AAMC 10Q_3.31.2015
 

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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2015

OR

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

COMMISSION FILE NUMBER: 000-54809
 

Altisource Asset Management Corporation
(Exact name of registrant as specified in its charter)
UNITED STATES VIRGIN ISLANDS
66-0783125
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

36C Strand Street
Christiansted, United States Virgin Islands 00820
(Address of principal executive office)

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

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

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

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

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



As of April 30, 2015, 2,228,823 shares of our common stock were outstanding (excluding 266,429 shares held as treasury stock).


Altisource Asset Management Corporation
March 31, 2015
Table of Contents



i

(table of contents)

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

Special note on forward-looking statements

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

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

•
our ability to implement our business strategy and the business strategy of Residential;
•
our ability to retain Residential as a client;
•
our ability to retain and maintain our strategic relationships with related parties;
•
the ability of Residential to generate cash available for distribution to its stockholders under our management;
•
our ability to effectively compete with our competitors;
•
Residential's ability to complete future or pending transactions;
•
the failure of Altisource to effectively perform its obligations under their agreements with us and Residential;
•
the failure of Residential’s mortgage loan servicers to effectively perform their services to Residential;
•
general economic and market conditions; and
•
governmental regulations, taxes and policies.

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 the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2014.



ii

(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

Certain information contained herein is presented as of April 30, 2015, which we have concluded is the latest practicable date for financial information prior to the filing of this quarterly report.





1

(table of contents)

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

 
March 31, 2015
 
December 31, 2014
Assets:
 
 
 
Real estate held for use:
 
 
 
Land (from consolidated VIE)
$
21,267

 
$
14,424

Rental residential properties (net of accumulated depreciation of $2,046 and $1,062, respectively - from consolidated VIE)
86,206

 
60,908

Real estate owned (from consolidated VIE)
456,479

 
457,045

Total real estate held for use, net
563,952

 
532,377

Real estate assets held for sale (from consolidated VIE)
150,807

 
92,230

Mortgage loans at fair value (from consolidated VIE)
1,853,495

 
1,959,044

Mortgage loans held for sale (from consolidated VIE)
12,485

 
12,535

Cash and cash equivalents (including from consolidated VIE $53,246 and $66,166, respectively)
98,386

 
116,782

Restricted cash (from consolidated VIE)
14,766

 
13,282

Accounts receivable (including from consolidated VIE $10,398 and $10,313, respectively)
10,399

 
11,068

Related party receivables (from consolidated VIE)
22,530

 
17,491

Deferred leasing and financing costs, net (from consolidated VIE)
5,384

 
4,251

Prepaid expenses and other assets (including from consolidated VIE $672 and $373, respectively)
2,261

 
1,638

Total assets
$
2,734,465

 
$
2,760,698

Liabilities:
 
 
 
Repurchase agreements (from consolidated VIE)
$
929,287

 
$
1,015,000

Other secured borrowings (from consolidated VIE)
364,849

 
324,082

Accounts payable and accrued liabilities (including from consolidated VIE $42,686 and $11,678, respectively)
48,314

 
16,726

Related party payables (including from consolidated VIE $5,782 and $4,879, respectively)
9,092

 
6,169

Total liabilities
1,351,542

 
1,361,977

Commitments and contingencies (Note 6)

 

Redeemable preferred stock:
 
 
 
Preferred stock, $0.01 par value, 250,000 shares issued and outstanding as of March 31, 2015 and December 31, 2014; redemption value $250,000
248,979

 
248,927

Equity:
 
 
 
Common stock, $.01 par value, 5,000,000 authorized shares; 2,470,783 and 2,206,652 shares issued and outstanding, respectively as of March 31, 2015 and 2,452,101 and 2,188,136 shares issued and outstanding, respectively, as of December 31, 2014
25

 
25

Additional paid-in capital
15,048

 
14,152

Retained earnings
61,009

 
54,174

Treasury stock, at cost, 264,131 shares as of March 31, 2015 and 263,965 shares as of December 31, 2014
(245,519
)
 
(245,468
)
Total stockholders' equity
(169,437
)
 
(177,117
)
Noncontrolling interest in consolidated affiliate
1,303,381

 
1,326,911

Total equity
1,133,944

 
1,149,794

Total liabilities and equity
$
2,734,465

 
$
2,760,698


See accompanying notes to Consolidated Financial Statements.



2

(table of contents)

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

 
 
Three months ended March 31, 2015
 
Three months ended March 31, 2014
 
 
 
 
 
Revenues:
 
 
 
 
Rental revenues
 
$
1,400

 
$
69

Net unrealized gain on mortgage loans
 
61,134

 
65,130

Net realized gain on mortgage loans
 
15,382

 
9,321

Net realized gain on re-performing mortgage loans
 
151

 
—

Net realized gain on real estate
 
10,608

 
—

Interest income
 
240

 
108

Total revenues
 
88,915

 
74,628

Expenses:
 
 
 
 
Residential property operating expenses
 
12,459

 
1,050

Real estate depreciation and amortization
 
998

 
48

Real estate selling costs and impairment
 
14,691

 
354

Mortgage loan servicing costs
 
18,266

 
11,437

Interest expense
 
11,483

 
5,708

General and administrative
 
10,790

 
5,601

Related party general and administrative
 
773

 
923

Total expenses
 
69,460

 
25,121

Income before income taxes
 
19,455

 
49,507

Income tax expense
 
143

 
766

Net income
 
19,312

 
48,741

Net income attributable to noncontrolling interest in consolidated affiliate
 
(12,424
)
 
(41,913
)
Net income attributable to common stockholders
 
$
6,888

 
$
6,828

 
 
 
 
 
Earnings per share of common stock – basic:
 
 
 
 
Earnings per basic share
 
$
3.10

 
$
2.88

Weighted average common stock outstanding – basic
 
2,203,699

 
2,367,202

Earnings per share of common stock – diluted:
 
 
 
 
Earnings per diluted share
 
$
2.50

 
$
2.39

Weighted average common stock outstanding – diluted
 
2,757,206

 
2,856,079


See accompanying notes to consolidated financial statements.


3

(table of contents)


Altisource Asset Management Corporation
Consolidated Statements of Equity
(In thousands, except share amounts)
(Unaudited)

 
Common stock
 
 
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Retained earnings
Treasury stock
Noncontrolling interest in consolidated affiliate
Total equity
December 31, 2014
2,452,101

$
25

$
14,152

$
54,174

$
(245,468
)
$
1,326,911

$
1,149,794

Issuance of common stock, including option exercises
18,682

—

7

—

—

—

7

Treasury shares repurchased
—

—

—

—

(51
)
—

(51
)
Capital contribution from noncontrolling interest
—

—

—

—

—

27

27

Distribution from noncontrolling interest
—

—

—

—

—

(36,038
)
(36,038
)
Amortization of preferred stock issuance costs
—

—

—

(53
)
—

—

(53
)
Share-based compensation
—

—

889

—

—

57

946

Net income
—

—

—

6,888

—

12,424

19,312

March 31, 2015
2,470,783

$
25

$
15,048

$
61,009

$
(245,519
)
$
1,303,381

$
1,133,944


 
Common stock
 
 
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Retained earnings (accumulated deficit)
Treasury stock
Noncontrolling interest in consolidated affiliate
Total equity
December 31, 2013
2,354,774

$
24

$
12,855

$
(5,339
)
$
—

$
785,427

$
792,967

Issuance of common stock, including option exercises
41,429

—

18

—

—

—

18

Treasury shares repurchased
 
 
 
 
(44,565
)
 
(44,565
)
Capital contribution from noncontrolling interest
—

—

—

—

—

468,491

468,491

Distribution from noncontrolling interest
 
 
 
 
 
(27,398
)
(27,398
)
Share-based compensation
—

—

3,316

—

—

—

3,316

Net income
—

—

—

6,828

—

41,913

48,741

March 31, 2014
2,396,203

$
24

$
16,189

$
1,489

$
(44,565
)
$
1,268,433

$
1,241,570


See accompanying notes to consolidated financial statements.
 




4

(table of contents)

Altisource Asset Management Corporation
Consolidated Statements of Cash Flows
(In thousands) (Unaudited)
 
Three months ended March 31, 2015
 
Three months ended March 31, 2014
Operating activities:
 
 
 
Net income
$
19,312

 
$
48,741

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(61,134
)
 
(65,130
)
Net realized gain on mortgage loans
(15,382
)
 
(9,321
)
Net realized gain on sale of re-performing mortgage loans
(151
)
 
—

Net realized gain on sale of real estate
(10,608
)
 
(55
)
Real estate depreciation and amortization
998

 
48

Real estate selling costs and impairment
14,691

 
355

Accretion of interest on re-performing mortgage loans
(232
)
 
—

Share-based compensation
946

 
3,316

Amortization of deferred financing costs
531

 
608

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
1,750

 
502

Related party receivables
(2,535
)
 
(53
)
Prepaid expenses and other assets
(623
)
 
(530
)
Accounts payable and accrued liabilities
1,613

 
1,118

Related party payables
2,923

 
871

Net cash used in operating activities
(47,901
)
 
(19,530
)
Investing activities:
 
 
 
Investment in mortgage loans
—

 
(611,357
)
Investment in renovations
(5,534
)
 
(447
)
Real estate tax advances
(6,556
)
 
(6,259
)
Mortgage loan dispositions
56,337

 
32,775

Mortgage loan payments
5,816

 
3,129

Disposition of real estate
32,139

 
734

Change in restricted cash
(1,484
)
 
(1,456
)
Net cash provided by (used in) investing activities
80,718

 
(582,881
)
Financing activities:
 
