S-11/A 1 d565777ds11a.htm AMENDMENT NO. 1 TO FORM S-11 Amendment No. 1 to Form S-11
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As filed with the Securities and Exchange Commission on October 9, 2013

Registration Statement No. 333-191300

 

 

 

Securities and Exchange Commission

Washington, D.C. 20549

 

 

Amendment No. 1

to

Form S-11

For Registration

Under

The Securities Act of 1933

of Certain Real Estate Companies

 

 

New Residential Investment Corp.

(Exact name of registrant as specified in its governing instruments)

 

 

1345 Avenue of the Americas,

New York, NY 10105

(212) 798-6100

(Address, including Zip Code, and Telephone Number, including Area Code, of Registrant’s Principal Executive Offices)

 

 

Cameron D. MacDougall

Secretary

1345 Avenue of the Americas,

New York, NY 10105

212-479-1522

(Name, Address, including Zip Code, and Telephone Number, including Area Code, of Agent for Service)

 

 

Copies to:

Richard B. Aftanas

Joseph A. Coco

Skadden, Arps, Slate, Meagher & Flom LLP

Four Times Square

New York, New York 10036

(212) 735-3000

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after the effective date of this registration statement.

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If any of the Securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  ¨

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   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

PRELIMINARY PROSPECTUS    SUBJECT TO COMPLETION, DATED OCTOBER 9, 2013

             Shares

New Residential Investment Corp.

Common Stock

We are a publicly traded real estate investment trust (“REIT”) primarily focused on investing in residential mortgage related assets. We are externally managed by an affiliate of Fortress Investment Group (“Fortress”). We were formed as a wholly owned subsidiary of Newcastle Investment Corp. (“Newcastle”) in September 2011 and were spun-off from Newcastle on May 15, 2013.

We are offering                      shares of our common stock as described in this prospectus. Our shares of common stock are listed on the New York Stock Exchange under the symbol “NRZ.” On October 8, 2013, the last reported sales price for our common stock on the New York Stock Exchange was $6.39 per share.

We intend to elect and qualify to be taxed as a REIT for U.S. federal income tax purposes commencing with our initial taxable year ending December 31, 2013. To assist us in qualifying as a REIT, among other purposes, stockholders are generally restricted from owning more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of capital stock. In addition, our certificate of incorporation contains various other restrictions on the ownership and transfer of our common stock. See “Description of Capital Stock—Restrictions on Ownership and Transfer of Our Capital Stock.”

We are an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”).

See “Risk Factors” beginning on page 24 for a discussion of the following and other risks:

 

    We have a very limited operating history as an independent company and may not be able to successfully operate our business strategy or generate sufficient revenue to make or sustain distributions to our stockholders;

 

    We rely heavily on mortgage servicers to achieve our investment objective and have no direct ability to influence their performance;

 

    We are subject to significant counterparty concentration and default risks;

 

    Many of our investments may be illiquid, and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are required to dispose of them;

 

    We may not be able to finance our investments on attractive terms or at all, and financing for our excess mortgage servicing rights investments may be particularly difficult or impossible to obtain;

 

    Maintenance of our Investment Company Act of 1940 exemption imposes limits on our operations;

 

    There are conflicts of interest in our relationship with FIG LLC, our Manager; and

 

    Our failure to qualify as a real estate investment trust would result in higher taxes and reduced cash available for distribution to our stockholders.

Neither the Securities and Exchange Commission (“SEC”) nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

     Per share      Total  

Public offering price

   $                    $                

Underwriting discounts and commissions

   $         $     

Proceeds to us, before expenses

   $         $     

The underwriters may also purchase up to an additional                      shares of our common stock at the public offering price from us, less the underwriting discounts and commissions payable by us, to cover over-allotments, if any, within 30 days from the date of this prospectus.

The underwriters expect to deliver the shares on or about                 , 2013.

Prospectus dated                 , 2013.


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You should rely only on the information contained in this prospectus, any free writing prospectus prepared by us or information to which we have referred you. Neither we nor the underwriters have authorized anyone to provide you with additional information or information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock.

TABLE OF CONTENTS

 

Prospectus Summary

     1   

Risk Factors

     24   

Cautionary Statement Regarding Forward-Looking Statements

     57   

Use of Proceeds

     59   

Distribution Policy

     60   

Capitalization

     61   

Price Range Of Common Stock

     62   

Selected Historical Financial Information

     63   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     64   

Business

     98   

Our Manager and Management Agreement

     124   

Management

     130   

Principal Stockholders

     139   

Certain Relationships and Transactions With Related Persons, Affiliates and Affiliated Entities

     141   

Description of Our Capital Stock

     148   

Certain Provisions of the Delaware General Corporation Law and Our Certificate of Incorporation and Bylaws

     152   

Shares Eligible for Future Sale

     155   

U.S. Federal Income Tax Considerations

     157   

Underwriting

     181   

Legal Matters

     184   

Experts

     184   

Where You Can Find More Information

     184   

Index to Financial Statements of New Residential Investment Corp. and Subsidiaries (formerly known as NIC MSR LLC)

     F-1   

 

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Industry Data

Unless otherwise indicated, information contained in this prospectus concerning the mortgage and mortgage servicing industry, including our general expectations and market position and market opportunity, is based on information from various sources (including government and industry publications, surveys, analyses, valuations and forecasts and our internal research), assumptions that we have made (which we believe are reasonable based on those data from such sources and other similar sources) and our knowledge of the markets. The projections, assumptions and estimates of our future performance and the future performance of the mortgage and mortgage servicing industry are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described under “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates included in this prospectus.

 

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PROSPECTUS SUMMARY

This summary highlights some of the information in this prospectus. It does not contain all of the information that you should consider before investing in our common stock. You should read carefully the more detailed information set forth under “Risk Factors” and the other information included in this prospectus.

Unless the context otherwise requires, any references in this prospectus to “we,” “our,” “us,” “New Residential” and the “Company” refer to New Residential Investment Corp. and its consolidated subsidiaries. Any references in this prospectus to “Newcastle” refer to Newcastle Investment Corp. and its consolidated subsidiaries. Our “Manager” refers to FIG LLC, a Delaware limited liability company, our external manager, and an affiliate of Fortress.

Our Company

New Residential is a publicly traded REIT primarily focused on investing in residential mortgage related assets. We are externally managed by an affiliate of Fortress. We were formed as a wholly owned subsidiary of Newcastle in September 2011 and were spun-off from Newcastle on May 15, 2013, which we refer to as the “separation date” or “distribution date.”

Our goal is to drive strong risk-adjusted returns primarily through investments in residential real estate related investments, including, but not limited to, excess mortgage servicing rights (“Excess MSRs”), Agency adjustable rate mortgage (“ARM”) and Non-Agency residential mortgage backed securities (“RMBS”) and residential mortgage loans. We generally target assets that generate significant current cash flows and/or have the potential for meaningful capital appreciation. We aim to generate attractive returns for our stockholders without the excessive use of financial leverage.

Our portfolio is currently composed of investments in Excess MSRs, Agency ARM RMBS, Non-Agency RMBS, residential mortgage loans, consumer loans and cash, as described in more detail under “—Our Portfolio.” A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the Investment Company Act of 1940 (the “1940 Act”), including investments in Agency ARM RMBS.

Our investment guidelines are purposefully broad to enable us to make investments in a wide array of assets, and our asset allocation and target assets may change over time depending on our Manager’s investment decisions in light of prevailing market conditions. For more information about our investment guidelines, see “Business—Investment Guidelines.”

Our Manager

We are managed by FIG LLC, an affiliate of Fortress. We are able to draw upon the long-standing expertise and resources of Fortress, a global investment management firm with $54.6 billion of alternative and traditional assets under management as of June 30, 2013.

We are also able to capitalize on our Manager’s relationship with Nationstar Mortgage LLC (“Nationstar”), which is majority-owned by Fortress funds managed by our Manager, to source investment opportunities. Nationstar (NYSE: NSM) is one of the largest residential loan servicers, according to Inside Mortgage Finance, and it was ranked among the highest quality servicers by Fannie Mae in April 2013. We have developed an innovative strategy for co-investing in Excess MSRs with Nationstar, as described below under “—Market Opportunity and Target Assets—Excess Mortgage Servicing Rights (Excess MSRs).”

Pursuant to the terms of our management agreement with FIG LLC (the “Management Agreement”), our Manager provides a management team and other professionals who are responsible for implementing our business strategy and performing certain services for us, subject to oversight by our board of directors. Our Manager’s duties include: (1) performing all of our day-to-day functions, (2) determining investment criteria in conjunction with, and subject to the supervision of, our board of directors, (3) sourcing, analyzing and executing

 

 

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on investments and sales, (4) performing investment and liability management duties, including financing and hedging, and (5) performing financial and accounting management. For its services, our Manager is entitled to an annual management fee and is eligible to receive incentive compensation, depending upon the performance of our assets, as described below under “—Management Agreement.”

Our Manager also manages our predecessor, Newcastle, a publicly traded REIT that pursues a broad range of real estate related investments. Our management team will not be required to exclusively dedicate their services to us and will provide services for other entities affiliated with our Manager, including, but not limited to, Newcastle.

Market Opportunity and Target Assets

We believe that unfolding developments in the U.S. residential housing market are generating significant investment opportunities. The U.S. residential real estate market is vast: the value of the housing market totaled approximately $19 trillion as of June 2013, including about $10 trillion of outstanding mortgages, according to Inside Mortgage Finance. In the aftermath of the U.S. financial crisis, the residential mortgage industry is undergoing major structural changes that are transforming the way mortgages are originated, owned and serviced. We believe these changes are creating a compelling set of investment opportunities.

We also believe that New Residential is one of only a select number of market participants that have the combination of capital, industry expertise and key business relationships we think are necessary to take advantage of this opportunity. We are focused on the investment opportunities described below, as well as other opportunities that may arise as the residential mortgage market evolves. A majority of our assets, including our Agency ARM RMBS, consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act.

For more information about the mortgage industry, see “Business—Mortgage Industry” included elsewhere in this prospectus.

Excess Mortgage Servicing Rights (Excess MSRs)

In our view, the mortgage servicing sector presents a number of compelling investment opportunities. A mortgage servicing right (“MSR”) provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made on the underlying mortgages. This amount typically ranges from 25 to 50 basis points (“bps”) times the unpaid principal balance (“UPB”) of the mortgages. Approximately 82% of MSRs were owned by banks as of the first quarter of 2013. We expect this number to decline as banks face pressure to reduce their MSR exposure as a result of heightened capital reserve requirements under Basel III, regulatory scrutiny and a more challenging servicing environment.

As banks sell MSRs, there may be an opportunity for entities such as New Residential to participate through co-investment in the corresponding Excess MSRs. An MSR is made up of two components: a basic fee and an Excess MSR. The basic fee is the amount of compensation for the performance of servicing duties, and the Excess MSR is the amount that exceeds the basic fee. For example, if an MSR is 30 bps and the basic fee is 5 bps, then the Excess MSR is 25 bps. As the owner of an Excess MSR, we are not required to assume any servicing duties, advance obligations or liabilities associated with the portfolios underlying our investment.

There are a number of reasons why we believe Excess MSRs are a compelling investment opportunity:

 

   

Supply-Demand Imbalance. Since 2010, banks have sold or committed to sell MSRs totaling approximately $1 trillion of the approximately $10 trillion mortgage market. As a result of the regulatory and other pressures facing bank servicers, we believe the volume of MSR sales is likely to be substantial for some period of time. We estimate that MSRs on approximately $300 billion of mortgages are currently for sale, which would require a capital investment of approximately $2-3 billion based on current pricing dynamics, and approximately $1-2 trillion of MSRs could be sold over the next several years. In addition, approximately $1-2 trillion of new loans are expected to be created annually according to Inside Mortgage Finance. We believe this creates an opportunity to enter

 

 

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into “flow arrangements,” whereby loan originators agree to sell Excess MSRs on a recurring basis (often monthly or quarterly) on newly originated loans. We believe many non-bank servicers who seek to acquire MSRs and are constrained by capital limitations will continue to sell a portion of the Excess MSR.

 

    Attractive Pricing. MSRs are currently being sold at a discount to historical pricing levels. While prices have rebounded from the lows, we believe that prices remain lower than their peak. At current prices, we believe investments in Excess MSRs can generate attractive returns without leverage.

 

    Significant Barrier to Entry. Non-servicers, like us, cannot own the basic fee component of an MSR directly and would therefore need to co-invest with a servicer in order to invest in an Excess MSR. The number of strong, scalable non-bank servicers is limited. Moreover, in the case of Excess MSRs on Agency pools, the servicer must be Agency-approved. As a result, non-servicers seeking to invest in Excess MSRs generally face a significant barrier to entering the market, particularly if they do not have a relationship with a quality servicer. We believe our track record of investing in Excess MSRs and our established relationship with Nationstar give us a competitive advantage over other potential investors.

We pioneered investments in Excess MSRs (while we were a wholly owned subsidiary of Newcastle). We believe we remain the most active REIT in the sector. For details about our investments in Excess MSRs, see “—Our Portfolio—Excess MSRs” below.

Residential Mortgage Backed Securities (RMBS)

We invest in both Agency ARM RMBS and Non-Agency RMBS, which we believe complement our Excess MSR investments. RMBS are securities created through the securitization of a pool of residential mortgage loans. As of March 2013, approximately $6 trillion of the $10 trillion of residential mortgages outstanding was securitized, according to Inside Mortgage Finance. Of the securitized mortgages, approximately $5 trillion are Agency RMBS, which are RMBS issued or guaranteed by a U.S. Government agency, such as the Government National Mortgage Association (“Ginnie Mae”), or by a government-sponsored enterprise (“GSE”), such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”). The balance has been securitized by either public or private trusts (“private label securitizations”), and these securities are referred to as Non-Agency RMBS. For more information about the securitization market, see “Business—Mortgage Industry—Overview” included elsewhere in this prospectus.

Agency ARM RMBS generally offer more stable cash flows and historically have been subject to lower credit risk and greater price stability than the other types of residential mortgage investments we target. More information about the types of Agency ARM RMBS in which we may invest is set forth under “Business—Market Opportunity and Target Assets—RMBS.” Details about our existing investments in Agency ARM RMBS are set forth under “—Our Portfolio—Agency ARM RMBS” below.

Since the onset of the financial crisis in 2007, there has been significant volatility in the prices for Non-Agency RMBS. This has resulted from a widespread contraction in capital available for this asset class, deteriorating housing fundamentals, and an increase in forced selling by institutional investors (often in response to rating agency downgrades). While the prices of these assets have started to recover from their lows, we believe a meaningful gap still exists between current prices and the recovery value of many Non-Agency RMBS. Accordingly, we believe there are opportunities to acquire Non-Agency RMBS at attractive risk-adjusted yields, with the potential for meaningful upside if the U.S. economy and housing market continue to strengthen. We believe the value of existing Non-Agency RMBS may also rise if the number of buyers returns to pre-2007 levels. Furthermore, we believe that in many Non-Agency RMBS vehicles there is a meaningful discrepancy between the value of the Non-Agency RMBS and the value of the underlying collateral. We intend to pursue opportunities to structure transactions that would enable us to realize this difference. For details about our investments in Non-Agency RMBS, see “—Our Portfolio—Non-Agency RMBS” below.

 

 

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Residential Mortgage Loans

We believe there may be attractive opportunities to invest in portfolios of non-performing and other residential mortgage loans. In these investments, we would expect to acquire the loans at a deep discount to their face amount, and we (either independently or with a servicing co-investor) would seek to resolve the loans at a substantially higher valuation. We would seek to improve performance by transferring the servicing to Nationstar or another reputable servicer, which we believe could increase unlevered yields. In addition, we may seek to employ leverage to increase returns, either through traditional financing lines or securitization options.

While a number of portfolios of non-performing residential loans have been sold since the financial crisis, we believe the volume of such sales may increase for a number of reasons. For example, with improved balance sheets, many large banks have more financial flexibility to recognize losses on non-performing assets. The U.S. Department of Housing and Urban Development (“HUD”), which acquires the non-performing loans from Ginnie Mae securitizations, has been increasing the number of portfolio sales. In addition, we believe that residential loan servicers – which have traditionally resorted to loan foreclosure procedures and subsequent property sales to maximize recoveries on non-performing loans – may increase sales of defaulted loans. To the extent any of these dynamics results in a meaningful volume of non-performing loan sales, we believe they may pose attractive investment opportunities for New Residential. For details about our investments in residential mortgage loans, see “—Our Portfolio—Residential Mortgage Loans” below.

Residential Mortgage Servicing Advances

We believe there may be attractive opportunities to invest in servicing advances. Servicing advances are reimbursable cash payments made by a loan servicer to the owner of a loan when the borrower fails to make required payments. Servicing advances typically fall into one of three categories:

 

    Principal and Interest Advances: Cash payments made by the servicer to the owner of the mortgage loan to cover scheduled payments of principal and interest on a mortgage loan that have not been paid on a timely basis by the borrower.

 

    Escrow Advances (Taxes and Insurance Advances): Cash payments made by the servicer to third parties on behalf of the borrower for real estate taxes and insurance premiums on the property that have not been paid on a timely basis by the borrower.

 

    Foreclosure Advances: Cash payments made by the servicer to third parties for the costs and expenses incurred in connection with the foreclosure, preservation and sale of the mortgaged property, including attorneys’ and other professional fees.

Servicing advances are usually reimbursed from amounts received with respect to the related mortgage loan, including payments from the borrower or amounts received from the liquidation of the property securing the loan, which is referred to as “loan level recovery.”

Servicing advances are structured to provide liquidity to mortgage loan securitization trusts. Servicers customarily have the right to cease making servicing advances on a loan if they determine that advances cannot be repaid from the proceeds of the loan or related property.

Servicing advances are typically financed through securitizations or loans structured by third parties such as investment banks. When servicing advances are financed through securitizations, recovery of advances are senior in the payment “waterfall.” In addition, in the event that the loan level recovery is not sufficient to reimburse the servicer in full for servicing advances, most pooling and servicing agreements provide that the servicer is entitled to be reimbursed from collections received with respect to other loans in the same securitized mortgage pool, which is referred to as “pool level recovery.”

 

 

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We believe there is an evolving market in the financing of servicing advances that could present us with a significant investment opportunity. We may seek to invest in servicing advances by providing financing to servicers through senior, mezzanine or equity positions. The status of investments in servicing advances for purposes of the REIT requirements is uncertain, and therefore our ability to make these kinds of investments may be limited.

Other Investments

We may pursue other types of investments as the market evolves, such as our opportunistic investment in consumer loans in April 2013. See “—Our Portfolio—Consumer Loans” below. Our Manager makes decisions about our investments in accordance with broad investment guidelines adopted by our board of directors. Accordingly, we may, without a stockholder vote, change our target asset classes and acquire a variety of assets that differ from, and are possibly riskier than, our portfolio of target assets. For more information about our investment guidelines, see “Business—Investment Guidelines” included elsewhere in this prospectus.

Our Strengths

Focused Strategy

We pursue an investment strategy focused primarily on attractive opportunities across the residential spectrum. With an approximately $19 trillion housing market undergoing major structural changes, we believe a dedicated strategy presents investors with an opportunity to participate in that restructuring.

Experienced Management Team

Our Manager is an affiliate of Fortress, a leading alternative asset manager with $54.6 billion of assets under management as of June 30, 2013. Residential and other real estate related assets, including those in our portfolio, have been a significant component of the investment strategies of both Fortress and Newcastle. Through our Manager, we have access to Fortress’s extensive and long-standing relationships with major issuers of real estate related securities and the broker-dealers that trade these securities, as well as their banking relationships in the mortgage servicing industry. We believe these relationships, together with Fortress’s infrastructure, provide us access to a pipeline of attractive investment opportunities, many of which may not be available to our competitors. We also believe that the breadth of Fortress’s experience enables us to react nimbly to the changing residential landscape in order to execute on emerging investment opportunities. For instance, in 2012, we obtained a private letter ruling from the Internal Revenue Service that permits us to treat Excess MSRs as qualifying assets that generate qualifying income for purposes of the REIT asset and income tests, which gave us an early advantage for investing in Excess MSRs.

Existing Portfolio of Residential Mortgage Related Assets

Our portfolio is currently composed of investments in Excess MSRs, Agency ARM RMBS, Non-Agency RMBS, residential mortgage loans, consumer loans and cash. We target returns on invested equity that average in the mid-teens. We believe these returns are attainable given the performance of our existing investments to date and based on market dynamics that we believe will foster significant opportunities to invest in additional residential real estate assets at similar returns. For example, our underwriting assumptions projected a weighted average internal rate of return (“IRR”) of 17% for the Excess MSRs we owned as of June 30, 2013, based on their original purchase price, and this portfolio has performed better than our underwriting assumptions. We believe that various market dynamics, including the current low-interest rate environment, a supply-demand imbalance for investments in Excess MSRs, and barriers to entry with respect to this asset class, support our target returns. However, the returns of individual assets, as well as different asset classes, will vary, and there can be no assurance that any of our assets, or our portfolio as a whole, will generate target returns. In addition, our ability to achieve target returns on our Agency ARM and Non-Agency RMBS, and potentially other assets, depends in part

 

 

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on the use of leverage and our ability to quickly deploy the proceeds of any financing at attractive returns. There can be no assurance that we will be able to secure financing on favorable terms, or at all. In addition, there can be no assurance that we will be able to source, or quickly complete, attractive investments for which the proceeds of any such financing could be used.

Relationship with Nationstar

As a result of our Manager’s relationship with Nationstar, which is majority-owned by Fortress funds managed by our Manager, we believe we are uniquely positioned to source opportunities to acquire Excess MSRs. Nationstar (NYSE: NSM) is one of the largest residential loan servicers, according to Inside Mortgage Finance, and it was ranked among the highest quality servicers by Fannie Mae in April 2013. We have developed an innovative strategy for co-investing in Excess MSRs with Nationstar. Given that non-servicers, like us, cannot own the basic fee component of an MSR directly, this strategy creates the opportunity for us to co-invest in Excess MSRs and affords Nationstar the opportunity to invest in MSRs on a “capital light” basis. To date, we have completed several co-investments with Nationstar, as described under “—Our Portfolio—Excess MSRs” below. In addition, we have capitalized on Nationstar’s origination capabilities by entering into a “recapture agreement” in each of our Excess MSR investments to date. Under the recapture agreements, we are generally entitled to a pro rata interest in the Excess MSRs on any initial or subsequent refinancing by Nationstar of a loan in the original portfolio. In other words, we are generally entitled to a pro rata interest in the Excess MSRs on both (i) a loan resulting from a refinancing by Nationstar of a loan in the original portfolio, and (ii) a loan resulting from a refinancing by Nationstar of a previously recaptured loan. We believe this arrangement mitigates our exposure to the prepayment risk associated with Excess MSRs. Furthermore, Nationstar is the master servicer and/or servicer of the vast majority of the loans underlying the Non-Agency RMBS in our portfolio.

Tax Efficient REIT Status

We will elect to be treated as, and expect to operate in conformity with the requirements for qualification and taxation as, a REIT. REIT status will provide us with certain tax advantages compared to some of our competitors. Those advantages include an ability to reduce our corporate-level income taxes by making dividend distributions to our stockholders, and an ability to pass our capital gains through to our stockholders in the form of capital gains dividends. We believe our REIT status will provide us with a significant advantage as compared to other companies or industry participants who do not have a similar tax efficient structure.

Our Portfolio

Our portfolio is currently composed of investments in Excess MSRs, Agency ARM RMBS, Non-Agency RMBS, residential mortgage loans, consumer loans and cash, as described in more detail below. A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act, including investments in Agency ARM RMBS. Over time, we expect to opportunistically adjust our portfolio composition in response to market conditions. Our Manager will make decisions about our investments in accordance with broad investment guidelines adopted by our board of directors. Accordingly, we may, without a stockholder vote, change our target asset classes and acquire a variety of assets that differ from, and are possibly riskier than, our current portfolio of target assets. For more information about our investment guidelines, see “Business—Investment Guidelines” included elsewhere in this prospectus.

Excess MSRs

As of June 30, 2013, we had approximately $153.8 billion UPB of Excess MSRs, of which a portion is held directly and the remainder is held through joint ventures, and we had agreed to invest in approximately $130.1 billion UPB of Excess MSRs that had not yet closed. Subsequent to June 30, 2013, we settled $98.2 billion UPB of the investments that had not yet closed. These investments are described in more detail below.

 

 

 

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As of June 30, 2013, our direct investments represented a 65% interest in the Excess MSRs on six pools of mortgage loans with an aggregate UPB of approximately $70.0 billion. As of June 30, 2013, we also owned a 50% interest in equity method investees that own a 67% interest on four pools of mortgage loans with an aggregate UPB of approximately $83.9 billion. Nationstar is the servicer of the loans underlying all of our investments in Excess MSRs to date, and it earns a basic fee in exchange for providing all servicing functions. In addition, Nationstar typically retains a 33-35% interest in the Excess MSRs and all ancillary income associated with the portfolios. We do not have any servicing duties, liabilities or obligations associated with the servicing of the portfolios underlying any of our investments.

Each of our investments to date is subject to a recapture agreement with Nationstar. Under the recapture agreements, we are generally entitled to a pro rata interest in the Excess MSRs on any initial or subsequent refinancing by Nationstar of a loan in the original portfolio. In other words, we are generally entitled to a pro rata interest in the Excess MSRs on both (i) a loan resulting from a refinancing by Nationstar of a loan in the original portfolio, and (ii) a loan resulting from a refinancing by Nationstar of a previously recaptured loan. The tables below summarize the terms of our completed investments in Excess MSRs as of June 30, 2013.

Summary of Direct Excess MSR Investments as of June 30, 2013

 

                            MSR Component           Excess MSR  
    Investment
Date
    Initial
UPB
(bn)
    Current1
UPB
(bn)
    Loan
Type2
    MSR
(bps)
    Excess
MSR
(bps)
    Interest
in Excess

MSR
(%)
    Purchase
Price
(mm)
    Carrying
Value
(mm)
 

Pool 1

    12/2011      $ 9.9      $ 7.6        GSE        35  bps      29  bps      65   $ 43.6      $ 44.5   

Pool 2

    06/2012        10.4        8.6        GSE        31        23        65     42.3        43.9   

Pool 3

    06/2012        9.8        8.4        GSE        32        23        65     36.2        38.9   

Pool 4

    06/2012        6.3        5.4        GSE        26        17        65     15.4        16.7   

Pool 5

    06/2012        47.6        40.0        PLS        32        13        65     124.8        125.0   

Pool 11

    05/2013                      GSE        N/A        N/A        65     2.5        2.4   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Total/Weighted Avg.

    $ 84.0      $ 70.0          32  bps      17  bps      $ 264.8      $ 271.4   
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

 

(1) As of June 30, 2013.
(2) “GSE” refers to loans in Fannie Mae or Freddie Mac securitizations. “PLS” refers to loans in private label securitizations.

Summary of Excess MSR Investments Through Equity Method Investees as of June 30, 2013

 

    Commitment/
Investment
Date
    Initial
UPB
(bn)
    Current
UPB
(bn)1
    Loan
Type2
    MSR Component     Interest
Investee

(%)
    Investee
Interest
in Excess
MSR
(%)
    Excess
MSR

Initial
Investment

(mm)
    Carrying
Value
(mm)
 
          MSR
(bps)
    Excess
MSR
(bps)
         

Pool 6

    01/2013      $ 13.0      $ 11.2        GM        40  bps      25  bps      50     67   $ 27.3      $ 28.7   

Pool 7

    01/2013        38.0        34.5        GSE        27        16        50     67     67.3        69.5   

Pool 8

    01/2013        17.6        15.4        GSE        28        19        50     67     36.0        36.0   

Pool 11

    05/2013        22.8        22.8        GSE        26        16        50     67     37.8        41.8   
   

 

 

   

 

 

     

 

 

   

 

 

       

 

 

   

 

 

 

Total/Weighted Avg.

    $ 91.4      $ 83.9          29  bps      18  bps        $ 168.4      $  176.0   
   

 

 

   

 

 

     

 

 

   

 

 

       

 

 

   

 

 

 

 

(1) As of June 30, 2013.
(2) “GM” refers to loans in Ginnie Mae securitizations. “GSE” refers to loans in Fannie Mae or Freddie Mac securitizations.

Pools 7 and 8 in the table above were acquired in the first closing of our agreement in January 2013 to acquire Excess MSRs on a $215 billion UPB portfolio as of November 30, 2012. This agreement also includes Pool 9, which closed in July 2013, and Pool 10, of which portions closed in the third quarter of 2013 and the remainder is pending, as described in the table below.

