%
Michigan
123

11,946

20,708

16,130

178.7
%
Minnesota
76

10,249

16,593

13,613

134.2
%
Mississippi
29

2,228

3,697

3,163

133.6
%
Missouri
113

7,028

13,883

10,165

172.8
%
Montana
5

512

824

720

121.5
%
Nebraska
10

1,204

1,860

1,586

121.1
%
Nevada
221

35,436

65,205

44,944

164.4
%
New Hampshire
19

2,634

4,497

3,992

124.3
%
New Jersey
927

128,431

283,001

208,227

162.3
%
New Mexico
99

8,090

14,328

12,421

123.6
%
New York
573

99,085

195,463

181,247

124.2
%
North Carolina
347

32,630

51,785

44,161

128.9
%

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North Dakota
1

99

123

138

89.5
%
Ohio
181

14,065

25,850

21,019

155.1
%
Oklahoma
33

3,379

4,732

4,641

108.3
%
Oregon
110

17,874

31,342

28,396

117.3
%
Pennsylvania
379

39,079

70,061

56,451

140.4
%
Puerto Rico
2

99

224

251

118.3
%
Rhode Island
97

7,811

23,095

12,324

221.7
%
South Carolina
236

21,117

36,318

29,383

139.2
%
South Dakota
5

432

743

695

107.8
%
Tennessee
101

11,146

16,574

15,102

121.6
%
Texas
272

28,352

37,008

38,522

103.5
%
Utah
113

17,685

24,905

23,239

113.9
%
Vermont
9

900

1,606

1,622

101.8
%
Virginia
105

23,000

34,766

32,359

118.5
%
Washington
396

73,859

114,298

101,408

123.3
%
West Virginia
7

637

1,076

858

134.2
%
Wisconsin
149

12,153

23,999

17,499

169.8
%
Wyoming
1

$
201

$
354

$
271

131.0
%
Total mortgage loans
11,509

$
1,766,142

$
3,049,929

$
2,514,366

142.0
%
_____________
(1)
The carrying value of an asset is based on our fair value model. The significant unobservable inputs used in the fair value measurement of our mortgage loans are discount rates, forecasts of future home prices, alternate resolution probabilities and timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. For a more complete description of the fair value measurements and the factors that may significantly affect the carrying value of our assets, please see Note 4 to our consolidated financial statements.
(2)
Market value is based on the most recent BPO provided to us by the applicable seller for each property in the respective portfolio as of its cut-off date or an updated BPO received since the acquisition was completed. Although we performed diligence on a representative sample of the properties in each portfolio to confirm the accuracy of the BPOs provided to us by the sellers, we cannot assure you that the BPOs set forth in this table accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.
(3)
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 months ended March 31, 2014 versus March 31, 2013

Rental revenues

Rental revenues increased to $69 thousand for the three months ended March 31, 2014 from zero rental revenue for the three months ended March 31, 2013. We expect to generate increasing rental revenues for the remainder of 2014 upon renovating, listing and renting additional residential rental properties. Our rental revenues will be dependent primarily on occupancy levels and rental rates for our residential rental properties. Because our lease terms generally are expected to be one to two years, our occupancy levels and rental rates will be highly dependent on localized residential rental markets.

Net unrealized gain on mortgage loans

Our net unrealized gains on mortgage loans increased to $65.1 million for the three months ended March 31, 2014 from $1.1 million for the three months ended March 31, 2013. The increase was primarily related to an increase in the number of loans . The net unrealized gains for the three months ended March 31, 2014 can be broken down into the following components:

•
First, we recognized $23.6 million for the three months ended March 31, 2014 in unrealized gains driven by a material change in loan status. We recognized a nominal amount in unrealized gains due to a change in loan status for the three months ended March 31, 2013. During the three months ended March 31, 2014 and 2013, respectively, we converted 637 mortgage loans and one mortgage loan to REO status, respectively. Upon conversion of these mortgage loans to

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REO, we marked these properties to the most recent market value (less estimated selling costs in the case of REO held for sale); and
•
Second, we recognized $41.6 million and $1.1 million in unrealized gains for the three months ended March 31, 2014 and 2013, respectively, in unrealized gains from the net increase in the fair value of loans during the period subsequent to acquisition. Adjustments to the fair value of loans after acquisition represent a change in the expected time required to complete the foreclosure process, among other factors. The reduction in time required 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 increase the fair value of the loans. The increase in the value of the loans is recognized in net unrealized gain on mortgage loans in our consolidated statements of operations.