 
 
Proceeds from issuance of preferred stock
—

 
250,000

Cost of issuance of preferred stock
—

 
(1,114
)
Issuance of common stock, including stock option exercises
411

 
2,732

Repurchase of common stock
(51
)
 
(44,565
)
Payment of tax withholdings on exercise of stock options
(404
)
 
(2,714
)
Capital contribution from noncontrolling interest
27

 
468,491

Distribution to noncontrolling interest
(4,576
)
 
(27,398
)
Proceeds from issuance of other secured debt
50,690

 
—

Repayments of secured notes
(9,256
)
 
—

Proceeds from repurchase agreement
33,877

 
127,664

Repayments of repurchase agreement
(119,590
)
 
(30,096
)
Payment of deferred financing costs
(2,341
)
 
(123
)
Net cash (used in) provided by financing activities
(51,213
)
 
742,877

Net (decrease) increase in cash and cash equivalents
(18,396
)
 
140,466

Cash and cash equivalents as of beginning of the period
116,782

 
140,000

Cash and cash equivalents as of end of the period
$
98,386

 
$
280,466

 
 
 
 

5

(table of contents)

Altisource Asset Management Corporation
Consolidated Statements of Cash Flows (continued)
(In thousands) (Unaudited)
 
Three months ended March 31, 2015
 
Three months ended March 31, 2014
Supplemental disclosure of cash flow information
 
 
 
Cash paid for interest
$
10,429

 
$
4,736

Transfer of mortgage loans to real estate owned
136,182

 
96,528

Transfer of real estate owned to mortgage loans
1,356

 
—

Change in accrued capital expenditures
(1,430
)
 
—

Change in accrued equity issuance costs
—

 
183

Changes in receivables from mortgage loan dispositions, payments and real estate tax advances, net
2,848

 
1,247

Changes in receivables from real estate owned dispositions
630

 
—

See accompanying notes to consolidated financial statements.

6

(table of contents)

Altisource Asset Management Corporation
Notes to Consolidated Financial Statements
March 31, 2015
(Unaudited)

1. Organization and basis of presentation

We were incorporated in the United States Virgin Islands on March 15, 2012, which we refer to as “inception.” Subsequent to our separation from Altisource Portfolio Solutions S.A. ("Altisource") on December 21, 2012, we immediately commenced operations. In October 2013, we applied for and were granted registration by the SEC as a registered investment adviser under section 203(c) of the Investment Advisers Act of 1940. Our primary business is to provide asset management and certain corporate governance services to Altisource Residential Corporation, which we refer to as “Residential.” Residential is a Maryland corporation that acquires and manages single-family rental properties by acquiring sub-performing and non-performing mortgages throughout the United States.

Residential is currently our primary source of revenue and will drive our results. On March 31, 2015, we entered into a new asset management agreement with Residential (the “AMA”) with an effective date of April 1, 2015. Prior to the AMA, we were party to an asset management agreement with Residential (the “Original AMA”) pursuant to which we received incentive fees, which we refer to as our “incentive management fees,” that gave us a share of Residential’s cash flow available for distribution to its stockholders as well as reimbursement for certain overhead and operating expenses. Although the new AMA provides for a new fee structure in which we are entitled to a base management fee, an incentive management fee and a conversion fee for properties that become rental properties during each quarter, our operating results are highly dependent on Residential's ability to achieve positive operating results. For additional details on the new AMA, please see “Note 7. Related Party Transactions.”

We have concluded that Residential is a variable interest entity (“VIE”) because Residential’s equity holders lack the ability through voting rights to make decisions about Residential’s activities that have a significant effect on the success of Residential. We have also concluded that we are the primary beneficiary of Residential because under the Residential AMA we have the power to direct the activities of Residential that most significantly impact Residential’s economic performance including establishing Residential’s investment and business strategy. As a result, we consolidate Residential in our consolidated financial statements.

Additionally, we provide management services to NewSource Reinsurance Company Ltd., which we refer to as “NewSource,” a title insurance and reinsurance company in Bermuda. In October 2013, we invested $2.0 million in 100% of the common stock of NewSource and Residential invested $18.0 million in the non-voting preferred stock of NewSource. On December 2, 2013, NewSource became registered as a licensed reinsurer with the Bermuda Monetary Authority (“BMA”). Because we own 100% of voting common stock of NewSource and there are no substantive kick-out rights granted to other equity owners, we consolidate NewSource in our consolidated financial statements. NewSource commenced reinsurance activities during the second quarter of 2014. In December 2014, NewSource determined that the economics of the initial business did not warrant the continuation of its initial reinsurance quota share agreement with an unrelated third party. NewSource therefore transferred all of the risk of claims and future losses underwritten to an unrelated third party.

Since Residential commenced operations, it has completed three public equity offerings with aggregate net proceeds of approximately $1.1 billion. Residential also entered into three separate repurchase agreements to finance the acquisition and ownership of residential mortgage loans and REO properties. The maximum aggregate funding available under these repurchase agreements at December 31, 2014 was $1.2 billion. Following the amendments described below, the maximum aggregate funding available to Residential under these repurchase agreements as of March 31, 2015 was $970.5 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. As of March 31, 2015, an aggregate of $929.3 million was outstanding under Residential's repurchase agreements. All obligations of Residential’s subsidiaries under the repurchase agreements are fully guaranteed by Residential.

Each of Residential's repurchase agreements is described below:

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

7
(table of contents)

increased the REO sublimit under the facility and extended the maturity date to April 18, 2016. Please see “Note 12. Subsequent Events” for additional information.

•
Deutsche Bank (“DB”) is the lender on the repurchase agreement entered into on September 12, 2013 (the “DB repurchase agreement”). The DB repurchase agreement was amended on December 18, 2013, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016. The DB repurchase agreement includes a provision that, beginning in April 2015, Residential will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of March 2015. Therefore, Residential's aggregate funding capacity under the DB repurchase agreement was reduced to $219.7 million in April 2015, which was the amount outstanding under the facility at the time.

•
Wells Fargo (“Wells”) is the lender on the repurchase agreement entered into on September 23, 2013 (the “Wells repurchase agreement”) with an initial aggregate maximum borrowing capacity of $200.0 million. Throughout 2013 and 2014 the Wells repurchase agreement was amended several times increasing the aggregate maximum borrowing capacity to a high of $1.0 billion, and on December 31, 2014 was reduced to $750.0 million, subject to certain sublimits, to reflect the securitization of a significant portion of Residential's non-performing loans that previously had been financed under the Wells repurchase agreement. The maturity date of the Wells repurchase agreement was March 23, 2015. However, on February 20, 2015, Residential exercised its option to extend the termination date of this facility to March 23, 2016 without any additional funding, thereby reducing Residential's aggregate funding capacity under the Wells repurchase agreement to $525.8 million which was the amount outstanding under the facility on the extension date. Residential is in discussions with Wells to further extend the repurchase agreement with an ability to obtain additional funding. No assurance can be provided that Residential will be able to renew this facility on reasonable terms, on a timely basis or at all. In the event Residential cannot extend the agreement with an ability to obtain additional funding, the advance rate will be reduced by 10% after the first 90 days of the extension term and Residential will not be entitled to draw additional funds under the facility.

On November 25, 2014, Residential completed a securitization transaction in which ARLP Securitization Trust, Series 2014-2 ("ARLP 2014-2") issued $270.8 million in Class A Notes (the “Class A Notes”) with a weighted coupon of approximately 3.85% and $234.0 million in Class M Notes (the “Class M Notes”). Residential initially retained $95.8 million of the Class A Notes and all of the Class M Notes in its taxable REIT subsidiary (“TRS”). On February 9, 2015, Residential sold $50.7 million of the retained Class A Notes to an unrelated third party. No interest will be paid on any Class M Notes while any Class A Notes remain outstanding. The Class A Notes and the Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-2 and not by any of Residential's other assets. The assets of ARLP 2014-2 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on January 26, 2054, and Residential does not guaranty any of the obligations of ARLP 2014-2 under the terms of the Indenture governing the notes or otherwise. As of March 31, 2015, the book value of the underlying securitized assets held by ARLP 2014-2 was $332.5 million.

On September 25, 2014, Residential completed a securitization transaction in which ARLP Securitization Trust, Series 2014-1 (“ARLP 2014-1”) issued $150.0 million in Class A Notes (the “Class A Notes”) with a weighted coupon of approximately 3.47% and $32.0 million in Class M Notes (the “Class M Notes”) with a weighted coupon of 4.25%. The Class A Notes and the Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-1 and not by any of Residential's other assets. The assets of ARLP 2014-1 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on September 25, 2044, and Residential does not guaranty any of the obligations of ARLP 2014-1 under the terms of the Indenture governing the notes or otherwise. As of March 31, 2015, the book value of the underlying securitized assets held by ARLP 2014-1 was $213.8 million.

Residential retained all of the Class M Notes issued by ARLP 2014-1 in its TRS. On September 30, 2014, pursuant to a master repurchase agreement, the TRS sold $15.0 million of the Class M Notes to NewSource Reinsurance Company Ltd, ("NewSource"), an entity in which Residential owns 100% of the outstanding preferred stock and in which we own 100% of the outstanding common stock, for a purchase price of $15.0 million. The master repurchase agreement initially required the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, with the parties having the option to extend the master repurchase agreement for additional 89-day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on June 25, 2015.