 

 

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Summary of Pending Excess MSR Investments Committed as of June 30, 2013

 

    Commitment
Date
    Initial
UPB
(bn)
    Current
UPB
(bn)2
    Loan
Type3
    MSR Component     Interest
Investee

(%)
    Investee
Interest
in Excess
MSR
(%)
    Excess
MSR

Initial
Investment

(mm)4
 
            MSR
(bps)
    Excess
MSR
(bps)
       

Pool 10 (net of portion closed in the third quarter of 2013)1

    01/2013      $ 31.9      $ 31.9        PLS        34 bps        10 bps        50     67   $ 19.2   

 

(1) Initial UPB, Current UPB and Excess MSR Initial Investment represent the pending investment for Pool 10.
(2) As of May 31, 2013.
(3) “PLS” refers to loans in private label securitizations.
(4) The actual amount invested will be based on the UPB at the time of close.

We expect to complete our pending investments in 2013, subject to the receipt of regulatory, third-party and certain rating agency approvals. There can be no assurance that we will complete this investment as anticipated or at all. However, we believe that it is probable that we will be able to obtain pending approvals and subsequently complete this investment.

In the third quarter of 2013, we completed the acquisition of a portion of Pool 10, (including a purchase price adjustment in September 2013 of $13.5 million, primarily as a result of a higher mortgage servicing amount on the portion of the pool that closed than was previously estimated) as described in the table below. In addition, on July 18, 2013, we acquired through a joint venture, an interest in Excess MSRs from Nationstar on a portfolio of mortgage loans with a UPB of approximately $34.7 billion as of June 30, 2013 (Pool 9). We have invested a total of approximately $73 million to date to acquire a one-third interest in the Excess MSRs. Nationstar is the servicer of the loans and has retained a one-third interest in the Excess MSRs; a Fortress managed fund has acquired the remaining one-third interest. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs will be included in the portfolio, subject to certain limitations. New Residential, Nationstar and the Fortress fund will share equally in these Excess MSRs. These acquisitions are described in the table below.

In September 2013, we increased our investment in the Excess MSRs in Pools 5 and 10. We purchased an additional 15% interest in the Excess MSRs in Pool 5 for approximately $26.6 million and now own an overall 80% interest in the Excess MSRs in Pool 5. We also increased our interest in the portion of the Excess MSRs in Pool 10 which had previously closed in the third quarter of 2013 from 33.3% to 38.5% for approximately $13.9 million.

In September 2013, we invested approximately $17.5 million to acquire a 40% interest in the Excess MSRs on a portfolio of residential mortgage loans with a UPB of approximately $5.4 billion (“Pool 12”), comprised of loans in private label securitizations. A Fortress-managed fund also acquired a 40% interest in the Excess MSRs and the remaining 20% interest in the Excess MSRs is owned by Nationstar. As the servicer, Nationstar performs all servicing and advancing functions, and it retains the ancillary income, servicing obligations and liabilities with this portfolio. Under the terms of this investment, to the extent that any loans in the portfolio are refinanced by Nationstar, the resulting Excess MSRs are shared on a pro rata basis by New Residential, the Fortress-managed funds and Nationstar, subject to certain limitations.

 

 

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Summary of Excess MSR Investments Through Equity

Method Investees Closed Subsequent to June 30, 2013

 

     Commitment
Date
    Initial
UPB
(bn)
    Current
UPB
(bn)1
    Loan
Type2
    MSR Component     Interest
Investee

(%)
    Investee
Interest
in Excess
MSR
(%)
    Excess
MSR

Initial
Investment

(mm)3
 
             MSR
(bps)
    Excess
MSR
(bps)
       

Pool 9

     01/2013      $ 34.7      $ 34.7        GM        40        22        50     67   $ 73.3   

Pool 10 (closed portion)

     01/2013        63.5        63.5        PLS        36        12        50     77     108.0   
    

 

 

   

 

 

     

 

 

   

 

 

       

 

 

 

Total/Weighted Avg.

     $ 98.2      $ 98.2          37  bps      16  bps        $ 181.3   
    

 

 

   

 

 

     

 

 

   

 

 

       

 

 

 

 

(1) As of May 31, 2013.
(2) “PLS” refers to loans in private label securitizations. “GM” refers to loans in Ginnie Mae securitizations.
(3) Amounts invested based on the UPB at the time of close.

We currently expect to continue to make co-investments with Nationstar, and we may also acquire Excess MSRs from other servicers. Nationstar does not, however, have any obligation to offer us any future co-investment opportunity. In the event that we cannot co-invest in Excess MSRs with Nationstar, we may not be able to find other suitable counterparties from which to acquire Excess MSRs, which could have a material adverse effect on our business. At the same time, our co-investments with Nationstar expose us to counterparty concentration risk, which could increase if we do not or cannot acquire Excess MSRs from other counterparties or continue to pursue co-investments with Nationstar. Nationstar publicly discloses its financial statements and other material information in filings with the SEC, which may be obtained at the SEC’s website, www.sec.gov. The contents of Nationstar’s public disclosure are not incorporated by reference herein, do not form part of this prospectus and have not been verified by us.

Additional information about our investments in Excess MSRs is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Portfolio—Excess MSRs” and “Business—Our Portfolio—Excess MSRs.”

Agency ARM RMBS

As of June 30, 2013, we owned $1.06 billion face amount of Agency ARM RMBS, as described in the table below (in thousands).

Summary of Agency ARM RMBS as of June 30, 2013

 

                   Gross Unrealized               

Asset Type

   Outstanding Face
Amount
     Amortized Cost
Basis
     Gains      Losses     Carrying
Value1
     Outstanding
Repurchase
Agreements
 

Agency ARM RMBS

   $ 1,059,950       $ 1,134,190       $ 1,430       $ (5,834   $ 1,129,786       $ 1,061,250   

 

(1) Fair value, which is equal to carrying value for all securities.

Subsequent to June 30, 2013, we settled purchases of $195 million face amount of Agency ARM RMBS for approximately $207 million. These securities were financed with $196 million of repurchase agreements which contain customary margin call provisions and a 30 to 90-day term. In addition, we purchased an additional $62 million face amount of Agency ARM RMBS for approximately $66 million, which had not yet settled as of October 8, 2013.

 

 

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Additional information about our investments in Agency ARM RMBS is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Portfolio—Agency ARM RMBS” and “Business—Our Portfolio—Agency ARM RMBS.”

Non-Agency RMBS

As of June 30, 2013, we had approximately $928 million face amount of Non-Agency RMBS, as described in the table below (in thousands).

Summary of Non-Agency RMBS as of June 30, 2013

 

                   Gross Unrealized               

Asset Type

   Outstanding Face
Amount
     Amortized
Cost Basis
     Gains      Losses     Carrying
Value(1)
     Outstanding
Repurchase
Agreements
 

Non-Agency RMBS

   $ 927,903       $ 605,835       $ 33,286       $ (9,668   $ 629,453       $ 413,088   

 

(1) Fair value, which is equal to carrying value for all securities.

On August 1, 2013, we replaced approximately $330 million in existing repurchase agreements collateralized by our Non-Agency RMBS with a one-year $350 million master repurchase agreement that is not subject to margin calls. The repurchase agreement has a 73% advance rate. One of our subsidiaries entered into the agreement, and we have guaranteed all of its obligations thereunder. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Debt Obligations.”

Subsequent to June 30, 2013, we acquired an additional $111 million face amount of Non-Agency RMBS for approximately $84 million. We financed these securities with $52 million of repurchase agreements which contain customary margin call provisions at a cost of one-month LIBOR plus 160 to 175 basis points and a 30-day term.

In addition, we sold $148 million face amount of Non-Agency RMBS for approximately $118 million. These securities were financed with $82 million of repurchase agreements which were repaid.

Additional information about our investments in Non-Agency RMBS is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Portfolio—Non-Agency RMBS” and “Business—Our Portfolio—Non-Agency RMBS.”

Residential Mortgage Loans

As of June 30, 2013, we had approximately $57 million outstanding face amount of residential mortgage loans. We invested approximately $35 million to acquire a 70% interest in the mortgage loans. Nationstar has co-invested pari passu with us in 30% of the mortgage loans and will be the servicer of the loans performing all servicing and advancing functions, and retaining the ancillary income, servicing obligations and liabilities as the servicer. Additional information about our investments in residential mortgage loans is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Portfolio—Residential Mortgage Loans” and “Business—Our Portfolio—Residential Mortgage Loans.”

 

 

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Consumer Loans

On April 1, 2013, we completed a co-investment in a portfolio of consumer loans. As of June 30, 2013, this portfolio had a UPB of approximately $3.7 billion. The portfolio includes over 350,000 personal unsecured loans and personal homeowner loans originated through subsidiaries of HSBC Finance Corporation. We completed the investment through newly formed limited liability companies (collectively, “the Consumer Loan Companies”), which acquired the portfolio from HSBC Finance Corporation and its affiliates. We invested approximately $250 million for 30% membership interests in each of the Consumer Loan Companies. Of the remaining 70% of the membership interests, Springleaf Finance Inc. (“Springleaf”), which is majority-owned by Fortress funds managed by our Manager, acquired 47%, and an affiliate of Blackstone Tactical Opportunities Advisors L.L.C. acquired 23%. Springleaf acts as the managing member of the Consumer Loan Companies. The Consumer Loan Companies financed $2.2 billion of the approximately $3.0 billion purchase price with asset-backed notes.

In September 2013, the Consumer Loan Companies issued and sold an additional $372 million of asset-backed notes for 96% of par. These notes are subordinate to the $2.2 billion of debt issued in April 2013, have a maturity of December 2024 and pay a coupon of 4%.

The Consumer Loan Companies were formed on March 19, 2013 for the purpose of making this investment and commenced operations upon the completion of the investment. After a servicing transition period, Springleaf will be the servicer of the loans and will provide all servicing and advancing functions for the portfolio. Additional information about our investment in consumer loans is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Our Portfolio—Consumer Loans” and “Business—Our Portfolio—Consumer Loans.”

Financing Strategy

Our objective is to generate attractive risk-adjusted returns for our stockholders without excessive use of leverage. We do not have a predetermined target leverage level. The amount of leverage we deploy for a particular investment depends upon an assessment of a variety of factors, which may include the anticipated liquidity and price volatility of our assets; the gap between the duration of assets and liabilities, including hedges; the availability and cost of financing the assets; our opinion of the creditworthiness of financing counterparties; the health of the U.S. economy and the residential mortgage and housing markets; our outlook for the level, slope and volatility of interest rates; the credit quality of the loans underlying our RMBS; and our outlook for asset spreads relative to financing costs.

We have funded the acquisition of Excess MSRs on an unlevered basis, but we may invest in Excess MSRs on a levered basis in the future. Our primary source of financing currently is repurchase agreements, although we may also pursue other sources of financing, such as securitizations and other secured and unsecured forms of borrowing.

As of June 30, 2013, we had outstanding repurchase agreements with an aggregate face amount of approximately $413.1 million to finance Non-Agency RMBS and approximately $1.1 billion to finance Agency ARM RMBS. These agreements, which had 30 day terms, were subject to margin calls. On August 1, 2013, we replaced approximately $330 million in existing repurchase agreements collateralized by our Non-Agency RMBS with a one-year $350 million master repurchase agreement that is not subject to margin calls. Under repurchase agreements, we sell a security to a counterparty and concurrently agreed to repurchase the same security at a later date for a higher specified price. The sale price represents financing proceeds, and the difference between the sale and repurchase prices represents interest on the financing. The price at which the security is sold generally represents the market value of the security less a discount or “haircut,” which can range broadly, for example from 5% for Agency ARM RMBS to between 20% and 40% for Non-Agency RMBS. During the term of the

 

 

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repurchase agreement, the counterparty holds the security as collateral. If the agreement is subject to margin calls, the counterparty monitors and calculates what it estimates to be the value of the collateral during the term of the agreement. If this value declines by more than a de minimis threshold, the counterparty could require us to post additional collateral (or “margin”) in order to maintain the initial haircut on the collateral. This margin is typically required to be posted in the form of cash and cash equivalents.

These repurchase agreements have terms that generally conform to the terms of the standard master repurchase agreement published by the Securities Industry and Financial Markets Association (“SIFMA”) as to repayment, margin requirements and segregation of all securities sold under any repurchase transactions. In addition, each counterparty typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include changes to the margin maintenance requirements, required haircuts, purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default provisions. These provisions may differ for each of our counterparties and are not determined until we engage in a specific repurchase transaction.

Management Agreement

In connection with our spin-off from Newcastle, we entered into a Management Agreement with our Manager. Our Management Agreement requires our Manager to manage our business affairs in conformity with broad investment guidelines adopted and monitored by our board of directors. For more information about our investment guidelines, see “Business—Investment Guidelines” included elsewhere in this prospectus.

Our Management Agreement has an initial one-year term and is automatically renewed for one-year terms thereafter unless terminated either by us or our Manager. Our Manager is entitled to receive from us a management fee and is eligible to receive incentive compensation that is based on our performance. In addition, we are obligated to reimburse certain expenses incurred by our Manager. Our Manager is also entitled to receive a termination fee from us under certain circumstances. The terms of our Management Agreement are summarized below and described in more detail under “Our Manager and Management Agreement” elsewhere in this prospectus.

 

Type

  

Description

Management Fee

   1.5% per annum of our gross equity calculated and payable monthly in arrears in cash. Gross equity is generally the equity that was transferred to us by Newcastle on the distribution date, plus total net proceeds from stock offerings, plus certain capital contributions to subsidiaries, less capital distributions and repurchases of common stock. From the date of the spin-off through June 30, 2013, we have accrued $2.3 million in management fees.

 

 

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Incentive Compensation

   Our Manager is entitled to receive annual incentive compensation in an amount equal to the product of (A) 25% of the dollar amount by which (1)(a) the funds from operations before the incentive compensation, excluding funds from operations from investments in equity method investees that are invested in consumer loans (the “Consumer Loan Companies”) and any unrealized gains or losses from mark-to-market valuation changes on Excess MSRs and on equity method investees invested in Excess MSRs, per share of common stock, plus (b) earnings (or losses) from the Consumer Loan Companies computed on a level-yield basis (such that the loans are treated as if they qualified as loans acquired with a discount for credit quality as set forth in ASC 310-30, as such codification was in effect on June 30, 2013) as if the Consumer Loan Companies had been acquired at their GAAP basis on the distribution date, earnings (or losses) from equity method investees invested in Excess MSRs as if such equity method investees had not made a fair value election, and gains (or losses) from debt restructuring and gains (or losses) from sales of property, in each case per share of common stock, exceed (2) an amount equal to (a) the weighted average of the book value per share of the equity that was transferred to us by Newcastle on the distribution date and the prices per share of our common stock in any offerings by us (adjusted for prior capital dividends or capital distributions) multiplied by (b) a simple interest rate of 10% per annum, multiplied by (B) the weighted average number of shares of common stock outstanding.
   “Funds from operations” means net income (computed in accordance with GAAP), excluding gains (losses) from debt restructuring and gains (or losses) from sales of property, plus depreciation on real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Funds from operations will be computed on an unconsolidated basis. The computation of funds from operations may be adjusted at the direction of our independent directors based on changes in, or certain applications of, GAAP. Funds from operations are determined from the date of our separation from Newcastle and without regard to Newcastle’s prior performance. Funds from operations does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income as an indication of our performance or to cash flows as a measure of liquidity or ability to make distributions. From the date of the spin-off through June 30, 2013, we have accrued $878 thousand in incentive compensation.

Reimbursement of Expenses

   We pay, or reimburse our Manager’s employees for performing certain legal, accounting, due diligence tasks and other services that outside professionals or outside consultants otherwise would perform, provided that such costs and reimbursements are no greater than those which would be paid to outside professionals or consultants on an arm’s-length basis and shall not be reimbursed in excess of $500,000 per annum. We also pay all operating expenses, except those specifically required to be borne by our Manager under our Management Agreement.

 

 

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   Our Manager is responsible for all costs incident to the performance of its duties under the Management Agreement, including compensation of our Manager’s employees, rent for facilities, and other “overhead” expenses; we do not reimburse our Manager for these expenses. The expenses required to be paid by us include, but are not limited to, issuance and transaction costs incident to the acquisition, disposition and financing of our investments, legal and auditing fees and expenses, the compensation and expenses of our independent directors, the costs associated with the establishment and maintenance of any credit facilities and other indebtedness of ours (including commitment fees, legal fees, closing costs, etc.), expenses associated with other securities offerings of ours, the costs of printing and mailing proxies and reports to our stockholders, costs incurred by employees of our manager for travel on our behalf, costs associated with any computer software or hardware that is used solely for us, costs to obtain liability insurance to indemnify our directors and officers and the compensation and expenses of our transfer agent. From the date of the spin-off through June 30, 2013, we have accrued $21 thousand for reimbursement to our Manager.

Termination Fee

   The termination fee is a fee equal to the sum of (1) the amount of the management fee during the 12 months immediately preceding the date of termination, and (2) the “Incentive Compensation Fair Value Amount.” The Incentive Compensation Fair Value Amount is an amount equal to the Incentive Compensation that would be paid to the Manager if our assets were sold for cash at their then current fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of the underlying investments).

Summary Risk Factors

You should carefully read and consider the risk factors set forth under “Risk Factors,” as well as all other information contained in this prospectus. If any of the following risks occur, our business, financial condition, liquidity and results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline.

 

    We have a very limited operating history as an independent company and may not be able to successfully operate our business strategy or generate sufficient revenue to make or sustain distributions to our stockholders. The financial information included in this prospectus may not be indicative of the results we would have achieved as a separate stand-alone company and are not a reliable indicator of our future performance or results.

 

    The value of our Excess MSRs is based on various assumptions that could prove to be incorrect and could have a negative impact on our financial results.

 

    We rely heavily on mortgage servicers to achieve our investment objective and have no direct ability to influence their performance.

 

    We have significant counterparty concentration risk in Nationstar and Springleaf and are subject to other counterparty concentration and default risks.

 

    GSE initiatives and other actions may adversely affect returns from investments in Excess MSRs.

 

 

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    Many of our investments may be illiquid, and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are required to dispose of them.

 

    We may invest in RMBS collateralized by subprime mortgage loans, which are subject to increased risks.

 

    The value of our RMBS may be adversely affected by deficiencies in servicing and foreclosure practices, as well as related delays in the foreclosure process.

 

    The lenders under our repurchase agreements may elect not to extend financing to us, which could quickly and seriously impair our liquidity.

 

    Our investments in RMBS may be subject to significant impairment charges, which would adversely affect our results of operations.

 

    We may not be able to finance our investments on attractive terms or at all, and financing for Excess MSRs may be particularly difficult or impossible to obtain.

 

    The consumer loans underlying our investments are subject to delinquency and loss, which could have a negative impact on our financial results.

 

    Interest rate fluctuations and shifts in the yield curve may cause losses.

 

    Maintenance of our 1940 Act exemption imposes limits on our operations.

 

    We are dependent on our Manager and may not find a suitable replacement if our Manager terminates the Management Agreement.

 

    There are conflicts of interest in our relationship with our Manager.

 

    Our directors have approved broad investment guidelines for our Manager and do not approve each investment decision made by our Manager. In addition, we may change our investment strategy without a stockholder vote, which may result in our making investments that are different, riskier or less profitable than our current investments.

 

    We may compete with affiliates of our Manager, including Newcastle, which could adversely affect our and their results of operations.

 

    We do not know what impact the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) will have on our business.

 

    Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

 

    The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to qualify as a REIT.

 

    The failure of our Excess MSRs to qualify as real estate assets or the income from our Excess MSRs to qualify as mortgage interest could adversely affect our ability to qualify as a REIT.

 

    REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan.

 

    Your percentage ownership in New Residential may be diluted in the future.

 

 

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Conflicts of Interest

Although we have established certain policies and procedures designed to mitigate conflicts of interest, there can be no assurance that these policies and procedures will be effective in doing so. It is possible that actual, potential or perceived conflicts of interest could give rise to investor dissatisfaction, litigation or regulatory enforcement actions.

One or more of our officers and directors have responsibilities and commitments to entities other than us, including, but not limited to, Newcastle. For example, we have some of the same directors and officers as Newcastle. In addition, we do not have a policy that expressly prohibits our directors, officers, securityholders or affiliates from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics prohibits, subject to the terms of our certificate of incorporation, the directors, officers and employees of our Manager from engaging in any transaction that involves an actual conflict of interest with us. See “Risk Factors—Risks Relating to Our Manager—There are conflicts of interest in our relationship with our Manager.”

Our key agreements, including our Management Agreement, were negotiated among related parties, and their respective terms, including fees and other amounts payable, may not be as favorable to us as terms negotiated on an arm’s-length basis with unaffiliated parties. Our independent directors may not vigorously enforce the provisions of our Management Agreement against our Manager. For example, our independent directors may refrain from terminating our Manager because doing so could result in the loss of key personnel.

The structure of the Manager’s compensation arrangement may have unintended consequences for us. We have agreed to pay our Manager a management fee that is not tied to our performance and incentive compensation that is based entirely on our performance. The management fee may not sufficiently incentivize our Manager to generate attractive risk-adjusted returns for us, while the performance-based incentive compensation component may cause our Manager to place undue emphasis on the maximization of earnings, including through the use of leverage, at the expense of other objectives, such as preservation of capital, to achieve higher incentive distributions. Investments with higher yield potential are generally riskier or more speculative than investments with lower yield potential. This could result in increased risk to the value of our portfolio of assets and your investment in us.

We may compete with entities affiliated with our Manager or Fortress, including Newcastle, for certain target assets. From time to time, affiliates of Fortress may focus on investments in assets with a similar profile as our target assets that we may seek to acquire. These affiliates may have meaningful purchasing capacity, which may change over time depending upon a variety of factors, including, but not limited to, available equity capital and debt financing, market conditions and cash on hand. Currently, Fortress has two funds primarily focused on investing in Excess MSRs with approximately $1.7 billion in capital commitments in aggregate. We intend to co-invest with these funds in Excess MSRs. Fortress funds generally have a fee structure similar to ours, but the fees actually paid will vary depending on the size, terms and performance of each fund. Fortress had approximately $54.6 billion of assets under management as of June 30, 2013.

Our Manager may determine, in its discretion, to make a particular investment through an investment vehicle other than us. Investment allocation decisions will reflect a variety of factors, such as a particular vehicle’s availability of capital (including financing), investment objectives and concentration limits, legal, regulatory, tax and other similar considerations, the source of the investment opportunity and other factors that the Manager, in its discretion, deems appropriate. Our Manager does not have an obligation to offer us the opportunity to participate in any particular investment, even if it meets our investment objectives.

 

 

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Operational and Regulatory Structure

REIT Qualification

We will elect to be taxed and intend to qualify as a REIT for U.S. federal income tax purposes commencing with our initial taxable year ending December 31, 2013. Our qualification as a REIT will depend upon our ability to meet, on a continuing basis, various complex requirements under the Internal Revenue Code of 1986, as amended (the “Code”), relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels to our stockholders and the concentration of ownership of our capital stock. We believe that, commencing with our initial taxable year ending December 31, 2013, we will be organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and that our intended manner of operation will enable us to meet the requirements for qualification and taxation as a REIT. In connection with this offering, we will receive an opinion of Skadden, Arps, Slate, Meagher & Flom LLP to the effect that we have been organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and that our proposed method of operation will enable us to meet the requirements for qualification and taxation as a REIT.

1940 Act Exemption

We conduct our operations in reliance on an exemption from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act, which is available for entities “primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” This exemption generally requires that at least 55% of our assets must be composed of qualifying real estate assets and at least 80% of each of our assets must be composed of qualifying real estate assets and real estate related assets under the 1940 Act. We monitor our holdings to ensure continuing and ongoing compliance with this test. See “Business—Operational and Regulatory Structure—1940 Act Exemption” for a further discussion of the exemption from registration under the 1940 Act that we rely on and the treatment of certain of our target asset classes for purposes of such exemption.

We rely on guidance published by the SEC or its staff or on our analyses of such guidance to determine which assets qualify for the exemption. In August 2011, the SEC issued a concept release pursuant to which they solicited public comments on a wide range of issues relating to companies engaged in the business of acquiring mortgages and mortgage-related instruments and that rely on Section 3(c)(5)(C) of the 1940 Act. The concept release and the public comments thereto have not yet resulted in SEC rulemaking or interpretative guidance and we cannot predict what form any such rulemaking or interpretive guidance may take. There can be no assurance, however, that the laws and regulations governing the 1940 Act status of REITs, or guidance from the SEC or its staff regarding the exemption from registration as an investment company on which we rely, will not change in a manner that adversely affects our operations.

Changes to such laws and regulations or new or different guidance from the SEC or its staff regarding the exemption from registration on which we rely, including with respect to which assets qualify for such exemption, could require us, among other things, either to (a) change the manner in which we conduct our operations in order to maintain our exemption from registration as an investment company, (b) limit our ability to make certain investments and/or effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company, any of which could have a material adverse effect on us and the market price of our securities. If we were required to register as an investment company under the 1940 Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), portfolio composition, including restrictions with respect to diversification and industry concentration, our ability to make distributions and other matters.

 

 

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Maintenance of our exemption under the 1940 Act generally limits the amount of our investments in non-real estate related assets to no more than 20% of our total assets. See “Risk Factors—Risks Related to Our Business—Maintenance of our 1940 Act exemption imposes limits on our operations.”

Emerging Growth Company Status

We are an “emerging growth company” as defined in the JOBS Act. As such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”) and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We have not made a decision whether to take advantage of any or all of these exemptions. If we do take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result. The result may be a less active trading market for our common stock, and our stock price may be more volatile.

In addition, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 13(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have elected not to take advantage of the benefits of this extended transition period and are therefore subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. This election is irrevocable.

We could remain an “emerging growth company” until the earliest of (a) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (b) the last day of the fiscal year following the fifth anniversary of the date of this offering, (c) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (d) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period.

Our Corporate Information

We were formed as NIC MSR LLC, a Delaware limited liability company, in September 2011 and were a wholly owned subsidiary of Newcastle. We converted to a Delaware corporation and changed our name to New Residential Investment Corp. in December 2012. On May 15, 2013, we separated from Newcastle through the distribution of our shares of common stock to the stockholders of Newcastle and became a stand-alone publicly traded company. Our principal executive offices are located at 1345 Avenue of the Americas, New York, New York 10105, c/o New Residential Investment Corp. Our telephone number is 212-479-3150. Our web address is www.newresi.com. The information on or otherwise accessible through our web site does not constitute a part of this prospectus or any other report or document we file with or furnish to the SEC.

 

 

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THE OFFERING

 

Common stock offered by us

             shares.

 

Common stock to be outstanding after this offering

            shares (             shares if the underwriters exercise their over-allotment option in full).

 

Options to purchase additional shares

We have granted the underwriters a 30-day option to purchase up to additional shares of our common stock to cover over-allotments at the initial public offering price.

 

Use of proceeds by us

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, will be approximately $         million, assuming a public offering price of $         per share, the last reported sales price of our common stock on the New York Stock Exchange (“NYSE”) on             , 2013 (the “Assumed Public Offering Price”) and after deducting estimated underwriting discounts and offering expenses (or $         million if the underwriters exercise their option to purchase additional shares of common stock in full). We intend to use the net proceeds from this offering for general corporate purposes, including to make a variety of investments, which may include, but is not limited to, investments in Excess MSRs, real estate securities and real estate related loans. See “Use of Proceeds.”

 

Distribution policy

We intend to make regular quarterly distributions, which include all or substantially all of our REIT taxable income, to holders of our common stock out of assets legally available for this purpose. Distributions will be authorized by our board of directors and declared by us based on a number of factors including actual results of operations, liquidity and financial condition restrictions under Delaware law, our financial condition, our taxable income, the annual distribution requirements under the REIT provisions of the Code, our operating expenses and other factors our directors deem relevant. For more information, see “Distribution Policy” included elsewhere in this prospectus.

 

NYSE symbol

“NRZ”

 

Ownership and transfer restrictions

To assist us in qualifying as a REIT, among other purposes stockholders are generally restricted from owning more than 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of common stock, or 9.8% by value or number of shares, whichever is more restrictive, of our outstanding shares of capital stock. In addition, our certificate of incorporation contains various other restrictions on the ownership and transfer of our common stock. See “Description of Capital Stock—Restrictions on Ownership and Transfer of Our Capital Stock.”

 

 

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Risk Factors

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 24.

Except as otherwise indicated, all information in this prospectus assumes no exercise by the underwriters of their option to purchase an additional                     shares of common stock from us to cover over-allotments.

