AAMC 10Q_3.31.2014

 

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

FORM 10-Q

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

OR

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

COMMISSION FILE NUMBER: 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.)

402 Strand Street
Frederiksted, United States Virgin Islands 00840-3531
(Address of principal executive office)

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

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

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

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

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

As of April 25, 2014, 2,241,097 shares of our common stock were outstanding.



Altisource Asset Management Corporation
March 31, 2014
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 quarterly report reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed in any forward-looking statement. Factors that may materially affect such forward-looking statements include, but are not limited to:

our ability to implement our business strategy and the business strategy of Residential;
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;
our ability to retain Residential as a client;
the failure of Altisource and Ocwen to effectively perform their obligations under their agreements with us and 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, 2013.


ii


(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

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





1


(table of contents)

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

 
March 31, 2014
 
December 31, 2013
Assets:
 
 
 
Real estate assets:
 
 
 
Land (from consolidated VIE)
$
1,367

 
$
478

Rental residential properties, net (from consolidated VIE)
6,488

 
3,092

Real estate owned (from consolidated VIE)
121,895

 
32,332

 
129,750

 
35,902

Real estate assets held for sale (from consolidated VIE)
4,224

 
1,186

Mortgage loans (from consolidated VIE)
1,766,142

 
1,207,163

Cash and cash equivalents (including from consolidated VIE $48,022 and $115,988, respectively)
280,466

 
140,000

Restricted cash (from consolidated VIE)
7,334

 
5,878

Accounts receivable (including from consolidated VIE $681 and $1,428, respectively)
926

 
1,428

Related party receivables (including from consolidated VIE $10,444 and $9,260, respectively)
10,560

 
9,260

Deferred leasing and financing costs, net (from consolidated VIE)
1,808

 
2,293

Prepaid expenses and other assets (including from consolidated VIE $353 and $1,542, respectively)
1,200

 
1,994

Total assets
$
2,202,410

 
$
1,405,104

Liabilities:
 
 
 
Repurchase agreements (from consolidated VIE)
$
699,950

 
$
602,382

Accounts payable and accrued liabilities (including from consolidated VIE $5,835 and $4,952, respectively)
8,250

 
6,872

Related party payables (including from consolidated VIE $359 and $1,409, respectively)
3,754

 
2,883

Total liabilities
711,954

 
612,137

Commitments and contingencies (Note 6)


 


Mezzanine Equity
 
 
 
Preferred stock, $0.01 par value, 250,000 shares issued and outstanding as of March 31, 2014 and none issued or outstanding as of December 31, 2013; redemption value $250,000
248,886

 

Equity:
 
 
 
Common stock, $.01 par value, 5,000,000 authorized shares; 2,396,203 and 2,353,963 shares issued and outstanding, respectively as of March 31, 2014 and 2,354,774 shares issued and outstanding as of December 31, 2013
24

 
24

Additional paid-in capital
16,189

 
12,855

Retained earnings
1,489

 
(5,339
)
Treasury stock, at cost, 42,240 shares as of March 31, 2014 and none as of December 31, 2013
(44,565
)
 

Total stockholders' equity
(26,863
)
 
7,540

Noncontrolling interest in consolidated affiliate
1,268,433

 
785,427

Total equity
1,241,570

 
792,967

Total liabilities and equity
$
2,202,410

 
$
1,405,104


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

 
$

Net unrealized gain on mortgage loans
65,130

 
1,128

Net realized gain on mortgage loans
9,321

 
387

Total revenues
74,520

 
1,515

Expenses:
 
 
 
Residential property operating expenses
1,050

 

Real estate depreciation and amortization
48

 

Mortgage loan servicing costs
11,437

 
392

Interest expense
5,708

 
42

General and administrative
5,955

 
2,698

Related party general and administrative
923

 
207

Total expenses
25,121

 
3,339

Other income
108

 

Net income (loss) before income taxes
49,507

 
(1,824
)
Income tax expense
766

 

Net income (loss)
48,741

 
(1,824
)
Net (income) loss attributable to noncontrolling interest in consolidated affiliate
(41,913
)
 
984

Net income (loss) attributable to common stockholders
$
6,828

 
$
(840
)
 
 
 
 
Earnings (loss) per share of common stock – basic:
 
 
 
Earnings (loss) per basic share
$
2.88

 
$
(0.36
)
Weighted average common stock outstanding – basic
2,367,202

 
2,343,213

Earnings (loss) per share of common stock – diluted:
 
 
 
Earnings (loss) per diluted share
$
2.39

 
$
(0.36
)
Weighted average common stock outstanding – diluted
2,856,079

 
2,343,213


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, 2013
2,354,774

$
24

$
12,855

$
(5,339
)
$

$
785,427

$
792,967

Issuance of common stock, including option exercises
41,429


18




18

Repurchase of 42,240 shares of common stock




(44,565
)

(44,565
)
Capital contribution from noncontrolling interest





468,491

468,491

Distribution to noncontrolling interest





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


3,316




3,316

Net income (loss)



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


 
Common stock
 
 
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Accumulated deficit
Treasury stock
Noncontrolling interest in consolidated affiliate
Total equity
December 31, 2012
2,343.213

$
23

$
4,993

$
(46
)
$

$
99,911

$
104,881

Share-based compensation


214




214

Net income (loss)



(840
)

(984
)
(1,824
)
March 31, 2013
2,343,213

$
23

$
5,207

$
(886
)
$

$
98,927

$
103,271


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, 2014
 
Three months ended March 31, 2013
Operating activities:
 
 
 
Net income
$
48,741

 
$
(1,824
)
Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(65,130
)
 