Through our acquisitions, our loan portfolio has grown from 8,054 loans at December 31, 2013 to 11,509 loans at March 31, 2014. The fair value of mortgage loans is based on a number of factors which are difficult to predict and may be subject to adverse changes in value depending on the financial condition of borrowers, as well as geographic, economic, market and other conditions. Therefore, we may experience unrealized losses on our mortgage loans in the future.

Net realized gain on mortgage loans

Net realized gains on mortgage loans increased to $9.3 million for the three months ended March 31, 2014 from $0.4 million for the three months ended March 31, 2013. We disposed of 116 mortgage loans in the three months ended March 31, 2014 and 10 mortgage loans in the three months ended March 31, 2013, primarily from short sales and foreclosure sales.

Residential property operating expenses

We incurred $1.0 million of residential property operating expenses for the three months ended March 31, 2014 compared to no residential property operating expenses for the same period in 2013. We expect to incur increasing residential property operating expenses in the remainder of 2014 upon converting our mortgage loans to and owning residential properties. Our residential property operating expenses will be dependent primarily on residential property taxes and insurance, property management fees and repair and maintenance expenditures.

Real estate depreciation and amortization

We incurred a nominal amount of real estate depreciation and amortization for the three months ended March 31, 2014 versus no real estate depreciation for the three months ended March 31, 2013. We expect to incur increasing real estate depreciation and amortization in 2014 upon converting our mortgage loans to, and owning, residential rental properties. Real estate depreciation and amortization are non-cash expenditures which generally are not expected to be indicative of the market value or condition of our residential rental properties.

Mortgage loan servicing costs

We incurred $11.4 million and $0.4 million of mortgage loan servicing costs primarily for servicing and foreclosure fees and advances of residential property insurance and servicer fees for the three months ended March 31, 2014 and 2013, respectively. We incur mortgage loan servicing and foreclosure costs as we service and/or foreclose loans, and we reimburse our servicers for advances relating to the loans for items such as property insurance and HOA dues that are made to protect our investment in the mortgage loans. Our loan servicing costs could be higher than expected in a given period if the number of non-performing mortgage loans exceeds expected levels.

Interest expense

We incurred $5.7 million and a nominal amount of interest expense (including amortization of deferred financing costs) due to borrowings under our repurchase agreement for the three months ended March 31, 2014 and 2013, respectively. The interest rate on our financing under our repurchase agreements is subject to change with changes in the relevant index. Market interest rates are currently at historically low levels, and any increase in market interest rates will cause our contractual interest expense to increase. We also expect our interest expense to increase as our debt increases to fund our ownership of existing and additional portfolios of sub-performing and non-performing loans and rental properties.

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Related party general and administrative

We incurred $12.6 million and $1.0 million of related party general and administrative expenses for the three months ended March 31, 2014 and 2013, respectively. This increase from 2013 to 2014 was primarily due to the $10.9 million incentive management fee due to AAMC under the asset management agreement. We did not have any cash available for distribution in the first quarter of 2013, which resulted in AAMC earning no incentive fee for the quarter. The remaining increase in related party general and administrative expenses related to increased expense reimbursements to AAMC for salaries and benefits attributable to AAMC’s hiring of additional personnel to provide services on behalf of our business.

General and administrative expenses

General and administrative expenses increased to $1.4 million for the three months ended March 31, 2014 from $1.1 million for the three months ended March 31, 2013, primarily due to an increase in professional fees and acquisition costs related to our equity offering in January 2014 and purchases of mortgage loan portfolios.