The number of shares of our common stock that will be outstanding after this offering is based on 253,186,279 shares of our common stock outstanding as of October 8, 2013, and excludes:

 

  (i) options to purchase an aggregate of 17,893,795 shares of our common stock held by an affiliate of our manager,

 

  (ii) options to purchase an aggregate of 3,129,267 shares of our common stock assigned to employees of affiliates of our manager,

 

  (iii) options to purchase an aggregate of 12,000 shares of our common stock held by our directors, and

 

  (iv) options to purchase                     shares of our common stock, representing 10% of the number of shares being offered hereby, that will be granted to an affiliate of our manager in connection with this offering, and subject to adjustment if the underwriters exercise their option to purchase additional shares of our common stock.

 

 

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SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION

We were formed in September 2011 as NIC MSR LLC, a Delaware limited liability company and wholly owned subsidiary of Newcastle. We converted to a Delaware corporation and changed our name to New Residential Corp. in December 2012. On May 15, 2013, which we refer to as the “separation date” or “distribution date,” we separated from Newcastle through the distribution of our shares of common stock to the stockholders of Newcastle and became a stand-alone publicly traded company.

The following table presents our summary historical and pro forma financial information for the period from the commencement of our operations on December 8, 2011 through December 31, 2011, for the year ended December 31, 2012, and for the six months ended June 30, 2013 and 2012.

The summary historical consolidated statements of income for the year ended December 31, 2012 and the period from December 8, 2011 (commencement of operations) to December 31, 2011 and the summary historical consolidated balance sheets as of December 31, 2012 and 2011 have been derived from our audited financial statements included elsewhere in this prospectus. The summary consolidated statement of income for the six months ended June 30, 2013 and 2012 and the summary consolidated balance sheet data as of June 30, 2013 have been derived from our unaudited financial statements included elsewhere in this prospectus. The unaudited financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information set forth herein. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any future period.

The unaudited pro forma condensed consolidated financial information presented below was derived from the application of pro forma adjustments to our consolidated financial statements. These unaudited pro forma condensed consolidated financial statements should be read in conjunction with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our historical financial statements and related notes, which are included elsewhere in this prospectus.

The unaudited pro forma information set forth below reflects our historical information with certain adjustments. The unaudited pro forma condensed consolidated balance sheet has been adjusted to give effect to all of the transactions described below as if each had occurred on June 30, 2013.

 

    Acquisition and settlement of additional Excess MSRs through equity method investees subsequent to June 30, 2013.

 

    Commitments to acquire additional Excess MSRs through equity method investees subsequent to June 30, 2013.

 

    The purchase of Agency ARM RMBS subsequent to June 30, 2013. The Agency ARM RMBS had a face amount of approximately $257 million and a purchase price of approximately $272 million.

 

    The financing of the Agency ARM RMBS subsequent to June 30, 2013. We financed these Agency ARM RMBS with approximately $196 million of repurchase agreements.

 

    The distribution of $106.5 million from the equity method investees, consumer loans related to the additional debt sold by the equity method investees.

 

    The offering of                    million of common stock to which this prospectus relates.

The unaudited pro forma condensed consolidated statements of income only include adjustments to reflect (i) interest income from certain Agency ARM RMBS acquired during the period from January 1, 2013 through October 8, 2013; (ii) interest expense from the financing of certain Agency ARM RMBS; and (iii) interest

 

 

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expense from the financing of certain Non-Agency RMBS during the period from January 1, 2013 through June 30, 2013, in each case as if the transactions giving rise to (i), (ii) and (iii), had occurred on January 1, 2012. Accordingly, the unaudited pro forma condensed consolidated statement of income excludes adjustments for (i) earnings from the consumer loan co-investment transaction; (ii) earnings from the additional Excess MSR transactions; and (iii) interest income from investments in Non-Agency RMBS.

Our decision to include or exclude an adjustment in the unaudited pro forma condensed consolidated statement of income was based on whether such adjustment would be factually supportable and historically based, as set forth in more detail below.

With respect to Agency ARM RMBS, Newcastle held substantial investments in Agency ARM RMBS during the entire period covered by the pro forma statement of income. Although Newcastle did not own the exact securities contributed to New Residential for the entire period presented, management considers Agency ARM RMBS to be fungible because, among other factors, they are guaranteed by the U.S. government and thus have consistent credit characteristics. As a result, New Residential determined that adjustments related to these securities are factually supportable.

In contrast to Agency ARM RMBS, the yields of Non-Agency RMBS can have significant variances as a result of differences in the collateral and credit characteristics of each asset. Newcastle did not hold the specific Non-Agency RMBS contributed to us during the entire period presented, and Newcastle does not have records relating to the performance of these assets prior to their acquisition. As a result, management believes that adjustments for the interest income from the Non-Agency RMBS would not be factually supportable.

The investments in equity method investees were made in newly formed entities with no historical operations. Neither we nor Newcastle owned any of the underlying excluded investments prior to their acquisition by the investee entities. Furthermore, the underlying loans were not serviced by an affiliate of our Manager prior to their acquisition. As a result, Newcastle does not have records relating to the performance of these loans prior to the acquisition of the related investments. In addition, the composition of the loan pools and the loans underlying the Excess MSRs and consumer loan investees necessarily differ from the composition of the respective pools during the period covered by the pro forma statement of income due to prepayment and default activity prior to acquisition. As a result, an adjustment related to these investees was not considered factually supportable.

In the opinion of management, all adjustments necessary to reflect the effects of the transactions described in the notes to the unaudited pro forma condensed consolidated balance sheet and pro forma condensed statement of income have been included and are based upon available information and assumptions that we believe are reasonable.

Further, the historical financial information presented herein has been adjusted to give pro forma effect to events that we believe are factually supportable and which are expected to have a continuing impact on our results. However, such adjustments are estimates and may not prove to be accurate. Information regarding these adjustments is subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. See “Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements.”

 

 

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The unaudited pro forma financial information below is provided for information purposes only. The unaudited pro forma financial information does not purport to represent what our results of operations and/or financial condition would have been had such transactions been consummated on the dates indicated, nor do they represent our financial position or results of operations for any future date.

 

    December 8,
2011 through
December 31,
2011
    Year Ended
December 31, 2012
    Six Months
Ended June 30,
2012
    Six Months Ended
June 30, 2013
 
    Historical     Pro Forma     Historical     Historical     Pro Forma     Historical  
          (unaudited)           (unaudited)     (unaudited)     (unaudited)  
    (in thousands, except per share data)  

Statement of income data:

  

         

Interest income

  $ 1,260      $ 54,663      $ 33,759      $ 6,516      $ 45,416      $ 39,190   

Interest expense

    —          12,485        704        —          6,686        3,550   

Other-than-temporary impairment (“OTTI”) on securities

    —          —          —          —          3,756        3,756   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after impairment

    1,260        42,178        33,055        6,516        34,974        31,884   

Change in fair value of investments in excess mortgage servicing rights

    367        9,023        9,023        4,739        43,691        43,691   

Change in fair value of investments in excess mortgage servicing rights, equity method investees

    —          —          —          —          21,096        21,096   

Earnings from investments in consumer loans, equity method investees

    —          —          —          —          36,164        36,164   

Gain on settlement of securities

    —          —          —          —          58        58   

Other income (loss)

    —          8,400        8,400        —          —          —     

Expenses

    913        9,519        9,231        2,093        10,667        10,596   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 714      $ 50,082      $ 41,247      $ 9,162      $ 125,316      $ 122,297   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share:

           

Basic

    N/A      $ 0.20        N/A        0.04      $ 0.50        0.48   

Diluted

    N/A      $ 0.20        N/A        0.04      $ 0.49        0.48   

Number of shares outstanding:

           

Basic

    N/A        253,025,645        N/A        253,025,645        253,025,645        253,025,645   

Diluted

    N/A        253,025,645        N/A        253,025,645        254,852,605        254,852,605   

 

     December 31,
2011
     December 31,
2012
     June 30,
2013
     June 30,
2013
 
   Historical      Historical      Pro Forma      Historical  
                   (unaudited)      (unaudited)  
     (in thousands)  

Balance sheet data:

  

Total assets

   $ 43,971       $ 534,876       $ 3,023,653       $ 2,742,442   

Total liabilities

   $ 4,163       $ 156,520       $ 1,777,928       $ 1,496,717   

Total equity

   $ 39,808       $ 378,356       $ 1,245,725       $ 1,245,725   

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully read and consider the following risk factors and all other information contained in this prospectus before making a decision to purchase our common stock. If any of the following risks occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, which could result in a partial or complete loss of your investment. The risk factors summarized below are categorized as follows: (i) Risks Related to Our Business, (ii) Risks Related to Our Manager, (iii) Risks Related to the Financial Markets, (iv) Risks Related to Our Taxation as a REIT, and (v) Risks Related to Our Common Stock. However, these categories do overlap and should not be considered exclusive.

RISKS RELATED TO OUR BUSINESS

We have a very limited operating history as an independent company and may not be able to successfully operate our business strategy or generate sufficient revenue to make or sustain distributions to our stockholders. The financial information included in this prospectus may not be indicative of the results we would have achieved as a separate stand-alone company and are not a reliable indicator of our future performance or results.

We have very limited experience operating as an independent company and cannot assure you that we will be able to successfully operate our business or implement our operating policies and strategies. We were formed in September 2011 as a subsidiary of Newcastle and spun-off from Newcastle on May 15, 2013. We completed our first investment in Excess MSRs in December 2011, and our Manager has limited experience with transactions involving GSEs. The timing, terms, price and form of consideration that we and servicers pay in future transactions may vary meaningfully from prior transactions.

There can be no assurance that we will be able to generate sufficient returns to pay our operating expenses and make satisfactory distributions to our stockholders, or any distributions at all. Our results of operations and our ability to make or sustain distributions to our stockholders depend on several factors, including the availability of opportunities to acquire attractive assets, the level and volatility of interest rates, the availability of adequate short- and long-term financing, conditions in the real estate market, the financial markets and economic conditions.

We did not operate as a separate, stand-alone company for the entirety of the historical periods presented in the financial information included in this prospectus, which has been derived from Newcastle’s historical financial statements. Therefore, the financial information in this prospectus does not necessarily reflect what our financial condition, results of operations or cash flows would have been had we been a separate, stand-alone public company prior to our separation from Newcastle. This is primarily a result of the following factors:

 

    The financial results in this prospectus do not reflect all of the expenses we will incur as a public company;

 

    The working capital requirements and capital for general corporate purposes for our assets were satisfied prior to the spin-off as part of Newcastle’s corporate-wide cash management policies of Newcastle. Newcastle is not required, and does not intend, to provide us with funds to finance our working capital or other cash requirements, so we may need to obtain additional financing from banks, through public offerings or private placements of debt or equity securities, strategic relationships or other arrangements; and

 

    Our cost structure, management, financing and business operations are significantly different as a result of operating as an independent public company. These changes result in increased costs, including, but not limited to, fees paid to our Manager, legal, accounting, compliance and other costs associated with being a public company with equity securities traded on the NYSE.

 

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The value of our Excess MSRs is based on various assumptions that could prove to be incorrect and could have a negative impact on our financial results.

When we invest in Excess MSRs, we base the price we pay and the rate of amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. We record Excess MSRs on our balance sheet at fair value, and we measure their fair value on a recurring basis. Our projections of the cash flow from Excess MSRs, and the determination of the fair value of Excess MSRs, are based on assumptions about various factors, including, but not limited to:

 

    rates of prepayment and repayment of the underlying mortgage loans;

 

    interest rates;

 

    rates of delinquencies and defaults; and

 

    recapture rates.

Our assumptions could differ materially from actual results. The use of different estimates or assumptions in connection with the valuation of these assets could produce materially different fair values for such assets, which could have a material adverse effect on our consolidated financial position, results of operations and cash flows. The ultimate realization of the value of Excess MSRs may be materially different than the fair values of such Excess MSRs as reflected in our consolidated statement of financial position as of any particular date.

Our expectation of prepayment speeds is a significant assumption underlying our cash flow projections. Prepayment speed is the measurement of how quickly borrowers pay down the UPB of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. If the fair value of our Excess MSRs decreases, we would be required to record a non-cash charge, which would have a negative impact on our financial results. Furthermore, a significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from Excess MSRs, and we could ultimately receive substantially less than what we paid for such assets. Consequently, the price we pay to acquire Excess MSRs may prove to be too high.

The values of Excess MSRs are highly sensitive to changes in interest rates. Historically, the value of Excess MSRs has increased when interest rates rise and decreased when interest rates decline due to the effect of changes in interest rates on prepayment speeds. However, prepayment speeds could increase in spite of the current interest rate environment, as a result of a general economic recovery or other factors, which would reduce the value of our Excess MSRs.

Moreover, delinquency rates have a significant impact on the value of Excess MSRs. When delinquent loans are resolved through foreclosure, the UPB of such loans cease to be a part of the aggregate UPB of the serviced loan pool when the related properties are foreclosed on and liquidated. An increase in delinquencies will generally result in lower revenue because typically we will only collect on our Excess MSRs from GSEs or mortgage owners for performing loans. If delinquencies are significantly greater than expected, the estimated fair value of the Excess MSRs could be diminished. As a result, we could suffer a loss, which would have a negative impact on our financial results.

We are party to “recapture agreements” whereby we receive a new Excess MSR with respect to a loan that was originated by the servicer and used to repay a loan underlying an Excess MSR that we previously acquired from that same servicer. In lieu of receiving an Excess MSR with respect to the loan used to repay a prior loan, the servicer may supply a similar Excess MSR. We believe that recapture agreements will mitigate the impact on our returns in the event of a rise in voluntary prepayment rates. There are no assurances, however, that servicers will enter into recapture agreements with us in connection with any future investment in Excess MSRs. If the servicer does not meet anticipated recapture targets, the servicing cash flow on a given pool could be significantly lower than projected, which could have a material adverse effect on the value of our Excess MSRs and consequently on our business, financial condition, results of operations and cash flows. Our recapture target for each of our

 

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current recapture agreements is stated in the table in Note 7 to our consolidated financial statements for the year ended December 31, 2012 and Note 9 to our consolidated financial statements for the six months ended June 30, 2013 included herein.

We will rely heavily on mortgage servicers to achieve our investment objective and have no direct ability to influence their performance.

The value of our investments in Excess MSRs and Non-Agency RMBS is dependent on the satisfactory performance of servicing obligations by the mortgage servicer. The duties and obligations of mortgage servicers are defined through contractual agreements, generally referred to as Servicing Guides in the case of GSEs, or Pooling and Servicing Agreements in the case of private-label securities (collectively, the “Servicing Guidelines”). Servicing Guidelines generally provide for the possibility for termination of the contractual rights of the servicer in the absolute discretion of the owner of the mortgages being serviced. In the event a mortgage owner terminates the servicer, the related Excess MSRs would under most circumstances lose all value on a going forward basis. It is expected that any termination by a mortgage owner of a servicer would take effect across all mortgages of such mortgage owner and would not be limited to a particular vintage or other subset of mortgages. Therefore, it is expected that all investments with a given servicer would lose all their value in the event a mortgage owner terminates a servicer. Nationstar is the servicer of all of the loans underlying all of our investments in Excess MSRs and the servicer or master servicer of the vast majority of the loans underlying our Non-Agency RMBS to date. See “—We have significant counterparty concentration risk in Nationstar and Springleaf and are subject to other counterparty concentration and default risks.” As a result, we could be materially and adversely affected if the servicer is unable to adequately service the underlying mortgage loans due to:

 

    its failure to comply with applicable laws and regulation;

 

    a downgrade in its servicer rating;

 

    its failure to maintain sufficient liquidity or access to sources of liquidity;

 

    its failure to perform its loss mitigation obligations;

 

    its failure to perform adequately in its external audits;

 

    a failure in or poor performance of its operational systems or infrastructure;

 

    regulatory scrutiny regarding foreclosure processes lengthening foreclosure timelines;

 

    a GSE’s or a whole-loan owner’s transfer of servicing to another party; or

 

    any other reason.

MSRs are subject to numerous federal, state and local laws and regulations and may be subject to various judicial and administrative decisions. If the servicer, actually or allegedly failed to comply with applicable laws, rules or regulations, it could be terminated as the servicer, which could have a material adverse effect on our business, financial condition, results of operations or cash flows.

Favorable ratings from third-party rating agencies such as Standard & Poor’s, Moody’s and Fitch are important to the conduct of a mortgage servicer’s loan servicing business, and a downgrade in a mortgage servicer’s ratings could have an adverse effect on us and the value of our Excess MSRs. Downgrades in a mortgage servicer’s servicer ratings could adversely affect their ability to finance servicing advances and maintain their status as an approved servicer by Fannie Mae and Freddie Mac. Downgrades in servicer ratings could also lead to the early termination of existing advance facilities and affect the terms and availability of match funded advance facilities that a mortgage servicer may seek in the future. A mortgage servicer’s failure to maintain favorable or specified ratings may cause their termination as a servicer and may impair their ability to consummate future servicing transactions, which could have an adverse effect on our operations since we will rely heavily on mortgage servicers to achieve our investment objective and have no direct ability to influence their performance.

 

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In addition, a bankruptcy by any mortgage servicer that services the mortgage loans underlying our Excess MSRs could result in:

 

    the validity and priority of our ownership in the Excess MSRs being challenged in a bankruptcy proceeding;

 

    payments made by such servicer to us, or obligations incurred by it, being voided by a court under federal or state preference laws or federal or state fraudulent conveyance laws;

 

    a re-characterization of any sale of Excess MSRs or other assets to us as a pledge of such assets in a bankruptcy proceeding; or

 

    any agreement pursuant to which we acquired the Excess MSRs being rejected in a bankruptcy proceeding.

We have significant counterparty concentration risk in Nationstar and Springleaf and are subject to other counterparty concentration and default risks.

We are not restricted from dealing with any particular counterparty or from concentrating any or all of our transactions with a few counterparties. Any loss suffered by us as a result of a counterparty defaulting, refusing to conduct business with us or imposing more onerous terms on us would also negatively affect our business, results of operations and financial condition.

To date, all of our co-investments in Excess MSRs relate to loans serviced by Nationstar. If Nationstar is terminated as the servicer of some or all of these portfolios, or in the event that it files for bankruptcy, our expected returns on these investments would be severely impacted. In addition, the vast majority of the loans underlying our Non-Agency RMBS are serviced by Nationstar. We closely monitor Nationstar’s mortgage servicing performance and overall operating performance, financial condition and liquidity, as well as its compliance with regulations and Servicing Guidelines. We have various information, access and inspection rights in our agreements with Nationstar that enable us to monitor Nationstar’s financial and operating performance and credit quality, which we periodically evaluate and discuss with Nationstar’s management. However, we have no direct ability to influence Nationstar’s performance, and our diligence cannot prevent, and may not even help us anticipate, the termination of a Nationstar servicing agreement. Furthermore, Nationstar has no obligation to offer us any future co-investment opportunity on the same terms as prior transactions, or at all, and we may not be able to find suitable counterparties other than Nationstar, from which to acquire Excess MSRs, which could impact our business strategy. See “—We will rely heavily on mortgage servicers to achieve our investment objective and have no direct ability to influence their performance.”

In addition, the consumer loans in which we have invested are or will be serviced by Springleaf. If Springleaf is terminated as the servicer of some or all of these portfolios, or in the event that it files for bankruptcy, our expected returns on these investments could be severely impacted.

Moreover, we are party to repurchase agreements with a limited number of counterparties. If any of our counterparties elected not to roll our repurchase agreements, we may not be able to find a replacement counterparty, which would have a material adverse effect on our financial condition.

Our risk-management processes may not accurately anticipate the impact of market stress or counterparty financial condition, and as a result, we may not take sufficient action to reduce our risks effectively. Although we will monitor our credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses.

In the event of a counterparty default, particularly a default by a major investment bank, we could incur material losses rapidly, and the resulting market impact of a major counterparty default could seriously harm our business,

 

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results of operations and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding.

Counterparty risks have increased in complexity and magnitude as a result of the insolvency of a number of major financial institutions (such as Lehman Brothers) and the consequent decrease in the number of potential counterparties. In addition, counterparties have generally tightened their underwriting standards and increased their margin requirements for financing, which could negatively impact us in several ways, including by decreasing the number of counterparties willing to provide financing to us, decreasing the overall amount of leverage available to us, and increasing the costs of borrowing.

GSE initiatives and other actions may adversely affect returns from investments in Excess MSRs.

On January 17, 2011, the Federal Housing Finance Agency (“FHFA”) announced that it had instructed Fannie Mae and Freddie Mac to study possible alternatives to the current residential mortgage servicing and compensation system used for single-family mortgage loans. It is unclear what the GSEs, including Fannie Mae or Freddie Mac, may propose as alternatives to current servicing compensation practices, or when any such alternatives may become effective. Although we do not expect MSRs that have already been created to be subject to any changes implemented by Fannie Mae or Freddie Mac, it is possible that, because of the significant role of Fannie Mae or Freddie Mac in the secondary mortgage market, any changes they implement could become prevalent in the mortgage servicing industry generally. Other industry stakeholders or regulators may also implement or require changes in response to the perception that the current mortgage servicing practices and compensation do not appropriately serve broader housing policy objectives. These proposals are still evolving. To the extent the GSEs implement reforms that materially affect the market for conforming loans, there may be secondary effects on the subprime and Alt-A markets. These reforms may have a material adverse effect on the economics or performance of any Excess MSRs that we may acquire in the future.

Changes to the minimum servicing amount for GSE loans could occur at any time and could impact us in significantly negative ways that we are unable to predict or protect against.

Currently, when a loan is sold into the secondary market for Fannie Mae or Freddie Mac loans, the servicer is generally required to retain a minimum servicing amount (“MSA”) of 25 bps of the UPB for fixed rate mortgages. As has been widely publicized, in September 2011, the FHFA announced that a Joint Initiative on Mortgage Servicing Compensation was seeking public comment on two alternative mortgage servicing compensation structures detailed in a discussion paper. Changes to the MSA structure could significantly impact our business in negative ways that we cannot predict or protect against. For example, the elimination of a MSA could radically change the mortgage servicing industry and could severely limit the supply of Excess MSRs available for sale. In addition, a removal of, or reduction in, the MSA could significantly reduce the recapture rate on the affected loan portfolio, which would negatively affect the investment return on our Excess MSRs. We cannot predict whether any changes to current MSA rules will occur or what impact any changes will have on our business, results of operations, liquidity or financial condition.

Our investments in Excess MSRs may involve complex or novel structures.

Investments in Excess MSRs are a new type of transaction and may involve complex or novel structures. Accordingly, the risks associated with the transaction and structure are not fully known to buyers and sellers. GSEs may require that we submit to costly or burdensome conditions as a prerequisite to their consent to an investment in Excess MSRs. GSE conditions may diminish or eliminate the investment potential of certain Excess MSRs by making such investments too expensive for us or by severely limiting the potential returns available from Excess MSRs.

It is possible that a GSE’s views on whether any such acquisition structure is appropriate or acceptable may not be known to us when we make an investment and may change from time to time for any reason or for no reason,

 

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even with respect to a completed investment. A GSE’s evolving posture toward an acquisition or disposition structure through which we invest in or dispose of Excess MSRs may cause such GSE to impose new conditions on our existing investments in Excess MSRs, including the owner’s ability to hold such Excess MSRs directly or indirectly through a grantor trust or other means. Such new conditions may be costly or burdensome and may diminish or eliminate the investment potential of the Excess MSRs that are already owned by us. Moreover, obtaining such consent may require us or our co-investment counterparties to agree to material structural or economic changes, as well as agree to indemnification or other terms that expose us to risks to which we have not previously been exposed and that could negatively affect our returns from our investments.

Many of our investments may be illiquid, and this lack of liquidity could significantly impede our ability to vary our portfolio in response to changes in economic and other conditions or to realize the value at which such investments are carried if we are required to dispose of them.

Many of our investments are illiquid. Illiquidity may result from the absence of an established market for the investments, as well as legal or contractual restrictions on their resale, refinancing or other disposition. Dispositions of investments may be subject to contractual and other limitations on transfer or other restrictions that would interfere with subsequent sales of such investments or adversely affect the terms that could be obtained upon any disposition thereof.

Excess MSRs are highly illiquid and subject to numerous restrictions on transfers, including without limitation the receipt of third-party consents. For example, the Servicing Guidelines of a mortgage owner generally require that holders of Excess MSRs obtain the mortgage owner’s prior approval of any change of direct ownership of such Excess MSRs. Such approval may be withheld for any reason or no reason in the discretion of the mortgage owner. Moreover, we have not received and do not expect to receive any assurances from any GSEs that their conditions for the sale by us of any Excess MSRs will not change. Therefore, the potential costs, issues or restrictions associated with receiving such GSEs’ consent for any such dispositions by us cannot be determined with any certainty. Additionally, investments in Excess MSRs are a new type of transaction, and the risks associated with the transaction and structure are not fully known to buyers or sellers. As a result of the foregoing, there is some risk that we will be unable to locate a buyer at the time we wish to sell an Excess MSR. There is some risk that we will be required to dispose of Excess MSRs either through an in-kind distribution or other liquidation vehicle, which will, in either case, provide little or no economic benefit to us, or a sale to a co-investor in the Excess MSR, which may be an affiliate. Accordingly, we cannot provide any assurance that we will obtain any return or any benefit of any kind from any disposition of Excess MSRs. We may not benefit from the full term of the assets and for the aforementioned reasons may not receive any benefits from the disposition, if any, of such assets.

In addition, some of our real estate related securities may not be registered under the relevant securities laws, resulting in a prohibition against their transfer, sale, pledge or other disposition except in a transaction that is exempt from the registration requirements of, or is otherwise in accordance with, those laws. There are also no established trading markets for a majority of our intended investments. Moreover, certain of our investments, including our investments in consumer loans and certain investments in Excess MSRs, are made indirectly through a vehicle that owns the underlying assets. Our ability to sell our interest may be contractually limited or prohibited. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may be limited.

Our real estate related securities have historically been valued based primarily on third-party quotations, which are subject to significant variability based on the liquidity and price transparency created by market trading activity. A disruption in these trading markets could reduce the trading for many real estate related securities, resulting in less transparent prices for those securities, which would make selling such assets more difficult. Moreover, a decline in market demand for the types of assets that we hold would make it more difficult to sell our assets. If we are required to liquidate all or a portion of our illiquid investments quickly, we may realize significantly less than the amount at which we have previously valued these investments.

 

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Market conditions could negatively impact our business, results of operations and financial condition.

The market in which we operate is affected by a number of factors that are largely beyond our control but can nonetheless have a potentially significant, negative impact on us. These factors include, among other things:

 

    Interest rates and credit spreads;

 

    The availability of credit, including the price, terms and conditions under which it can be obtained;

 

    The quality, pricing and availability of suitable investments and credit losses with respect to our investments;

 

    The ability to obtain accurate market-based valuations;

 

    Loan values relative to the value of the underlying real estate assets;

 

    Default rates on the loans underlying our investments and the amount of the related losses;

 

    Prepayment speeds, delinquency rates and legislative/regulatory changes with respect to our investments in Excess MSRs, RMBS, and loans;

 

    The actual and perceived state of the real estate markets, market for dividend-paying stocks and public capital markets generally;

 

    Unemployment rates; and

 

    The attractiveness of other types of investments relative to investments in real estate or REITs generally.

Changes in these factors are difficult to predict, and a change in one factor can affect other factors. For example, during 2007, increased default rates in the subprime mortgage market played a role in causing credit spreads to widen, reducing availability of credit on favorable terms, reducing liquidity and price transparency of real estate related assets, resulting in difficulty in obtaining accurate mark-to-market valuations, and causing a negative perception of the state of the real estate markets and of REITs generally. These conditions worsened during 2008, and intensified meaningfully during the fourth quarter of 2008 as a result of the global credit and liquidity crisis, resulting in extraordinarily challenging market conditions. Since then, market conditions have generally improved, but they could deteriorate in the future as a result of the mandatory reductions in federal spending beginning in 2013 or other factors.

The geographic distribution of the loans underlying, and collateral securing, certain of our investments subjects us to geographic real estate market risks, which could adversely affect the performance of our investments, our results of operations and financial condition.