On March 18, 2014, we closed a private placement for the issuance and sale of 250,000 shares of our Series A Convertible Preferred Stock to Luxor Capital Group, LP, a New York based investment manager, and other institutional investors for proceeds of $250.0 million. In connection with the foregoing, the Company's Board of Directors has approved a share

8

(table of contents)

repurchase program that authorizes us to repurchase up to $300.0 million of our common stock. We used substantially all of the proceeds from this transaction to repurchase shares of our common stock and for other corporate purposes. We have an aggregate of $59.4 million remaining for repurchases under our Board-approved repurchase plan.

Basis of presentation and use of estimates

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

The unaudited consolidated financial statements and accompanying unaudited consolidated financial information, in our opinion, contain all adjustments that are of a normal recurring nature and necessary for a fair presentation of our financial position, results of operations and cash flows for the interim periods. The interim results are not necessarily indicative of results for a full year. We have omitted certain notes and other information from the interim consolidated financial statements presented in this Quarterly Report as permitted by SEC rules and regulations. These consolidated financial statements should be read in conjunction with our 2014 annual report on Form 10-K.

Preferred stock

During the first quarter of 2014, we issued $250.0 million of convertible preferred stock. All of the outstanding shares of preferred stock are redeemable by us in March 2020, the sixth anniversary of the date of issuance, and every five years thereafter. On these same redemption dates, each holder of preferred stock may cause us to redeem all the shares of preferred stock held by such holder at a redemption price equal to $1,000 per share. Accordingly, we classify these shares as mezzanine equity, outside of permanent stockholders' equity.

The holders of shares of Series A Preferred Stock will not be entitled to receive dividends with respect to the Series A Preferred Stock. The shares of Series A Preferred Stock are convertible into shares of our common stock at a conversion price of $1,250 per share, subject to certain anti-dilution adjustments.

Upon a change of control or upon a liquidation, dissolution or winding up of the Company, holders of the Series A Preferred Stock will be entitled to receive an amount in cash per Series A Preferred Stock equal to the greater of:

(i)    $1,000 plus the aggregate amount of cash dividends paid on the number of shares of Common Stock into which such share of Series A Preferred Stock was convertible on each ex-dividend date for such dividends; and
(ii)    the number of shares of Common Stock into which the Series A Preferred Stock is then convertible multiplied by the then current market price of the Common Stock.

The Series A Preferred Stock confers no voting rights to holders, except with respect to matters that materially and adversely affect the voting powers, rights or preferences of the Series A Preferred Stock or as otherwise required by applicable law.

With respect to the distribution of assets upon the liquidation, dissolution or winding up of the Company, the Series A Preferred Stock ranks senior to our common stock and on parity with all other classes of preferred stock that may be issued by us in the future.

Treasury Stock

We account for repurchased common stock under the cost method and include such treasury stock as a component of total shareholders’ equity. We have repurchased shares of our common stock (i) under our Board approval to repurchase up to $300.0 million in shares of our common stock and (ii) upon our withholding of shares of our common stock to satisfy tax withholding obligations in connection with the vesting of our restricted stock.


9

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Recently issued accounting standards

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

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

2. Mortgage loans

Acquisitions of non-performing residential mortgage loans

During the first quarter of 2015, Residential did not acquire any portfolios of residential mortgage loans. During the three months ended March 31, 2014, Residential acquired 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 acquisitions was approximately $611 million.

During the three months ended March 31, 2015, Residential expensed $0.1 million for due diligence costs related to a potential purchase of a portfolio that was not ultimately acquired. During the three months ended March 31, 2014, Residential recognized $0.5 million for due diligence costs related to transactions in both general and administrative expense and related party general and administrative expense.

Generally, we expect that Residential's mortgage loan and REO portfolios 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 Residential's success in acquiring such loans cannot be predicted. In addition, for any given portfolio of loans that Residential agrees to acquire, it typically acquires fewer loans than originally expected, as certain loans may be resolved prior to the closing date or may fail to meet Residential's diligence standards. The number of loans excluded from an acquisition typically constitutes a relatively small portion of a particular portfolio. In some cases, the number of loans Residential does not acquire could be significant. In any case where Residential does not acquire the full portfolio, appropriate adjustments are made to the applicable purchase price.

Throughout this report, all unpaid principal balance and market value amounts for the portfolios Residential has 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.


10

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Transfer of mortgage loans to real estate owned

During the three months ended March 31, 2015 and 2014, Residential transferred 724 and 636 mortgage loans, respectively, to REO at an aggregate fair value based on BPOs, of $134.8 million and $96.5 million respectively. Such transfers occur when the foreclosure sale is complete. In connection with these transfers to REO, Residential recorded $18.4 million and $23.6 million, respectively, in net unrealized gains on mortgage loans. At March 31, 2015 Residential had 7,021 loans with a carrying value of $1.4 billion that were in the foreclosure process compared to 7,841 loans with a carrying value of $1.5 billion at March 31, 2014.

Dispositions

During the three months ended March 31, 2015 and 2014, Residential disposed of 150 and 116 mortgage loans, respectively, primarily through short sales, refinancing and foreclosure sales. In connection with these dispositions, Residential recorded $15.4 million and $9.3 million, respectively, of net realized gains on mortgage loans.

Acquisition of re-performing residential mortgage loans

On June 27, 2014, Residential acquired 879 re-performing mortgage loans with an aggregate market value of underlying properties of $271.1 million for an aggregate purchase price of $144.6 million. Under ASC 310-30, acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. These 879 re-performing residential mortgage loans were determined to have common risk characteristics and have been accounted for as a single loan pool. During October 2014, Residential sold an aggregate of 934 re-performing loans to an unrelated third party for an aggregate purchase price of $164 million. The sale included 770 loans from the re-performing mortgage loans purchased in June 2014, and 164 loans that had transitioned to re-performing status from prior non-performing loan acquisitions.

Under ASC 310-30, Residential estimates cash flows expected to be collected, adjusted for expected prepayments and defaults expected to be incurred over the life of the loan pool. Residential determines the excess of the loan pool's contractually required principal and interest payments over the expected cash flows as an amount that should not be accreted, the nonaccretable yield. The difference between expected cash flows and the present value of the expected cash flows is referred to as the accretable yield, which represents the amount that is expected to be recorded as interest income over the remaining life of the loan pool. For the three months ended March 31, 2015, Residential recognized no provision for loan loss and no adjustments to the amount of the accretable yield. For the three months ended March 31, 2015, Residential accreted $0.2 million into interest income with respect to these re-performing loans. As of March 31, 2015, these re-performing loans, having a UPB of $17.5 million and a carrying value of $12.5 million, were held for sale.
   
The following tables present information regarding the estimates of the contractually required payments and the cash flows expected to be collected as of the date of the acquisition and changes in the balance of the accretable yield ($ in thousands):
 
Three months ended March 31, 2015
 
Accretable Yield
Carrying Amount of Loans
Balance at the beginning of the period
$
7,640

$
12,535

Additions
—

37

Payments and other reductions, net
(201
)
(319
)
Accretion
(232
)
232

Balance at the end of the period
$
7,207

$
12,485


3. Real estate assets, net

Real estate held for use

As of March 31, 2015, Residential had 3,464 REO properties held for use. Of these properties, 587 had been rented, 151 were being listed for rent and 116 were in varying stages of renovation. With respect to the remaining 2,610 REO properties, we will make a final determination whether each property meets Residential’s rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified (c) Residential has recorded the deed for the property, (d) utilities have been activated and (e) Residential has secured access for interior inspection. A majority of the REO properties are subject to

11
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state regulations which require Residential to await the expiration of a redemption period before a foreclosure can be finalized. Residential includes these redemption periods in its portfolio pricing which generally reduces the price Residential pays for the mortgage loans. Once the redemption period expires, Residential immediately proceeds to record the new deed, take possession of the property, activate utilities, and start the inspection process in order to make its final determination. As of December 31, 2014, Residential had 3,349 REO properties held for use. Of these properties, 336 had been rented, 197 were being listed for rent and 254 were in various stages of renovation. With respect to the remaining 2,562 REO properties, we were in the process of determining whether these properties would meet Residential's rental profile. As of March 31, 2014, Residential 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 were in the process of determining whether these properties would meet Residential's rental profile. If a REO property meets Residential's 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 Residential's rental profile, we list the property for sale, in certain instances after renovations are made to optimize the sale proceeds.

Real estate held for sale

As of March 31, 2015, Residential classified 966 properties having an aggregate carrying value of $150.8 million as real estate held for sale as they do not meet its residential rental property investment criteria. As of December 31, 2014, Residential had 611 REO properties having an aggregate carrying value of $92.2 million held for sale, and as of March 31, 2014, Residential had 44 REO properties having an aggregate carrying value of $4.2 million held for sale. None of these REO properties have any operations; therefore, we are not presenting discontinued operations related to these properties.

Residential records residential properties held for sale at the lower of either the carrying amount of REO or its estimated fair value less estimated selling costs. If the carrying amount exceeds the estimated fair value, as adjusted, Residential records impairment equal to the amount of such excess. If an increase in fair value is noted at a subsequent measurement date, a gain is recognized to the extent of any previous impairment recognized. As of March 31, 2015 Residential had $9.0 million of impairment on the 966 REO properties having a fair value of $168.9 million. As of December 31, 2014 Residential had $4.9 million of impairment on the 611 REO properties having a fair value of $96.0 million. There was no impairment on the 44 REO properties held at March 31, 2014.

Dispositions

During the three months ended March 31, 2015, Residential disposed of 254 residential properties and recorded $10.6 million of net realized gains on real estate. During the three months ended March 31, 2014, Residential disposed of two residential properties. There were no significant gain or losses on the dispositions in 2014.