Liquidity and capital resources

As of March 31, 2014, we had cash and cash equivalents of $48.0 million compared to $116.0 million as of December 31, 2013. Our liquidity reflects our ability to meet our current obligations (including our operating expenses and, when applicable, retirement of, and margin calls relating to, our financing arrangements), purchase additional portfolios of sub-performing and non-performing residential mortgage loans when our Manager identifies them and make distributions to our stockholders. We generally need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our stockholders to qualify as a REIT under the Internal Revenue Code. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities.

We were initially funded with $100.0 million we received from Altisource in connection with our separation on December 21, 2012. Since our separation, our primary sources of liquidity have been proceeds from equity offerings, borrowings under our repurchase agreements, interest we receive from our portfolio of assets, cash generated from loan liquidations and our cash generated from operating results. Based on our current borrowing capacity and leverage ratio, we believe that these sources of liquidity will be sufficient to enable us to meet anticipated short-term (one year) liquidity requirements, including funding our current investment opportunities, paying expenses on our existing loan portfolio, funding distributions to our stockholders, paying fees to AAMC under the asset management agreement and general corporate expenses.

To date, we have used the proceeds of our equity offerings and the available funding under our repurchase agreements to finance the acquisition of our portfolio of residential mortgage loans and REO properties. These equity offerings and repurchase facilities are described below.

Equity Offerings

Since December 21, 2012, we have completed three public equity offerings with aggregate net proceeds of approximately $1.1 billion. On May 1, 2013, we completed a public offering of 17,250,000 shares of common stock at $18.75 per share and received net proceeds of approximately $309.5 million. On October 1, 2013, we completed our second public offering of 17,187,000 shares of common stock at $21.00 per share and received net proceeds of $349.4 million. On January 22, 2014, we completed our third public offering of 14,200,000 shares of common stock at $34.00 per share and received net proceeds of approximately $467.6 million.

Repurchase Facilities

On March 22, 2013, September 12, 2013 and September 23, 2013, we entered into three separate repurchase agreements to finance the acquisition and ownership of residential mortgage loans and REO properties. In December 2013, we increased the maximum aggregate funding available under our repurchase agreements by an additional $325.0 million. On April 21, 2014, we increased the aggregate maximum borrowing capacity under the repurchase agreement dated as of March 22, 2013 from $100.0 million to $200.0 million, subject to certain sublimits. The maturity date of the repurchase agreement was also extended to April 20, 2015 subject to an additional one-year extension at the option of the lender. The repurchase agreement dated September 12, 2013, as amended, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016 and includes a provision that, beginning in the nineteenth month, we will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of the eighteenth month. The repurchase agreement dated September 23, 2013,

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as amended, has an aggregate funding capacity of $400.0 million and matures on March 23, 2015. The maximum aggregate funding available to us under these repurchase agreements is currently $850.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. All obligations under the repurchase agreements are fully guaranteed by us. As of March 31, 2014, an aggregate of $700.0 million was outstanding under our repurchase agreements, and as of April 25, 2014, an aggregate of $692.8 million was outstanding under our repurchase agreements.

Under the terms of each repurchase agreement, as collateral for the funds we draw thereunder, subject to certain conditions, the 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 sell directly such underlying mortgage assets. In the event the lender determines the value of the collateral has decreased, it has the right to initiate a margin call and require us to post additional collateral or to repay a portion of the outstanding borrowings. The price paid by the lender for each underlying mortgage asset we finance under the applicable repurchase agreement is subject to agreement between the lender and us and is based on a percentage of the market value of the underlying mortgage asset and depends on its delinquency status. Our cost of borrowing under the repurchase agreements generally corresponds to LIBOR, or the lender interest at the lender’s cost of funds plus a margin. We are also required to pay certain other customary fees, administrative costs and expenses to maintain and administer the repurchase agreements.

The repurchase agreements, as amended, 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 currently in compliance with the covenants and other requirements with respect to our 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.