The geographic distribution of the loans underlying, and collateral securing, our investments, including our Excess MSRs, Non-Agency RMBS and consumer loans, exposes us to risks associated with the real estate and commercial lending industry in general within the states and regions in which we hold significant investments. These risks include, without limitation: possible declines in the value of real estate; risks related to general and local economic conditions; possible lack of availability of mortgage funds; overbuilding; extended vacancies of properties; increases in competition, property taxes and operating expenses; changes in zoning laws; increased energy costs; unemployment; costs resulting from the clean-up of, and liability to third parties for damages resulting from, environmental problems; casualty or condemnation losses; uninsured damages from floods, earthquakes or other natural disasters; and changes in interest rates. As of December 31, 2012, 32.0% of the total unpaid principal amount of the residential mortgage loans underlying our Excess MSRs was secured by properties located in California and 10.1% was secured by properties located in Florida. As of December 31, 2012, 34.9% of the collateral securing our real estate securities was located in the Western U.S., 23.2% was located in the Southeastern U.S., 22.0% was located in the Northeastern U.S., 10.0% was located in the Midwestern U.S. and 9.9% was located in the Southwestern U.S. To the extent any of the foregoing risks arise in

 

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states and regions where we hold significant investments, the performance of our investments, our results of operations and our financial condition could suffer a material adverse effect.

We may invest in RMBS collateralized by subprime mortgage loans, which are subject to increased risks.

We may invest in RMBS backed by collateral pools of subprime residential mortgage loans. “Subprime” mortgage loans refer to mortgage loans that have been originated using underwriting standards that are less restrictive than the underwriting requirements used as standards for other first and junior lien mortgage loan purchase programs, such as the programs of Fannie Mae and Freddie Mac. These lower standards include mortgage loans made to borrowers having imperfect or impaired credit histories (including outstanding judgments or prior bankruptcies), mortgage loans where the amount of the loan at origination is 80% or more of the value of the mortgage property, mortgage loans made to borrowers with low credit scores, mortgage loans made to borrowers who have other debt that represents a large portion of their income and mortgage loans made to borrowers whose income is not required to be disclosed or verified. Due to economic conditions, including increased interest rates and lower home prices, as well as aggressive lending practices, subprime mortgage loans have in recent periods experienced increased rates of delinquency, foreclosure, bankruptcy and loss, and they are likely to continue to experience delinquency, foreclosure, bankruptcy and loss rates that are higher, and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus, because of the higher delinquency rates and losses associated with subprime mortgage loans, the performance of RMBS backed by subprime mortgage loans in which we may invest could be correspondingly adversely affected, which could adversely impact our results of operations, financial condition and business.

The value of our RMBS may be adversely affected by deficiencies in servicing and foreclosure practices, as well as related delays in the foreclosure process.

Allegations of deficiencies in servicing and foreclosure practices among several large sellers and servicers of residential mortgage loans that surfaced in 2010 raised various concerns relating to such practices, including the improper execution of the documents used in foreclosure proceedings (so-called “robo signing”), inadequate documentation of transfers and registrations of mortgages and assignments of loans, improper modifications of loans, violations of representations and warranties at the date of securitization and failure to enforce put-backs.

As a result of alleged deficiencies in foreclosure practices, a number of servicers temporarily suspended foreclosure proceedings beginning in the second half of 2010 while they evaluated their foreclosure practices. In late 2010, a group of state attorneys general and state bank and mortgage regulators representing nearly all 50 states and the District of Columbia, along with the U.S. Justice Department and the Department of Housing and Urban Development, began an investigation into foreclosure practices of banks and servicers. The investigations and lawsuits by several state attorneys general led to a settlement agreement in early February 2012 with five of the nation’s largest banks, pursuant to which the banks agreed to pay more than $25 billion to settle claims relating to improper foreclosure practices. The settlement does not prohibit the states, the federal government, individuals or investors in RMBS from pursuing additional actions against the banks and servicers in the future.

The integrity of the servicing and foreclosure processes are critical to the value of the mortgage loan portfolios underlying our RMBS, and our financial results could be adversely affected by deficiencies in the conduct of those processes. For example, delays in the foreclosure process that have resulted from investigations into improper servicing practices may adversely affect the values of, and our losses on, our Non-Agency RMBS. Foreclosure delays may also increase the administrative expenses of the securitization trusts for the Non-Agency RMBS, thereby reducing the amount of funds available for distribution to investors. In addition, the subordinate classes of securities issued by the securitization trusts may continue to receive interest payments while the defaulted loans remain in the trusts, rather than absorbing the default losses. This may reduce the amount of credit support available for the senior classes we own, thus possibly adversely affecting these securities. Additionally, a substantial portion of the $25 billion settlement is a “credit” to the banks and servicers for

 

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principal write-downs or reductions they may make to certain mortgages underlying RMBS. There remains uncertainty as to how these principal reductions will work and what effect they will have on the value of related RMBS. As a result, there can be no assurance that any such principal reductions will not adversely affect the value of certain of our RMBS.

While we believe that the sellers and servicers would be in violation of their servicing contracts to the extent that they have improperly serviced mortgage loans or improperly executed documents in foreclosure or bankruptcy proceedings, or do not comply with the terms of servicing contracts when deciding whether to apply principal reductions, it may be difficult, expensive and time consuming for us to enforce our contractual rights. While we cannot predict exactly how the servicing and foreclosure matters or the resulting litigation or settlement agreements will affect our business, there can be no assurance that these matters will not have an adverse impact on our results of operations and financial condition.

The loans underlying the securities we invest in are subject to delinquency, foreclosure and loss, which could result in losses to us.

Mortgage backed securities are bonds or notes backed by loans. The ability of borrowers to repay these loans is dependent upon the income or assets of these borrowers. If a borrower has insufficient income or assets to repay these loans, it will default on its loan. Our investments in RMBS will be adversely affected by defaults under the loans underlying such securities. To the extent losses are realized on the loans underlying the securities in which we invest, we may not recover the amount invested in, or, in extreme cases, any of our investment in such securities.

Our investments in real estate related securities are subject to changes in credit spreads, which could adversely affect our ability to realize gains on the sale of such investments.

Real estate related securities are subject to changes in credit spreads. Credit spreads measure the yield demanded on securities by the market based on their credit relative to a specific benchmark.

Fixed rate securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Floating rate securities are valued based on a market credit spread over LIBOR and are affected similarly by changes in LIBOR spreads. Excessive supply of these securities combined with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher, or “wider,” spread over the benchmark rate to value such securities. Under such conditions, the value of our real estate related securities portfolios would tend to decline. Conversely, if the spread used to value such securities were to decrease, or “tighten,” the value of our real estate related securities portfolio would tend to increase. Such changes in the market value of our real estate securities portfolios may affect our net equity, net income or cash flow directly through their impact on unrealized gains or losses on available-for-sale securities, and therefore our ability to realize gains on such securities, or indirectly through their impact on our ability to borrow and access capital. During 2008 through the first quarter of 2009, credit spreads widened substantially. Widening credit spreads could cause the net unrealized gains on our securities and derivatives, recorded in accumulated other comprehensive income or retained earnings, and therefore our book value per share, to decrease and result in net losses.

Prepayment rates on the mortgage loans underlying our real estate related securities may adversely affect our profitability.

In general, the mortgages collateralizing our real estate related securities may be prepaid at any time without penalty. Prepayments on our real estate related securities result when homeowners/mortgagees satisfy (i.e., pay off) the mortgage upon selling or refinancing their mortgaged property. When we acquire a particular security, we anticipate that the underlying mortgage loans will prepay at a projected rate which, together with expected coupon income, provides us with an expected yield on such securities. If we purchase assets at a premium to par

 

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value, and borrowers prepay their mortgage loans faster than expected, the corresponding prepayments on the real estate related security may reduce the expected yield on such securities because we will have to amortize the related premium on an accelerated basis. Conversely, if we purchase assets at a discount to par value, when borrowers prepay their mortgage loans slower than expected, the decrease in corresponding prepayments on the real estate related security may reduce the expected yield on such securities because we will not be able to accrete the related discount as quickly as originally anticipated. Prepayment rates on loans are influenced by changes in mortgage and market interest rates and a variety of economic, geographic and other factors, all of which are beyond our control. Consequently, such prepayment rates cannot be predicted with certainty and no strategy can completely insulate us from prepayment or other such risks. In periods of declining interest rates, prepayment rates on mortgage loans generally increase. If general interest rates decline at the same time, the proceeds of such prepayments received during such periods are likely to be reinvested by us in assets yielding less than the yields on the assets that were prepaid. In addition, the market value of our real estate related securities may, because of the risk of prepayment, benefit less than other fixed-income securities from declining interest rates.

With respect to Agency ARM RMBS, we intend to purchase securities that have a higher coupon rate than the prevailing market interest rates. In exchange for a higher coupon rate, we would then pay a premium over par value to acquire these securities. In accordance with GAAP, we will amortize the premiums on our Agency ARM RMBS over the life of the related securities. If the mortgage loans securing these securities prepay at a more rapid rate than anticipated, we will have to amortize our premiums on an accelerated basis which may adversely affect our profitability. Defaults on Agency ARM RMBS typically have the same effect as prepayments because of the underlying Agency guarantee.

Prepayments, which are the primary feature of mortgage backed securities that distinguish them from other types of bonds, are difficult to predict and can vary significantly over time. As the holder of the security, on a monthly basis, we receive a payment equal to a portion of our investment principal in a particular security as the underlying mortgages are prepaid. In general, on the date each month that principal prepayments are announced (i.e., factor day), the value of our real estate related security pledged as collateral under our repurchase agreements is reduced by the amount of the prepaid principal and, as a result, our lenders will typically initiate a margin call requiring the pledge of additional collateral or cash, in an amount equal to such prepaid principal, in order to re-establish the required ratio of borrowing to collateral value under such repurchase agreements. Accordingly, with respect to our Agency ARM RMBS, the announcement on factor day of principal prepayments is in advance of our receipt of the related scheduled payment, thereby creating a short-term receivable for us in the amount of any such principal prepayments. However, under our repurchase agreements, we may receive a margin call relating to the related reduction in value of our Agency ARM RMBS and, prior to receipt of this short-term receivable, be required to post additional collateral or cash in the amount of the principal prepayment on or about factor day, which would reduce our liquidity during the period in which the short-term receivable is outstanding. As a result, in order to meet any such margin calls, we could be forced to sell assets in order to maintain liquidity. Forced sales under adverse market conditions may result in lower sales prices than ordinary market sales made in the normal course of business. If our real estate related securities were liquidated at prices below our amortized cost (i.e., the cost basis) of such assets, we would incur losses, which could adversely affect our earnings. In addition, in order to continue to earn a return on this prepaid principal, we must reinvest it in additional real estate related securities or other assets; however, if interest rates decline, we may earn a lower return on our new investments as compared to the real estate related securities that prepay.

Prepayments may have a negative impact on our financial results, the effects of which depend on, among other things, the timing and amount of the prepayment delay on our Agency ARM RMBS, the amount of unamortized premium on our real estate related securities, the rate at which prepayments are made on our Non-Agency RMBS, the reinvestment lag and the availability of suitable reinvestment opportunities.

 

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Our investments in RMBS may be subject to significant impairment charges, which would adversely affect our results of operations.

We will be required to periodically evaluate our investments for impairment indicators. The value of an investment is impaired when our analysis indicates that, with respect to a security, it is probable that the value of the security is other than temporarily impaired. The judgment regarding the existence of impairment indicators is based on a variety of factors depending upon the nature of the investment and the manner in which the income related to such investment was calculated for purposes of our financial statements. If we determine that an impairment has occurred, we are required to make an adjustment to the net carrying value of the investment, which would adversely affect our results of operations in the applicable period and thereby adversely affect our ability to pay dividends to our stockholders.

The lenders under our repurchase agreements may elect not to extend financing to us, which could quickly and seriously impair our liquidity.

We finance a meaningful portion of our investments in RMBS with repurchase agreements, which are short-term financing arrangements. Under the terms of these agreements, we will sell a security to a counterparty for a specified price and concurrently agree to repurchase the same security from our counterparty at a later date for a higher specified price. During the term of the repurchase agreement—which can be as short as 30 days—the counterparty will make funds available to us and hold the security as collateral. Our counterparties can also require us to post additional margin as collateral at any time during the term of the agreement. When the term of a repurchase agreement ends, we will be required to repurchase the security for the specified repurchase price, with the difference between the sale and repurchase prices serving as the equivalent of paying interest to the counterparty in return for extending financing to us. If we want to continue to finance the security with a repurchase agreement, we ask the counterparty to extend—or “roll”—the repurchase agreement for another term.

Our counterparties are not required to roll our repurchase agreements upon the expiration of their stated terms, which subjects us to a number of risks. Counterparties electing to roll our repurchase agreements may charge higher spread and impose more onerous terms upon us, including the requirement that we post additional margin as collateral. More significantly, if a repurchase agreement counterparty elects not to extend our financing, we would be required to pay the counterparty the full repurchase price on the maturity date and find an alternate source of financing. Alternate sources of financing may be more expensive, contain more onerous terms or simply may not be available. If we were unable to pay the repurchase price for any security financed with a repurchase agreement, the counterparty has the right to sell the underlying security being held as collateral and require us to compensate it for any shortfall between the value of our obligation to the counterparty and the amount for which the collateral was sold (which may be a significantly discounted price). As of June 30, 2013, we had outstanding repurchase agreements with an aggregate face amount of approximately $413 million to finance Non-Agency RMBS and approximately $1.1 billion to finance Agency ARM RMBS. Moreover, our repurchase agreement obligations are currently with a limited number of counterparties. If any of our counterparties elected not to roll our repurchase agreements, we may not be able to find a replacement counterparty in a timely manner.

We may not be able to finance our investments on attractive terms or at all, and financing for Excess MSRs may be particularly difficult or impossible to obtain.

The ability to finance investments with securitizations or other long-term non-recourse financing not subject to margin requirements has been impaired since 2007 as a result of market conditions. In addition, it may be particularly challenging to securitize our investments in consumer loans, given that consumer loans are generally riskier than mortgage financing. These conditions make it highly likely that we will have to use less efficient forms of financing for any new investments, which will likely require a larger portion of our cash flows to be put toward making the initial investment and thereby reduce the amount of cash available for distribution to our stockholders and funds available for operations and investments, and which will also likely require us to assume higher levels of risk when financing our investments. In addition, there is no established market for financing of investments in Excess MSRs, and it is possible that one will not develop for a variety of reasons, such as the challenges with perfecting security interests in the underlying collateral.

 

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As non-recourse long-term financing structures become available to us and are utilized, such structures expose us to risks which could result in losses to us.

We may use securitization and other non-recourse long-term financing for our investments to the extent available. In such structures, our lenders typically would have only a claim against the assets included in the securitizations rather than a general claim against us as an entity. Prior to any such financing, we would seek to finance our investments with relatively short-term facilities until a sufficient portfolio is accumulated. As a result, we would be subject to the risk that we would not be able to acquire, during the period that any short-term facilities are available, sufficient eligible assets or securities to maximize the efficiency of a securitization. We also bear the risk that we would not be able to obtain new short-term facilities or would not be able to renew any short-term facilities after they expire should we need more time to seek and acquire sufficient eligible assets or securities for a securitization. In addition, conditions in the capital markets may make the issuance of any such securitization less attractive to us even when we do have sufficient eligible assets or securities. While we would intend to retain the unrated equity component of securitizations and, therefore, still have exposure to any investments included in such securitizations, our inability to enter into such securitizations may increase our overall exposure to risks associated with direct ownership of such investments, including the risk of default. Our inability to refinance any short-term facilities would also increase our risk because borrowings thereunder would likely be recourse to us as an entity. If we are unable to obtain and renew short-term facilities or to consummate securitizations to finance our investments on a long-term basis, we may be required to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price.

Risks associated with our investment in the consumer loan sector could have a material adverse effect on our business and financial results.

We recently completed an investment in the consumer loan sector. Although many of the risks applicable to consumer loans are also applicable to residential real estate loans, and thus the type of risks that we have experience managing, there are nevertheless substantial risks and uncertainties associated with engaging in a new category of investment. There may be factors that affect the consumer loan sector with which we are not as familiar compared to the residential mortgage loan sector. Moreover, our underwriting assumptions for these investments may prove to be materially incorrect. It is also possible that the addition of consumer loans to our investment portfolio could divert our Manager’s time away from our other investments. Furthermore, external factors, such as compliance with regulations, may also impact our ability to succeed in the consumer loan investment sector. Failure to successfully manage these risks could have a material adverse effect on our business and financial results.

The consumer loans underlying our investments are subject to delinquency and loss, which could have a negative impact on our financial results.

The ability of borrowers to repay the consumer loans underlying our investments may be adversely affected by numerous personal factors, including unemployment, divorce, major medical expenses or personal bankruptcy. General factors, including an economic downturn, high energy costs or acts of God or terrorism, may also affect the financial stability of borrowers and impair their ability or willingness to repay the consumer loans in our investment portfolio. In the event of any default under a loan in the consumer loan portfolio in which we have invested, we will bear a risk of loss of principal to the extent of any deficiency between the value of the collateral securing the loan, if any, and the principal and accrued interest of the loan. In addition, our investments in consumer loans may entail greater risk than our investments in residential real estate loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. There can be no guarantee that we will not suffer unexpected losses on our investments as a result of the factors set out above, which could have a negative impact on our financial results.

 

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The servicer of the loans underlying our consumer loan investment may not be able to accurately track the default status of senior lien loans in instances where our consumer loan investments are secured by second or third liens on real estate.

A portion of our investment in consumer loans is secured by second and third liens on real estate. When we hold the second or third lien another creditor or creditors, as applicable, holds the first and/or second, as applicable, lien on the real estate that is the subject of the security. In these situations our second or third lien is subordinate in right of payment to the first and/or second, as applicable, holder’s right to receive payment. Moreover, as the servicer of the loans underlying our consumer loan portfolio is not able to track the default status of a senior lien loan in instances where we do not hold the related first mortgage, the value of the second or third lien loans in our portfolio may be lower than our estimates indicate.

The consumer loan investment sector is subject to various initiatives on the part of advocacy groups and extensive regulation and supervision under federal, state and local laws, ordinances and regulations, which could have a negative impact on our financial results.

In recent years consumer advocacy groups and some media reports have advocated governmental action to prohibit or place severe restrictions on the types of short-term consumer loans in which we have invested. Such consumer advocacy groups and media reports generally focus on the Annual Percentage Rate to a consumer for this type of loan, which is compared unfavorably to the interest typically charged by banks to consumers with top-tier credit histories. The fees charged on the consumer loans in the portfolio in which we have invested may be perceived as controversial by those who do not focus on the credit risk and high transaction costs typically associated with this type of investment. If the negative characterization of these types of loans becomes increasingly accepted by consumers, demand for the consumer loan products in which we have invested could significantly decrease. Additionally, if the negative characterization of these types of loans is accepted by legislators and regulators, we could become subject to more restrictive laws and regulations in the area.

In addition, we are, or may become, subject to federal, state and local laws, regulations, or regulatory policies and practices, including the Dodd-Frank Act (which, among other things, established the Consumer Finance Protection Bureau with broad authority to regulate and examine financial institutions), which may, amongst other things, limit the amount of interest or fees allowed to be charged on the consumer loans underlying our investments, or the number of consumer loans that customers may receive or have outstanding. The operation of existing or future laws, ordinances and regulations could interfere with the focus of our investments which could have a negative impact on our financial results.

Our determination of how much leverage to apply to our investments may adversely affect our return on our investments and may reduce cash available for distribution.

We may leverage our assets through a variety of borrowings. Our investment guidelines do not limit the amount of leverage we may incur with respect to any specific asset or pool of assets. The return we are able to earn on our investments and cash available for distribution to our stockholders may be significantly reduced due to changes in market conditions, which may cause the cost of our financing to increase relative to the income that can be derived from our assets.

Certain of our investments are not match funded, which may increase the risks associated with these investments.

When available, a match funding strategy mitigates the risk of not being able to refinance an investment on favorable terms or at all. However, our Manager may elect for us to bear a level of refinancing risk on a short-term or longer-term basis, as in the case of investments financed with repurchase agreements (such as our Agency ARM and Non-Agency RMBS portfolios), when, based on its analysis, our Manager determines that bearing such risk is advisable or unavoidable. In addition, we may be unable, as a result of conditions in the credit markets, to match fund our investments. For example since the 2008 recession, non-recourse term

 

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financing not subject to margin requirements has been more difficult to obtain, which impairs our ability to match fund our investments. Moreover, we may not be able to enter into interest rate swaps. A decision not to, or the inability to, match fund certain investments exposes us to additional risks.

Furthermore, we anticipate that, in most cases, for any period during which our floating rate assets are not match funded with respect to maturity (as is the case with most of our RMBS portfolios), the income from such assets may respond more slowly to interest rate fluctuations than the cost of our borrowings. Because of this dynamic, interest income from such investments may rise more slowly than the related interest expense, with a consequent decrease in our net income. Interest rate fluctuations resulting in our interest expense exceeding interest income would result in operating losses for us from these investments.

Accordingly, to the extent our investments are not match funded with respect to maturities and interest rates, we are exposed to the risk that we may not be able to finance or refinance our investments on economically favorable terms or may have to liquidate assets at a loss.

Interest rate fluctuations and shifts in the yield curve may cause losses.

Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Our primary interest rate exposures relate to our investments in Excess MSRs, RMBS, consumer loans and any floating rate debt obligations that we may incur. Changes in interest rates, including changes in expected interest rates or “yield curves,” affect our business in a number of ways. Changes in the general level of interest rates can affect our net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities and hedges. Changes in the level of interest rates also can affect, among other things, our ability to acquire real estate related securities at attractive prices, the value of our real estate related securities and derivatives and our ability to realize gains from the sale of such assets. We may wish to use hedging transactions to protect certain positions from interest rate fluctuations, but we may not be able to do so as a result of market conditions, REIT rules or other reasons. In such event, interest rate fluctuations could adversely affect our financial condition and results of operations.

In the event of a significant rising interest rate environment and/or economic downturn, loan and collateral defaults may increase and result in credit losses that would adversely affect our liquidity and operating results.

Our ability to execute our business strategy, particularly the growth of our investment portfolio, depends to a significant degree on our ability to obtain additional capital. Our financing strategy for our real estate related securities is dependent on our ability to place the debt we use to finance our investments at rates that provide a positive net spread. If spreads for such liabilities widen or if demand for such liabilities ceases to exist, then our ability to execute future financings will be severely restricted.

Interest rate changes may also impact our net book value as our real estate related securities are marked to market each quarter. Debt obligations are not marked to market. Generally, as interest rates increase, the value of our fixed rate securities decreases, which will decrease the book value of our equity.

Furthermore, shifts in the U.S. Treasury yield curve reflecting an increase in interest rates would also affect the yield required on our real estate related securities and therefore their value. For example, increasing interest rates would reduce the value of the fixed rate assets we hold at the time because the higher yields required by increased interest rates result in lower market prices on existing fixed rate assets in order to adjust the yield upward to meet the market, and vice versa. This would have similar effects on our real estate related securities portfolio and our financial position and operations to a change in interest rates generally.

 

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Any hedging transactions that we enter into may limit our gains or result in losses.

We may use, when feasible and appropriate, derivatives to hedge a portion of our interest rate exposure, and this approach has certain risks, including the risk that losses on a hedge position will reduce the cash available for distribution to stockholders and that such losses may exceed the amount invested in such instruments. We have adopted a general policy with respect to the use of derivatives, which generally allows us to use derivatives where appropriate, but does not set forth specific policies and procedures or require that we hedge any specific amount of risk. From time to time, we may use derivative instruments, including forwards, futures, swaps and options, in our risk management strategy to limit the effects of changes in interest rates on our operations. A hedge may not be effective in eliminating all of the risks inherent in any particular position. Our profitability may be adversely affected during any period as a result of the use of derivatives.

There are limits to the ability of any hedging strategy to protect us completely against interest rate risks. When rates change, we expect the gain or loss on derivatives to be offset by a related but inverse change in the value of any items that we hedge. We cannot assure you, however, that our use of derivatives will offset the risks related to changes in interest rates. We cannot assure you that our hedging strategy and the derivatives that we use will adequately offset the risk of interest rate volatility or that our hedging transactions will not result in losses. In addition, our hedging strategy may limit our flexibility by causing us to refrain from taking certain actions that would be potentially profitable but would cause adverse consequences under the terms of our hedging arrangements.

The REIT provisions of the Code limit our ability to hedge. In managing our hedge instruments, we consider the effect of the expected hedging income on the REIT qualification tests that limit the amount of gross income that a REIT may receive from hedging. We need to carefully monitor, and may have to limit, our hedging strategy to assure that we do not realize hedging income, or hold hedges having a value, in excess of the amounts that would cause us to fail the REIT gross income and asset tests.

Accounting for derivatives under U.S. generally accepted accounting principles (“GAAP”) is extremely complicated. Any failure by us to account for our derivatives properly in accordance with GAAP in our financial statements could adversely affect our earnings.

Maintenance of our 1940 Act exemption imposes limits on our operations.

We intend to conduct our operations in reliance on an exemption from registration as an investment company under the 1940 Act. The assets that we may acquire, therefore, are limited by the provisions of the 1940 Act and the rules and regulations promulgated under the 1940 Act.

We intend to conduct our operations so that we may rely upon the exemption from registration as an investment company under the 1940 Act pursuant to Section 3(c)(5)(C) of the 1940 Act. We expect to rely on guidance published by the SEC or its staff or on our analyses of such guidance to determine which assets are qualifying real estate assets and real estate related assets. To the extent that the SEC or its staff publishes new or different guidance with respect to these matters, we may be required to adjust our strategy and portfolio composition accordingly. In addition, we may be limited in our ability to make certain investments and these limitations could result in our holding assets that we might wish to sell or selling assets we might wish to hold. In addition, we could, among other things, be required either (a) to change the manner in which we conduct our operations in order to maintain our exemption from registration as an investment company or (b) to register as an investment company, either of which could adversely affect us and the market price for our stock.

In August 2011, the SEC issued a concept release pursuant to which it solicited public comments on a wide range of issues relating to companies engaged in the business of acquiring mortgages and mortgage-related instruments and that rely on Section 3(c)(5)(C) of the 1940 Act. The SEC solicited views about the application of the 1940 Act to mortgage REITs and suggestions on the steps that the SEC should take to provide greater clarity, consistency or regulatory certainty with respect to Section 3(c)(5)(C). The SEC noted that in light of the

 

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evolution of mortgage REITs and the development of new and complex mortgage-related instruments, the SEC was reviewing interpretive issues under Section 3(c)(5)(C) and the sufficiency of SEC guidance pursuant to which such companies make judgments regarding their qualification under Section 3(c)(5)(C). The SEC sought comments on topics including the operation of mortgage REITs and their role in the mortgage markets; the similarities and differences between mortgage REITs and investment companies, the nature of the assets that qualify for purposes of the exemption, the sufficiency of the SEC’s guidance with respect to such assets, types of assets where further guidance may be needed and whether the existing asset qualification tests are appropriate; and whether mortgage REITs should be regulated in a manner similar to investment companies. The SEC requested comments on the concept release by November 7, 2011. The concept release and the public comments thereto have not yet resulted in SEC rulemaking or interpretative guidance and we cannot predict what form any such rulemaking or interpretive guidance may take. There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, or guidance from the SEC or its staff regarding these exemptions, will not change in a manner that adversely affects our operations. If the SEC takes action that could result in our failure to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (a) change the manner in which we conduct our operations in order to maintain our exemption from registration as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so, or (c) register as an investment company, any of which could have a material adverse effect on us and the market price of our securities. If we were required to register as an investment company under the 1940 Act, we would become subject to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the 1940 Act), portfolio composition, including restrictions with respect to diversification and industry concentration, our ability to make distributions and other matters. Maintenance of our exemption under the 1940 Act generally limits the amount of our investments in non-real estate related assets to no more than 20% of our total assets. To the extent we acquire significant non-real estate related assets in the future, in order to maintain our exemption under the 1940 Act, we may need to offset those acquisitions with additional qualifying assets which may not generate risk-adjusted returns as attractive as those generated by the non-real estate related assets.

Rapid changes in the values of assets that we hold may make it more difficult for us to maintain our qualification as a REIT or our exemption from the 1940 Act.

If the market value or income potential of qualifying assets for purposes of our qualification as a REIT or our exemption from registration as an investment company under the 1940 Act declines as a result of increased interest rates, changes in prepayment rates or other factors, we may need to increase our investments in qualifying assets and/or liquidate our non-qualifying assets to maintain our REIT qualification or our exemption from registration under the 1940 Act. If the decline in market values or income occurs quickly, this may be especially difficult to accomplish. This difficulty may be exacerbated by the illiquid nature of any non-qualifying assets we may own. We may have to make investment decisions that we otherwise would not make absent the intent to maintain our qualification as a REIT and exemption from registration under the 1940 Act.