(1,128
)
Net realized gain on mortgage loans
(9,321
)
 
(387
)
Net realized gain on real estate
(55
)
 

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

 

Amortization of deferred financing costs
608

 
30

Share-based compensation
3,316

 
214

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
502

 

Related party receivables
(53
)
 
518

Prepaid expenses and other assets
(530
)
 
(360
)
Accounts payable and accrued liabilities
1,118

 
711

Related party payables
871

 
(200
)
Net cash used in operating activities
(19,530
)
 
(2,426
)
Investing activities:
 
 
 
Investment in mortgage loans
(611,357
)
 
(88,257
)
Investment in real estate

 
(278
)
Investment in renovations
(447
)
 

Real estate tax advances to borrowers
(6,259
)
 

Mortgage loan dispositions
32,775

 
88

Mortgage loan payments
3,129

 

Disposition of real estate
734

 

Change in restricted cash
(1,456
)
 

Net cash used in investing activities
(582,881
)
 
(88,447
)
Financing activities:
 
 
 
Proceeds from issuance of preferred stock
250,000

 

Cost of issuance of preferred stock
(1,114
)
 

Issuance of common stock, including stock option exercises
2,732

 

Repurchase of common stock
(44,565
)
 

Payment of tax withholdings on exercise of stock options
(2,714
)
 

Cost of issuance of common stock

 
(73
)
Capital contribution from noncontrolling interest
468,491

 

Distribution to noncontrolling interest
(27,398
)
 

Proceeds from repurchase agreement
127,664

 
12,926

Repayments of repurchase agreement
(30,096
)
 

Payment of deferred financing costs
(123
)
 
(1,100
)
Net cash provided by financing activities
742,877

 
11,753

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

 
(79,120
)
Cash and cash equivalents as of beginning of the period
140,000

 
105,014

Cash and cash equivalents as of end of the period
$
280,466

 
$
25,894



 

Supplemental disclosure of cash flow information

 

Cash paid for interest
$
4,736

 
$

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

 
$
156

Changes in accrued for equity issuance costs
$
183

 
$
370

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

 
$
1,858


5


(table of contents)

See accompanying notes to consolidated financial statements.

6


(table of contents)

Altisource Asset Management Corporation
Notes to Consolidated Financial Statements
March 31, 2014
(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” under a 15-year asset management agreement beginning December 21, 2012, which we refer to as the “Residential asset management agreement.” 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 potential future growth. The Residential asset management agreement entitles us to incentive fees, which we refer to as our “incentive management fees,” that gives us a share of Residential’s cash flow available for distribution to its stockholders as well as reimbursement for certain overhead and operating expenses. Accordingly, our operating results are highly dependent on Residential's ability to achieve positive operating results.

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 asset management agreement 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.

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

On March 22, 2013, September 12, 2013 and September 23, 2013, Residential entered into three separate repurchase agreements to finance the acquisition and ownership of residential mortgage loans and REO properties. In December 2013, Residential increased the maximum aggregate funding available under its repurchase agreements by an additional $325.0 million. The maximum aggregate funding available to us under these repurchase agreements as of March 31, 2013 was $750.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. On April 21, 2014, we increased the aggregate maximum borrowing capacity under the repurchase agreement dated as of March 22, 2013 from $100.0 million to $200.0 million, subject to certain sublimits. The maturity date of the repurchase agreement was also extended to April 20, 2015 subject to an additional one-year extension at the option of the lender. The repurchase agreement dated September 12, 2013, as amended, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016 and includes a provision that, beginning in the nineteenth month, Residential will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of the eighteenth month. The repurchase agreement dated September 23, 2013, as amended, has an aggregate funding capacity of $400.0 million and matures on March 23, 2015. All obligations under the repurchase agreements are fully guaranteed by Residential. As of March 31, 2014, an aggregate of $700.0 million was outstanding under Residential’s repurchase agreements.


7

(table of contents)

On March 18, 2014, we closed a private placement for the issuance and sale of an aggregate 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 aggregate proceeds of $250.0 million. We intend to use the proceeds from this transaction to repurchase shares of our common stock and for other corporate purposes. Such stock repurchases may be made in the open market, block trades or privately-negotiated transactions. 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 of our common stock.

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

Basis of presentation and use of estimates

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

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

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, which could result in a redemption not solely under our control. 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 each cash dividend 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 dividend; 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.



8


(table of contents)


Recently issued accounting standards

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

2. Mortgage loans

Acquisitions

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

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

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

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

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

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

Transfer of mortgage loans to real estate owned

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

Dispositions

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


9


(table of contents)

3. Real estate assets, net

Acquisitions

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

Real estate held for use

As of March 31, 2014, Residential had 852 REO properties held for use. Of these properties, 35 of these properties had been rented, 17 were being listed for rent and 48 were in various stages of renovation. With respect to the remaining 752 REO properties, we will make a final determination whether each property meets 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 state regulations which require Residential to await the expiration of a redemption period before a foreclosure can be finalized and title transferred to Residential. 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 March 31, 2013, Residential had seven REO properties held for use, all of which were in the process of our determining whether these properties would meet our rental profile. If a REO property meets 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 many instances after renovations are made to optimize the sale proceeds.

Real estate held for sale

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

Dispositions

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


10

(table of contents)

4. Fair value of financial instruments


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

Level 1
Level 2
Level 3
 
Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
March 31, 2014
 
 
 
Recurring basis (assets)
 
 
 
Mortgage loans
$

$

$
1,766,142

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

Transfer of mortgage loans to real estate owned
$

$

$
96,528

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

$
699,950

$

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

$

$
1,207,163

Nonrecurring basis (assets)
 
 
 
Real estate assets held for sale
 
 
$
1,520

Transfer of mortgage loans to real estate owned
$

$

$
31,014

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

$
602,382

$


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

The carrying values of 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 New Source 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 the repurchase agreements is estimated using the income approach based on credit spreads available currently in the market for similar floating rate debt.