12
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4. Fair value of financial instruments

The following table sets forth the fair value of financial assets and liabilities by level within the fair value hierarchy as of March 31, 2015 and December 31, 2014 ($ in thousands):
 
Level 1
Level 2
Level 3
 
Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
March 31, 2015
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
1,853,495

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

$
—

$
168,942

Transfer of real estate owned to mortgage loans
$
—

$
—

$
1,356

Transfer of mortgage loans to real estate owned
$
—

$
—

$
136,182

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

$
—

$
12,485

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

$
929,287

$
—

Other secured borrowings
$
—

$
362,429

$
—

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

$
—

$
1,959,044

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

$
—

$
96,041

Transfer of real estate owned to mortgage loans
$
—

$
—

$
8,400

Transfer of mortgage loans to real estate owned
$
—

$
—

$
595,668

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

$
—

$
12,535

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

$
1,015,000

$
—

Other secured borrowings
$
—

$
336,409

$
—


Residential has not transferred any assets from one level to another level during the three months ended March 31, 2015 or during the year ended December 31, 2014.

The carrying values of Residential's and our cash and cash equivalents, restricted cash, related party receivables, accounts payable and accrued liabilities, related party payables, preferred stock, and investment in NewSource are equal to or approximate fair value. The fair value of mortgage loans is estimated using our proprietary pricing model. The fair value of transfers of mortgage loans to real estate owned is estimated using BPOs. The fair value of re-performing mortgage loans held for sale is estimated using the present value of the future estimated principal and interest payments of the loan, with the discount rate used in the present value calculation representing the estimated effective yield of the loan. The fair value of the repurchase agreements is estimated using the income approach based on credit spreads available currently in the market for similar floating rate debt. The fair value of other secured borrowings is estimated using observable market data.

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

13
(table of contents)

 
Three months ended March 31, 2015
 
Three months ended March 31, 2014
Mortgage loans
 
 
 
Beginning balance
$
1,959,044

 
$
1,207,163

Investment in mortgage loans
—

 
612,508

Net unrealized gain on mortgage loans
61,134

 
65,130

Net realized gain on mortgage loans
15,382

 
9,321

Mortgage loan dispositions and payments
(65,168
)
 
(39,458
)
Real estate tax advances to borrowers
7,127

 
8,006

Reclassification of realized gains on real estate sold from unrealized gains
10,802

 
—

Transfer of real estate owned to mortgage loans
1,356

 
—

Transfer of mortgage loans to real estate owned
(136,182
)
 
(96,528
)
Ending balance at March 31
$
1,853,495

 
$
1,766,142

 
 
 
 
Net unrealized gain on mortgage loans held at the end of the period
$
51,068

 
$
38,197


The following table sets forth the fair value of Residential's mortgage loans, the related unpaid principal balance and market value of underlying properties by delinquency status as of March 31, 2015 and December 31, 2014 ($ in thousands):
 
Number of loans
Carrying Value
Unpaid principal balance
Market value of underlying properties
March 31, 2015
 
 
 
 
Current
794

$
127,984

$
183,091

$
188,031

30
95

13,653

20,233

20,694

60
41

6,423

8,986

10,288

90
2,138

332,892

531,217

502,562

Foreclosure
7,021

1,372,543

1,964,595

1,801,433

Mortgage loans
10,089

$
1,853,495

$
2,708,122

$
2,523,008

December 31, 2014
 
 
 
 
Current
670

$
107,467

$
159,731

$
160,654

30
109

15,424

22,629

24,046

60
57

7,921

11,624

12,510

90
2,286

361,434

569,930

544,709

Foreclosure
7,841

1,466,798

2,172,047

1,951,606

Mortgage Loans
10,963

$
1,959,044

$
2,935,961

$
2,693,525



14
(table of contents)

The following table sets forth the carrying value of Residential's re-performing mortgage loans held for sale, the related unpaid principal balance and market value of underlying properties by delinquency status as of March 31, 2015.
 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties
March 31, 2015
 
 
 
 
Current
69

$
8,597

$
12,004

$
15,102

30
6

498

1,018

1,074

60
—

—

—

—

90
24

3,390

4,498

5,931

Mortgage loans held for sale
99

$
12,485

$
17,520

$
22,107

December 31, 2014
 
 
 
 
Current
68

$
8,317

$
11,938

$
15,154

30
6

1,118

1,667

2,004

60
4

359

644

670

90
24

2,741

4,149

4,624

Mortgage loans held for sale
102

$
12,535

$
18,398

$
22,452


The significant unobservable inputs used in the fair value measurement of Residential's 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 Residential's mortgage loans as of March 31, 2015 and December 31, 2014:
Input
March 31, 2015
December 31, 2014
Equity discount rate
15.0%
15.0%
Debt to asset ratio
65.0%
65.0%
Cost of funds
3.5% over 1 month LIBOR
3.5% over 1 month LIBOR
Annual change in home pricing index  
0% to 7.6%
-0.1% to 7.6%
Loan resolution probabilities — modification
0% to 44.7%
0% to 44.7%
Loan resolution probabilities — rental
0% to 100.0%
0% to 100.0%
Loan resolution probabilities — liquidation
0% to 100.0%
0% to 100.0%
Loan resolution timelines (in years)
0.1 to 5.3
0.1 to 5.3
Value of underlying properties
$500 - $5,500,000
$3,000 - $5,300,000

5. Borrowings

Repurchase Agreements

Residential's operating partnership and certain of its Delaware Statutory Trust subsidiaries, as applicable, have entered into master repurchase agreements with major financial institutions. The purpose of these repurchase agreements is to finance the acquisition and ownership of mortgage loans, rental properties and REO properties in its portfolio. Residential has effective control of the assets associated with these agreements and therefore it has concluded these are financing arrangements. As of March 31, 2015, the weighted average annualized interest rate on borrowing under Residential's repurchase agreements was 3.06%, excluding amortization of deferred financing costs. The following table sets forth data with respect to Residential's repurchase agreements as of March 31, 2015 and December 31, 2014 ($ in thousands):

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(table of contents)

 
Maximum borrowing capacity
Book value of collateral
Amount outstanding
March 31, 2015
 
 
 
CS repurchase agreement due April 20, 2015
$
225,000

$
331,633

$
183,806

Wells repurchase agreement due March 23, 2016
525,780

986,572

525,780

DB repurchase agreement due March 11, 2016
219,701

457,553

219,701

 
$
970,481

$
1,775,758

$
929,287

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

$
332,618

$
222,044

Wells repurchase agreement due March 23, 2015
750,000

1,036,409

569,509

DB repurchase agreement due March 11, 2016
250,000

450,532

223,447

 
$
1,225,000

$
1,819,559

$
1,015,000


Under the terms of each repurchase agreement, as collateral for the funds Residential draws thereunder, subject to certain conditions, Residential's operating partnership will sell to the applicable lender equity interests in its Delaware statutory trust subsidiaries that owns the applicable underlying assets on its behalf, or the trust will directly sell such underlying mortgage assets. In the event the lender determines the value of the collateral has decreased, the lender has the right to initiate a margin call and require Residential, 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 Residential finances 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, Residential's operating partnership 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. Residential does not collateralize any of its repurchase facilities with cash. Pursuant to the CS Repurchase Agreement, Residential is entitled to collateralize a portion of the facility with securities. As of March 31, 2015, approximately $10.6 million of the amounts outstanding under the CS Repurchase Agreement was collateralized by $17.0 million of the Class M Notes issued and retained by Residential in connection with the securitization completed in September 2014 by ARLP 2014-1, and approximately $29.4 million of the amounts outstanding under the CS Repurchase Agreement was collateralized by $45.1 million of the Class A2 Notes issued and retained by Residential in connection with the securitization completed in November 2014 by ARLP 2014-2.

The repurchase agreements require Residential 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. Residential is restricted by the terms of its repurchase agreements from paying dividends greater than its REIT taxable income in a calendar year.

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

Other Secured Debt

On November 25, 2014, Residential completed a securitization transaction in which ARLP 2014-2 issued $270.8 million in Class A Notes with a weighted coupon of approximately 3.85% and $234.0 million in Class M Notes. Residential initially retained $95.8 million of the Class A Notes and all of the Class M Notes in its TRS. On February 9, 2015, Residential sold $50.7 million of the retained Class A Notes to an unrelated third party. No interest will be paid on any Class M Notes while any Class A Notes remain outstanding. The Class A Notes and Class M Notes are secured solely by the non-performing mortgage loans and REO properties of ARLP 2014-2 and not by any of Residential's other assets. The assets of ARLP 2014-2 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on January 26, 2054, and Residential does not guaranty any of the obligations of ARLP 2014-2 under the terms of the Indenture governing the notes or otherwise. As of March 31, 2015, the book value of the underlying securitized assets held by ARLP 2014-2 was $332.5 million.

On September 25, 2014, Residential completed a securitization transaction in which ARLP 2014-1 issued $150.0 million in Class A Notes with a weighted coupon of approximately 3.5% and $32.0 million in Class M Notes with a weighted coupon of 4.25%. The Class A Notes and the Class M Notes are secured solely by the non-performing mortgage loans of ARLP 2014-1

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(table of contents)

and not by any of Residential's other assets. The assets of ARLP 2014-1 are the only source of repayment and interest on the Class A Notes and the Class M Notes. The Class A Notes and the Class M Notes mature on September 25, 2044, and Residential does not guaranty any of the obligations of ARLP 2014-1 under the terms of the Indenture governing the notes or otherwise. As of March 31, 2015, the book value of the underlying securitized assets held by ARLP 2014-1 was $213.8 million.