We are subject to significant competition, and we may not compete successfully.

We are subject to significant competition in seeking investments. We compete with other companies, including other REITs, insurance companies and other investors, including funds and companies affiliated with our Manager. Some of our competitors have greater resources than we possess or have greater access to capital or various types of financing structures than are available to us, and we may not be able to compete successfully for investments or provide attractive investment returns relative to our competitors. These competitors may be willing to accept lower returns on their investments and, as a result, our profit margins could be adversely affected. Furthermore, competition for investments that are suitable for us may lead to the returns available from such investments decreasing, which may further limit our ability to generate our desired returns. We cannot assure you that other companies will not be formed that compete with us for investments or otherwise pursue investment strategies similar to ours or that we will be able to complete successfully against any such companies.

 

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Furthermore, we currently do not intend to build a mortgage servicing platform. Therefore, we may not be an attractive buyer for those sellers of MSRs that prefer to sell MSRs and their mortgage servicing platform in a single transaction. Since our business model does not currently include acquiring and running servicing platforms, to engage in a bid for such a business we would need to find a servicer to acquire and run the platform or we would need to incur additional costs to shut down the acquired servicing platform. The need to work with a servicer in these situations increases the complexity of such potential acquisitions, and Nationstar may be unwilling or unable to act as servicer or subservicer on any Excess MSRs acquisition we want to execute. The complexity of these transactions and the additional costs incurred by us if we were to execute future acquisitions of this type could adversely affect our future operating results.

The valuations of our assets are subject to uncertainty since most of our assets are not traded in an active market.

There is not anticipated to be an active market for most of the assets in which we will invest. In the absence of market comparisons, we will use other pricing methodologies, including, for example, models based on assumptions regarding expected trends, historical trends following market conditions believed to be comparable to the then current market conditions and other factors believed at the time to be likely to influence the potential resale price of, or the potential cash flows derived from, an investment. Such methodologies may not prove to be accurate and any inability to accurately price assets may result in adverse consequences for us. A valuation is only an estimate of value and is not a precise measure of realizable value. Ultimate realization of the market value of a private asset depends to a great extent on economic and other conditions beyond our control. Further, valuations do not necessarily represent the price at which a private investment would sell since market prices of private investments can only be determined by negotiation between a willing buyer and seller. If we were to liquidate a particular private investment, the realized value may be more than or less than the valuation of such asset as carried on our books.

Changes in accounting rules could occur at any time and could impact us in significantly negative ways that we are unable to predict or protect against.

As has been widely publicized, the SEC, the Financial Accounting Standards Board (the “FASB”) and other regulatory bodies that establish the accounting rules applicable to us have recently proposed or enacted a wide array of changes to accounting rules. Moreover, in the future these regulators may propose additional changes that we do not currently anticipate. Changes to accounting rules that apply to us could significantly impact our business or our reported financial performance in negative ways that we cannot predict or protect against. We cannot predict whether any changes to current accounting rules will occur or what impact any codified changes will have on our business, results of operations, liquidity or financial condition.

A prolonged economic slowdown, a lengthy or severe recession, or declining real estate values could harm our operations.

We believe the risks associated with our business are more severe during periods in which an economic slowdown or recession is accompanied by declining real estate values, as was the case in 2008. Declining real estate values generally reduce the level of new mortgage loan originations, since borrowers often use increases in the value of their existing properties to support the purchase of, or investment in, additional properties. Borrowers may also be less able to pay principal and interest on the loans underlying our securities and our Excess MSRs, if the real estate economy weakens. Further, declining real estate values significantly increase the likelihood that we will incur losses on our securities in the event of default because the value of our collateral may be insufficient to cover our basis. Any sustained period of increased payment delinquencies, foreclosures or losses could adversely affect our net interest income from the assets in our portfolio, which would significantly harm our revenues, results of operations, financial condition, liquidity, business prospects and our ability to make distributions to our stockholders.

 

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Compliance with changing regulation of corporate governance and public disclosure has and will continue to result in increased compliance costs and pose challenges for our management team.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us and, more generally, the financial services and mortgage industries. Additionally, we cannot predict whether there will be additional proposed laws or reforms that would affect us, whether or when such changes may be adopted, how such changes may be interpreted and enforced or how such changes may affect us. However, the costs of complying with any additional laws or regulations could have a material effect on our financial condition and results of operations.

RISKS RELATED TO OUR MANAGER

We are dependent on our Manager and may not find a suitable replacement if our Manager terminates the Management Agreement.

We have no employees. Our officers and other individuals who perform services for us are employees of our Manager. We are completely reliant on our Manager, which has significant discretion as to the implementation of our operating policies and strategies, to conduct our business. We are subject to the risk that our Manager will terminate the Management Agreement and that we will not be able to find a suitable replacement for our Manager in a timely manner, at a reasonable cost or at all. Furthermore, we are dependent on the services of certain key employees of our Manager whose compensation is partially or entirely dependent upon the amount of incentive or management compensation earned by our Manager and whose continued service is not guaranteed, and the loss of such services could adversely affect our operations.

There are conflicts of interest in our relationship with our Manager.

Our Management Agreement with our Manager was not negotiated at arm’s-length, and its terms, including fees payable, may not be as favorable to us as if it had been negotiated with an unaffiliated third party.

There are conflicts of interest inherent in our relationship with our Manager insofar as our Manager and its affiliates—including investment funds, private investment funds, or businesses managed by our Manager, including Newcastle, Nationstar and Springleaf—invest in real estate related securities, consumer loans and Excess MSRs and whose investment objectives overlap with our investment objectives. Certain investments appropriate for us may also be appropriate for one or more of these other investment vehicles. Certain members of our board of directors and employees of our Manager who are our officers also serve as officers and/or directors of these other entities. For example, we have some of the same directors and officers as Newcastle. Although we have the same Manager, we may compete with entities affiliated with our Manager or Fortress, including Newcastle, for certain target assets. From time to time, affiliates of Fortress focus on investments in assets with a similar profile as our target assets that we may seek to acquire. These affiliates may have meaningful purchasing capacity, which may change over time depending upon a variety of factors, including, but not limited to, available equity capital and debt financing, market conditions and cash on hand. Currently, Fortress has two funds primarily focused on investing in Excess MSRs with approximately $1.7 billion and $600 million in capital commitments in aggregate. We intend to co-invest with these funds in Excess MSRs. Fortress funds generally have a fee structure similar to ours, but the fees actually paid will vary depending on the size, terms and performance of each fund. Fortress had approximately $54.6 billion of assets under management as of June 30, 2013.

Our Management Agreement with our Manager generally does not limit or restrict our Manager or its affiliates from engaging in any business or managing other pooled investment vehicles that invest in investments that meet our investment objectives. Our Manager intends to engage in additional real estate related management and real estate and other investment opportunities in the future, which may compete with us for investments or result in a change in our current investment strategy. In addition, our certificate of incorporation provides that if Fortress or an affiliate or any of their officers, directors or employees acquire knowledge of a potential transaction that could be a corporate opportunity, they have no duty, to the fullest extent permitted by law, to offer such corporate opportunity to us, our

 

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stockholders or our affiliates. In the event that any of our directors and officers who is also a director, officer or employee of Fortress or its affiliates acquires knowledge of a corporate opportunity or is offered a corporate opportunity, provided that this knowledge was not acquired solely in such person’s capacity as a director or officer of New Residential and such person acts in good faith, then to the fullest extent permitted by law such person is deemed to have fully satisfied such person’s fiduciary duties owed to us and is not liable to us if Fortress or its affiliates pursues or acquires the corporate opportunity or if such person did not present the corporate opportunity to us.

The ability of our Manager and its officers and employees to engage in other business activities, subject to the terms of our Management Agreement with our Manager, may reduce the amount of time our Manager, its officers or other employees spend managing us. In addition, we may engage (subject to our investment guidelines) in material transactions with our Manager or another entity managed by our Manager or one of its affiliates, including Newcastle, Nationstar and Springleaf, which may include, but are not limited to, certain financing arrangements, purchases of debt, co-investments in Excess MSRs, consumer loans, servicing advances and other assets that present an actual, potential or perceived conflict of interest. It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction, litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult, and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential, actual or perceived conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest could have a material adverse effect on our reputation, which could materially adversely affect our business in a number of ways, including causing an inability to raise additional funds, a reluctance of counterparties to do business with us, a decrease in the prices of our equity securities and a resulting increased risk of litigation and regulatory enforcement actions.

The management compensation structure that we have agreed to with our Manager, as well as compensation arrangements that we may enter into with our Manager in the future (in connection with new lines of business or other activities), may incentivize our Manager to invest in high risk investments. In addition to its management fee, our Manager is currently entitled to receive incentive compensation. In evaluating investments and other management strategies, the opportunity to earn incentive compensation may lead our Manager to place undue emphasis on the maximization of such measures at the expense of other criteria, such as preservation of capital, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier or more speculative than lower-yielding investments. Moreover, because our Manager receives compensation in the form of options in connection with the completion of our common equity offerings, our Manager may be incentivized to cause us to issue additional common stock, which could be dilutive to existing stockholders.

It would be difficult and costly to terminate our Management Agreement with our Manager.

It would be difficult and costly for us to terminate our Management Agreement with our Manager. The Management Agreement may only be terminated annually upon (i) the affirmative vote of at least two-thirds of our independent directors, or by a vote of the holders of a simple majority of the outstanding shares of our common stock, that there has been unsatisfactory performance by our Manager that is materially detrimental to us or (ii) a determination by a simple majority of our independent directors that the management fee payable to our Manager is not fair, subject to our Manager’s right to prevent such a termination by accepting a mutually acceptable reduction of fees. Our Manager will be provided 60 days’ prior notice of any termination and will be paid a termination fee equal to the amount of the management fee earned by the Manager during the twelve-month period preceding such termination. In addition, following any termination of the Management Agreement, our Manager may require us to purchase its right to receive incentive compensation at a price determined as if our assets were sold for their fair market value (as determined by an appraisal, taking into account, among other things, the expected future value of the underlying investments) or otherwise we may continue to pay the incentive compensation to our Manager. These provisions may increase the effective cost to us of terminating the Management Agreement, thereby adversely affecting our ability to terminate our Manager without cause.

 

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Our directors have approved broad investment guidelines for our Manager and do not approve each investment decision made by our Manager. In addition, we may change our investment strategy without a stockholder vote, which may result in our making investments that are different, riskier or less profitable than our current investments.

Our Manager is authorized to follow broad investment guidelines. For more information about our investment guidelines, see “Business—Investment Guidelines” included elsewhere in this prospectus. Consequently, our Manager has great latitude in determining the types and categories of assets it may decide are proper investments for us, including the latitude to invest in types and categories of assets that may differ from those in which we currently invest. Our directors will periodically review our investment guidelines and our investment portfolio. However, our board does not review or pre-approve each proposed investment or our related financing arrangements. In addition, in conducting periodic reviews, the directors rely primarily on information provided to them by our Manager. Furthermore, transactions entered into by our Manager may be difficult or impossible to unwind by the time they are reviewed by the directors even if the transactions contravene the terms of the Management Agreement. In addition, we may change our investment strategy, including our target asset classes, without a stockholder vote.

Our investment strategy may evolve in light of existing market conditions and investment opportunities, and this evolution may involve additional risks depending upon the nature of the assets in which we invest and our ability to finance such assets on a short or long-term basis. Investment opportunities that present unattractive risk-return profiles relative to other available investment opportunities under particular market conditions may become relatively attractive under changed market conditions and changes in market conditions may therefore result in changes in the investments we target. Decisions to make investments in new asset categories present risks that may be difficult for us to adequately assess and could therefore reduce our ability to pay dividends on our common stock or have adverse effects on our liquidity or financial condition. A change in our investment strategy may also increase our exposure to interest rate, foreign currency, real estate market or credit market fluctuations. In addition, a change in our investment strategy may increase our use of non-match-funded financing, increase the guarantee obligations we agree to incur or increase the number of transactions we enter into with affiliates. Our failure to accurately assess the risks inherent in new asset categories or the financing risks associated with such assets could adversely affect our results of operations and our financial condition.

Our Manager will not be liable to us for any acts or omissions performed in accordance with the Management Agreement, including with respect to the performance of our investments.

Pursuant to our Management Agreement, our Manager will not assume any responsibility other than to render the services called for thereunder in good faith and will not be responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager, its members, managers, officers and employees will not be liable to us or any of our subsidiaries, to our board of directors, or our or any subsidiary’s stockholders or partners for any acts or omissions by our Manager, its members, managers, officers or employees, except by reason of acts constituting bad faith, willful misconduct, gross negligence or reckless disregard of our Manager’s duties under our Management Agreement. We shall, to the full extent lawful, reimburse, indemnify and hold our Manager, its members, managers, officers and employees and each other person, if any, controlling our Manager harmless of and from any and all expenses, losses, damages, liabilities, demands, charges and claims of any nature whatsoever (including attorneys’ fees) in respect of or arising from any acts or omissions of an indemnified party made in good faith in the performance of our Manager’s duties under our Management Agreement and not constituting such indemnified party’s bad faith, willful misconduct, gross negligence or reckless disregard of our Manager’s duties under our Management Agreement.

 

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Our Manager’s due diligence of investment opportunities or other transactions may not identify all pertinent risks, which could materially affect our business, financial condition, liquidity and results of operations.

Our Manager intends to conduct due diligence with respect to each investment opportunity or other transaction it pursues. It is possible, however, that our Manager’s due diligence processes will not uncover all relevant facts, particularly with respect to any assets we acquire from third parties. In these cases, our Manager may be given limited access to information about the investment and will rely on information provided by the target of the investment. In addition, if investment opportunities are scarce, the process for selecting bidders is competitive, or the timeframe in which we are required to complete diligence is short, our ability to conduct a due diligence investigation may be limited, and we would be required to make investment decisions based upon a less thorough diligence process than would otherwise be the case. Accordingly, investments and other transactions that initially appear to be viable may prove not to be over time, due to the limitations of the due diligence process or other factors.

The ownership by our executive officers and directors of shares of common stock, options, or other equity awards of Newcastle may create, or may create the appearance of, conflicts of interest.

Some of our directors, officers and other employees of our Manager hold positions with Newcastle and own Newcastle common stock, options to purchase Newcastle common stock or other equity awards. Such ownership may create, or may create the appearance of, conflicts of interest when these directors and officers are faced with decisions that could have different implications for Newcastle than they do for us.

RISKS RELATED TO THE FINANCIAL MARKETS

We do not know what impact the Dodd-Frank Act will have on our business.

On July 21, 2010, the U.S. enacted the Dodd-Frank Act. The Dodd-Frank Act affects almost every aspect of the U.S. financial services industry, including certain aspects of the markets in which we operate. The Dodd-Frank Act imposes new regulations on us and how we conduct our business. For example, the Dodd-Frank Act will impose additional disclosure requirements for public companies and generally require issuers or originators of asset-backed securities to retain at least five percent of the credit risk associated with the securitized assets.

The Dodd-Frank Act imposes mandatory clearing and will impose exchange-trading and margin requirements on many derivatives transactions (including formerly unregulated over-the-counter derivatives) in which we may engage. The Dodd-Frank Act also creates new categories of regulated market participants, such as “swap-dealers,” “security-based swap dealers,” “major swap participants” and “major security-based swap participants,” who will be subject to significant new capital, registration, recordkeeping, reporting, disclosure, business conduct and other regulatory requirements that will give rise to new administrative costs.

Even if certain new requirements are not directly applicable to us, they may still increase our costs of entering into transactions with the parties to whom the requirements are directly applicable. Moreover, new exchange-trading and trade reporting requirements may lead to reductions in the liquidity of derivative transactions, causing higher pricing or reduced availability of derivatives, or the reduction of arbitrage opportunities for us, which could adversely affect the performance of certain of our trading strategies. Importantly, many key aspects of the changes imposed by the Dodd-Frank Act will be established by various regulatory bodies and other groups over the next several years. As a result, we do not know how significantly the Dodd-Frank Act will affect us. It is possible that the Dodd-Frank Act could, among other things, increase our costs of operating as a public company, impose restrictions on our ability to securitize assets and reduce our investment returns on securitized assets.

We do not know what impact certain U.S. government programs intended to stabilize the economy and the financial markets will have on our business.

In recent years, the U.S. government has taken a number of steps to attempt to strengthen the financial markets and U.S. economy, including direct government investments in, and guarantees of, troubled financial institutions

 

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as well as government-sponsored programs such as the Term Asset-Backed Securities Loan Facility program and the Public Private Investment Partnership Program. The U.S. government continues to evaluate or implement an array of other measures and programs intended to help improve U.S. financial and market conditions. While conditions appear to have improved relative to the depths of the global financial crisis, it is not clear whether this improvement is real or will last for a significant period of time. It is not clear what impact the government’s future actions to improve financial and market conditions will have on our business. We may not derive any meaningful benefit from these programs in the future. Moreover, if any of our competitors are able to benefit from one or more of these initiatives, they may gain a significant competitive advantage over us.

The federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and regulations affecting the relationship between these agencies and the U.S. government, may adversely affect our business.

Due to increased market concerns about the ability of Fannie Mae and Freddie Mac to withstand future credit losses associated with securities held in their investment portfolios, and on which they provide guarantees without the direct support of the U.S. federal government, on July 30, 2008, the U.S. government passed the Housing and Economic Recovery Act of 2008. On September 7, 2008, the FHFA, placed Fannie Mae and Freddie Mac into conservatorship and, together with the U.S. Treasury, established a program designed to boost investor confidence in their respective debt and MBS.

As the conservator of Fannie Mae and Freddie Mac, the FHFA controls and directs the operations of Fannie Mae and Freddie Mac and may (i) take over the assets and operations of Fannie Mae and Freddie Mac with all the powers of the shareholders, the directors and the officers of Fannie Mae and Freddie Mac and conduct all business of Fannie Mae and Freddie Mac; (ii) collect all obligations and money due to Fannie Mae and Freddie Mac; (iii) perform all functions of Fannie Mae and Freddie Mac which are consistent with the conservator’s appointment; (iv) preserve and conserve the assets and property of Fannie Mae and Freddie Mac; and (v) contract for assistance in fulfilling any function, activity, action or duty of the conservator.

In addition to the FHFA becoming the conservator of Fannie Mae and Freddie Mac, the U.S. Treasury and the FHFA have entered into preferred stock purchase agreements among the U.S. Treasury, Fannie Mae and Freddie Mac pursuant to which the U.S. Treasury will ensure that each of Fannie Mae and Freddie Mac maintains a positive net worth.

Although the U.S. Treasury has committed capital to Fannie Mae and Freddie Mac, these actions may not be adequate for their needs. If these actions are inadequate, Fannie Mae and Freddie Mac could continue to suffer losses and could fail to honor their guarantees and other obligations. The future roles of Fannie Mae and Freddie Mac could be significantly reduced and the nature of their guarantees could be considerably limited relative to historical measurements. Any changes to the nature of the guarantees provided by Fannie Mae and Freddie Mac could redefine what constitutes agency and government conforming MBS and could have broad adverse market implications. Such market implications could adversely affect our business and prospects.

Legislation that permits modifications to the terms of outstanding loans may negatively affect our business, financial condition and results of operations.

The U.S. government has enacted legislation that enables government agencies to modify the terms of a significant number of residential and other loans to provide relief to borrowers without the applicable investor’s consent. These modifications allow for outstanding principal to be deferred, interest rates to be reduced, the term of the loan to be extended or other terms to be changed in ways that can permanently eliminate the cash flow (principal and interest) associated with a portion of the loan. These modifications are currently reducing, or in the future may reduce, the value of a number of our current or future investments, including investments in mortgage backed securities and Excess MSRs. As a result, such loan modifications are negatively affecting our business, results of operations and financial condition. In addition, certain market participants propose reducing the amount of paperwork required by a borrower to modify a loan, which could increase the likelihood of fraudulent

 

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modifications and materially harm the U.S. mortgage market and investors that have exposure to this market. Additional legislation intended to provide relief to borrowers may be enacted and could further harm our business, results of operations and financial condition.

RISKS RELATED TO OUR TAXATION AS A REIT

Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our stockholders.

We intend to operate in a manner intended to qualify us as a REIT for U.S. federal income tax purposes. Our ability to satisfy the asset tests depends upon our analysis of the fair market values of our assets, some of which are not susceptible to a precise determination, and for which we do not obtain independent appraisals. Our compliance with the REIT income and quarterly asset requirements also depends upon our ability to successfully manage the composition of our income and assets on an ongoing basis. Moreover, the proper classification of one or more of our investments may be uncertain in some circumstances, which could affect the application of the REIT qualification requirements. Accordingly, there can be no assurance that the IRS, will not contend that our investments violate the REIT requirements.

If we were to fail to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates, and distributions to stockholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of, and trading prices for, our stock. Unless entitled to relief under certain provisions of the Code, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we initially ceased to qualify as a REIT. The rule against re-electing REIT status following a loss of such status would also apply to us if Newcastle fails to qualify as a REIT, and we are treated as a successor to Newcastle for U.S. federal income tax purposes. Although, as described under the heading “Certain Relationships and Transactions with Related Persons, Affiliates and Affiliated Entities,” Newcastle has (i) represented in the separation and distribution agreement that it entered into with us on April 26, 2013 (the “Separation and Distribution Agreement”) that it has no knowledge of any fact or circumstance that would cause us to fail to qualify as a REIT and (ii) covenanted in the Separation and Distribution Agreement to use its reasonable best efforts to maintain its REIT status for each of Newcastle’s taxable years ending on or before December 31, 2014 (unless Newcastle obtains an opinion from a nationally recognized tax counsel or a private letter ruling from the IRS to the effect that Newcastle’s failure to maintain its REIT status will not cause us to fail to qualify as a REIT under the successor REIT rule referred to above), no assurance can be given that such representation and covenant would prevent us from failing to qualify as a REIT. Although, in the event of a breach, we may be able to seek damages from Newcastle, there can be no assurance that such damages, if any, would appropriately compensate us. In addition, if Newcastle were to fail to qualify as a REIT despite its reasonable best efforts, we would have no claim against Newcastle. See “U.S. Federal Income Tax Considerations” for a discussion of material U.S. federal income tax consequences relating to us and our common stock.

Our failure to qualify as a REIT would cause our stock to be delisted from the NYSE.

The NYSE requires, as a condition to the listing of our shares, that we maintain our REIT status. Consequently, if we fail to maintain our REIT status, our shares would promptly be delisted from the NYSE, which would decrease the trading activity of such shares. This could make it difficult to sell shares and would likely cause the market volume of the shares trading to decline.

If we were delisted as a result of losing our REIT status and desired to relist our shares on the NYSE, we would have to reapply to the NYSE to be listed as a domestic corporation. As the NYSE’s listing standards for REITs are less onerous than its standards for domestic corporations, it would be more difficult for us to become a listed company under these heightened standards. We might not be able to satisfy the NYSE’s listing standards for a domestic corporation. As a result, if we were delisted from the NYSE, we might not be able to relist as a domestic corporation, in which case our shares could not trade on the NYSE.

 

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The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to qualify as a REIT.

We enter into financing arrangements that are structured as sale and repurchase agreements pursuant to which we nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these assets at a later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold pursuant thereto. We believe that, for purposes of the REIT asset and income tests, we should be treated as the owner of the assets that are the subject of any such sale and repurchase agreement, notwithstanding that those agreements generally transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did not own the assets during the term of the sale and repurchase agreement, in which case we might fail to qualify as a REIT.

The failure of our Excess MSRs to qualify as real estate assets or the income from our Excess MSRs to qualify as mortgage interest could adversely affect our ability to qualify as a REIT.

We have received from the IRS a private letter ruling substantially to the effect that our Excess MSRs represent interests in mortgages on real property and thus are qualifying “real estate assets” for purposes of the REIT asset test, which generate income that qualifies as interest on obligations secured by mortgages on real property for purposes of the REIT income test. The ruling is based on, among other things, certain assumptions as well as on the accuracy of certain factual representations and statements that we and Newcastle have made to the IRS. If any of the representations or statements that we have made in connection with the private letter ruling, are, or become, inaccurate or incomplete in any material respect with respect to one or more Excess MSR investments, or if we acquire an Excess MSR investment with terms that are not consistent with the terms of the Excess MSR investments described in the private letter ruling, then we will not be able to rely on the private letter ruling. If we are unable to rely on the private letter ruling with respect to an Excess MSR investment, the IRS could assert that such Excess MSR investments do not qualify under the REIT asset and income tests, and if successful, we might fail to qualify as a REIT.

Dividends payable by REITs do not qualify for the reduced tax rates available for some dividends.

Dividends payable to domestic stockholders that are individuals, trusts, and estates are generally taxed at reduced tax rates. Dividends payable by REITs, however, generally are not eligible for the reduced rates. The more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock. In addition, the relative attractiveness of real estate in general may be adversely affected by the favorable tax treatment given to non-REIT corporate dividends, which could affect the value of our real estate assets negatively.

Qualifying as a REIT involves highly technical and complex provisions of the Code.

Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT will depend on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. Compliance with these requirements must be carefully monitored on a continuing basis, and there can be no assurance that our Manager’s personnel responsible for doing so will be able to successfully monitor our compliance.

REIT distribution requirements could adversely affect our liquidity and our ability to execute our business plan.

We generally must distribute annually at least 90% of our REIT taxable income, excluding any net capital gain, in order for corporate income tax not to apply to earnings that we distribute. We intend to make distributions to

 

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our stockholders to comply with the REIT requirements of the Code. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets or borrow funds on a short-term or long-term basis to meet the 90% distribution requirement of the Code. Certain of our assets may generate substantial mismatches between taxable income and available cash. As a result, the requirement to distribute a substantial portion of our net taxable income could cause us to: (i) sell assets in adverse market conditions; (ii) borrow on unfavorable terms; (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt; or (iv) make taxable distributions of our capital stock or debt securities in order to comply with REIT requirements. Further, amounts distributed will not be available to fund investment activities. If we fail to obtain debt or equity capital in the future, it could limit our ability to satisfy our liquidity needs, which could adversely affect the value of our common stock.

We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize from them.

Based on IRS guidance concerning the classification of Excess MSRs, we intend to treat our Excess MSRs as ownership interests in the interest payments made on the underlying mortgage loans, akin to an “interest only” strip. Under this treatment, for purposes of determining the amount and timing of taxable income, each Excess MSR is treated as a bond that was issued with original issue discount on the date we acquired such Excess MSR. In general, we will be required to accrue original issue discount based on the constant yield to maturity of each Excess MSR, and to treat such original issue discount as taxable income in accordance with the applicable U.S. federal income tax rules. The constant yield of an Excess MSR will be determined, and we will be taxed, based on a prepayment assumption regarding future payments due on the mortgage loans underlying the Excess MSR. If the mortgage loans underlying an Excess MSR prepay at a rate different than that under the prepayment assumption, our recognition of original issue discount will be either increased or decreased depending on the circumstances. Thus, in a particular taxable year, we may be required to accrue an amount of income in respect of an Excess MSR that exceeds the amount of cash collected in respect of that Excess MSR. Furthermore, it is possible that, over the life of the investment in an Excess MSR, the total amount we pay for, and accrue with respect to, the Excess MSR may exceed the total amount we collect on such Excess MSR. No assurance can be given that we will be entitled to a deduction for such excess, meaning that we may be required to recognize “phantom income” over the life of an Excess MSR.

Other debt instruments that we may acquire, including consumer loans, may be issued with, or treated as issued with, original issue discount. Those instruments would be subject to the original issue discount accrual and income computations that are described above with regard to Excess MSRs.

We may acquire debt instruments in the secondary market for less than their face amount. The discount at which such debt instruments are acquired may reflect doubts about their ultimate collectability rather than current market interest rates. The amount of such discount will nevertheless generally be treated as “market discount” for U.S. federal income tax purposes. Accrued market discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made. If we collect less on the debt instrument than our purchase price plus the market discount we had previously reported as income, we may not be able to benefit from any offsetting loss deductions.

In addition, we may acquire debt instruments that are subsequently modified by agreement with the borrower. If the amendments to the outstanding instrument are “significant modifications” under the applicable Treasury regulations, the modified instrument will be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, we may be required to recognize taxable gain to the extent the principal amount of the modified instrument exceeds our adjusted tax basis in the unmodified instrument, even if the value of the instrument or the payment expectations have not changed. Following such a taxable modification, we would hold the modified loan with a cost basis equal to its principal amount for U.S. federal tax purposes.