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):

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Three months ended March 31, 2014
 
Three months ended March 31, 2013
Mortgage loans
 
 
 
Beginning balance at December 31
$
1,207,163

 
$

Investment in mortgage loans
612,508

 
88,257

Net unrealized gain on mortgage loans
65,130

 
1,128

Net realized gain on mortgage loans
9,321

 
387

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

 

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

 
$
87,670

 
 
 
 
Net unrealized gain on mortgage loans held
$
38,197

 
$
1,128


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, 2014 and December 31, 2013 ($ in thousands):
 
Number of loans
Carrying value
Unpaid principal balance
Market value of underlying properties
March 31, 2014
 
 
 
 
Current
329

$
44,280

$
86,860

$
76,452

30
25

2,838

5,238

4,995

60
20

2,446

4,046

4,068

90
2,120

326,308

566,858

483,245

Foreclosure
9,015

1,390,270

2,386,927

1,945,606

Mortgage loans
11,509

$
1,766,142

$
3,049,929

$
2,514,366

December 31, 2013
 
 
 
 
Current
238

$
31,649

$
60,051

$
52,506

30
26

2,087

4,492

3,763

60
23

3,376

5,683

4,738

90
1,555

245,024

419,836

355,451

Foreclosure
6,212

925,027

1,609,546

1,310,439

Mortgage Loans
8,054

$
1,207,163

$
2,099,608

$
1,726,897


The significant unobservable inputs used in the fair value measurement of 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, 2014 and December 31, 2013:


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

5. Repurchase agreements

Residential's operating partnership has entered into master repurchase agreements with major financial institutions. The purpose of these repurchase agreements is to finance the acquisition and ownership of mortgage loans and REO properties in 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, 2014, the weighted average annualized interest rate on borrowing under Residential's repurchase agreements was 3.08%. The following table sets forth data with respect to Residential's repurchase agreements as of March 31, 2014 and December 31, 2013 ($ in thousands):
 
Maximum borrowing capacity
Book value of collateral
Amount outstanding
March 31, 2014
 
 
 
Repurchase agreement due April 21, 2014(1)
$
100,000

$
158,576

$
76,800

Repurchase agreement due March 23, 2015
$
400,000

678,779

400,000

Repurchase agreement due March 11, 2016
$
250,000

396,916

223,150

 
$
750,000

$
1,234,271

$
699,950

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

$
166,350

$
85,364

Repurchase agreement due March 23, 2015
400,000

634,234

398,602

Repurchase agreement due March 11, 2016
250,000

205,328

118,416

 
$
750,000

$
1,005,912

$
602,382

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

Under the terms of the repurchase agreements, as collateral for the funds Residential draws thereunder, Residential's operating partnership will sell to the lender the mortgage assets or equity interests in its statutory trust subsidiaries that own the mortgage assets on its behalf. In the event the lender determines the value of the collateral has decreased, it has the right to initiate a margin call and require Residential 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 at the lender's cost of funds plus a spread calculated based on the type of applicable underlying 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.

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 as well as restrictions on net losses in excess of specified amounts. In addition, the repurchase agreements contain customary events of default.

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.

6. Commitments and contingencies

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Litigation, claims and assessments

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

7. Related party transactions

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

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

$

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

$
392

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

$
183

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

$
24

Ocwen
Related party general and administrative expenses
Salaries and benefits
$
517

$

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

$
895

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

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

8. Share-based payments

During the three months ended March 31, 2014 and 2013, we granted 8,765 and 32,197 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 $791.27 and $63.98, 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, 2014 and 2013, we granted no share-based payments to directors.

We recorded $3.3 million and $0.2 million of compensation expense related to these grants for the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014 and 2013, we had an aggregate $30.0 million and $6.0 million, respectively, of total unrecognized share-based compensation cost to be recognized over a weighted average remaining estimated term of 3.20 years and 5.20 years, respectively.

9. Income taxes

We are domiciled in the United States Virgin Islands and under current United States Virgin Islands 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 income taxes until 2043. From inception to December 31, 2012 we had future taxable income deductions (deferred tax assets) related to initial year expenditures, including the results of operations attributable to noncontrolling interest in consolidated affiliates. Previously, we had recorded a valuation allowance equal to 100% of the resulting gross deferred tax asset; however, due to year-to-date actual activity and forecasted income, management believes it is more likely than not that the majority of the deferred tax asset will be realized and therefore the valuation allowance was substantially eliminated.

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As of March 31, 2014 and 2013, 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, 2014 and 2013. Residential recorded nominal state and local tax expense on income and property for the three months ended March 31, 2014. Our subsidiaries and we remain subject to tax examination for the period from inception to December 31, 2013.

10. Earnings per share

The following table sets forth the components of diluted earnings per share (in thousands, except share and per share amounts):

 
Three months ended March 31, 2014
 
Three months ended March 31, 2013
Numerator
 
 
 
Net income (loss)
$
6,828

 
$
(840
)
 
 
 
 
Denominator
 
 
 
Weighted average common stock outstanding – basic
2,367,202

 
2,343,213

Stock options using treasury method
273,778

 

Restricted stock
183,988

 

Preferred shares if converted
31,111

 

Weighted average common stock outstanding – diluted
2,856,079

 
2,343,213

 
 
 
 
Earnings (loss) per basic share
$
2.88

 
$
(0.36
)
Earnings (loss) per diluted share
$
2.39

 
$
(0.36
)

Because we incurred a net loss attributable to common stockholders for the three months ended March 31, 2013, basic and diluted earnings per share are equivalent for the period. For the three months ended March 31, 2013, there were 305,824 stock options and 204,512 units of restricted stock excluded from the calculation of diluted earnings per share because inclusion would have been anti-dilutive.