Residential retained all of the Class M Notes in its TRS. On September 30, 2014, pursuant to a master repurchase agreement, the TRS sold $15.0 million of the Class M Notes to NewSource for a purchase price of $15.0 million. The master repurchase agreement initially required the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, with the parties having the option to extend the master repurchase agreement for additional 89-day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on June 25, 2015.

The following table sets forth data with respect to these notes as of March 31, 2015 ($ in thousands):
 
Interest Rate
Amount outstanding
March 31, 2015
 
 
ARLP Securitization Trust, Series 2014-1
 
 
ARLP 2014-1 Class A Notes due September 25, 2044(1)
3.47
%
$
145,953

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

ARLP Securitization Trust, Series 2014-2
 
 
ARLP 2014-2 Class A Notes due January 26, 2054(3)
3.85
%
264,034

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

ARNS, Inc.
 
 
Securities sold under agreement to repurchase due June 25, 2015
5.00
%
14,991

Intercompany eliminations
 
 
Elimination of ARLP 2014-1 Class A Notes due to ARNS, Inc.
 
(14,991
)
Elimination of ARLP 2014-1 Class M Notes due to ARNS, Inc.
 
(32,000
)
Elimination of ARLP 2014-2 Class A Notes due to ARNS, Inc.
 
(45,138
)
Elimination of ARLP 2014-2 Class M Notes due to ARNS, Inc.
 
(234,010
)
 
 
$
364,849

December 31, 2014
 
 
ARLP Securitization Trust, Series 2014-1
 
 
ARLP 2014-1 Class A Notes due September 25, 2044(1)
3.47
%
$
150,000

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

ARLP Securitization Trust, Series 2014-2
 
 
ARLP 2014-2 Class A Notes due January 26, 2054(3)
3.85
%
269,820

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

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

Intercompany eliminations
 
 
Elimination of ARLP 2014-1 Class A Notes due to ARNS, Inc.
 
(15,000
)
Elimination of ARLP 2014-1 Class M Notes due to ARNS, Inc.
 
(32,000
)
Elimination of ARLP 2014-2 Class A Notes due to ARNS, Inc.
 
(95,729
)
Elimination of ARLP 2014-2 Class M Notes due to ARNS, Inc.
 
(234,010
)
 
 
$
324,082

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



17
(table of contents)

6. Commitments and Contingencies

Litigation, claims and assessments

There have been no material new developments in our legal proceedings since the March 2, 2015 filing of our annual report on Form 10-K for the year ended December 31, 2014, except as follows:

The Police Retirement System of Saint Louis v. Erbey, et al. On April 2, 2015, The Police Retirement System of Saint Louis and the defendants entered into a Memorandum of Understanding (“MOU”) reflecting an agreement in principle to settle the action with the settlement consideration being the new AMA. The MOU contemplates the negotiation and execution of a stipulation of settlement. The stipulation of settlement will be subject to customary conditions, including court approval. If the settlement is finally approved by the court, it will resolve and release all claims in the action that were, or could have been brought by or on behalf of Residential challenging any aspect of the Original AMA and the negotiation of, the terms and provisions of, or the approval of the new AMA. In addition, in connection with the settlement, the parties agreed that plaintiff’s counsel will apply to the court for an award of fees and expenses. There can be no assurances that the parties will ultimately enter into a stipulation of settlement or that the court will approve the settlement.

City of Cambridge Retirement System v. Altisource Asset Management Corp., et al. On March 17, 2015, four plaintiffs filed motions to be appointed as Lead Plaintiff, and these motions are currently before the Court. AAMC’s time to answer or otherwise plead has been extended until after a Lead Plaintiff is appointed.
Kanga v. Altisource Asset Management Corporation, et al. On March 12, 2015, a shareholder derivative action was filed in the Superior Court of the Virgin Islands, Division of St. Croix by a purported shareholder of AAMC under the caption Nanzeen Kanga v. William Erbey et al., SX-15-CV-105.  The action names as defendants William C. Erbey and each of the current and former members of AAMC's Board of Directors and alleges that Mr. Erbey and AAMC’s directors breached fiduciary duties in connection with the disclosures that are the subject of the City of Cambridge Retirement System case described above and certain other matters involving the relationship of Residential and AAMC. At this time, we are not able to predict the ultimate outcome of this matter, nor can we estimate the range of possible loss, if any.
For the litigation described above where an estimate is possible, management has established a litigation accrual in the amount of $3.0 million on a consolidated basis. This estimated liability is based upon currently available information and is subject to significant judgment and a variety of assumptions, as well as known and unknown uncertainties. Matters underlying the Company’s litigation accrual may change from time to time, and actual results may vary significantly from the current estimate, including as a result of changes in our ongoing and future legal proceedings. Those matters for which an estimate is not possible are not included within this litigation accrual. Therefore, this estimated liability represents what we believe to be an estimate of liability only for certain liabilities that are estimable and probable, and does not represent our maximum loss exposure.
7. Related party transactions

New Asset Management Agreement with Residential

On March 31, 2015, we entered into a new Asset Management Agreement ("AMA") with Residential.

The AMA, which became effective on April 1, 2015, provides for a new management fee structure which replaces the incentive fee structure under the original asset management agreement (the “Original AMA”) as follows:

•
We are entitled to a quarterly base management fee equal to 1.5% of the product of (i) Residential’s average invested capital for the quarter multiplied by (ii) 0.25, while Residential has fewer than 2,500 single family rental properties actually rented (“Rental Properties”). The base management fee percentage increases to 1.75% of invested capital while Residential has between 2,500 and 4,499 Rental Properties and increases to 2.0% of invested capital while Residential has 4,500 or more Rental Properties; 

•
We are entitled to a quarterly incentive management fee equal to 20% of the amount by which Residential's return on invested capital exceeds a hurdle return rate of between 7.0% and 8.25% (depending on the 10-year treasury rate). The incentive management fee increases to 22.5% while Residential has between 2,500 and 4,499 Rental Properties and increases to 25% while Residential has 4,500 or more Rental Properties; and 

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

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

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

Summary of Related Party Transaction Expenses

Through January 16, 2015, William C. Erbey served as our Chairman as well as the Executive Chairman of Ocwen, Chairman of Altisource, and Chairman of Residential. Effective January 16, 2015, Mr. Erbey stepped down as the Executive Chairman of Ocwen and Chairman of each of Altisource, Residential and AAMC and is no longer a member of the Board of Directors for any of these companies. As of March 31, 2015, Mr. Erbey owned or controlled approximately 28% of our common stock, approximately 4% of the common stock of Residential, approximately 30% of the common stock of Altisource, and approximately 14% of the common stock of Ocwen. As of March 31, 2015, Mr. Erbey also held 857,543 options to purchase Altisource common stock (all of which were exercisable), 3,572,626 options to purchase Ocwen common stock (3,322,626 of which were exercisable) and 85,755 options to purchase our common stock (all of which were exercisable).

As a result of Mr. Erbey’s position as our Chairman and as Chairman of each of Ocwen, Altisource and Residential during the beginning of the first quarter, combined with his share ownership, these companies are considered related parties of Residential for the first quarter of 2015. We will continue to monitor the facts and circumstances with respect to Mr. Erbey, as well as our continuing officers and directors, to determine whether any of Altisource, Ocwen or Residential will be related parties in future periods.



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Our Consolidated Statements of Operations included the following significant related party transactions ($ in thousands):
 
Three months ended March 31, 2015
Counter-party
Consolidated Statements of Operations location
2015
 
 
 
Residential property operating expenses
$
9,512

Ocwen/Altisource
Residential property operating expenses
Mortgage loan servicing costs
16,985

Ocwen
Mortgage loan servicing costs
Office and occupancy costs
107

Ocwen/Altisource
Related party general and administrative expenses
Salaries and benefits
214

Ocwen/Altisource
Related party general and administrative expenses
Other general and administrative expenses
451

Altisource
Related party general and administrative expenses
Expense reimbursements
960

Residential/NewSource
Net income attributable to noncontrolling interest in consolidated affiliate
Professional fee sharing for negotiation of AMA
2,000

Residential
Net income attributable to noncontrolling interest in consolidated affiliate
Management incentive fee
14,900

Residential
Net income attributable to noncontrolling interest in consolidated affiliate
 
Three months ended March 31, 2014
Counter-party
Consolidated Statements of Operations location
2014
 
 
 
Residential property operating expenses
$
1,050

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

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

Altisource
Related party general and administrative expenses
Office and occupancy costs
74

Ocwen
Related party general and administrative expenses
Salaries and benefits
517

Ocwen/Altisource
Related party general and administrative expenses
Other general and administrative expenses
—

Altisource
Related party general and administrative expenses
Expense reimbursements
1,780

Residential/NewSource
Net loss (income) attributable to noncontrolling interest in consolidated affiliate
Management incentive fee
10,911

Residential
Net loss (income) attributable to noncontrolling interest in consolidated affiliate

On September 30, 2014, pursuant to a master repurchase agreement, Residential's TRS sold $15.0 million of the Class M Notes to NewSource for a purchase price of 15.0 million. The master repurchase agreement initially required the TRS to repurchase the Class M Notes from NewSource at a 5.0% yield on December 28, 2014, with the parties having the option to extend the master repurchase agreement for additional 89 day periods. In no event can the master repurchase agreement be extended beyond September 29, 2015. The agreement is currently due to expire on June 25, 2015.

8. Share-based payments

During the three months ended March 31, 2015 and 2014, we granted 44,132 and 8,765 shares, respectively, of market-based restricted stock to certain members of executive management under our 2012 Equity Incentive Plan with a weighted average grant date fair value per share of $181.02 and $791.27, respectively.