Finally, in the event that any debt instruments acquired by us are delinquent as to mandatory principal and interest payments, or in the event payments with respect to a particular instrument are not made when due, we

 

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may nonetheless be required to continue to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. Similarly, we may be required to accrue interest income with respect to debt instruments at the stated rate regardless of whether corresponding cash payments are received or are ultimately collectible. In each case, while we would in general ultimately have an offsetting loss deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our having taxable income of an appropriate character in that later year or thereafter.

In any event, if our investments generate more taxable income than cash in any given year, we may have difficulty satisfying our annual REIT distribution requirement. See “U.S. Federal Income Tax Considerations—Annual Distribution Requirements.”

We may be unable to generate sufficient revenue from operations to pay our operating expenses and to pay distributions to our stockholders.

As a REIT, we are generally required to distribute at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and not including net capital losses) each year to our stockholders. To qualify for the tax benefits accorded to REITs, we intend to make distributions to our stockholders in amounts such that we distribute all or substantially all of our net taxable income each year, subject to certain adjustments. However, our ability to make distributions may be adversely affected by the risk factors described herein.

The stock ownership limit imposed by the Code for REITs and our certificate of incorporation may inhibit market activity in our stock and restrict our business combination opportunities.

In order for us to maintain our qualification as a REIT under the Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year after our first taxable year. Our certificate of incorporation, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Unless exempted by our board of directors, no person may own more than 9.8% of the aggregate value of our outstanding capital stock, treating classes and series of our stock in the aggregate. Our board may grant an exemption in its sole discretion, subject to such conditions, representations and undertakings as it may determine in its sole discretion. These ownership limits could delay or prevent a transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.

Even if we remain qualified for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. Moreover, if a REIT distributes less than 85% of its taxable income to its stockholders during any calendar year (including any distributions declared by the last day of the calendar year but paid in the subsequent year), then it is required to pay an excise tax on 4% of any shortfall between the required 85% and the amount that was actually distributed. Any of these taxes would decrease cash available for distribution to our stockholders. In addition, in order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we currently hold some of our assets through taxable REIT subsidiaries (“TRS”). Such subsidiaries will be subject to corporate level income tax at regular rates.

Complying with the REIT requirements may negatively impact our investment returns or cause us to forego otherwise attractive opportunities, liquidate assets or contribute assets to a TRS.

To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to

 

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our stockholders and the ownership of our stock. As a result of these tests, we may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, forego otherwise attractive investment opportunities, liquidate assets in adverse market conditions or contribute assets to a TRS that is subject to regular corporate federal income tax. Our ability to acquire Excess MSRs and other investments will be subject to the applicable REIT qualification tests, and we may have to hold these interests through TRSs, which would negatively impact our returns from these assets. In general, compliance with the REIT requirements may hinder our ability to make and retain certain attractive investments.

Complying with the REIT requirements may limit our ability to hedge effectively.

The existing REIT provisions of the Code may substantially limit our ability to hedge our operations because a significant amount of the income from those hedging transactions is likely to be treated as non-qualifying income for purposes of both REIT gross income tests. In addition, we must limit our aggregate income from non-qualified hedging transactions, from our provision of services and from other non-qualifying sources, to less than 5% of our annual gross income (determined without regard to gross income from qualified hedging transactions). As a result, we may have to limit our use of certain hedging techniques or implement those hedges through total return swaps. This could result in greater risks associated with changes in interest rates than we would otherwise want to incur or could increase the cost of our hedging activities. If we fail to comply with these limitations, we could lose our REIT qualification for U.S. federal income tax purposes, unless our failure was due to reasonable cause, and not due to willful neglect, and we meet certain other technical requirements. Even if our failure were due to reasonable cause, we might incur a penalty tax.

Distributions to tax-exempt investors may be classified as unrelated business taxable income.

Neither ordinary nor capital gain distributions with respect to our stock nor gain from the sale of stock should generally constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:

 

    part of the income and gain recognized by certain qualified employee pension trusts with respect to our stock may be treated as unrelated business taxable income if shares of our stock are predominantly held by qualified employee pension trusts, and we are required to rely on a special look-through rule for purposes of meeting one of the REIT ownership tests, and we are not operated in a manner to avoid treatment of such income or gain as unrelated business taxable income;

 

    part of the income and gain recognized by a tax-exempt investor with respect to our stock would constitute unrelated business taxable income if the investor incurs debt in order to acquire the stock; and

 

    to the extent that we are (or a part of us, or a disregarded subsidiary of ours, is) a “taxable mortgage pool,” or if we hold residual interests in a real estate mortgage investment conduit (“REMIC”), a portion of the distributions paid to a tax-exempt stockholder that is allocable to excess inclusion income may be treated as unrelated business taxable income.

The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur, and may limit the manner in which we effect future securitizations.

We may enter into securitization or other financing transactions that result in the creation of taxable mortgage pools for U.S. federal income tax purposes. As a REIT, so long as we own 100% of the equity interests in a taxable mortgage pool, we would generally not be adversely affected by the characterization of a securitization as a taxable mortgage pool. Certain categories of stockholders, however, such as foreign stockholders eligible for treaty or other benefits, stockholders with net operating losses, and certain tax-exempt stockholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income from us that is attributable to the taxable mortgage pool. In addition, to the extent that our stock is owned by tax-exempt “disqualified organizations,” such as certain government-related entities and charitable remainder

 

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trusts that are not subject to tax on unrelated business income, we could incur a corporate level tax on a portion of our income from the taxable mortgage pool. In that case, we might reduce the amount of our distributions to any disqualified organization whose stock ownership gave rise to the tax. Moreover, we may be precluded from selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes. These limitations may prevent us from using certain techniques to maximize our returns from securitization transactions.

Uncertainty exists with respect to the treatment of TBAs for purposes of the REIT asset and income tests.

We may purchase and sell Agency ARM RMBS through “to-be-announced” forward contracts (“TBAs”) and recognize income or gains from the disposition of those TBAs, through dollar roll transactions or otherwise. There is no direct authority with respect to the qualification of TBAs as real estate assets or U.S. Government securities for purposes of the 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the sale of real property (including interests in real property and interests in mortgages on real property) or other qualifying income for purposes of the 75% gross income test. To the extent we enter into any TBAs in the future, we intend to treat such TBAs as qualifying assets for purposes of the REIT asset tests, and we intend to treat income and gains from such TBAs as qualifying income for purposes of the 75% gross income test, based on an opinion we would expect to receive from Skadden, Arps, Slate, Meagher & Flom LLP substantially to the effect that (i) for purposes of the REIT asset tests, our ownership of a TBA should be treated as ownership of the underlying Agency ARM RMBS, and (ii) for purposes of the 75% REIT gross income test, any gain recognized by us in connection with the settlement of such TBAs should be treated as gain from the sale or disposition of the underlying Agency ARM RMBS. Opinions of counsel are not binding on the IRS, and no assurance can be given that the IRS will not successfully challenge the conclusions set forth in such opinions. In addition, it must be emphasized that the opinion of Skadden, Arps, Slate, Meagher & Flom LLP would be based on various assumptions relating to any TBAs that we may enter into and would be conditioned upon fact-based representations and covenants made by our management regarding such TBAs. No assurance can be given that the IRS would not assert that such assets or income are not qualifying assets or income. If the IRS were to successfully challenge the conclusions of Skadden, Arps, Slate, Meagher & Flom LLP, we could be subject to a penalty tax or we could fail to qualify as a REIT if a sufficient portion of our assets consists of TBAs or a sufficient portion of our income consists of income or gains from the disposition of TBAs.

The tax on prohibited transactions will limit our ability to engage in transactions which would be treated as prohibited transactions for U.S. federal income tax purposes.

Net income that we derive from a prohibited transaction is subject to a 100% tax. The term “prohibited transaction” generally includes a sale or other disposition of property (including mortgage loans, but other than foreclosure property, as discussed below) that is held primarily for sale to customers in the ordinary course of our trade or business. We might be subject to this tax if we were to dispose of or securitize loans or Excess MSRs in a manner that was treated as a prohibited transaction for U.S. federal income tax purposes.

We intend to conduct our operations so that no asset that we own (or are treated as owning) will be treated as, or as having been, held for sale to customers, and that a sale of any such asset will not be treated as having been in the ordinary course of our business. As a result, we may choose not to engage in certain sales of loans or Excess MSRs at the REIT level, and may limit the structures we utilize for our securitization transactions, even though the sales or structures might otherwise be beneficial to us. In addition, whether property is held “primarily for sale to customers in the ordinary course of a trade or business” depends on the particular facts and circumstances. No assurance can be given that any property that we sell will not be treated as property held for sale to customers, or that we can comply with certain safe-harbor provisions of the Code that would prevent such treatment. The 100% prohibited transaction tax does not apply to gains from the sale of property that is held through a TRS or other taxable corporation, although such income will be subject to tax in the hands of the corporation at regular corporate rates. We intend to structure our activities to prevent prohibited transaction characterization.

 

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New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT.

The present U.S. federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the U.S. federal income tax treatment of an investment in us. The U.S. federal income tax rules dealing with REITs constantly are under review by persons involved in the legislative process, the IRS and the U.S. Treasury Department, which results in statutory changes as well as frequent revisions to regulations and interpretations. Revisions in U.S. federal tax laws and interpretations thereof could affect or cause us to change our investments and commitments and affect the tax considerations of an investment in us.

Liquidation of assets may jeopardize our REIT qualification or create additional tax liability for us.

To qualify as a REIT, we must comply with requirements regarding the composition of our assets and our sources of income. If we are compelled to liquidate our investments to repay obligations to our lenders, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory.

RISKS RELATED TO OUR COMMON STOCK

There can be no assurance that the market for our stock will provide you with adequate liquidity.

Our common stock began trading (on a when issued basis) on the New York Stock Exchange on May 2, 2013. There can be no assurance that an active trading market for our common stock will develop or be sustained in the future, and the market price of our common stock may fluctuate widely, depending upon many factors, some of which may be beyond our control. These factors include, without limitation:

 

    a shift in our investor base;

 

    our quarterly or annual earnings, or those of other comparable companies;

 

    actual or anticipated fluctuations in our operating results;

 

    changes in accounting standards, policies, guidance, interpretations or principles;

 

    announcements by us or our competitors of significant investments, acquisitions or dispositions;

 

    the failure of securities analysts to cover our common stock;

 

    changes in earnings estimates by securities analysts or our ability to meet those estimates;

 

    the operating and stock price performance of other comparable companies;

 

    overall market fluctuations; and

 

    general economic conditions.

Stock markets in general have experienced volatility that has often been unrelated to the operating performance of a particular company. These broad market fluctuations may adversely affect the trading price of our common stock.

Sales or issuances of shares of our common stock could adversely affect the market price of our common stock.

Sales of substantial amounts of shares of our common stock in the public market, or the perception that such sales might occur, could adversely affect the market price of our common stock. The issuance of our common stock in connection with property, portfolio or business acquisitions or the exercise of outstanding stock options or otherwise could also have an adverse effect on the market price of our common stock. See “Shares Eligible for Future Sale.”

 

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We and our officers and directors have agreed that, for a period of     days from the date of this prospectus, we and they will not, without the prior written consent of                     , dispose of or hedge any shares or any securities convertible into or exchangeable for our common stock.                     , in its sole discretion, may release any of the securities subject to these lock-up agreements at any time, which, in the case of officers and directors, shall be with notice. If the restrictions under the lock-up agreements are waived, our common stock may become available for sale into the market, subject to applicable law, which could reduce the market price for our common stock.

We are an emerging growth company within the meaning of the Securities Act, and if we decide to take advantage of certain exemptions from various reporting requirements applicable to emerging growth companies, our common stock could be less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act. As such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. As a result, our stockholders may not have access to certain information they may deem important. We will remain an emerging growth company until the earliest of (a) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (b) the last day of the fiscal year following the fifth anniversary of this offering, (c) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter or (d) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three-year period. If we take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result. The result may be a less active trading market for our common stock and our stock price may be more volatile.

Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price.

As a public company, we will be required to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Internal control over financial reporting is complex and may be revised over time to adapt to changes in our business, or changes in applicable accounting rules. We cannot assure you that our internal control over financial reporting will be effective in the future or that a material weakness will not be discovered with respect to a prior period for which we had previously believed that internal controls were effective. If we are not able to maintain or document effective internal control over financial reporting, our independent registered public accounting firm will not be able to certify as to the effectiveness of our internal control over financial reporting. Matters impacting our internal controls may cause us to be unable to report our financial information on a timely basis, or may cause us to restate previously issued financial information, and thereby subject us to adverse regulatory consequences, including sanctions or investigations by the SEC, or violations of applicable stock exchange listing rules. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in the reliability of our financial statements is also likely to suffer if we or our independent registered public accounting firm reports a material weakness in our internal control over financial reporting. This could materially adversely affect us by, for example, leading to a decline in our share price and impairing our ability to raise capital.

Your percentage ownership in New Residential may be diluted in the future.

Your percentage ownership in New Residential may be diluted in the future because of equity awards that we expect will be granted to our Manager, to the directors, officers and employees of our Manager who perform services for us, and to our directors, officers and employees, as well as other equity instruments such as debt and

 

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equity financing. Our board of directors has approved a Nonqualified Stock Option and Incentive Award Plan (the “Plan”) which provides for the grant of equity-based awards, including restricted stock, stock options, stock appreciation rights, performance awards, tandem awards and other equity-based and non equity-based awards, in each case to our Manager, to the directors, officers, employees, service providers, consultants and advisor of our Manager who perform services for us, and to our directors, officers, employees, service providers, consultants and advisors. We reserved 30,000,000 shares of our common stock for issuance under the Plan. On the first day of each fiscal year beginning during the ten-year term of the Plan and in and after calendar year 2014, that number will be increased by a number of shares of our common stock equal to 10% of the number of shares of our common stock newly issued by us during the immediately preceding fiscal year (and, in the case of fiscal year 2013, after the effective date of the Plan). For a more detailed description of the Plan, see “Management—Nonqualified Stock Option and Incentive Award Plan.” In connection with this offering, we will issue to our Manager options to purchase shares of our common stock, representing 10% of the number of shares being offered hereby, that will be granted to an affiliate of our manager in connection with this offering, and subject to adjustment if the underwriters exercise their option to purchase additional shares of our common stock. Our board of directors may also determine to issue options to the Manager that are not subject to the Plan, provided that the number of shares underlying any options granted to the Manager in connection with capital raising efforts would not exceed 10% of the shares sold in such offering and would be subject to NYSE rules.

We may incur or issue debt or issue equity, which may negatively affect the market price of our common stock.

We may in the future incur or issue debt or issue equity or equity-related securities. Upon our liquidation, lenders and holders of our debt and holders of our preferred stock (if any) would receive a distribution of our available assets before common stockholders. Any future incurrence or issuance of debt would increase our interest cost and could adversely affect our results of operations and cash flows. We are not required to offer any additional equity securities to existing common stockholders on a preemptive basis. Therefore, additional issuances of common stock, directly or through convertible or exchangeable securities (including limited partnership interests in our operating partnership), warrants or options, will dilute the holdings of our existing common stockholders and such issuances, or the perception of such issuances, may reduce the market price of our common stock. Any preferred stock issued by us would likely have a preference on distribution payments, periodically or upon liquidation, which could eliminate or otherwise limit our ability to make distributions to common stockholders. Because our decision to incur or issue debt or issue equity or equity-related securities in the future will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing, nature or success of our future capital raising efforts. Thus, common stockholders bear the risk that our future incurrence or issuance of debt or issuance of equity or equity-related securities will adversely affect the market price of our common stock.

We have not established a minimum distribution payment level and we cannot assure you of our ability to pay distributions in the future.

We intend to make quarterly distributions of all or substantially all of our net taxable income to holders of our common stock out of assets legally available therefore. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described in this prospectus. Distributions will be authorized by our board of directors and declared by us based upon a number of factors, including actual results of operations, restrictions under Delaware law or applicable debt covenants, our financial condition, our taxable income, the annual distribution requirements under the REIT provisions of the Code, our operating expenses and other factors our directors deem relevant. We cannot assure you that we will achieve investment results that will allow us to make a specified level of cash distributions or year-to-year increases in cash distributions in the future.

Furthermore, while we are required to make distributions in order to maintain our REIT status (as described above under “Risks Related to our Taxation as a REIT—We may be unable to generate sufficient revenue from

 

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operations to pay our operating expenses and to pay distributions to our stockholders”), we may elect not to maintain our REIT status, in which case we would no longer be required to make such distributions. Moreover, even if we do elect to maintain our REIT status, we may elect to comply with the applicable requirements by, after completing various procedural steps, distributing, under certain circumstances, a portion of the required amount in the form of shares of our common stock in lieu of cash. If we elect not to maintain our REIT status or to satisfy any required distributions in shares of common stock in lieu of cash, such action could negatively affect our business and financial condition as well as the price of our common stock. No assurance can be given that we will pay any dividends on shares of our common stock in the future.

We may in the future choose to pay dividends in our own stock, in which case you could be required to pay income taxes in excess of the cash dividends you receive.

We may in the future distribute taxable dividends that are payable in cash and shares of our common stock at the election of each stockholder. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend as ordinary income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sale proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.

It is unclear whether and to what extent we will be able to pay taxable dividends in cash and stock in later years. Moreover, various aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock dividends, including on a retroactive basis, or assert that the requirements for such taxable cash/stock dividends have not been met.

An increase in market interest rates may have an adverse effect on the market price of our common stock.

One of the factors that investors may consider in deciding whether to buy or sell shares of our common stock is our distribution rate as a percentage of our share price relative to market interest rates. If the market price of our common stock is based primarily on the earnings and return that we derive from our investments and income with respect to our investments and our related distributions to stockholders, and not from the market value of the investments themselves, then interest rate fluctuations and capital market conditions will likely affect the market price of our common stock. For instance, if market interest rates rise without an increase in our distribution rate, the market price of our common stock could decrease as potential investors may require a higher distribution yield on our common stock or seek other securities paying higher distributions or interest. In addition, rising interest rates would result in increased interest expense on our variable rate debt, thereby adversely affecting cash flow and our ability to service our indebtedness and pay distributions.

Provisions in our certificate of incorporation and bylaws and of Delaware law may prevent or delay an acquisition of our company, which could decrease the trading price of our common stock.

Our certificate of incorporation, bylaws and Delaware law contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the raider and to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover. These provisions include, among others:

 

    a classified board of directors with staggered three-year terms;

 

 

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    amendment of provisions in our certificate of incorporation and bylaws regarding the election of directors, classes of directors, the term of office of directors, the filling of director vacancies and the resignation and removal of directors only upon the affirmative vote of at least 80% of the then issued and outstanding shares of our capital stock entitled to vote thereon;

 

    amendment of provisions in our certificate of incorporation regarding corporate opportunity only upon the affirmative vote of at least 80% of the then issued and outstanding shares of our capital stock entitled to vote thereon;

 

    removal of directors only for cause and only with the affirmative vote of at least 80% of the then issued and outstanding shares of our capital stock entitled to vote in the election of directors;

 

    our board of directors to determine the powers, preferences and rights of our preferred stock and to issue such preferred stock without stockholder approval;

 

    advance notice requirements applicable to stockholders for director nominations and actions to be taken at annual meetings;

 

    a prohibition, in our certificate of incorporation, stating that no holder of shares of our common stock will have cumulative voting rights in the election of directors, which means that the holders of a majority of the issued and outstanding shares of common stock can elect all the directors standing for election; and

 

    a requirement in our bylaws specifically denying the ability of our stockholders to consent in writing to take any action in lieu of taking such action at a duly called annual or special meeting of our stockholders.

Public stockholders who might desire to participate in these types of transactions may not have an opportunity to do so, even if the transaction is considered favorable to stockholders. These anti-takeover provisions could substantially impede the ability of public stockholders to benefit from a change in control or a change in our management and board of directors and, as a result, may adversely affect the market price of our common stock and your ability to realize any potential change of control premium. See “Description of Our Capital Stock— Anti-Takeover Effects of Delaware Law, Our Certificate of Incorporation and Bylaws.”

ERISA may restrict investments by plans in our common stock.

A plan fiduciary considering an investment in our common stock should consider, among other things, whether such an investment is consistent with the fiduciary obligations under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), including whether such investment might constitute or give rise to a prohibited transaction under ERISA, the Code or any substantially similar federal, state or local law and, if so, whether an exemption from such prohibited transaction rules is available.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which statements involve substantial risks and uncertainties. Such forward-looking statements relate to, among other things, the operating performance of our investments, the stability of our earnings, and our financing needs. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “endeavor,” “seek,” “anticipate,” “estimate,” “overestimate,” “underestimate,” “believe,” “could,” “project,” “predict,” “continue” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain projections of results of operations or of financial condition or state other forward-looking information. Our ability to predict results or the actual outcome of future plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. These forward-looking statements involve risks, uncertainties and other factors that may cause our actual results in future periods to differ materially from forecasted results. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to:

 

    reductions in cash flows received from our investments;

 

    our ability to take advantage of investment opportunities at attractive risk-adjusted prices;

 

    our ability to take advantage of investment opportunities in Excess MSRs;

 

    our ability to deploy capital accretively;

 

    our counterparty concentration and default risks in Nationstar, Springleaf and other third-parties;

 

    a lack of liquidity surrounding our investments which could impede our ability to vary our portfolio in an appropriate manner;

 

    the impact that risks associated with subprime mortgage loans and consumer loans, as well as deficiencies in servicing and foreclosure practices, may have on the value of our RMBS and consumer loan portfolios;

 

    the risks that default and recovery rates on our real estate securities, residential mortgage loans and consumer loans deteriorate compared to our underwriting estimates;

 

    changes in prepayment rates on the loans underlying certain of our assets, including, but not limited to, our Excess MSRs;

 

    the risk that projected recapture rates on the portfolios underlying our Excess MSRs are not achieved;

 

    the relationship between yields on assets which are paid off and yields on assets in which such monies can be reinvested;

 

    the relative spreads between the yield on the assets we invest in and the cost of financing;

 

    changes in economic conditions generally and the real estate and bond markets specifically;

 

    adverse changes in the financing markets we access affecting our ability to finance our investments;

 

    the quality and size of the investment pipeline and the rate at which we can invest our cash;

 

    changing risk assessments by lenders that potentially lead to increased margin calls, not extending our repurchase agreements or other financings in accordance with their current terms or entering into new financings with us;

 

    changes in interest rates and/or credit spreads, as well as the success of any hedging strategy we may undertake in relation to such changes;

 

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    impairments in the value of the collateral underlying our investments and the relation of any such impairments to our judgments as to whether changes in the market value of our securities or loans are temporary or not and whether circumstances bearing on the value of such assets warrant changes in carrying values;

 

    the availability and cost of capital for future investments;

 

    competition within the finance and real estate industries;

 

    the legislative/regulatory environment, including, but not limited to, the impact of the Dodd-Frank Act, U.S. government programs intended to stabilize the economy, the federal conservatorship of Fannie Mae and Freddie Mac and legislation that permits modification of the terms of loans;

 

    our ability to maintain our qualification as a REIT for U.S. federal income tax purposes and the potentially onerous consequences that any failure to maintain such qualification would have on our business; and

 

    our ability to maintain our exemption from registration under the 1940 Act and the fact that maintaining such exemption imposes limits on our operations.

We also direct readers to other risks and uncertainties referenced in this prospectus, including those set forth under “Risk Factors.” We caution that you should not place undue reliance on any of our forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise from time to time, and it is impossible for us to predict those events or how they may affect us. Except as required by law, we are under no obligation (and expressly disclaim any obligation) to update or alter any forward-looking statement, whether written or oral, that we may make from time to time, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, will be approximately $         million, assuming a public offering price of $         per share, the last reported sales price of our common stock on the NYSE on              , 2013 and after deducting estimated underwriting discounts and offering expenses (or $         million if the underwriters exercise their option to purchase additional shares of common stock in full).

We intend to use the net proceeds from this offering for general corporate purposes, including to make a variety of investments, which may include, but is not limited to, investments in Excess MSRs, real estate securities and real estate related loans.

A $1.00 increase (decrease) in the Assumed Public Offering Price of $         per share (the last reported sales price of our common stock on the NYSE on                     , 2013) would increase (decrease) the net proceeds to us from this offering by $         million, assuming the number of shares of common stock offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

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DISTRIBUTION POLICY

We intend to make regular quarterly distributions, which include all or substantially all of our taxable income, to holders of our common stock out of assets legally available therefore. We declared a quarterly dividend of $0.07 per common share for the quarter ended June 30, 2013, which was paid in July 2013. We declared a quarterly dividend of $0.175 per common share for the quarter ending September 30, 2013, which will be paid on October 31, 2013 to holders of record as of September 27, 2013. The dividend was based on estimated taxable earnings during the quarter. The amount of any future dividend is subject to board approval and depends on a variety of factors, as set forth below. As a result, the amount of any future dividend is uncertain, and dividends declared in future periods may differ materially from dividends declared in past periods.

To qualify as a REIT we must distribute annually to our stockholders an amount at least equal to:

 

    90% of our REIT taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains (which does not necessarily equal net income as calculated in accordance with GAAP); plus

 

    90% of the excess of our taxable income from foreclosure property (as defined in Section 856 of the Code) over the tax imposed on such income by the Code; less

 

    Any excess non-cash income (as determined under the Code). See “U.S. Federal Income Tax Considerations.”

We will be subject to income tax on our taxable income that is not distributed and to an excise tax to the extent that certain percentages of our taxable income are not distributed by specified dates. See “U.S. Federal Income Tax Considerations—Taxation of New Residential—Annual Distribution Requirements.” Income as computed for purposes of the foregoing tax rules will not necessarily correspond to our income as determined for financial reporting purposes.

Distributions will be authorized by our board of directors and declared by us based upon a number of factors, including actual results of operations, restrictions under Delaware law or applicable debt covenants, our financial condition, our taxable income, the annual distribution requirements under the REIT provisions of the Code, our operating expenses and other factors our directors deem relevant. Our ability to make distributions to our stockholders will depend upon the performance of our asset portfolio, and, in turn, upon our Manager’s management of our business. Distributions will be made in cash to the extent that cash is available for distribution. We may not be able to generate sufficient net interest income to pay distributions to our stockholders. In addition, our board of directors may change our distribution policy in the future. See “Risk Factors.”

Distributions to stockholders will generally be taxable to our stockholders as ordinary income. However, a portion of such distributions may be designated by us as long-term capital gain to the extent that such portion is attributable to our sale of capital assets held for more than one year. If we pay distributions in excess of our current and accumulated earnings and profits, such distributions will be treated as a tax-free return of capital to the extent of each stockholder’s tax basis in our common stock and as capital gain thereafter. We will furnish annually to each of our stockholders a statement setting forth distributions paid during the preceding year and their U.S. federal income tax status. For a discussion of the U.S. federal income tax treatment of our distributions, see “U.S. Federal Income Tax Considerations—Taxation of New Residential” and “U.S. Federal Income Tax Considerations—Taxation of Stockholders.”

Our certificate of incorporation allows us to issue preferred stock that could have a preference on distributions. We currently have no intention to issue any preferred stock, but if we do, the distribution preference on the preferred stock could limit our ability to make distributions to the holders of our common stock.

To the extent that our cash available for distribution is less than the amount required to be distributed under the REIT provisions of the Code, we may consider various funding sources to cover any such shortfall, including borrowing under available debt facilities, selling certain of our assets or using a portion of the net proceeds we receive in future offerings. Our distribution policy enables us to review the alternative funding sources available to us from time to time.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization at June 30, 2013 (1) on an actual basis and (2) as adjusted to reflect the issuance and sale of the                  shares of our common stock in this offering at the Assumed Public Offering Price and after deducting estimated underwriting discounts and offering expenses. You should read this table together with the section titled “Use of Proceeds” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of June 30, 2013  
     Actual     As Adjusted  
     (Unaudited)  
     (In thousands)  

Cash and cash equivalents

   $ 209,699      $                

Restricted cash

     —       

Debt:

    

Repurchase Agreements on Agency ARM RMBS

     1,061,250     

Repurchase Agreements on Non-Agency RMBS

     413,088     
  

 

 

   

Total debt

     1,474,338     

Equity:

    

Common Stock, $0.01 par value, 2,000,000,000 shares authorized, 253,025,645 issued and outstanding at June 30, 2013

     2,530     

Additional paid-in capital

     1,157,042     

Retained earnings

     66,939     

Accumulated other comprehensive income

     19,214     
  

 

 

   
     1,245,725     
  

 

 

   

 

 

 

Total capitalization

   $ 2,929,762      $     
  

 

 

   

 

 

 

 

 

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PRICE RANGE OF COMMON STOCK

Our common stock has been listed on the New York Stock Exchange (the “NYSE”) under the symbol “NRZ” since May 2, 2013, and regular-way trading began on May 16, 2013. Prior to the listing, there was no public market for our common stock. The following table presents the high and low sales prices for our common stock on the NYSE for the periods indicated.