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.

12. Subsequent events

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


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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 under our asset management agreement with Residential. 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.

We have a capital light operating strategy. Residential is currently our primary source of revenue and will drive our potential future growth. The asset management agreement with Residential entitles us to “incentive management fees,” that give us a share of Residential’s cash flow available for distribution to its stockholders, as well as reimbursement for certain overhead and operating expenses. Accordingly, our operating results are highly dependent on Residential's ability to achieve positive operating results.

On March 18, 2014, we closed a private placement for the issuance and sale of an aggregate 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 aggregate proceeds of $250.0 million. We intend to use the proceeds from this transaction to repurchase shares of our common stock and for other corporate purposes. Such stock repurchases may be made in the open market, block trades or privately-negotiated transactions. 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 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 Residential asset management agreement 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.

In its initial fifteen months of operations, 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:

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

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

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

Following the above-referenced transactions, as of March 31, 2014, Residential's portfolio consisted of 11,509 residential mortgage loans, substantially all of which were non-performing, having an aggregate UPB of approximately $3.0 billion and an aggregate market value of underlying properties of $2.5 billion. We also had 896 REO properties with an aggregate carrying value of $134.0 million, of which 35 REO properties were rented and 17 were being listed for rent or prepared for rental.


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

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

Observations on Current Market Opportunities

We believe there is currently a significant market opportunity to acquire single-family rental properties through the distressed loan channel and expect the supply of non-performing loans, sub-performing loans, properties in foreclosure and REO to remain steady over the next several years as banks and other mortgage lenders seek to dispose of their distressed inventories. We continue to see substantial volumes of distressed residential mortgage loan sales offered for sale by banks, HUD and private equity funds, among others. We believe that the distressed loan channel gives 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.”

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 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 (less estimated selling costs in the case of REO held for sale). The difference between the carrying value of the asset at the time of conversion and most recent market value, based on BPOs, is recorded in 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; federal, state or local legislative action or initiatives designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures and continued declines in real estate values and/or sustained high levels of unemployment that increase the number of foreclosures and which place additional pressure and/or delays on the already overburdened judicial and administrative proceedings.

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

iii.
Net realized gain on mortgage loans. 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

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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.

As a greater number of Residential’s REO 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 marketing costs, or reduced rental revenues.

Although we generally seek to lease the REO Residential acquires on foreclosure, we may determine to sell the properties that do not meet Residential’s 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.

Expenses

Residential’s expenses primarily consist of loan servicing fees and advances, rental property operating expenses, depreciation and amortization, general and administrative expenses, expense reimbursement, incentive management fees and interest expense. From time to time, expenses also may include impairments of assets. Loan servicing fees and advances are expenses paid to Ocwen to service Residential’s acquired loans and for real estate insurance and other corporate advances. Rental property operating expenses are expenses associated with Residential’s ownership and operation of rental properties including expenses such as Altisource’s inspection, property preservation and renovation fees, property management fees, turnover costs, property taxes, insurance and 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 it depreciate its properties on a straight-line basis over a fixed life. Interest expense consists of the costs to borrow money in connection with Residential’s debt financing of our portfolios. General and administrative expenses consist of the costs related to the general operation and overall administration of our business. Expense reimbursement consists primarily of our employee salaries in direct correlation to the services they provide on Residential’s behalf and other personnel costs and corporate overhead. We are not reimbursed by Residential for certain general and administrative expenses pertaining to stock-based compensation and our expenditures that are not for the benefit of Residential. The incentive management fees consist of compensation due to us, based on the amount of cash available for distribution to Residential’s stockholders for each period. 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. We believe that there is currently a large supply of sub-performing and nonperforming mortgage loans available to Residential for acquisition. We believe the available supply provides for a steady acquisition pipeline of assets since we plan on targeting just a small percentage of the population.

Generally, we expect that 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 involve large portfolios of loans, and the timing and extent of our success in acquiring such loans cannot be predicted.

Financing

Our ability to grow Residential’s business by acquiring sub-performing and non-performing loans is dependent on the availability of adequate financing including additional equity financing, debt financing or both in order to meet Residential’s

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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 generally will need to distribute at least 90% of its taxable income each year (subject to certain adjustments) to its stockholders. This distribution requirement limits its ability to retain earnings and thereby replenish or increase capital to support its activities.

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

Resolution Activities
 
First quarter 2013
 
First quarter 2014
Mortgage Loans
 
 
 
Beginning balance

 
8,054

Acquisitions
684

 
4,207

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

 
1

Ending balance
673

 
11,509

 
 
 
 
Modifications

 
81

 
 
 
 
Real Estate Owned
 
 
 
Beginning balance

 
262

Acquisitions
6

 

Dispositions

 
(2
)
Conversions to REO
1

 
637

Reversions to mortgage loans

 
(1
)
Ending balance
7

 
896

 
 
 
 
Leased

 
35

Renovations complete

 
17

Renovations in process

 
48

Evaluating strategy/held for sale
7

 
796

 
7

 
896

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

Portfolio size

The size of Residential’s investment portfolio will also be a key revenue driver. 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 to Ocwen and property management fees to Altisource. Residential may also incur additional interest expense if it incurs debt to finance the purchase of its assets.