We expect our existing business strategy will require additional debt and/or equity financing. Our Manager continues to explore a variety of financing sources to support our growth, including, but not limited to, debt financing through bank warehouse lines of credit, additional and/or amended repurchase agreements, term financing, securitization transactions and additional debt or equity offerings. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or that such efforts will be successful. If we are unable to renew, replace or expand our sources of financing, our business, financial condition, liquidity and results of operations may be materially and adversely affected.

The following table sets forth data with respect to our repurchase agreements as of and for the three months ended March 31, 2014, March 31, 2013 and December 31, 2013 ($ in thousands):

 
Three months ended March 31, 2014
Three months ended March 31, 2013
Three months ended December 31, 2013
Balance at end of period
$
699,950

12,926

$
602,382

Maximum month-end balance outstanding during the period
703,147

12,926

602,382

Weighted average quarterly balance
666,132

1,436

364,665


The repurchase agreements provide for the lenders to finance our portfolio at advance rates (or purchase prices) ranging from 40% to 70% of the “asset value” of the mortgage loans and REO properties. Under the repurchase agreements, the “asset value” generally is an amount that is based on the market value of the mortgage loan or REO property. We believe these are typical market terms which are designed to provide protection for the lender to collateralize its advances to us in the event the collateral declines in value. Under each of the repurchase agreements, if the carrying value of the collateral declines beyond certain limits, we would have to either (a) provide additional collateral or (b) repurchase certain assets under the agreement to maintain the applicable advance rate.

The increase in amounts outstanding under our repurchase agreements from December 31, 2013 to March 31, 2014 relate primarily to funds we drew down under a repurchase facility in January 2014 to complete our acquisitions of portfolios of mortgage loans. As a result of the January 2014 funding, our overall advance rate under the repurchase agreements decreased slightly from 59.9% at December 31, 2013 to 56.7% at March 31, 2014. We do not collateralize any of our repurchase facilities with cash.

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(table of contents)


Cash flows

We report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in our cash flows ($ in thousands):
 
Three months ended March 31, 2014
Three months ended March 31, 2013
Change
Net cash used in operating activities
$
(23,567
)
(1,364
)
$
(22,203
)
Net cash used in investing activities
(582,881
)
(88,447
)
(494,434
)
Net cash provided by financing activities
538,482

11,753

526,729

Total cash flows
$
(67,966
)
$
(78,058
)
$
10,092


The change in net cash used in operating activities for the three months ended March 31, 2014 and 2013 consisted primarily of related party mortgage servicing costs including net advances of taxes and insurance on delinquent loans, interest expense, professional fees, acquisition costs and expense reimbursements to our manager for salaries and benefits.

The change in net cash used in investing activities for the three months ended March 31, 2014 consisted primarily of investments in non-performing loan portfolios, partly offset by proceeds from the disposition of loans. The change in net cash used in investing activities for the three months ended March 31, 2013 consisted primarily of investments in non-performing loan portfolios. During periods in which we purchase a significant number of mortgage loans and conduct substantial renovations of residential real estate, our cash used in investing activities is generally expected to exceed cash provided by investing activities.

The change in net cash provided by financing activities for the three months ended March 31, 2014 consisted primarily of the net proceeds from the issuance of common stock, payment of dividends and net borrowings under repurchase agreements. The change in net cash provided by financing activities for the three months ended March 31, 2013 consisted primarily of net borrowings under repurchase agreements. Net cash related to financing activities will generally consist of the incurrence by us of debt, repayment of debt previously incurred by us, payment of dividends and issuance of common stock.

Off-balance sheet arrangements

We have no off-balance sheet arrangements as of March 31, 2014.