 

     High      Low  

2013:

     

Second Quarter from May 2, 2013 through June 30, 2013

   $ 7.29       $ 5.85   

Third Quarter

   $ 6.99       $ 5.89   

Fourth Quarter through October 8, 2013

   $ 6.74       $ 6.38   

The closing sale price of our common stock, as reported by the NYSE, on October 8, 2013, was $6.39. As of October 8, 2013, there were 46 holders of record of our common stock. The number of beneficial stockholders is substantially greater than the number of holders of record as a large portion of our stock is held through brokerage firms.

 

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SELECTED HISTORICAL FINANCIAL INFORMATION

We were formed in September 2011 as NIC MSR LLC, a Delaware limited liability company and wholly owned subsidiary of Newcastle. We converted to a Delaware corporation and changed our name to New Residential Investment Corp. in December 2012. On May 15, 2013, we were spun-off from Newcastle and became a stand-alone public company.

The following table presents our selected historical financial information for the period from the commencement of our operations on December 8, 2011 through December 31, 2011, for the year ended December 31, 2012, and for the six months ended June 30, 2013 and 2012.

The selected historical consolidated statements of income for the year ended December 31, 2012 and the period from December 8, 2011 (commencement of operations) to December 31, 2011 and the selected historical consolidated balance sheets as of December 31, 2012 and 2011 have been derived from our audited financial statements included elsewhere in this prospectus. The summary consolidated statement of income for the six months ended June 30, 2013 and 2012 and the summary consolidated balance sheet data as of June 30, 2013 have been derived from our unaudited financial statements included elsewhere in this prospectus. The unaudited financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the information set forth herein. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 or for any future period.

You should read the following selected financial information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes included elsewhere in this prospectus.

 

    December 8, 2011
through
December 31,
2011
    Year
Ended
December
31,
2012
    Six
Months
Ended
June 30,
2012
    Six
Months
Ended

June 30,
2013
 
                (unaudited)     (unaudited)  
    (in thousands, except per share data)  

Statement of income data

       

Interest income

  $ 1,260      $ 33,759      $ 6,516      $ 39,190   

Interest expense

    —          704        —          3,550   

Other-than-temporary-impairment (“OTTI”) on securities

    —          —          —          3,756   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after impairment

    1,260        33,055        6,516        31,884   

Change in fair value of investments in excess mortgage servicing rights

    367        9,023        4,739        43,691   

Change in fair value of investments in excess mortgage servicing rights, equity method investees

    —          —          —          21,096   

Earnings from investments in consumer loans, equity method investees

    —          —          —          36,164   

Gain on settlement of securities

    —          —          —          58   

Other income

    —          8,400        —          —     

Expenses

    913        9,231        2,093        10,596   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 714      $ 41,247      $ 9,162      $ 122,297   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income per share:

       

Basic

    N/A        N/A        0.04        0.48   

Diluted

    N/A        N/A        0.04        0.48   

Number of shares outstanding:

       

Basic

    N/A        N/A        253,025,645        253,025,645   

Diluted

    N/A        N/A        253,025,645        254,852,605   

 

     December 31, 2011      December 31, 2012      June 30, 2013  
                   (unaudited)  
     (in thousands)  

Balance sheet data

        

Total assets

   $ 43,971       $ 534,876       $ 2,742,442   

Total liabilities

   $ 4,163       $ 156,520       $ 1,496,717   

Total equity

   $ 39,808       $ 378,356       $ 1,245,725   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the financial statements and related notes appearing elsewhere in this prospectus. This section contains forward-looking statements that involve risks and uncertainties. Our actual results may vary materially from those discussed in the forward-looking statements as a result of various factors, including, without limitation, those set forth in “Risk Factors.” See “Cautionary Statement Regarding Forward-Looking Statements.”

We were formed as NIC MSR LLC, a Delaware limited liability company and wholly owned subsidiary of Newcastle, in September 2011. We converted to a Delaware corporation and changed our name to New Residential Investment Corp. in December 2012. On May 15, 2013, we were spun-off from Newcastle and became a stand-alone public company. We have not yet completed a full year as a stand-alone public company. The historical results presented below may not be indicative of our future performance and do not necessarily reflect what our financial position would have been had we operated as a separate, stand-alone entity since our formation.

GENERAL

New Residential is a publicly traded REIT primarily focused on investing in residential mortgage related assets. We are externally managed by an affiliate of Fortress. Our goal is to drive strong risk-adjusted returns primarily through investments in residential real estate related investments, including, but not limited to, Excess MSRs, RMBS and residential mortgage loans. New Residential’s investment guidelines are purposefully broad to enable us to make investments in a wide array of assets, including mortgage servicing advances and non-real estate related assets such as consumer loans. We generally target assets that generate significant current cash flows and/or have the potential for meaningful capital appreciation. We aim to generate attractive returns for our stockholders without the excessive use of financial leverage.

Our portfolio is currently composed of investments in Excess MSRs, Agency ARM RMBS, Non-Agency RMBS, residential mortgage loans, consumer loans and cash. A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act, including investments in Agency ARM RMBS. Our asset allocation and target assets may change over time, depending on our Manager’s investment decisions in light of prevailing market conditions. The assets in our portfolio are described in more detail below under “—Results of Operations—Our Portfolio.”

On May 15, 2013, Newcastle completed the distribution of shares of New Residential to Newcastle stockholders of record as of May 6, 2013. Following the distribution, New Residential is an independent, publicly-traded REIT (NYSE: NRZ).

MARKET CONSIDERATIONS

Various market factors, which are outside of our control, affect our results of operations and financial condition. One such factor is developments in the U.S. residential housing market, which we believe are generating significant investment opportunities. Since the 2008 financial crisis, the residential mortgage industry has been undergoing major structural changes that are transforming the way mortgages are originated, owned and serviced.

Since 2010, banks have sold or committed to sell mortgage servicing rights, or “MSRs,” totaling more than $1 trillion of the approximately $10 trillion mortgage market. An MSR provides a mortgage servicer with the right to service a pool of mortgages in exchange for a portion of the interest payments made on the underlying mortgages. This amount typically ranges from 25 to 50 bps times the UPB of the mortgages. As of the first quarter of 2013, approximately 82% of MSRs were still owned by banks. We expect this number to decline as

 

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banks face pressure to reduce their MSR exposure as a result of heightened capital reserve requirements under Basel III, regulatory scrutiny and a more challenging servicing environment. As a result, we believe the volume of MSR sales is likely to be substantial for some period of time.

We estimate that MSRs on approximately $300 billion of mortgages are currently for sale, which would require a capital investment of approximately $2-3 billion based on current pricing dynamics. We believe many non-bank servicers, who acquire MSRs and are constrained by capital limitations, will continue to sell a portion of the Excess MSR. We also estimate that approximately $1-2 trillion of MSRs could be sold over the next several years. In addition, approximately $1-2 trillion of new loans are expected to be created annually. We believe this creates an opportunity to enter into “flow arrangements,” whereby loan originators agree to sell Excess MSRs on newly originated loans on a recurring basis (often monthly or quarterly). We believe that MSRs are being sold at a discount to historical pricing levels, although increased competition for these assets has driven prices higher recently. There can be no assurance that any future investment in Excess MSRs will generate returns similar to the returns on our current investments in Excess MSRs.

As of March 2013, approximately $6 trillion of the $10 trillion of residential mortgages outstanding has been securitized, according to Inside Mortgage Finance. Approximately $5 trillion are Agency RMBS, which are securities issued or guaranteed by a U.S. Government agency, such as Ginnie Mae, or by a GSE, such as Fannie Mae or Freddie Mac. The balance has been securitized by either public trusts or private label securitizations, and are referred to as Non-Agency RMBS.

Since the financial crisis, there has been significant volatility in the prices for Non-Agency RMBS, which resulted from a widespread contraction in capital available for this asset class, deteriorating housing fundamentals, and an increase in forced selling by institutional investors (often in response to rating agency downgrades). While the prices of these assets have started to recover from their lows, we believe a meaningful gap still exists between current prices and the recovery value of many Non-Agency RMBS. Accordingly, we believe there are opportunities to acquire Non-Agency RMBS at attractive risk-adjusted yields, with the potential for meaningful upside if the U.S. economy and housing market continue to strengthen. We believe the value of existing Non-Agency RMBS may also rise if the number of buyers returns to pre-2007 levels. The primary causes of mark to market changes in our RMBS portfolio are changes in interest rates and credit spreads.

Interest rates have risen significantly in recent months and may continue to increase, although the timing of any further increases is uncertain. In periods of rising interest rates, the rates of prepayments and delinquencies with respect to mortgage loans generally decline. Generally, the value of our Excess MSRs is expected to increase when interest rates rise or delinquencies decline, and the value is expected to decrease when interest rates decline or delinquencies increase, due to the effect of changes in interest rates on prepayment speeds and delinquencies. However, prepayment speeds and delinquencies could increase even in the current interest rate environment, as a result of, among other things, a general economic recovery, government programs intended to foster refinancing activity or other reasons, which could reduce the value of our investments. Moreover, the value of our Excess MSRs is subject to a variety of factors, as described elsewhere in this prospectus. In the second quarter of 2013, the fair value of our investments in Excess MSRs (directly and through equity method investees) increased by approximately $59 million, and we reduced our discount rate assumption from approximately 18% in the first quarter to 12.5% in the second quarter, in part due to the substantial rise in interest rates.

Like our Excess MSRs, the value of our Non-Agency RMBS is also affected by delinquencies. The weighted average percentage of loans underlying our Non-Agency RMBS that were delinquent in the second quarter was 29.1%, compared to 30.2% in the first quarter.

We do not expect changes in interest rates to have a meaningful impact on the net interest spread of our Agency ARM and Non-Agency portfolios. Our RMBS are primarily floating rate or hybrid (i.e., fixed to floating rate) securities, which we generally finance with floating rate debt. Therefore, while rising interest rates will generally result in a higher cost of financing, they will also result in a higher coupon payable on the securities. The net

 

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interest spread on our Agency ARM RMBS portfolio as of June 30, 2013 was 1.08%, compared to 1.01% as of March 31, 2013. The net interest spread on our Non-Agency RMBS portfolio as of June 30, 2013 was 2.84%, compared to 4.00% as of March 31, 2013. This difference is primarily attributable to purchases of Non-Agency RMBS in the second quarter with lower projected yields than most of the securities acquired prior to the second quarter. The lower yield on these new securities reflects higher purchase prices due to increased investor demand and improved real estate values.

Credit spreads decreased in the first half of 2013 relative to 2012, which has had a favorable impact on the value of our securities and loan portfolio. Credit spreads measure the yield relative to a specified benchmark that the market demands on securities and loans based on such assets’ credit risk. For a discussion of the way in which interest rates, credit spreads and other market factors affect us, see “— Quantitative and Qualitative Disclosures About Market Risk.”

The value of our consumer loan portfolio is influenced by, among other factors, the U.S. macroeconomic environment, and unemployment rates in particular. We believe that losses are highly correlated to unemployment; therefore, we expect that an improvement in unemployment rates would support the value of our investment, while deterioration in unemployment rates would result in a decline in its value.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions that could affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Management believes that the estimates and assumptions utilized in the preparation of the consolidated financial statements are prudent and reasonable. Actual results historically have been in line with management’s estimates and judgments used in applying each of the accounting policies described below, as modified periodically to reflect current market conditions. The following is a summary of our accounting policies that are most affected by judgments, estimates and assumptions.

Excess MSRs

Upon acquisition, we elected to record each investment in Excess MSRs at fair value. We elected to record our investments in Excess MSRs at fair value in order to provide users of the financial statements with better information regarding the effects of prepayment risk and other market factors on the Excess MSRs.

GAAP establishes a framework for measuring fair value of financial instruments and a set of related disclosure requirements. A three-level valuation hierarchy has been established based on the transparency of inputs to the valuation of a financial instrument as of the measurement date. The three levels are defined as follows:

Level 1—Quoted prices in active markets for identical instruments.

Level 2—Valuations based principally on other observable market parameters, including:

 

    Quoted prices in active markets for similar instruments,

 

    Quoted prices in less active or inactive markets for identical or similar instruments,

 

    Other observable inputs (such as interest rates, yield curves, volatilities, prepayment speeds, loss severities, credit risks and default rates), and

 

    Market corroborated inputs (derived principally from or corroborated by observable market data).

Level 3—Valuations based significantly on unobservable inputs.

 

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The level in the fair value hierarchy within which a fair value measurement or disclosure in its entirety is based on the lowest level of input that is significant to the fair value measurement or disclosure in its entirety.

Our Excess MSRs are categorized as Level 3 under the GAAP hierarchy. The inputs used in the valuation of Excess MSRs include prepayment speed, delinquency rate, recapture rate, excess mortgage servicing amount and discount rate. The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. The methods used to estimate fair value may not result in an amount that is indicative of net realizable value or reflective of future fair values. Changes in market conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase or decrease in fair value. Management validates significant inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we use are within the range that a market participant would use, and factor in the liquidity conditions in the markets. Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate.

In order to evaluate the reasonableness of its fair value determinations, management engages an independent valuation firm to separately measure the fair value of its Excess MSRs pools. The independent valuation firm determines an estimated fair value range based on its own models and issues a “fairness opinion” with this range. Management compares the range included in the opinion to the values generated by its internal models. For Excess MSRs acquired prior to the current quarter, the fairness opinion relates to the valuation at the current quarter end date. For Excess MSRs acquired during the current quarter, the fairness opinion relates to the valuation at the time of acquisition. To date, we have not made any significant valuation adjustments as a result of these fairness opinions.

For Excess MSRs acquired during the current quarter, we revalue the Excess MSRs at the quarter end date if a payment is received between the acquisition date and the end of the quarter. Otherwise, Excess MSRs acquired during the current quarter are carried at their amortized cost basis if there has been no change in assumptions since acquisition.

Investments in Excess MSRs are aggregated into pools as applicable; each pool of Excess MSRs is accounted for in the aggregate. Interest income for Excess MSRs is accreted using an effective yield or “interest” method, based upon the expected income from the Excess MSRs through the expected life of the underlying mortgages. Changes to expected cash flows result in a cumulative retrospective adjustment, which will be recorded in the period in which the change in expected cash flows occurs. Under the retrospective method, the interest income recognized for a reporting period would be measured as the difference between the amortized cost basis at the end of the period and the amortized cost basis at the beginning of the period, plus any cash received during the period. The amortized cost basis is calculated as the present value of estimated future cash flows using an effective yield, which is the yield that equates all past actual and current estimated future cash flows to the initial investment. In addition, our policy is to recognize interest income only on Excess MSRs in existing eligible underlying mortgages.

Under the fair value election, the difference between the fair value of Excess MSRs and their amortized cost basis is recorded as “Change in fair value of investments in excess mortgage servicing rights,” as applicable. Fair value is generally determined by discounting the expected future cash flows using discount rates that incorporate the market risks and liquidity premium specific to the Excess MSRs, and therefore may differ from their effective yields.

 

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The following tables summarize the estimated change in fair value of our interests in the Excess MSRs owned directly as of June 30, 2013 given several parallel shifts in the discount rate, prepayment rate, delinquency rate and recapture rate (dollars in thousands):

 

Fair value at June 30, 2013

   $ 271,420       

Discount rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 296,070      $ 283,152      $ 260,722      $ 250,933   

Change in estimated fair value:

    

Amount

   $ 24,650      $ 11,732      $ (10,698   $ (20,487

%

     9.1     4.3     -3.9     -7.5

Prepayment rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 298,388      $ 284,382      $ 259,395      $ 248,217   

Change in estimated fair value:

      

Amount

   $ 26,968      $ 12,962      $ (12,025   $ (23,203

%

     9.9     4.8     -4.4     -8.5

Delinquency rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 276,466      $ 273,943      $ 268,897      $ 266,373   

Change in estimated fair value:

      

Amount

   $ 5,046      $ 2,523      $ (2,523   $ (5,047

%

     1.9     0.9     -0.9     -1.9

Recapture rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 266,113      $ 268,750      $ 274,005      $ 276,473   

Change in estimated fair value:

      

Amount

   $ (5,307   $ (2,670   $ 2,585      $ 5,053   

%

     -2.0     -1.0     1.0     1.9

 

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The following tables summarize the estimated change in fair value of our interests in the Excess MSRs owned through equity method investees as of June 30, 2013 given several parallel shifts in the discount rate, prepayment rate, delinquency rate and recapture rate (dollars in thousands):

 

Fair value at June 30, 2013

   $ 175,932 (A)     

Discount rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 192,594      $ 183,326      $ 167,410      $ 160,530   

Change in estimated fair value:

    

Amount

   $ 16,662      $ 7,394      $ (8,522   $ (15,402

%

     9.5     4.2     -4.8     -8.8

Prepayment rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 190,237      $ 182,345      $ 168,083      $ 161,627   

Change in estimated fair value:

      

Amount

   $ 14,305      $ 6,413      $ (7,849   $ (14,305

%

     8.1     3.6     -4.5     -8.1

Delinquency rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 179,581      $ 177,278      $ 172,671      $ 170,366   

Change in estimated fair value:

      

Amount

   $ 3,649      $ 1,346      $ (3,261   $ (5,566

%

     2.1     0.8     -1.9     -3.2

Recapture rate shift in %

   -20%     -10%     +10%     +20%  

Estimated fair value

   $ 166,129      $ 170,500      $ 179,554      $ 184,243   

Change in estimated fair value:

      

Amount

   $ (9,803   $ (5,432   $ 3,622      $ 8,311   

%

     -5.6     -3.1     2.1     4.7

 

(A) The total fair value of investments held through equity method investees as of June 30, 2013 excludes our share of the non-Excess MSR net assets of the equity method investees of $7.2 million.

The sensitivity analysis is hypothetical and should be used with caution. In particular, the results are calculated by stressing a particular economic assumption independent of changes in any other assumption; in practice, changes in one factor may result in changes in another, which might counteract or amplify the sensitivities. Also, changes in the fair value based on a 10% variation in an assumption generally may not be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear.

RMBS

Our Non-Agency RMBS and Agency ARM RMBS are classified as available-for-sale. As such, they are carried at fair value, with net unrealized gains or losses reported as a component of accumulated other comprehensive income, to the extent impairment losses are considered temporary, as described below.

We expect that any RMBS we acquire will be categorized under Level 2 or Level 3 of the GAAP hierarchy described above under “—Application of Critical Account Policies—Excess MSRs,” depending on the observability of the inputs. Fair value may be based upon broker quotations, counterparty quotations, pricing services quotations or internal pricing models. The significant inputs used in the valuation of our securities include the discount rate, prepayment speeds, default rates and loss severities, as well as other variables.

The determination of estimated cash flows used in pricing models is inherently subjective and imprecise. The methods used to estimate fair value may not be indicative of net realizable value or reflective of future fair values. Changes in market conditions, as well as changes in the assumptions or methodology used to determine

 

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fair value, could result in a significant increase or decrease in fair value. Management validates significant inputs and outputs of our models by comparing them to available independent third party market parameters and models for reasonableness. We believe the assumptions we use are within the range that a market participant would use, and factor in the liquidity conditions in the markets. Any changes to the valuation methodology will be reviewed by management to ensure the changes are appropriate.

Pursuant to ASC 320-10-35, we must also assess whether unrealized losses on securities, if any, reflect a decline in value that is other-than-temporary and, if so, record an other-than-temporary impairment through earnings. A decline in value is deemed to be other-than-temporary if (i) it is probable that we will be unable to collect all amounts due according to the contractual terms of a security that was not impaired at acquisition (there is an expected credit loss), or (ii) if we have the intent to sell a security in an unrealized loss position or it is more likely than not that we will be required to sell a security in an unrealized loss position prior to its anticipated recovery (if any). For the purposes of performing this analysis, we will assume the anticipated recovery period is until the expected maturity of the applicable security. Also, for securities that represent beneficial interests in securitized financial assets within the scope of ASC 325-40, whenever there is a probable adverse change in the timing or amounts of estimated cash flows of a security from the cash flows previously projected, an other-than-temporary impairment will be deemed to have occurred. Our Non-Agency RMBS acquired with evidence of deteriorated credit quality for which it was probable, at acquisition, that we would be unable to collect all contractually required payments receivable, fall within the scope of ASC 310-30, as opposed to ASC 325-40. All of our other Non-Agency RMBS, those not acquired with evidence of deteriorated credit quality, fall within the scope of ASC 325-40.

Pursuant to ASC 835-30-35, income on these securities is recognized using a level yield methodology based upon a number of cash flow assumptions that are subject to uncertainties and contingencies. Such assumptions include the rate and timing of principal and interest receipts (which may be subject to prepayments and defaults). These assumptions are updated on at least a quarterly basis to reflect changes related to a particular security, actual historical data, and market changes. These uncertainties and contingencies are difficult to predict and are subject to future events, and economic and market conditions, which may alter the assumptions. For securities acquired at a discount for credit losses, we recognize the excess of all cash flows expected over our investment in the securities as Interest Income on a “loss adjusted yield” basis. The loss-adjusted yield is determined based on an evaluation of the credit status of securities, as described in connection with the analysis of impairment above.

Loans

We invest in loans, including but not limited to, residential mortgage loans. Loans for which we have the intent and ability to hold for the foreseeable future, or until maturity or payoff, are classified as held-for-investment. Loans are presented in the consolidated balance sheet at cost net of any unamortized discount (or gross of any unamortized premium). We determine at acquisition whether loans will be aggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination or acquisition); loans aggregated into pools are accounted for as if each pool were a single loan.

Income on these loans is recognized similarly to that on our securities using a level yield methodology and is subject to similar uncertainties and contingencies, which are also analyzed on at least a quarterly basis.

Impairment of Loans

To the extent that they are classified as held-for-investment, we must periodically evaluate each of these loans or loan pools for possible impairment. Impairment is indicated when it is deemed probable that we will be unable to collect all amounts due according to the contractual terms of the loan, or for loans acquired at a discount for credit losses, when it is deemed probable that we will be unable to collect as anticipated. Upon determination of impairment, we would establish a specific valuation allowance with a corresponding charge to earnings. We continually evaluate our loans receivable for impairment.

 

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Our residential mortgage loans are aggregated into pools for evaluation based on like characteristics, such as loan type and acquisition date. Pools of loans are evaluated based on criteria such as an analysis of borrower performance, credit ratings of borrowers, loan to value ratios, the estimated value of the underlying collateral, the key terms of the loans and historical and anticipated trends in defaults and loss severities for the type and seasoning of loans being evaluated. This information is used to estimate provisions for estimated unidentified incurred losses on pools of loans. Significant judgment is required in determining impairment and in estimating the resulting loss allowance. Furthermore, we must assess our intent and ability to hold our loan investments on a periodic basis. If we do not have the intent to hold a loan for the foreseeable future or until its expected payoff, the loan must be classified as “held for sale” and recorded at the lower of cost or estimated value.

Investment Consolidation

The analysis as to whether to consolidate an entity is subject to a significant amount of judgment. Some of the criteria considered are the determination as to the degree of control over an entity by its various equity holders, the design of the entity, how closely related the entity is to each of its equity holders, the relation of the equity holders to each other and a determination of the primary beneficiary in entities in which we have a variable interest. These analyses involve estimates, based on the assumptions of management, as well as judgments regarding significance and the design of entities.

Variable interest entities (“VIEs”) are defined as entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, and only by its primary beneficiary, which is defined as the party who has the power to direct the activities of a VIE that most significantly impact its economic performance and who has the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.

Our investments in Non-Agency RMBS are variable interests. We monitor these investments and analyze the potential need to consolidate the related securitization entities pursuant to the VIE consolidation requirements.

These analyses require considerable judgment in determining whether an entity is a VIE and determining the primary beneficiary of a VIE since they involve subjective determinations of significance, with respect to both power and economics. The result could be the consolidation of an entity that otherwise would not have been consolidated or the de-consolidation of an entity that otherwise would have been consolidated.

We have not consolidated the securitization entities that issued our Non-Agency RMBS. This determination is based, in part, on our assessment that we do not have the power to direct the activities that most significantly impact the economic performance of these entities, such as if we owned a majority of the currently controlling class. In addition, we are not obligated to provide, and have not provided, any financial support to these entities.

We have not consolidated the entities in which we hold a 50% interest that made an investment in Excess MSRs. We have determined that the decisions that most significantly impact the economic performance of these entities will be made collectively by us and the other investor in the entities. In addition, these entities have sufficient equity to permit the entities to finance their activities without additional subordinated financial support. Based on our analysis, these entities do not meet any of the VIE criteria under ASC 810-10-15-14.

Investments in Equity Method Investees

We account for our investment in the Consumer Loan Companies pursuant to the equity method of accounting because we can exercise significant influence over the Consumer Loan Companies, but the requirements for consolidation are not met. Our share of earnings and losses in these equity method investees is included in “Earnings from investments in consumer loans, equity method investees” on the Consolidated Statements of Income. Equity method investments are included in “Investments in consumer loans, equity method investees” on the Consolidated Balance Sheets.

 

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The Consumer Loan Companies classify their investments in consumer loans as held-for-investment, as they have the intent and ability to hold for the foreseeable future, or until maturity or payoff. The Consumer Loan Companies record the consumer loans at cost net of any unamortized discount or loss allowance. The Consumer Loan Companies determined at acquisition that these loans would be aggregated into pools based on common risk characteristics (credit quality, loan type, and date of origination or acquisition); the loans aggregated into pools are accounted for as if each pool were a single loan.

Pursuant to ASC 825-10-25, we have elected to measure our investments in equity method investees which are invested in Excess MSRs at fair value. The equity method investees have also elected to measure their investments in Excess MSRs at fair value pursuant to ASC 825-10-25.

Income Taxes

Our financial results are generally not expected to reflect provisions for current or deferred income taxes. We intend to operate in a manner that allows us to qualify for taxation as a REIT. As a result of our expected REIT qualification, we do not generally expect to pay U.S. federal or state and local corporate level taxes. Many of the REIT requirements, however, are highly technical and complex. If we were to fail to meet the REIT requirements, we would be subject to U.S. federal, state and local income and franchise taxes.

RECENT ACCOUNTING PRONOUNCEMENTS

In February 2013, the FASB issued new guidance regarding the reporting of reclassifications out of accumulated other comprehensive income. The new guidance does not change current requirements for reporting net income or other comprehensive income in the financial statements. However, it requires companies to present the effects on the line items of net income of significant amounts reclassified out of accumulated OCI if the item reclassified is required to be reclassified to net income in its entirety during the same reporting period. Presentation should occur either on the face of the income statement where net income is presented or in the notes to the financial statements. We early adopted this accounting standard and opted to present this information in a note to the financial statements.

The FASB has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, financial instruments, hedging, and contingencies. Some of the proposed changes are significant and could have a material impact on our reporting. We have not yet fully evaluated the potential impact of these proposals, but will make such an evaluation as the standards are finalized.

We are an emerging growth company as defined in the JOBS Act, and we have irrevocably elected not to take advantage of the delayed adoption of new or revised accounting standards applicable to public companies. We will therefore be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

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RESULTS OF OPERATIONS

We have a limited operating history and we acquired our first portfolio of Excess MSRs in December 2011 and as a result, a comparison of the year ended December 31, 2012 against the one month ended December 31, 2011 would not be meaningful. Because we were not operating as a separate, stand-alone entity during the period from our formation to the date of our separation from Newcastle, our results of operations for this period are not necessarily indicative of our future performance.

The following tables summarize the changes in our results of operations for the three and six months ended June 30, 2013 compared to the three and six months ended June 30, 2012 (dollars in thousands):

 

     Three Months
Ended June 30,
     Increase (Decrease)  
     2013      2012      Amount     %  

Interest income

   $ 22,999       $ 4,479       $ 18,520        413.5

Interest expense

     2,651         —           2,651        N.M.   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net Interest Income

     20,348         4,479         15,869        354.3
  

 

 

    

 

 

    

 

 

   

 

 

 

Impairment

          

Other-than-temporary impairment (“OTTI”) on securities

     3,756         —           3,756        N.M.   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net interest income after impairment

     16,592         4,479         12,113        270.4

Other Income

          

Change in fair value of investments in excess mortgage servicing rights

     41,833         3,523         38,310        1087.4

Change in fair value of investments in excess mortgage servicing rights, equity method investees

     20,127         —           20,127        N.M.   