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(table of contents)

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

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

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

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

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

Throughout this quarterly report, all unpaid principal balance and market value amounts for the portfolios 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 through March 31, 2014 as Residential’s “Current Portfolio.”

Residential’s mortgage loans become REO properties when it has obtained title to the property through completion of the foreclosure process. 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, 2014, Residential had 896 REO properties. The aggregate fair value of these 896 REO properties as of March 31, 2014 was approximately $134.0 million, or approximately 7% of the total fair value of its Current Portfolio.

As of March 31, 2014, 35 of Residential’s 896 REO properties had been rented and were occupied by tenants, 17 were being listed for rent, 48 were in varying stages of renovation and 44 were being held for sale. With respect to the remaining 752 REO properties, 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 and title transferred to Residential. 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. As of March 31, 2013, Residential had seven REO properties held for use and were in the process of determining whether these properties would meet their 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 some instances after renovations are made to optimize the sale proceeds.

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(table of contents)

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

$
775

15

Arizona
34

6,010

19

Arkansas
3

369

42

California
106

27,791

40

Colorado
9

1,561

22

Connecticut
5

935

49

Delaware
3

485

29

Florida
193

27,204

23

Georgia
12

1,670

26

Hawaii
1

67

24

Idaho
1

175

30

Illinois
101

14,802

40

Indiana
30

3,327

38

Kansas
11

942

49

Kentucky
8

802

39

Louisiana
6

587

41

Maine
5

587

68

Maryland
12

1,901

47

Massachusetts
6

856

93

Michigan
30

3,457

43

Minnesota
23

4,085

37

Missouri
4

525

17

Nebraska
2

212

103

Nevada
9

1,497

20

New Hampshire
1

158

33

New Jersey
13

1,623

84

New Mexico
17

1,729

22

New York
7

1,318

56

North Carolina
75

8,189

26

Ohio
34

3,808

42

Oklahoma
7

772

23

Oregon
2

458

25

Pennsylvania
18

2,506

50

South Carolina
8

762

20

Tennessee
6

573

33

Texas
15

1,916

23

Utah
9

1,488

34

Vermont
1

185

113

Virginia
4

973

30

Washington
2

256

38

West Virginia
2

416

41

Wisconsin
58

6,222

54

Total
896

$
133,974

35

_____________

21


(table of contents)

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

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

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

Location
Loan count
Carrying value (1)
UPB
Market value of underlying properties (2)
Weighted average market LTV (3)
Alabama
66

$
6,462

$
10,449

$
8,691

200.3
%
Alaska
3

678

687

963

76.2
%
Arizona
220

37,823

59,479

48,286

135.6
%
Arkansas
62

4,068

7,221

5,891

141.0
%
California
1679

517,391

755,931

686,525

123.6
%
Colorado
70

12,118

16,289

15,594

114.3
%
Connecticut
117

15,066

30,907

24,981

149.2
%
Delaware
58

6,918

11,494

9,801

132.4
%
Dist. of Columbia
39

9,291

12,001

13,049

104.9
%
Florida
2176

282,668

528,190

381,094

157.6
%
Georgia
344

32,241

59,391

43,529

154.2
%
Hawaii
47

11,502

20,890

20,210

110.8
%
Idaho
29

3,719

5,973

4,898

135.1
%
Illinois
516

56,715

122,137

85,683

205.2
%
Indiana
369

28,489

44,432

40,775

120.6
%
Iowa
11

693

1,262

986

134.6
%
Kansas
28

2,329

3,374

3,138

122.0
%
Kentucky
92

7,420

11,256

10,254

119.5
%
Louisiana
22

2,249

3,454

3,578

106.7
%
Maine
27

3,532

5,885

5,421

119.1
%
Maryland
538

72,926

147,248

111,326

151.2
%
Massachusetts
257

40,483

73,061

65,146

126.2
%
Michigan
123

11,946

20,708

16,130

178.7
%
Minnesota
76

10,249

16,593

13,613

134.2
%
Mississippi
29

2,228

3,697

3,163

133.6
%
Missouri
113

7,028

13,883

10,165

172.8
%
Montana
5

512

824

720

121.5
%
Nebraska
10

1,204

1,860

1,586

121.1
%
Nevada
221

35,436

65,205

44,944

164.4
%
New Hampshire
19

2,634

4,497

3,992

124.3
%
New Jersey
927

128,431

283,001

208,227

162.3
%
New Mexico
99

8,090

14,328

12,421

123.6
%
New York
573

99,085

195,463

181,247

124.2
%
North Carolina
347

32,630

51,785

44,161

128.9
%

22


(table of contents)