Recent accounting pronouncements

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

Critical accounting judgments

Accounting standards require information in financial statements about the risks and uncertainties inherent in significant estimates, and the application of generally accepted accounting principles involves the exercise of varying degrees of judgment. Certain amounts included in or affecting our financial statements and related disclosures must be estimated requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time our consolidated financial statements are prepared. These estimates and assumptions affect the amounts we report for our assets and liabilities and our revenues and expenses during the reporting period and our disclosure of contingent assets and liabilities at the date of

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(table of contents)

our consolidated financial statements. Actual results may differ significantly from our estimates and any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.

We consider our critical accounting judgments to be those used in the determination of the reported amounts and disclosure related to the following:

Income taxes

We believe that we have complied and will continue to comply with the provisions of the federal income tax code applicable to REITs beginning for the year ended December 31, 2013 and have elected REIT status with the filing of our 2013 income tax return. Accordingly, we believe that we will not be subject to federal income tax beginning in the year ended December 31, 2013 on the portion of our REIT taxable income that is distributed to our stockholders as long as certain asset, income and share ownership tests are met. If after electing to be taxed as a REIT, we subsequently fail to qualify as a REIT in any taxable year, we generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost.

Our TRSs will be subject to federal and state income taxes. Income taxes are provided for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which management expects those temporary differences to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period in which the change occurs. Subject to our judgment, we reduce a deferred tax asset by a valuation allowance if it is “more likely than not” that some or all of the deferred tax asset will not be realized. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in evaluating tax positions, and we recognize tax benefits only if it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authority.

Mortgage loans

Upon the acquisition of mortgage loans, we record the assets at fair value which is the purchase price we paid for the loans on the acquisition date. Mortgage loans are subsequently accounted for at fair value under the fair value option election with unrealized gains and losses recorded in current period earnings. We have concluded that mortgage loans accounted for at fair value timely reflect the results of our investment performance.

We determine the purchase price for mortgage loans at the time of acquisition by using a discounted cash flow valuation model and considering alternate loan resolution probabilities including modification, liquidation or conversion to rental property. Observable inputs to the model include current interest rates, loan amounts, status of payments and property types. Unobservable inputs to the model include discount rates, forecast of future home prices, alternate loan resolution probabilities, resolution timelines and the value of underlying properties.

After 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.

We also recognize unrealized gains and losses in the fair value of the loans in each reporting period when our mortgage loans are transferred to real estate owned. The transfer to real estate owned occurs when we have obtained title to the property through completion of the foreclosure process. The fair value of these assets at the time of transfer to real estate owned is estimated using BPOs. BPOs are subject to judgments of a particular broker formed by visiting a property, assessing general home values in an area, reviewing comparable listings and reviewing comparable completed sales. These judgments may vary among brokers and may fluctuate over time based on housing market activities and the influx of additional comparable listings and sales. Our results could be materially and adversely affected if the judgments used by a broker prove to be incorrect or inaccurate.


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(table of contents)

AAMC’s capital markets group determines the fair value of mortgage loans monthly and has developed procedures and controls governing the valuation process relating to these assets. The capital markets group reports to our Investment Committee, a committee of our Chief Executive Officer and our Chairman that oversees and approves the valuations. The capital markets group also monitors the valuation model for performance against actual results which is reported to the Investment Committee and used to continuously improve the model.
Real estate impairment

With respect to residential rental properties classified as held for use, we perform an impairment analysis using estimated cash flows if events or changes in circumstances indicate that the carrying value may be impaired, such as prolonged vacancy, identification of materially adverse legal or environmental factors, changes in expected ownership period or a decline in market value to an amount less than cost. This analysis is performed at the property level. These cash flows are estimated based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for rental properties, competition for customers, changes in market rental rates, costs to operate each property and expected ownership periods.

If the carrying amount of a held for use asset exceeds the sum of its undiscounted future operating and residual cash flows, an impairment loss is recorded for the difference between estimated fair value of the asset and the carrying amount. We generally estimate the fair value of assets held for use by using BPOs. In some instances, appraisal information may be available and is used in addition to BPOs.