Earnings from investments in consumer loans, equity method investees

     36,164         —           36,164        N.M.   

Gain on settlement of securities

     58         —           58        N.M.   
  

 

 

    

 

 

    

 

 

   

 

 

 
     98,182         3,523         94,659        2686.9
  

 

 

    

 

 

    

 

 

   

 

 

 

Operating Expenses

          

General and administrative expenses

     602         1,266         (664     -52.4

Management fee allocated by Newcastle

     1,809         262         1,547        590.5

Management fee to affiliate

     2,263         —           2,263        N.M.   

Incentive compensation to affiliate

     878         —           878        N.M.   
  

 

 

    

 

 

    

 

 

   

 

 

 
     5,552         1,528         4,024        263.4
  

 

 

    

 

 

    

 

 

   

 

 

 

Net Income

   $ 109,222       $ 6,474       $ 102,748        1587.1
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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    Six Months
Ended June 30,
    Increase (Decrease)  
    2013     2012     Amount     %  

Interest income

  $ 39,190      $ 6,516      $ 32,674        501.4

Interest expense

    3,550        —          3,550        N.M.   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net Interest Income

    35,640        6,516        29,124        447.0
 

 

 

   

 

 

   

 

 

   

 

 

 

Impairment

       

Other-than-temporary impairment (“OTTI”) on securities

    3,756        —          3,756        N.M.   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after impairment

    31,884        6,516        25,368        389.3

Other Income

       

Change in fair value of investments in excess mortgage servicing rights

    43,691        4,739        38,952        821.9

Change in fair value of investments in excess mortgage servicing rights, equity method investees

    21,096        —          21,096        N.M.   

Earnings from investments in consumer loans, equity method investees

    36,164        —          36,164        N.M.   

Gain on settlement of securities

    58        —          58        N.M.   
 

 

 

   

 

 

   

 

 

   

 

 

 
    101,009        4,739        96,270        2031.4
 

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses

       

General and administrative expenses

    3,321        1,677        1,644        98.0

Management fee allocated by Newcastle

    4,134        416        3,718        893.8

Management fee to affiliate

    2,263        —          2,263        N.M.   

Incentive compensation to affiliate

    878        —          878        N.M.   
 

 

 

   

 

 

   

 

 

   

 

 

 
    10,596        2,093        8,503        406.3
 

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

  $ 122,297      $ 9,162      $ 113,135        1234.8
 

 

 

   

 

 

   

 

 

   

 

 

 

Interest Income

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Interest income increased by $18.5 million primarily due to increases in interest income as a result of new investments in real estate securities and excess mortgage servicing rights.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Interest income increased by $32.7 million primarily due to increases in interest income as a result of new investments in real estate securities and excess mortgage servicing rights.

Interest Expense

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Interest expense increased by $2.7 million due to repurchase agreement financing entered into since June 2012 on our Agency ARM RMBS and Non-Agency RMBS.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Interest expense increased by $3.6 million due to repurchase agreement financing entered into since June 2012 on our Agency ARM RMBS and Non-Agency RMBS.

Other than Temporary Impairment (“OTTI”) on Securities

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

The other-than-temporary impairment on securities increased by $3.8 million due to the recognition of impairment on our Agency ARM RMBS and Non-Agency RMBS securities in connection with the spin-off on May 15, 2013.

 

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Six months ended June 30, 2013 compared to the six months ended June 30, 2012

The other-than-temporary impairment on securities increased by $3.8 million due to the recognition of impairment on our Agency ARM RMBS and Non-Agency RMBS securities in connection with the spin-off on May 15, 2013.

Change in Fair Value of Investments in Excess Mortgage Servicing Rights

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

The change in fair value of investments in excess mortgage servicing rights increased $38.3 million due to the acquisition of investments in the second quarter of 2012 and subsequent net increases in value.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

The change in fair value of investments in excess mortgage servicing rights increased $39.0 million due to the acquisition of investments in the second quarter of 2012 and subsequent net increases in value.

Change in Fair Value of Investments in Excess Mortgage Servicing Rights, Equity Method Investees

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

The change in fair value of investments in excess mortgage servicing rights, equity method investees increased $20.1 million due to the acquisition of these investments in 2013 and subsequent net increases in value.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

The change in fair value of investments in excess mortgage servicing rights, equity method investees increased $21.1 million due to the acquisition of these investments in 2013 and subsequent net increases in value.

Earnings from Investments in Consumer Loans, Equity Method Investees

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Earnings from investments in consumer loans, equity method investees increased $36.2 million due to the acquisition of these investments in the second quarter of 2013 and subsequent income recognized by the investees.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Earnings from investments in consumer loans, equity method investees increased $36.2 million due to the acquisition of these investments in the second quarter of 2013 and subsequent income recognized by the investees.

Gain on Settlement of Securities

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Gain on settlement of securities increased by $58 thousand due to the sale of two Non-Agency RMBS during the three months ended June 30, 2013.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Gain on settlement of securities increased by $58 thousand due to the sale of two Non-Agency RMBS during the six months ended June 30, 2013.

 

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General and Administrative Expenses

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

General and administrative expenses decreased by $0.7 million primarily due to a decrease in professional fees associated with acquiring new investments.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

General and administrative expense increased by $1.6 million primarily due to an increase in professional fees primarily related to the investment in consumer loans.

Management Fee Allocated by Newcastle

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Management fee allocated by Newcastle increased $1.5 million due to an increase in our equity, as a result of capital contributions from Newcastle subsequent to the first quarter of 2012.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Management fee allocated by Newcastle increased by $3.7 million due to an increase in our equity, as a result of capital contributions from Newcastle subsequent to the first quarter of 2012.

Management Fee to Affiliate

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Management fee to affiliate increased $2.3 as a result of the management agreement becoming effective on May 15, 2013.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Management fee to affiliate increased $2.3 as a result of the management agreement becoming effective on May 15, 2013.

Incentive Compensation to Affiliate

Three months ended June 30, 2013 compared to the three months ended June 30, 2012.

Incentive compensation to affiliate increased $0.9 million as a result of the management agreement becoming effective on May 15, 2013 and subsequent investment performance.

Six months ended June 30, 2013 compared to the six months ended June 30, 2012

Incentive compensation to affiliate increased $0.9 million as a result of the management agreement becoming effective on May 15, 2013 and subsequent investment performance.

OUR PORTFOLIO

Our portfolio is currently composed of investments in Excess MSRs, Agency ARM RMBS, Non-Agency RMBS, residential mortgage loans, consumer loans and cash, as described in more detail below. A majority of our assets consist of qualifying real estate assets for purposes of Section 3(c)(5)(C) of the 1940 Act, including investments in Agency ARM RMBS. Our asset allocation and target assets may change over time, depending on our Manager’s investment decisions in light of prevailing market conditions. The assets in our portfolio are described in more detail below.

 

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Excess MSRs

As of June 30, 2013, we had approximately $454.6 million estimated carrying value of Excess MSRs (held directly and through joint ventures), including deposits on investments that have not closed through joint ventures. As of June 30, 2013, our completed investments represent a 33% to 65% interest in the Excess MSRs (held either directly or through joint ventures) on pools of mortgage loans with an aggregate UPB of approximately $153.8 billion. Nationstar is the servicer of the loans underlying all of our investments in Excess MSRs to date, and it earns a basic fee in exchange for providing all servicing functions. In addition, Nationstar retains a 33% to 35% interest in the Excess MSRs and all ancillary income associated with the portfolios. We do not have any servicing duties, liabilities or obligations associated with the servicing of the portfolios underlying any of our investments. Each of our investments to date is subject to a recapture agreement with Nationstar. Under the recapture agreements, we are generally entitled to a pro rata interest in the Excess MSRs on any initial or subsequent refinancing by Nationstar of a loan in the original portfolio. In other words, we are generally entitled to a pro rata interest in the Excess MSRs on both (i) a loan resulting from a refinancing by Nationstar of a loan in the original portfolio, and (ii) a loan resulting from a refinancing by Nationstar of a previously recaptured loan.

 

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The following table summarizes the collateral characteristics of the loans underlying our direct Excess MSR investments as of June 30, 2013 (dollars in thousands):

 

          Collateral Characteristics  
    Current
Carrying
Amount
    Original
Principal
Balance
    Current
Principal
Balance
    Number
of Loans
    WA
FICO
Score
(A)
    WA
Coupon
    WA
Maturity
(months)
    Average
Loan
Age
(months)
    Adjustable
Rate
Mortgage
% (B)
    1 Month
CPR
(D)
    1 Month
CRR
(E)
    1 Month
CDR
(F)
    1 Month
Recapture
Rate
 

Pool 1

                         

Original Pool

  $ 34,515      $ 9,940,385      $ 6,579,008        46,209        678        5.7     277        79        20.0     32.2     29.3     4.1     53.3

Recaptured Loans

    4,632        —          1,014,430        5,155        747        4.3     329        5        0.0     3.1     3.1     0.0     0.0

Recapture Agreements

    5,383        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    44,530        9,940,385        7,593,438        51,364        687        5.5     284        69        17.3     28.3     25.8     3.5     46.2

Pool 2

                         

Original Pool

    33,309        10,383,891        7,843,608        40,966        611        5.0     317        69        11.0     27.1     22.9     5.3     53.6

Recaptured Loans

    4,030        —          726,797        3,685        750        4.3     331        3        0.0     0.7     0.7     0.0     0.0

Recapture Agreements

    6,557        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    43,896        10,383,891        8,570,405        44,651        623        4.8     318        63        10.1     24.9     21.0     4.9     49.1

Pool 3

                         

Original Pool

    31,663        9,844,114        8,039,505        49,890        677        4.3     287        92        39.0     20.0     17.5     3.0     39.2

Recaptured Loans

    1,520        —          341,019        2,080        733        4.1     329        2        0.0     0.9     0.9     0.0     0.0

Recapture Agreements

    5,755        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    38,938        9,844,114        8,380,524        51,970        679        4.3     289        88        37.4     19.2     16.8     2.9     37.6

Pool 4

                         

Original Pool

    12,755        6,250,549        5,286,319        26,393        675        3.5     309        83        58.0     15.3     7.3     8.5     40.0

Recaptured Loans

    421        —          94,814        484        752        4.2     340        3        0.0     0.2     0.2     0.0     0.0

Recapture Agreements

    3,533        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    16,709        6,250,549        5,381,133        26,877        676        3.5     310        82        57.0     15.0     7.2     8.4     39.3

Pool 5

                         

Original Pool

    121,009        47,572,905        39,967,801        172,125        655        4.5     290        88        55.0     14.8     6.3     9.0     0.6

Recapture Loans

    93        —          21,230        74        755        3.6     334        4        2.0     0.0     0.0     0.0     0.0

Recapture Agreements

    3,854        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    124,956        47,572,905        39,989,031        172,199        655        4.5     290        88        55.0     14.8     6.3     9.0     0.6

Pool 11

                         

Recapture Agreements

    2,391        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    2,391        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

  $ 271,420      $ 83,991,844      $ 69,914,531        347,061        659        4.6     294        82        43.4     18.0     11.6     7.1     34.7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Continued on next page.

 

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Table of Contents
     Collateral Characteristics  
     Uncollected
Payments (C)
    Delinquency
30 Days (C)
    Delinquency
60 Days (C)
    Delinquency
90+ Days (C)
    Loans in
Foreclosure
    Real
Estate
Owned
    Loans in
Bankruptcy
 

Pool 1

              

Original Pool

     10.1     6.0     1.9     1.2     4.2     0.9     2.7

Recaptured Loans

     0.5     0.4     0.1     0.0     0.1     0.0     0.0

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     8.8     5.3     1.7     1.0     3.7     0.8     2.3

Pool 2

              

Original Pool

     14.8     5.3     2.1     1.6     7.9     1.0     4.9

Recaptured Loans

     0.1     0.2     0.0     0.0     0.0     0.0     0.0

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     13.6     4.9     1.9     1.5     7.2     0.9     4.5

Pool 3

              

Original Pool

     13.6     4.6     1.3     1.0     7.3     2.2     3.3

Recaptured Loans

     0.2     0.2     0.0     0.0     0.0     0.0     0.1

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     13.1     4.4     1.2     1.0     7.0     2.1     3.2

Pool 4

              

Original Pool

     17.0     3.6     1.7     1.3     10.5     2.0     4.2

Recaptured Loans

     0.0     0.4     0.0     0.0     0.0     0.0     0.0

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     16.7     3.5     1.7     1.3     10.3     2.0     4.1

Pool 5

              

Original Pool

     25.1     9.8     2.0     3.4     15.7     1.9     4.9

Recapture Loans

     0.0     0.0     0.0     0.0     0.0     0.0     0.0

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     25.1     9.8     2.0     3.4     15.7     1.9     4.9

Pool 11

              

Recapture Agreements

     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     —          —          —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

     19.8     7.6     1.8     2.4     11.9     1.7     4.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(A) The WA FICO score is based on the weighted average of information provided by the loan servicer on a monthly basis. The loan servicer generally updates the FICO score on a monthly basis.
(B) Adjustable Rate Mortgage % represents the percentage of the total principal balance of the pool that corresponds to adjustable rate mortgages.
(C) Uncollected Payments represents the percentage of the total principal balance of the pool that corresponds to loans for which the most recent payment was not made. Delinquency 30 Days, Delinquency 60 Days and Delinquency 90+ Days represent the percentage of the total principal balance of the pool that corresponds to loans that are delinquent by 30–59 days, 60–89 days or 90 or more days, respectively.
(D) 1 Month CPR or the constant prepayment rate represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(E) 1 Month CRR, or the voluntary prepayment rate, represents the annualized rate of the voluntary prepayments during the month as a percentage of the total principal balance of the pool.
(F) 1 Month CDR, or the involuntary prepayment rate, represents the annualized rate of the involuntary prepayments (defaults) during the month as a percentage of the total principal balance of the pool.

 

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The following table summarizes the collateral characteristics as of June 30, 2013 of the loans underlying Excess MSR investments made through equity method investees (dollars in thousands). For each of these pools, we own a 50% interest in an entity that invested in a 67% interest in the Excess MSRs.

 

    Current
Carrying
Amount
    Collateral Characteristics  
    Original
Principal
Balance
    Current
Principal
Balance
    Number
of Loans
    WA
FICO
Score
(A)
    WA
Coupon
    WA
Maturity
(months)
    Average
Loan
Age
(months)
    Adjustable
Rate
Mortgage
% (B)
    1 Month
CPR
(D)
    1 Month
CRR
(E)
    1 Month
CDR
(F)
    1 Month
Recapture
Rate
 

Pool 6

                         

Original Pool

  $ 43,649      $ 12,987,190      $ 10,800,203        75,183        662        5.6     307        52        0.0     26.2     22.5     4.8     20.5

Recaptured Loans

    490        —          349,152        721        717        3.5     357        1        0.0     0.0     0.0     0.0     0.0

Recapture Agreements

    13,284        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    57,423        12,987,190        11,149,355        75,904        664        5.5     309        50        0.0     25.5     21.9     4.6     19.9

Pool 7 (G)

                         

Original Pool

    112,559        37,965,199        34,244,919        234,275        682        5.1     282        83        24.0     22.5     22.4     0.1     23.8

Recaptured Loans

    387        —          235,779        1,525        727        4.3     325        1        0.0     0.0     0.0     0.0     0.0

Recapture Agreements

    25,965        —            —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    138,911        37,965,199        34,480,698        235,800        682        5.1     282        82        23.8     22.3     22.2     0.1     23.6

Pool 8 (H)

                         

Original Pool

    57,538        17,655,383        15,140,773        93,328        701        5.5     292        73        14.0     35.5     34.4     1.7     38.3

Recapture Loans

    422        —          276,771        1,539        763        4.3     322        1        0.0     0.1     0.1     0.0     0.0

Recapture Agreements

    14,103        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    72,063        17,655,383        15,417,544        94,867        702        5.5     293        72        13.7     34.9     33.8     1.7     37.6

Pool 11

                         

Original Pool

    55,797        22,817,213        22,817,213        137,843        614        5.4     294        68        4.0     N/A        N/A        N/A        N/A   

Recapture Agreements

    27,669        —          —          —          —          —          —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    83,466        22,817,213        22,817,213        137,843        614        5.4     294        68        4.0     0.0     0.0     0.0     0.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

  $ 351,863      $ 91,424,985      $ 83,864,810        544,414        665        5.3     291        72        13.4     19.0     18.3     1.0     28.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Continued on next page.

 

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Table of Contents
    Collateral Characteristics  
    Uncollected
Payments (C)
    Delinquency
30 Days (C)
    Delinquency
60 Days (C)
    Delinquency
90+ Days (C)
    Loans in
Foreclosure
    Real Estate
Owned
    Loans in
Bankruptcy
 

Pool 6

             

Original Pool

    12.4     6.2     1.7     1.7     6.6     0.6     2.2

Recaptured Loans

    0.0     0.0     0.2     0.0     0.0     0.0     0.0

Recapture Agreements

    —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    12.0     6.0     1.7     1.6     6.4     0.6     2.1

Pool 7

             

Original Pool

    12.4     4.0     1.0     2.4     6.2     0.3     3.7

Recaptured Loans

    0.0     0.0     0.0     0.0     0.0     0.0     0.0

Recapture Agreements

    —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    12.3     4.0     1.0     2.4     6.2     0.3     3.7

Pool 8

             

Original Pool

    38.3     3.4     1.1     1.3     5.2     0.3     3.0

Recapture Loans

    0.0     0.0     0.0     0.0     0.0     0.0     0.0

Recapture Agreements

    —          0.0     —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    37.6     3.3     1.1     1.3     5.1     0.3     2.9

Pool 11

             

Original Pool

    7.3     13.4     2.3     2.6     6.5     0.4     2.5

Recapture Agreements

    —          —          —          —          —          —          —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    7.3     13.4     2.3     2.6     6.5     0.4     2.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

    15.6     6.7     1.5     2.1     6.1     0.4     3.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(A) The WA FICO score is based on the weighted average of information provided by the loan servicer on a monthly basis. The loan servicer generally updates the FICO score on a monthly basis.
(B) Adjustable Rate Mortgage % represents the percentage of the total principal balance of the pool that corresponds to adjustable rate mortgages.
(C) Uncollected Payments represents the percentage of the total principal balance of the pool that corresponds to loans for which the most recent payment was not made. Delinquency 30 Days, Delinquency 60 Days and Delinquency 90+ Days represent the percentage of the total principal balance of the pool that corresponds to loans that are delinquent by 30-59 days, 60-89 days or 90 or more days, respectively.
(D) 1 Month CPR, or the constant prepayment rate, represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(E) 1 Month CRR, or the voluntary prepayment rate, represents the annualized rate of the voluntary prepayments during the month as a percentage of the total principal balance of the pool.
(F) 1 Month CDR, or the involuntary prepayment rate, represents the annualized rate of the involuntary prepayments (defaults) during the month as a percentage of the total principal balance of the pool.
(G) Collateral information excludes $2.24 billion for which collateral data was not available as of the report date.
(H) Collateral information excludes $1.25 billion for which collateral data was not available as of the report date.

 

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The following table summarizes the collateral characteristics for the additional pools committed to and/or closed subsequent to June 30, 2013, of the loans underlying Excess MSR investments made through equity method investees (dollars in thousands). For pools 9 and 10, New Residential owns a 50% interest in entities that invested in a 67% and 77% interest in Excess MSRs, respectively.

 

     Collateral Characteristics (G)  
     Unpaid
Principal
Balance
     Number
of Loans
     WA
Original
FICO
Score (A)
     WA
Coupon
    WA
Maturity
(months)
     Average
Loan
Age
(months)
     Adjustable
Rate
Mortgage
% (B)
 

Pool 9 (H)

   $ 34,738,833         268,841         687         5.0     305         44         4.0

Pool 10 (H)

     95,407,638         571,417         703         5.2     269         90         42.7
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Total/Weighted Avg

   $ 130,146,471         840,258         699         5.1     279         78         32.4
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

 

    Collateral Characteristics (G)  
    Uncollected
Payments (C)
    Delinquency
30 Days (C)
    Delinquency
60 Days (C)
    Delinquency
90+ Days (C)
    Loans in
Foreclosure
    Real Estate
Owned
    Loans in
Bankruptcy
    1 Month
CPR (D)
    1 Month
CRR (E)
    1 Month
CDR (F)
 

Pool 9 (H)

    9.2     3.9     1.2     4.8     1.1     0.2     1.2     23.2     21.8     1.8

Pool 10 (H)

    31.5     3.5     1.5     19.3     7.0     2.5     3.9     16.9     10.5     7.2
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/Weighted Avg

    25.6     3.6     1.4     15.4     5.4     1.9     3.2     18.6     13.5     5.8
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(A) WA Original FICO Score represents the FICO score at the time the loan was originated.
(B) Adjustable Rate Mortgage % represents the percentage of the total principal balance of the pool that corresponds to adjustable rate mortgages.
(C) Uncollected Payments represents the percentage of the total principal balance of the pool that corresponds to loans for which the most recent payment was not made. Delinquency 30 Days, Delinquency 60 Days and Delinquency 90+ Days represent the percentage of the total principal balance of the pool that corresponds to loans that are delinquent by 30-59 days, 60-89 days or 90 or more days, respectively.
(D) 1 Month CPR, or constant prepayment rate, represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(E) 1 Month CRR, or the voluntary prepayment rate, represents the annualized rate of the prepayments during the month as a percentage of the total principal balance of the pool.
(F) 1 Month CDR, or the involuntary prepayment rate, represents the annualized rate of the involuntary prepayments (defaults) during the month as a percentage of the total principal balance of the pool.
(G) The collateral characteristics are presented as of May 31, 2013.
(H) Pools 9 and 10 are transactions that were committed to in January 2013. The closings are subject to certain closing requirements and regulatory approvals. Pool 9 closed subsequent to June 30, 2013. See Note 15 to the unaudited consolidated financial statements included elsewhere in this prospectus.

For information about the weighted average yield of our investments in Excess MSRs and about the geographic diversification of the underlying loans, see Notes 3 and 6 to our unaudited consolidated financial statements included elsewhere in this prospectus.

We currently expect to continue to make co-investments with Nationstar, and we may also acquire Excess MSRs from other servicers. Nationstar does not, however, have any obligation to offer us any future co-investment opportunity. In the event that we cannot co-invest in Excess MSRs with Nationstar, we may not be able to find other suitable counterparties from which to acquire Excess MSRs, which could have a material adverse effect on our business. At the same time, our co-investments with Nationstar expose us to counterparty concentration risk, which could increase if we do not or cannot acquire Excess MSRs from other counterparties or continue to pursue co-investments with Nationstar.

 

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Table of Contents

Agency ARM RMBS

The following table summarizes the reset dates of our Agency ARM RMBS portfolio as of June 30, 2013 (dollars in thousands):

 

Months
to Next
Reset (A)

  Number of
Securities
    Outstanding
Face Amount
    Amortized
Cost Basis (B)
    Percentage
of Total
Amortized
Cost Basis
    Carrying
Value (B)
    Weighted Average  
            Coupon     Margin     Periodic Cap     Lifetime
Cap (E)
    Months
to
Reset (F)
 
                1st
Coupon
Adjustment
(C)
    Subsequent
Coupon
Adjustment
(D)
     

1 - 12

    22      $ 177,904      $ 188,060        16.8   $ 189,177        2.6     1.6     N/A (G)      2.0     10.2     6   

13 - 24

    23        351,821        373,352        33.3     371,759        3.7     1.8     5.0     2.0     8.8     20   

25 - 36

    18        457,100        481,752        43.0     479,107        3.3     1.8     5.0     2.0     8.3     32   

Over 36

    3        73,125        77,182        6.9     75,899        2.9     1.8     5.0     2.0     7.9     43   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

    66      $ 1,059,950      $ 1,120,346        100.0   $ 1,115,942        3.3     1.8     5.0     2.0     8.7     24   
   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(A) Of these investments, 89.5% reset based on 12 month LIBOR index, 4.5% reset based on 6 month LIBOR Index, 1.5% reset based on 1 month LIBOR, and 4.5% reset based on the 1 year Treasury Constant Maturity Rate. After the initial fixed period, 97% of these securities will reset annually and 3% will reset semi-annually.
(B) Amortized cost basis and carrying value exclude $13.8 million of principal receivables as of June 30, 2013.
(C) Represents the maximum change in the coupon at the end of the fixed rate period.
(D) Represents the maximum change in the coupon at each reset date subsequent to the first coupon adjustment.
(E) Represents the maximum coupon on the underlying security over its life.
(F) Represents recurrent weighted average months to the next interest rate reset.
(G) Not applicable as 20 of the securities (96% of the current face of this category) are past the first coupon adjustment period. The remaining 2 securities (4% of the current face of this category) have a maximum change in the coupon of 5.0% at the end of the fixed rate period.

The following table summarizes the characteristics of our Agency ARM RMBS portfolio and of the collateral underlying our Agency ARM RMBS as of June 30, 2013 (dollars in thousands):

 

     Agency ARM RMBS Characteristics  

Vintage (A)

   Number of
Securities
     Outstanding
Face Amount
     Amortized
Cost Basis (C)
     Percentage of
Total
Amortized
Cost Basis
    Carrying
Value(C)
     WAL
(Years)
 

Pre-2005

     12       $ 75,349       $ 79,650         7.1   $ 80,288         4.7   

2006

     3         31,044         33,117         2.9     33,178         2.7   

2007

     4         15,690         16,396         1.5     16,653         5.9   

2008

     3         16,542         17,613         1.6     17,648         4.4   

2009

     8         90,842         96,884         8.6     96,748         2.7   

2010

     21         332,931         351,523         31.4     350,550         2.3   

2011

     12         340,063         358,116         32.0     355,721         2.5   

2012 and later

     3         157,489         167,047         14.9     165,156         5.9   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total / WA

     66       $ 1,059,950       $ 1,120,346         100.0   $ 1,115,942         3.2   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Collateral
Characteristics
 

Vintage (A)

   3 Month CPR (B)  

Pre-2005

     27.4

2006

     27.3

2007

     33.8

2008

     15.3

2009

     34.9

2010

     42.1

2011

     39.1

2012 & After

     29.8
  

 

 

 
     36.7
  

 

 

 

 

(A) The year in which the securities were issued.
(B) Three month average constant prepayment rate.
(C) Amortized cost basis and carrying value exclude $13.8 million of principal receivables as of June 30, 2013.

The following table summarizes the net interest spread of our Agency ARM RMBS portfolio as of June 30, 2013:

 

Net Interest Spread (A)

 

Weighted Average Asset Yield

     1.47

Weighted Average Funding Cost

     0.39
  

 

 

 

Net Interest Spread

     1.08
  

 

 

 

 

(A) The entire Agency ARM RMBS portfolio consists of floating rate securities.

Non-Agency RMBS

The following tables summarize the characteristics of our Non-Agency RMBS portfolio and of the collateral underlying our Non-Agency RMBS as of June 30, 2013 (dollars in thousands):

 

    Non-Agency RMBS Characteristics  

Vintage (A)

  Average
Minimum
Rating (B)
  Number of
Securities
    Outstanding
Face
Amount
    Amortized
Cost Basis
    Percentage
of Total
Amortized
Cost Basis
    Carrying
Value
    Principal
Subordination
(C)
    Excess
Spread (D)
    Weighted
Average
Life
(Years)
 

Pre 2004

  CCC-     46      $ 48,279      $ 39,441        6.5   $ 40,886        14.4     3.0     3.5   

2004

  B-     9        66,242        41,109        6.8     47,931        15.2     4.4     3.6   

2005

  CC     9        100,625        74,299        12.3     71,655        15.5     3.8     4.8   

2006

  CC     18        486,668        302,610        49.9     310,694        2.0     3.7     3.9   

2007 and later

  CC     16        226,089        148,376        24.5     158,287        8.9     4.0     3.1   
 

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total/WA

  CC     98      $ 927,903      $ 605,835        100.0   $ 629,453        6.7     3.8     3.8   
 

 

 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

     Collateral Characteristics(H)  

Vintage (A)

   Average Loan
Age (years)
     Collateral
Factor (E)
     3 month
CPR (F)
    Delinquency
(G)
    Cumulative
Losses to Date
 

Pre 2004

     10.3         0.08         16.0     14.5     1.3

2004

     8.8         0.08         12.0     19.2     3.6

2005

     8.1         0.11         15.0     23.9     6.3

2006

     6.9         0.28         16.0     30.6     24.1

2007 and later

     6.1         0.37         16.0     34.3     29.4
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total / WA

     7.2