Our directors each receive annual grants of restricted stock equal to $45,000 based on the market value of our common stock at the time of the annual stockholders meeting. This restricted stock vests and is issued after a one-year service period subject to each director attending at least 75% of the Board and committee meetings. No dividends are paid on the shares until the award is issued. During the three months ended March 31, 2015 and 2014, we granted no share-based payments to directors.

We recorded $0.9 million and $3.3 million of compensation expense related to these grants for the three months ended March 31, 2015 and 2014, respectively. As of March 31, 2015 and 2014, we had an aggregate $25.6 million and $30.0 million, respectively, of total unrecognized share-based compensation cost to be recognized over a weighted average remaining estimated term of 2.0 years and 3.2 years, respectively.


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9. Income taxes

We are domiciled in the United States Virgin Islands ("USVI") and under current USVI law are obligated to pay taxes in the United States Virgin Islands on income and/or capital gains. We applied for tax benefits from the United States Virgin Islands Economic Development Commission and received our certificate of benefits, effective as of February 1, 2013. Under the certificate of benefits, so long as we comply with the provisions of the certificate, we will receive a 90% exemption on our USVI sourced income taxes until 2043. NewSource is considered a controlled foreign corporation ("CFC") to AAMC. Subpart F income generated by a CFC is taxed currently in the USVI and is not eligible for the reduced tax rate under the certificate of benefits.

As of March 31, 2015 and 2014, neither Residential nor we accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense or penalty recognized during the three months ended March 31, 2015 and 2014. Residential recorded nominal state and local tax expense on income and property for the three months ended March 31, 2015. Our subsidiaries and we remain subject to tax examination for the period from inception to December 31, 2014.

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, 2015
 
Three months ended March 31, 2014
Numerator
 
 
 
 
Net income
 
$
6,888

 
6,828

Amortization of preferred stock issuance costs
 
53

 
—

Numerator for basic EPS - income available to common stockholders
 
6,835

 
6,828

Add back amortization of preferred stock issuance costs
 
53

 
—

Numerator for diluted EPS - income available to common stockholders after assumed conversions
 
$
6,888

 
$
6,828

 
 
 
 
 
Denominator
 
 
 
 
Weighted average common stock outstanding – basic
 
2,203,699

 
2,367,202

Stock options using treasury method
 
232,712

 
273,778

Restricted stock
 
120,795

 
183,988

Preferred shares if converted
 
200,000

 
31,111

Weighted average common stock outstanding – diluted
 
2,757,206

 
2,856,079

 
 
 
 
 
Earnings per basic share
 
$
3.10

 
$
2.88

Earnings per diluted share
 
$
2.50

 
$
2.39


As of March 31, 2015, we had 42,198 restricted shares that were excluded from the calculation of diluted earnings per share as they were antidilutive. 
11. Segment information

Our primary business is to provide asset management and certain corporate governance services to Residential. Residential's primary business is the acquisition and ownership of single-family rental assets. Residential's 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 management of Residential's resolution of sub-performing and non-performing mortgages with the intent to modify as many loans as possible to keep borrowers in their homes or own the collateral which is suitable as long-term rental properties.



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12. Subsequent events

New Loan and Security Agreement with Nomura

On April 10, 2015, Residential entered into a Loan and Security Agreement (the “Loan Agreement”) with Nomura Corporate Funding Americas, LLC (“Nomura”). The purpose of the Loan Agreement is to finance Residential's beneficial ownership of REO properties. These obligations are fully guaranteed pursuant to a guaranty (the “Guaranty”) made by Residential in favor of Nomura. The Loan Agreement terminates on April 8, 2016.

Under the terms of the Loan Agreement, subject to certain conditions, Nomura may advance funds to Residential from time to time, with such advances collateralized by REO properties. The maximum aggregate advance for the REO properties under the Loan Agreement is $100.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding.

The advances paid by Nomura under the Loan Agreement with respect to the REO properties from time to time will be based on a percentage of the market value of the applicable REO properties. Under the terms of the Loan Agreement, Residential is required to pay to Nomura interest based on the one-month LIBOR plus a spread and certain other customary fees, administrative costs and expenses in connection with Nomura's structuring, management and ongoing administration of the Loan Agreement. The Loan Agreement requires Residential to maintain various standard financial and other covenants.

In addition, the Loan Agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, certain material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the Loan Agreement and the liquidation by Nomura of the REO properties then subject to the Loan Agreement.

Amended and Restated Repurchase Agreement with CS

On April 20, 2015, Residential entered into an Amended and Restated Master Repurchase Agreement with CS. The CS Repurchase Agreement, as amended and restated, increases the aggregate maximum funding capacity to finance the purchase and beneficial ownership of non-performing, re-performing and performing mortgage loans and REO properties from $225.0 million to $275.0 million, and also increases the sublimit for REO properties that can be financed on the facility.

The obligations of Residential's subsidiaries continue to be fully guaranteed by Residential pursuant to an amended and restated guaranty (the “Amended Guaranty”) made in favor of CS. As amended and restated, the Repurchase Agreement has been extended to mature on April 21, 2016.

All other material terms and conditions of the Repurchase Agreement remain the same as the original repurchase agreement in all material respects.



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

Overview

Our primary business is to provide asset management and certain corporate governance services to Residential and NewSource. We are an SEC-registered investment adviser under section 203(c) of the Investment Advisers Act of 1940. We have a capital light operating strategy. Residential is currently our primary source of revenue and currently drives our results.

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

•
We are entitled to a quarterly base management fee equal to 1.5% of the product of (i) Residential’s average invested capital for the quarter multiplied by (ii) 0.25, while Residential has fewer than 2,500 single family rental properties actually rented (“Rental Properties”). The base management fee percentage increases to 1.75% of invested capital while Residential has between 2,500 and 4,499 Rental Properties and increases to 2.0% of invested capital while Residential has 4,500 or more Rental Properties; 

•
We are entitled to a quarterly incentive management fee equal to 20% of the amount by which Residential's return on invested capital exceeds a hurdle return rate of between 7.0% and 8.25% (depending on the 10-year treasury rate). The incentive management fee increases to 22.5% while Residential has between 2,500 and 4,499 Rental Properties and increases to 25% while Residential has 4,500 or more Rental Properties; and 

•
We are entitled to a quarterly conversion fee equal to 1.5% of the market value of the single-family homes leased by Residential for the first time during the quarter.

Residential has the flexibility to pay up to 25% of the incentive management fee to us in shares of Residential common stock.

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

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

We have concluded that Residential is a variable interest entity because Residential’s equity holders lack the ability through voting rights to make decisions about Residential’s activities that have a significant effect on the success of Residential. We have also concluded that we are the primary beneficiary of Residential’s financial condition and results of operations because under the AMA we have the power to direct the activities of Residential that most significantly impact Residential’s economic performance including establishing Residential’s investment and business strategy. As a result, we consolidate Residential’s financial results in our consolidated financial statements.

Additionally, we provide management services to NewSource. On December 2, 2013, NewSource became registered as a licensed reinsurer with the BMA. Because we own 100% of voting common stock of NewSource and there are no substantive kick-out rights granted to other equity owners, we consolidate NewSource in our consolidated financial statements.

Since Residential has commenced operations, we have advised Residential and conducted portfolio analysis and the bidding process to facilitate the acquisition and growth of Residential’s portfolio of residential mortgage loans as follows:

During 2014 and 2013, Residential completed the acquisition of an aggregate of 15,817 residential mortgage loans, substantially all of which were non-performing, and 277 REO properties having an aggregate unpaid principal balance (“UPB”) of approximately $4.2 billion and an aggregate market value of underlying properties of approximately $3.6 billion. The

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aggregate purchase price for these acquisitions was approximately $2.4 billion. There were no portfolio acquisitions completed in the first quarter of 2015.

Additionally, in June 2014, Residential acquired 879 re-performing mortgage loans with an aggregate market value of underlying properties of $271.1 million for an aggregate purchase price of $144.6 million. During October 2014, Residential sold 770 of these re-performing mortgage loans.

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

From inception through March 31, 2015, Residential modified an aggregate of 745 mortgage loans, converted an aggregate of 4,632 mortgage loans into REO properties and disposed of an aggregate of 1,096 mortgage loans through short sale, refinancing or other liquidation events.

Following the above-referenced transactions, as of March 31, 2015, Residential's portfolio consisted of 10,089 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $2.7 billion and an aggregate market value of underlying properties of $2.5 billion. Residential also owned 4,430 REO properties with an aggregate carrying value of $714.8 million, of which 3,464 were held for use and 966 were held for sale. Of the 3,464 REO properties held for use, 587 REO properties had been rented and were occupied by tenants, 151 were being listed for rent and 116 were in varying stages of renovation. With respect to the remaining 2,610 REO properties held for use, Residential will make a final determination whether each property meets its rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified, (c) Residential has recorded the deed for the property, (d) utilities have been activated and (e) Residential has secured access for interior inspection. Residential also owned 99 re-performing mortgage loans held for sale having an aggregate UPB of approximately $17.5 million and an aggregate market value of underlying properties of approximately $22.1 million as of March 31, 2015.

NewSource commenced reinsurance activities during the second quarter of 2014. In December 2014, NewSource determined that the economics of the initial business did not warrant the continuation of its initial reinsurance quota share agreement with an unrelated third party. NewSource therefore transferred all of the risk of claims and future losses underwritten to an unrelated third party.