North Dakota
1

99

123

138

89.5
%
Ohio
181

14,065

25,850

21,019

155.1
%
Oklahoma
33

3,379

4,732

4,641

108.3
%
Oregon
110

17,874

31,342

28,396

117.3
%
Pennsylvania
379

39,079

70,061

56,451

140.4
%
Puerto Rico
2

99

224

251

118.3
%
Rhode Island
97

7,811

23,095

12,324

221.7
%
South Carolina
236

21,117

36,318

29,383

139.2
%
South Dakota
5

432

743

695

107.8
%
Tennessee
101

11,146

16,574

15,102

121.6
%
Texas
272

28,352

37,008

38,522

103.5
%
Utah
113

17,685

24,905

23,239

113.9
%
Vermont
9

900

1,606

1,622

101.8
%
Virginia
105

23,000

34,766

32,359

118.5
%
Washington
396

73,859

114,298

101,408

123.3
%
West Virginia
7

637

1,076

858

134.2
%
Wisconsin
149

12,153

23,999

17,499

169.8
%
Wyoming
1

$
201

$
354

$
271

131.0
%
Total mortgage loans
11,509

$
1,766,142

$
3,049,929

$
2,514,366

142.0
%
_____________
(1)
The carrying value of an asset is based on our fair value model. The significant unobservable inputs used in the fair value measurement of Residential's mortgage loans are discount rates, forecasts of future home prices, alternate resolution probabilities and timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. For a more complete description of the fair value measurements and the factors that may significantly affect the carrying value of Residential's assets, please see Note 4 to our consolidated financial statements.
(2)
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 in each of Residential's portfolios 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.
(3)
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. We also look at our stand-alone results because the effect of amounts received from Residential and NewSource are still recognized in net income attributable to our stockholders through the adjustment for earnings attributable to our noncontrolling interest in Residential.

In evaluating our operating performance and managing our business, we consider the incentive management fees and reimbursement of expenses paid to us by Residential under our asset management agreement 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.

23


(table of contents)



Altisource Asset Management Corporation
Consolidating Statement of Operations
Three months ended March 31, 2014
(In thousands, unaudited)

 
 Residential (GAAP)
NewSource Stand-alone (Non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
 
Revenues and net gain on investments:
 
 
 
 
 
Rental revenues
$
69

$

$

$

$
69

Net unrealized gain on mortgage loans
65,130




65,130

Net realized gain on mortgage loans
9,321




9,321

Incentive management fee


10,911

(10,911
)

Expense reimbursements


1,780

(1,780
)

Total revenues
74,520


12,691

(12,691
)
74,520

Expenses:
 
 




 
Residential property operating expenses
1,050




1,050

Real estate depreciation and amortization
48




48

Mortgage loan servicing costs
11,437




11,437

Interest expense
5,708




5,708

General and administrative
1,392

30

4,533


5,955

Related party general and administrative
12,632

311

671

(12,691
)
923

Total expenses
32,267

341

5,204

(12,691
)
25,121

Other income
108




108

Income (loss) 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) loss attributable to noncontrolling interest in consolidated affiliate



(41,913
)
(41,913
)
Net income (loss) attributable to common stockholders
$
41,913

$
(341
)
$
7,169

$
(41,913
)
$
6,828



24


(table of contents)

Altisource Asset Management Corporation
Consolidating Statement of Operations
Three months ended March 31, 2013
(In thousands, unaudited)

 
 Residential (GAAP)
NewSource Stand-alone (Non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
 
Revenues and net gain on investments:
 
 
 
 
 
Rental revenues
$

$

$

$

$

Net unrealized gain on mortgage loans
1,128




1,128

Net realized gain on mortgage loans
387




387

Expense reimbursements


895

(895
)

Total revenues
1,515


895

(895
)
1,515

Expenses:
 
 
 
 
 
Mortgage loan servicing costs
392




392

Interest expense
42




42

General and administrative
987


1,711


2,698

Related party general and administrative
1,078


24

(895
)
207

Total expenses
2,499


1,735

(895
)
3,339

Net income (loss)
(984
)

(840
)

(1,824
)
Net (income) loss attributable to noncontrolling interest in consolidated affiliate



984

984

Net income (loss) attributable to common stockholders
$
(984
)
$

$
(840
)
$
984

$
(840
)


25


(table of contents)

Altisource Asset Management Corporation
Consolidating Balance Sheet
March 31, 2014
(In thousands, unaudited)

 
 Residential (GAAP)
NewSource stand-alone (non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
 
Assets:
 
 
 
 
 
Real estate assets:
 
 
 
 
 
Land
$
1,367

$

$

$

$
1,367

Rental residential properties, net
6,488




6,488

Real estate owned
121,895




121,895

 
129,750




129,750

Real estate assets held for sale
4,224




4,224

Mortgage loans
1,766,142




1,766,142

Cash and cash equivalents
48,022

19,892

212,552


280,466

Restricted cash
7,334




7,334

Accounts receivable
681


245


926

Related party receivables
10,444


12,308

(12,192
)
10,560

Investment in affiliate
18,000


2,000

(20,000
)

Deferred leasing and financing costs, net
1,808




1,808

Prepaid expenses and other assets
353

25

822


1,200

Total assets
1,986,758

19,917

227,927

(32,192
)
2,202,410

Liabilities:
 
 
 
 
 
Repurchase agreements
699,950




699,950

Accounts payable and accrued liabilities
5,835

17

2,398


8,250

Related party payables
12,540

320

3,086

(12,192
)
3,754

Total liabilities
718,325

337

5,484

(12,192
)
711,954

Commitments and contingencies
 
 
 
 
 
Preferred stock


248,886


248,886

Equity:
 
 
 
 
 
Common stock
571


24

(571
)
24

Additional paid-in capital
1,226,927

20,000

16,189

(1,246,927
)
16,189

Retained earnings/(accumulated deficit)
40,935

(420
)
1,909

(40,935
)
1,489

Treasury stock


(44,565
)

(44,565
)
Total stockholders' equity
1,268,433

19,580

(26,443
)
(1,288,433
)
(26,863
)
Noncontrolling interest in consolidated affiliate



1,268,433

1,268,433

Total equity
1,268,433

19,580

(26,443
)
(20,000
)
1,241,570

Total liabilities and equity
$
1,986,758

$
19,917

$
227,927

$
(32,192
)
$
2,202,410


26


(table of contents)

Altisource Asset Management Corporation
Consolidating Balance Sheet
December 31, 2013
(In thousands, unaudited)