Residential properties, net

Upon the acquisition of real estate, generally through completion of foreclosure, we record the residential property at fair value as of the acquisition date as a component of real estate owned based on information obtained from a BPO, a full appraisal or the price given in a current contract of sale of the property. After a short evaluation period, we perform property renovations to maximize the value of the property for our rental strategy. Such expenditures are part of our initial investment in a property and, therefore, are classified as investing activities in our consolidated statement of cash flows. Subsequently, the residential property, including any renovations that improve or extend the life of the asset, are accounted for at cost. The cost basis is depreciated using the straight-line method over an estimated useful life of three to 27.5 years based on the nature of the components. Interest and other carrying costs incurred during the renovation period are capitalized until the property is ready for its intended use. Expenditures for ordinary maintenance and repairs are charged to expense as incurred.

Expenditures directly related to successful leasing efforts such as lease commissions are included in deferred leasing and financing costs, net and are stated at amortized cost. Such expenditures are part of our operations and, therefore, are classified as operating activities in our consolidated statement of cash flows. Capitalized leasing costs are amortized on a straight-line basis over the lease term of the respective leases which generally are from one to two years.

Residential properties are classified either as held for use or held for sale. Residential properties are classified as real estate and related assets held for sale when sale of the assets has been formally approved and is expected to occur in the next twelve months. We record residential properties held for sale at the lower of the carrying amount or estimated fair value. Fair value of assets held for sale is equal to the estimated or contracted sales price with a potential buyer less costs to sell. The impairment loss is the amount by which the carrying amount exceeds the estimated fair value.

Rental revenues

Minimum contractual rents from leases are recognized on a straight-line basis over the terms of the leases in rental revenues. Therefore, actual amounts billed in accordance with the lease during any given period may be higher or lower than the amount of rental revenue recognized for the period. Straight-line rental revenue commences when the customer takes control of the leased premises. Deferred rents receivable, net represents the amount by which straight-line rental revenue exceeds rents currently billed in accordance with lease agreements. Contingent rental revenue is accrued when the contingency is removed. Termination fee income is recognized when the customer has vacated the rental property, the amount of the fee is determinable and collectability is reasonably assured.

Rents receivable, net and deferred rents receivable, net are reduced by an allowance for amounts that become uncollectible. We regularly evaluate the adequacy of our allowance for doubtful accounts. The evaluation takes into consideration the aging of accounts receivable, our analysis of customer personal profile and review past due account balances. Rents receivable, net and deferred rents receivable, net are written-off when we have deemed that the amounts are uncollectible.

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(table of contents)


Non-GAAP measures - Estimated REIT taxable income

Estimated REIT taxable income is a measure that we use in connection with monitoring our compliance with certain REIT requirements. Estimated REIT taxable income should not be considered as an alternative to net income or net income per share as indicators of our operating performance.

The following table is a reconciliation of U.S. GAAP net income to estimated REIT taxable income (unaudited, $ in thousands):

 
U.S. GAAP
 
Adjustments
 
Tax
 
For the three months ended March 31, 2014
 
For the three months ended March 31, 2014
 
For the three months ended March 31, 2014
Rental revenues and net gain on investments:
 
 
 
 
 
Rental revenues
$
69

 
$
—

 
$
69

Net unrealized gain on mortgage loans
65,130

 
(25,539
)
 
39,591

Net realized gain on mortgage loans
9,321

 
(123
)
 
9,198

Total revenues
74,520

 
(25,662
)
 
48,858

Expenses:
 
 
 
 
 
Residential property operating expenses
1,050

 
—

 
1,050

Real estate depreciation and amortization
48

 
(32
)
 
16

Mortgage loan servicing costs
11,437

 
(8,622
)
 
2,815

Interest expense
5,708

 
—

 
5,708

Related party general and administrative
12,632

 
(26
)
 
12,606

General and administrative
1,392

 
(428
)
 
964

Total expenses
32,267

 
(9,108
)
 
23,159

Other income
108

 
—

 
108

Net income
$
42,361

 
$
(16,554
)
 
$
25,807


Item 3. Quantitative and qualitative disclosures about market risk

Market risk includes risks that arise from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market sensitive instruments. The primary market risks that we are currently exposed to are real estate risk and interest rate risk. A substantial portion of our investments are, and we expect will continue to be, comprised of non-performing loans and rental properties. The primary driver of the value of both these asset classes is the fair value of the underlying real estate.
 