On March 18, 2014, we closed a private placement for the issuance and sale of 250,000 shares of our Series A Convertible Preferred Stock, to Luxor Capital Group, LP, a New York based investment manager, and other institutional investors for proceeds of $250.0 million. In connection with the foregoing, the Company's Board of Directors has approved a share repurchase program that authorizes us to repurchase up to $300.0 million in shares of our common stock. We used substantially all of the proceeds from this transaction to repurchase shares of our common stock and for other corporate purposes. We have an aggregate of $59.4 million remaining for repurchases under our Board-approved repurchase plan. In the future we may consider using excess cash generated from operations to repurchase shares of our common stock when trading at attractive prices. Such stock repurchases may be made in the open market, block trades or privately-negotiated transactions.

Observations on Current Market Opportunities

We believe there are market opportunities 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 two years as GSEs, HUD, banks and other mortgage lenders seek to dispose of their distressed inventories. We are also beginning to see opportunities in the marketplace in which entities are seeking to sell portfolios of REO properties and rental properties. We have been and will consider these REO and rental portfolio opportunities as they may provide alternative attractive avenues to grow Residential’s rental portfolio.

Despite these potential REO portfolio opportunities, we continue to believe that the distressed loan channel gives Residential a cost advantage over other acquisition channels such as foreclosure auctions and REO acquisitions, involves less competition and positions Residential to be selected as the buyer of diverse portfolios of such loans since Residential is not geographically constrained. Residential’s 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 Residential and is a socially responsible business strategy because it keeps more families in their homes.


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Metrics Affecting Our Consolidated Results

As described above, our operating results depend heavily on Residential’s operating results. Residential’s results are affected by various factors, some of which are beyond our control, including the following:

Revenues

Residential’s revenues primarily consist of the following:

i.
Net realized gain on mortgage loans. Residential records 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. Residential generally expects to collect proceeds of loan liquidations in cash and, thereafter, have no continuing involvement with the asset.

ii.
Net unrealized gains from the conversion of loans to REO. Upon conversion of loans to REO, Residential marks the properties to the most recent market value. The difference between the carrying value of the asset at the time of conversion and the most recent market value, based on BPOs, is recorded in Residential's 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 Residential's revenue recognition and its operating performance from period to period. The factors that may affect the timelines to foreclose upon a residential mortgage loan include, without limitation, state foreclosure timelines and deferrals associated therewith; unauthorized parties occupying the property; inadequacy of documents necessary to foreclose; bankruptcy proceedings initiated by borrowers; federal, state or local legislative action or initiatives designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures and continued declines in real estate values and/or sustained high levels of unemployment that increase the number of foreclosures and which place additional pressure and/or delays on the already overburdened judicial and administrative proceedings.

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

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

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

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


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Expenses

Residential's expenses have primarily consisted of rental property operating expenses, depreciation and amortization, real estate selling cost and impairment, mortgage loan servicing, interest expense, general and administrative expenses, and expense reimbursement and incentive management fees under the Original AMA. Rental property operating expenses are expenses associated with Residential's ownership and operation of rental properties including expenses such as property management fees, expenses towards repairs, utility expenses on vacant properties, turnover costs, property taxes, insurance and HOA dues. Depreciation and amortization is a non-cash expense associated with the ownership of real estate and generally remains relatively consistent each year in relation to Residential's asset levels since these properties are depreciated on a straight-line basis over a fixed life. Real estate selling cost and impairment represents Residential's estimate for the costs to be incurred to sell a property and an amount that represents the carrying amount over the estimated fair value less costs to sell. Mortgage loan servicing costs are primarily for servicing fees, foreclosure fees and advances of residential property insurance. Interest expense consists of the costs to borrow money in connection with Residential's debt financing of its portfolios. General and administrative expenses consist of the costs related to the general operation and overall administration of Residential's and our business. Historically, expense reimbursement consisted primarily of our employee salaries in direct correlation to the services they provided on Residential’s behalf and other personnel costs and corporate overhead. We were not reimbursed by Residential for certain general and administrative expenses pertaining to stock-based compensation and our expenditures that were not for the benefit of Residential. Under the new AMA, there are no general expense reimbursements. The incentive management fees consist of compensation due to us. Historically, this was based on the amount of cash available for distribution to Residential’s stockholders for each period. Under the new AMA, the management fees are based on Residential's invested capital and leased properties. The expense reimbursement and incentive management fee are eliminated in consolidation but increase our net income by reducing the amount of net income attributable to noncontrolling interest.

Other factors affecting our consolidated results

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

Acquisitions

Residential’s operating results will depend on our ability to source sub-performing and non-performing loans, as well as other residential mortgage loans and REO property assets. We believe that there is currently a large supply of sub-performing and non-performing mortgage loans available to Residential for acquisition.

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

Financing

Our ability to grow Residential’s business is dependent on the availability of adequate financing including additional equity financing, debt financing or both in order to meet Residential’s objectives. We intend to leverage Residential’s investments with debt, the level of which may vary based upon the particular characteristics of its portfolio and on market conditions. To the extent available at the relevant time, Residential’s 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 for Residential through public or private offerings of debt or equity securities, depending upon market conditions. To qualify as a REIT under the Code, Residential will need to distribute at least 90% of its taxable income each year to its stockholders. This distribution requirement limits its ability to retain earnings and thereby replenish or increase capital to support its activities.



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Resolution Activities
 
Three months ended March 31, 2014
 
Three months ended March 31, 2015
Mortgage Loans (1)
 
 
 
Beginning balance
8,054

 
10,963

Acquisitions
4,207

 
—

Dispositions
(116
)
 
(150
)
Mortgage loan conversions to REO
(637
)
 
(728
)
Reversions to mortgage loans (2)
1

 
4

Ending balance
11,509

 
10,089

 
 
 
 
Modifications
81

 
126

Loan reinstatements
19

 
67

 
 
 
 
Real Estate Owned
 
 
 
Beginning balance
262

 
3,960

Acquisitions
—

 
—

Dispositions
(2
)
 
(254
)
Mortgage loan conversions to REO
637

 
728

Reversions to mortgage loans
(1
)
 
(4
)
Ending balance
896

 
4,430

 
 
 
 
Leased
35

 
587

Renovations complete
17

 
151

Renovations in process
48

 
116

Evaluating strategy/held for sale
796

 
3,576

 
896

 
4,430

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

In addition, as of March 31, 2015, 181 of Residential's mortgage loans were on trial modification plans, compared to 207 mortgage loans on trial modification plans as of December 31, 2014.

Portfolio size

The size of Residential’s investment portfolio will also impact operating results. Generally, as the size of Residential’s investment portfolio grows, the amount of revenue it expects to generate will increase. A growing investment portfolio, however, will drive increased expenses including possibly higher servicing fees, property management fees and fees payable to us. Residential may also incur additional interest expense if it incurs additional debt to finance the purchase of its assets.

Existing Portfolio
 
We advised Residential and conducted portfolio analysis and the bidding process to facilitate the acquisition and growth of Residential’s portfolio of residential mortgage loans as follows:

During 2014 and 2013, Residential completed the acquisition of an aggregate of 15,817 residential mortgage loans, substantially all of which were non-performing, and 277 REO properties having an aggregate unpaid principal balance (“UPB”) of approximately $4.2 billion and an aggregate market value of underlying properties of approximately $3.6 billion. The aggregate purchase price for these acquisitions was approximately $2.4 billion. Residential did not complete any portfolio acquisitions in the first quarter of 2015.


27

(table of contents)

Throughout this report, all unpaid principal balance and market value amounts for the portfolios Residential has acquired are provided as of the applicable “cut-off” date for each transaction unless otherwise indicated. We refer to the assets underlying Residential’s completed acquisitions as Residential’s “Existing Portfolio.” The Existing Portfolio does not include assets acquired as REO. As defined in this report, Residential's “Existing Portfolio” does not include the 99 re-performing mortgage loans having an aggregate UPB of approximately $17.5 million and an aggregate market value of underlying properties of approximately $22.1 million as of March 31, 2015, which are considered “Mortgage loans held for sale.”

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

As of March 31, 2015, Residential had 4,430 REO properties, consisting of 3,464 REO properties held for use and 966 held for sale. Of the 3,464 REO properties held for use, 587 properties had been rented and were occupied by tenants, 151 were being listed for rent and 116 were in varying stages of renovation. With respect to the remaining 2,610 REO properties held for use, Residential will make a final determination whether each property meets its rental profile after (a) applicable state redemption periods have expired, (b) the foreclosure sale has been ratified, (c) Residential has recorded the deed for the property, (d) utilities have been activated and (e) Residential has secured access for interior inspection. A majority of the REO properties are subject to state regulations which require Residential to await the expiration of a redemption period before a foreclosure can be finalized. Residential includes these redemption periods in its pricing which generally reduces the price Residential pays for the mortgage loans. Once the redemption period expires, Residential immediately proceeds to record the new deed, take possession of the property, activate utilities, and start the inspection process in order to make its final determination on whether to rent or liquidate the property. If an REO property meets Residential’s rental investment criteria, Residential determines the extent of renovations that are needed to generate an optimal rent and maintain consistency of renovation specifications for future branding. If it is determined that the REO property will not meet Residential’s rental investment criteria, the property is listed for sale, in some instances after renovations are made to optimize the sale proceeds. As of March 31, 2014, Residential 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 at March 31, 2014, Residential was in the process of determining whether these properties would meet its rental profile. Additionally, 44 REO properties owned as of March 31, 2014 were held for sale.