 
 Residential (GAAP)
NewSource stand-alone (non-GAAP)
 AAMC Stand-alone
(Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
Assets:
 
 
 
 
 
Real estate assets:
 
 
 
 
 
Land
$
478

$

$

$

$
478

Rental residential properties, net
3,092




3,092

Real estate owned
32,332




32,332

 
35,902




35,902

Real estate assets held for sale
1,186




1,186

Mortgage loans
1,207,163




1,207,163

Cash and cash equivalents
115,988

19,923

4,089


140,000

Restricted cash
5,878




5,878

Accounts receivable
1,428




1,428

Related party receivables
9,260


4,486

(4,486
)
9,260

Investment in affiliate
18,000


2,000

(20,000
)

Deferred leasing and financing costs, net
2,293




2,293

Prepaid expenses and other assets
1,542


452


1,994

Total assets
1,398,640

19,923

11,027

(24,486
)
1,405,104

Liabilities:
 
 
 
 
 
Repurchase agreement
602,382




602,382

Accounts payable and accrued liabilities
4,952


1,920


6,872

Related party payables
5,879


1,490

(4,486
)
2,883

Total liabilities
613,213


3,410

(4,486
)
612,137

Commitments and contingencies
 
 
 
 
 
Equity:
 
 
 
 
 
Common stock
423


24

(423
)
24

Additional paid-in capital
758,584

20,000

12,855

(778,584
)
12,855

Retained earnings (accumulated deficit)
26,420

(77
)
(5,262
)
(26,420
)
(5,339
)
Total stockholders' equity
785,427

19,923

7,617

(805,427
)
7,540

Noncontrolling interest in consolidated affiliate



785,427

785,427

Total equity
785,427

19,923

7,617

(20,000
)
792,967

Total liabilities and equity
$
1,398,640

$
19,923

$
11,027

$
(24,486
)
$
1,405,104


Primary driver of our stand-alone operating results

As described above under “— Factors affecting our consolidated results,” our incentive management fees will be directly linked to the results of Residential which we expect will be affected by various factors including, but not limited to, the number and performance of Residential's mortgage loan acquisitions, its ability to use financing to grow its business, its ability to convert mortgage loans into residential rental properties, its operating expenses, the success of its loan resolution methodologies and the size of its portfolio. The extent to which we are successful in managing these factors for Residential will affect our ability to generate incentive management fees, which is our sole source of income other than the reimbursement of our expenses pursuant to the Residential asset management agreement. As Residential generates taxable income, our incentive management fees will provide us with a share of Residential's cash available for distribution to its stockholders. If there is a decline in the cash distributable by Residential to its stockholders in any period, or if Residential is unable to make distributions to its stockholders in any period, the amount of our incentive management fees would be adversely affected.

27


(table of contents)


Results of operations

The following sets forth discussion of our results of operations for the three months ended March 31, 2014 and 2013. Because the results of Residential are consolidated into our financial statements, the results of operations disclosures set forth below include the results of Residential. We eliminate all intercompany amounts in our consolidated financial statements, including the expense reimbursement and incentive management fees, if any, paid or owed to us by Residential. However, the effect of such amounts received from Residential is still recognized in net income attributable to our stockholders through the adjustment for earnings attributable to noncontrolling interest.

Three months ended March 31, 2014 versus March 31, 2013

Rental revenues

Residential's rental revenues increased to $69 thousand for the three months ended March 31, 2014 from no rental revenue for the three months ended March 31, 2013. We expect Residential to generate increasing rental revenues for the remainder of 2014 upon renovating, listing and renting additional residential rental properties. Residential's rental revenues will be dependent primarily on occupancy levels and rental rates for its residential rental properties. Because Residential's lease terms generally are expected to be one to two years, Residential's occupancy levels and rental rates will be highly dependent on localized residential rental markets.

Net unrealized gain on mortgage loans

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

First, Residential recognized $23.6 million for the three months ended March 31, 2014 in unrealized gains driven by a material change in loan status. The amount of unrealized gains due to a change in loan status for the three months ended March 31, 2013 was nominal. During the three months ended March 31, 2014 and 2013, Residential converted 637 mortgage loans and 1 mortgage loan to REO status, respectively. Upon conversion of these mortgage loans to REO, Residential marked these properties to the most recent market value (less estimated selling costs in the case of REO held for sale); and
Second, Residential recognized $41.6 million and $1.1 million unrealized gains for the three months ended March 31, 2014 and 2013, respectively, in unrealized gains from the net increase in the fair value of loans during the period subsequent to acquisition. Adjustments to the fair value of loans after acquisition represent a change in the expected time required to complete the foreclosure process, among other factors. The reduction in time required to complete the foreclosure is driven by the completion of activities in the foreclosure process after we acquired the loans. This reduction in timeline results in reduced carrying costs and reduced future expenses for the loans, each of which increase the fair value of the loans. The increase in the value of the loans is recognized in net unrealized gain on mortgage loans in our consolidated statements of operations.

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

Net realized gain on mortgage loans

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

28


(table of contents)


Residential property operating expenses

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

Real estate depreciation and amortization

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

Mortgage loan servicing costs

Residential incurred $11.4 million and $0.4 million of mortgage loan servicing costs primarily for servicing and foreclosure fees and advances of residential property insurance and servicer fees for the three months ended March 31, 2014 and 2013, respectively. Residential incurs mortgage loan servicing and foreclosure costs as it services and/or forecloses on loans and it pay for advances relating to the loans on payment of items such as property insurance and HOA dues that are made to protect our investment in mortgage loans and to continue to service the acquired loans. Residential's loan servicing costs could be higher than expected in a given period if the number of non-performing mortgage loans exceeds expected levels.