Real Estate Risk
 
Residential property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to: national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing); construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. Decreases in property values could cause us to suffer losses.
 
Interest Rate Risk
 
We will be exposed to interest rate risk from our (a) acquisition and ownership of residential mortgage loans and (b) debt financing activities. Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Changes in interest rates may affect the fair value of the residential mortgage loans and real estate underlying our portfolios as well as our financing interest rate expense.
 
We currently do not intend to hedge the risk associated with the residential mortgage loans and real estate underlying our portfolios. However, although we have not yet done so, we may undertake risk mitigation activities with respect to our debt financing interest rate obligations. We expect that our debt financing may at times be based on a floating rate of interest calculated on a fixed spread over the relevant index, as determined by the particular financing arrangement. A significantly rising interest rate environment could have an adverse effect on the cost of our financing. To mitigate this risk, we may use

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derivative financial instruments such as interest rate swaps and interest rate options in an effort to reduce the variability of earnings caused by changes in the interest rates we pay on our debt.
 
These derivative transactions will be entered into solely for risk management purposes, not for investment purposes. When undertaken, these derivative instruments likely will expose us to certain risks such as price and interest rate fluctuations, timing risk, volatility risk, credit risk, counterparty risk and changes in the liquidity of markets. Therefore, although we expect to transact in these derivative instruments purely for risk management, they may not adequately protect us from fluctuations in our financing interest rate obligations.

We currently borrow funds at variable rates using secured financings. At March 31, 2014, we had $700.0 million of variable rate debt outstanding not protected by interest rate hedge contracts. The estimated aggregate fair market value of this debt was $700.0 million. If the weighted average interest rate on this variable rate debt had been 100 basis points higher or lower, the annual interest expense would increase or decrease by $7.0 million, respectively.

Item 4. Controls and procedures

SEC rules require us to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our annual and periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Our CEO and CFO have concluded that the disclosure controls and procedures were effective at the end of the period covered by this quarterly report.

SEC rules also require us to establish and maintain internal control over financial reporting designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepting accounting principles. There were no changes in internal control over financial reporting during the three months ended March 31, 2014 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


Part II

Item 1A. Risk factors

There have been no material changes in our risk factors since December 31, 2013. For information regarding our risk factors, you should carefully consider the risk factors discussed in "Item 1A. Risk factors" in our annual report on Form 10-K for the year ended December 31, 2013 filed on February 20, 2014.

Item 4. Mine safety disclosures
    
Not applicable.


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Item 6. Exhibits

Exhibits
Exhibit Number
 
Description
 
2.1
 
Separation Agreement, dated as of December 21, 2012, between Altisource Residential Corporation and Altisource Portfolio Solutions S.A. (incorporated by reference to Exhibit 2.1 of the Registrant's Current Report on Form 8-K filed with the Commission on December 28, 2012).
 
3.1
 
Articles of Restatement of Altisource Residential Corporation (incorporated by reference to Exhibit 3.3 of the registrant's Current Report on Form 8-K filed on April 8, 2013).
 
3.2
 
By-laws of Altisource Residential Corporation (incorporated by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form 10 filed with the Commission on December 5, 2012).
 
31.1*
 
Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act
 
31.2*
 
Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act
 
32.1*
 
Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act
 
32.2*
 
Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act
 
101.INS*
 
XBRL Instance Document
 
101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB*
 
XBRL Extension Labels Linkbase
 
101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
__________

* Filed herewith.


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Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
 
 
Altisource Residential Corporation
Date: 
April 29, 2014
By:
/s/
Kenneth D. Najour
 
 
 
 
Kenneth D. Najour
 
 
 
 
Chief Financial Officer


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