The following table sets forth a summary of Residential's REO properties as of March 31, 2015 ($ in thousands):

28

(table of contents)

State / District
Number of properties
Carrying value (1)
Weighted average age in years (2)
Alabama
27

$
4,011

23

Alaska
1

185

28

Arizona
106

17,492

22

Arkansas
50

4,459

31

California
595

178,339

33

Colorado
29

6,125

25

Connecticut
28

5,265

46

Delaware
11

2,033

34

District of Columbia
1

242

103

Florida
799

120,791

24

Georgia
170

21,217

21

Hawaii
2

339

20

Idaho
11

1,374

30

Illinois
409

60,909

42

Indiana
162

18,083

32

Iowa
8

547

58

Kansas
28

2,243

47

Kentucky
57

6,113

32

Louisiana
21

2,154

27

Maine
15

1,659

117

Maryland
128

24,811

34

Massachusetts
39

7,343

79

Michigan
89

9,715

46

Minnesota
74

12,147

39

Mississippi
11

1,051

27

Missouri
77

6,894

42

Montana
5

1,010

29

Nebraska
8

1,213

44

Nevada
15

2,037

16

New Hampshire
14

2,154

59

New Jersey
56

8,970

67

New Mexico
30

3,860

21

New York
55

10,062

69

North Carolina
257

30,306

19

Ohio
130

14,757

41

Oklahoma
22

2,293

30

Oregon
10

1,595

29

Pennsylvania
217

28,154

52

Rhode Island
54

6,842

76

South Carolina
103

11,273

23

South Dakota
2

295

52

Tennessee
77

9,200

23

Texas
144

17,979

22

Utah
70

12,560

28

Vermont
3

548

142

Virginia
52

13,536

26

Washington
26

5,281

37

West Virginia
3

647

25

Wisconsin
128

14,371

49

Wyoming
1

$
275

21

Total
4,430

$
714,759

34


29

(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 Residential’s Existing Portfolio consists of a diversified pool of sub-performing and non-performing residential mortgage loans with the underlying properties located across the United States. The aggregate purchase price of Residential’s Existing Portfolio for acquisitions completed through March 31, 2015 was 67% of the aggregate market value, as determined by the most recent BPO provided by the applicable seller for each property in the respective portfolio as of its cut-off date. We cannot assure you that the BPOs accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.

As of March 31, 2015, the aggregate carrying value of Residential's Existing Portfolio was $1.9 billion (which does not include the carrying value of Residential's REO properties of an additional $714.8 million). The carrying value of mortgage loans is based on our proprietary pricing model. The significant unobservable inputs used in the fair value measurement of Residential's mortgage loans are discount rates, forecasts of future home prices, alternate resolution probabilities and foreclosure timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. For a more complete description of the fair value measurements and the factors that may significantly affect the carrying value of Residential's assets, please see Note 4 to our consolidated financial statements.

The table below provides a summary of the sub-performing and non-performing residential mortgage loans in Residential’s Existing Portfolio based on the respective UPB and respective market values of underlying properties as of March 31, 2015 ($ in thousands):
Location
Loan count
UPB
Market value of underlying properties (1)
Weighted average market LTV (2)
Alabama
56

$
8,359

$
7,103

177.5
%
Alaska
3

672

1,011

68.8
%
Arizona
124

35,523

32,751

120.6
%
Arkansas
49

3,883

4,572

107.2
%
California
1108

533,355

571,934

105.8
%
Colorado
49

12,939

13,940

101.4
%
Connecticut
134

41,203

36,826

141.5
%
Delaware
57

10,901

9,626

132.7
%
Dist. of Columbia
66

17,358

20,857

107.1
%
Florida
1977

482,614

400,789

141.5
%
Georgia
248

45,660

40,991

133.1
%
Hawaii
53

27,836

28,591

104.5
%
Idaho
31

7,420

6,790

133.3
%
Illinois
318

79,353

63,784

185.9
%
Indiana
241

30,447

27,761

122.4
%
Iowa
24

2,030

2,178

102.8
%
Kansas
24

2,584

3,004

105.6
%
Kentucky
47

5,722

5,221

120.3
%
Louisiana
38

6,491

6,846

111.6
%
Maine
37

6,915

6,877

110.3
%
Maryland
581

155,135

127,474

142.9
%
Massachusetts
271

74,420

74,619

115.8
%
Michigan
79

12,646

12,639

164.5
%
Minnesota
38

8,015

8,173

122.1
%
Mississippi
25

2,897

2,845

114.2
%
Missouri
71

6,817

5,868

171.3
%

30

(table of contents)

Montana
2

461

560

84.3
%
Nebraska
4

465

440

105.9
%
Nevada
230

73,018

56,329

143.4
%
New Hampshire
11

3,013

3,200

100.8
%
New Jersey
1062

318,192

250,343

157.5
%
New Mexico
123

17,473

17,040

112.6
%
New York
720

248,166

254,231

113.9
%
North Carolina
215

28,655

27,136

119.2
%
North Dakota
1

123

140

87.9
%
Ohio
113

16,575

14,475

282.2
%
Oklahoma
32

4,136

4,214

122.6
%
Oregon
103

30,424

28,364

116.5
%
Pennsylvania
256

46,795

39,820

143.0
%
Puerto Rico
2

218

285

77.2
%
Rhode Island
49

11,290

6,377

230.1
%
South Carolina
189

33,746

31,193

119.2
%
South Dakota
3

395

325

132.0
%
Tennessee
75

11,062

10,971

121.2
%
Texas
422

48,992

68,197

83.3
%
Utah
52

11,463

11,989

101.9
%
Vermont
9

1,451

1,383

128.9
%
Virginia
136

44,543

42,928

118.6
%
Washington
466

126,931

122,573

115.6
%
West Virginia
8

1,009

838

128.0
%
Wisconsin
57

8,331

6,587

154.3
%
Total mortgage loans
10,089

$
2,708,122

$
2,523,008

130.3
%
_____________

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

Summary Management Reporting Information

In addition to evaluating our consolidated financial performance, we also evaluate the operations of AAMC on a stand-alone basis because our financial statements consolidate the results of Residential and NewSource under U.S. GAAP.

In evaluating our operating performance and managing our business under the Original AMA, we consider the incentive management fees and, if any, reimbursement of expenses paid to us by Residential under our AMA as well as our stand-alone operating expenses. We maintain our internal management reporting on this basis. The following table presents our consolidating balance sheet and statement of operations which are reconciled to U.S. GAAP.

The following tables include non-GAAP performance measures that we believe are useful to assist investors in gaining an understanding of the trends and operating results for our business. This information should be considered in addition to, and not as a substitute for our financial results determined in accordance with U.S. GAAP.


31

(table of contents)

Altisource Asset Management Corporation
Consolidating Statement of Operations
Three months ended March 31, 2015
(In thousands)

 
 Residential (GAAP)
NewSource Stand-alone (Non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
Revenues:
 
 
 
 
 
Rental revenues
$
1,400

$
—

$
—

$
—

$
1,400

Net unrealized gain on mortgage loans
61,134

—

—

—

61,134

Net realized gain on mortgage loans
15,382

—

—

—

15,382

Net realized gain on re-performing mortgage loans
151

—

—

—

151

Net realized gain on real estate
10,608

—

—

—

10,608

Interest income
240

160

—

(160
)
240

Incentive management fee
—

—

14,900

(14,900
)
—

Expense reimbursements
—

—

960

(960
)
—

Total revenues
88,915

160

15,860

(16,020
)
88,915

Expenses:
 
 
 
 
 
Residential property operating expenses
12,459

—

—

—

12,459

Real estate depreciation and amortization
998

—

—

—

998

Real estate selling costs and impairment
14,691

—

—

—

14,691

Mortgage loan servicing costs
18,266

—

—

—

18,266

Interest expense
11,643

—

—

(160
)
11,483

General and administrative
4,379

75

6,336

—

10,790

Related party general and administrative
16,052

210

2,371

(17,860
)
773

Total expenses
78,488

285

8,707

(18,020
)
69,460

Other income
2,000

—

—

(2,000
)
—

Income before income taxes
12,427

(125
)
7,153

—

19,455

Income tax expense
3

—

140

—

143

Net income
12,424

(125
)
7,013

—

19,312

Net income attributable to noncontrolling interest in consolidated affiliate
—

—

—

(12,424
)
(12,424
)
Net income attributable to common stockholders
$
12,424

$
(125
)
$
7,013

$
(12,424
)
$
6,888




32

(table of contents)

Altisource Asset Management Corporation
Consolidating Statement of Operations
Three months ended March 31, 2014
(In thousands)
 
 Residential (GAAP)
NewSource Stand-alone (Non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
Revenues:
 
 
 
 
 
Rental revenues
$
69

$
—

$
—

$
—

$
69

Net unrealized gain on mortgage loans
65,130

—

—

—

65,130

Net realized gain on mortgage loans
9,321

—

—

—

9,321

Interest income
108

—

—

—

108

Incentive management fee
—

—

10,911

(10,911
)
—

Expense reimbursements
—

—

1,780

(1,780
)
—

Total revenues
74,628

—

12,691

(12,691
)
74,628

Expenses:
 
 
 
 
 
Residential property operating expenses
1,050

—

—

—

1,050

Real estate depreciation and amortization
48

—

—

—

48

Real estate selling costs and impairment
354

—

—

—

354

Mortgage loan servicing costs
11,437

—

—

—

11,437

Interest expense
5,708

—

—

—

5,708

General and administrative
1,038

30

4,533

—

5,601

Related party general and administrative
12,632

311

671

(12,691
)
923

Total expenses
32,267

341

5,204

(12,691
)
25,121

Income before income taxes
42,361

(341
)
7,487

—

49,507

Income tax expense
448

—

318

—

766

Net income (loss)
41,913

(341
)
7,169

—

48,741

Net income attributable to noncontrolling interest in consolidated affiliate
—