Interest expense

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

General and administrative expenses

General and administrative expenses increased to $6.0 million for the three months ended March 31, 2014 from $2.7 million for the three months ended March 31, 2013, primarily due to an increase in salaries and benefits attributable to the hiring of additional personnel to provide services on behalf of Residential and higher professional fees and acquisition costs related to purchases of mortgage loan portfolios.

Related party general and administrative expenses

Residential and we incurred $0.9 million and $0.2 million of related party general and administrative expenses for the three months ended March 31, 2014 and 2013, respectively, primarily consisting of increased personnel costs attributable to additional services provided on behalf of our business and due diligence costs related to the acquisition of loan portfolios.

Net income attributable to noncontrolling interest in consolidated affiliate

We have recorded $41.9 million and $1.0 million of net income attributable to noncontrolling interest in consolidated affiliate which is equivalent to Residential's net income for the three months ended March 31, 2014 and 2013, respectively, because although we consolidate Residential, we have no ownership in Residential.

Incentive management fees and expense reimbursements

We recorded incentive management fees of approximately $10.9 million for the three months ended March 31, 2014 in connection with the cash available for distribution from Residential. No incentive management fees were received from

29


(table of contents)

Residential for the three months ended March 31, 2013. The incentive management fees have been eliminated under U.S. GAAP in consolidation. We recorded $1.8 million and $0.9 million of expense reimbursements from Residential and NewSource that also have been eliminated in consolidation for the three months ended March 31, 2014 and 2013, respectively. We are not reimbursed by Residential for certain general and administrative expenses pertaining to stock-based compensation and our expenditures that are not for the benefit of Residential.

Liquidity and capital resources

As of March 31, 2014, we had stand-alone cash and cash equivalents of $212.6 million, which reflects the issuance and sale of 250,000 shares of our Series A Convertible Preferred Stock for aggregate proceeds of $250.0 million on March 18, 2014. We intend to use the proceeds from this transaction to repurchase shares of our common stock and for other corporate purposes. In connection with the foregoing, the 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. As of March 31, 2014, a total of $44.4 million of common stock have been repurchased under this program.

We believe this cash is sufficient to fund our operations since Residential has begun paying the incentive management fees to us as a result of paying cash dividends to its stockholders. Our only stand-alone cash expenditures to date are leasehold improvements and general and administrative expenses, including unreimbursed salaries and professional expenses.

On a consolidated basis, our cash and cash equivalents as of March 31, 2014 was $280.5 million, of which approximately $48.0 million was attributable to Residential. Residential’s liquidity reflects its ability to meet its current obligations (including its operating expenses and, when applicable, retirement of, and margin calls relating to, its financing arrangements), purchase additional portfolios of sub-performing and non-performing residential mortgage loans and make distributions to its stockholders. Residential generally needs to distribute at least 90% of its taxable income each year (subject to certain adjustments) to its stockholders to qualify as a REIT under the Internal Revenue Code. This distribution requirement limits Residential’s ability to retain earnings and thereby replenish or increase capital to support its activities. Our consolidated cash and cash equivalents as of March 31, 2014 also include $19.9 million attributable to NewSource, representing the cash invested by Residential and us into NewSource in October 2013.

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

To date, under our management, Residential has used the proceeds of its equity offerings and the available funding under its repurchase agreements to finance its acquisition of its portfolio of residential mortgage loans and REO properties. Residential’s equity offerings and repurchase facilities are described below.
    
Equity Offerings

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

Repurchase Facilities

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

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lender. The repurchase agreement dated September 12, 2013, as amended, has an aggregate funding capacity of $250.0 million and matures on March 11, 2016 and includes a provision that beginning in the nineteenth month, Residential will not be able to finance mortgage loans in excess of amounts outstanding under the facility at the end of the eighteenth month. The repurchase agreement dated September 23, 2013, as amended, has an aggregate funding capacity of $400.0 million and matures on March 23, 2015. The maximum aggregate funding available to Residential under these repurchase agreements is currently $850.0 million, subject to certain sublimits, eligibility requirements and conditions precedent to each funding. All obligations under the repurchase agreements are fully guaranteed by Residential. As of March 31, 2014, an aggregate of $700.0 million was outstanding under Residential’s repurchase agreements, and as of April 25, 2014, an aggregate of $692.8 million was outstanding under Residential's repurchase agreements.

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 the Delaware statutory trust subsidiary that owns the applicable underlying mortgage assets on Residential’s behalf, or the trust will sell directly such underlying mortgage assets. In the event the lender determines the value of the collateral has decreased, it has the right to initiate a margin call and require Residential to post additional collateral or to repay a portion of the outstanding borrowings. The price paid by the lender for each underlying mortgage asset Residential finances under the applicable repurchase agreement is subject to agreement between the lender and Residential and is based on a percentage of the market value or, in certain circumstances, the book value of the underlying mortgage asset and depends on its delinquency status. Residential’s cost of borrowing under the repurchase agreements generally corresponds to LIBOR, or the lender interest at the lender’s cost of funds plus a margin. Residential is also required to pay certain other customary fees, administrative costs and expenses to maintain and administer the repurchase agreements.

The repurchase agreements, as amended, require 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 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.

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

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

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

12,926

$
602,382

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

12,926

602,382

Weighted average quarterly balance
666,132

1,436

364,665


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

The increase in amounts outstanding under our repurchase agreements from December 31, 2013 to March 31, 2014 relate primarily to funds Residential drew down under a repurchase facility in January 2014 to complete its acquisitions of portfolios

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