Note 5 — Investments in Servicing Related Assets

In October 2013, the Company entered into an agreement (“MSR Agreement 1”) with Freedom Mortgage Corporation (“Freedom Mortgage”) to invest in Excess MSRs with Freedom Mortgage. Freedom Mortgage originated the mortgage servicing rights on the related pool of residential fixed rate Ginnie Mae-eligible FHA and VA mortgage loans with an aggregate unpaid principal balance (“UPB”) of approximately $10.0 billion (“MSR Pool 1”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of approximately 28 basis points (“bps”) on the performing UPB, as well as any ancillary income from MSR Pool 1. Pursuant to MSR Agreement 1, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 1 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 8 bps. The remainder, or “excess mortgage servicing amount,” is initially equal to a weighted average of 20 bps.

The Company acquired the right to receive 85% of the excess mortgage servicing amount on MSR Pool 1 and, subject to certain limitations and pursuant to a loan replacement agreement (the “MSR Pool 1—Recapture Agreement”), 85% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool l (which loans then become part of MSR Pool 1) for approximately $60.6 million. Freedom Mortgage has co-invested, pari passu with the Company, in 15% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 85%, of such termination payment.

The value, and absolute amount, of recapture activity tends to vary inversely with the direction of interest rates. When interest rates are falling, recapture rates tend to be higher due to increased opportunities for borrowers to refinance. As interest rates increase, however, there is likely to be less recapture activity.

In October 2013, the Company entered into an agreement (“MSR Agreement 2”) with Freedom Mortgage to invest with Freedom Mortgage in another pool of Excess MSRs. Freedom Mortgage acquired the mortgage servicing rights from a third-party seller on a pool of residential Ginnie Mae-eligible VA hybrid adjustable rate mortgage loans with an outstanding principal balance of approximately $10.7 billion (“MSR Pool 2”). Freedom Mortgage is entitled to receive an initial weighted average total mortgage servicing amount of 44 bps on the performing UPB, as well as any ancillary income from MSR Pool 2. Pursuant to MSR Agreement 2, Freedom Mortgage performs all servicing functions and advancing functions related to MSR Pool 2 for a basic fee (the amount representing reasonable compensation for performing the servicing duties) of 10 bps. Therefore, the remainder, or “excess mortgage servicing amount” is initially equal to a weighted average of 34 bps.

The Company acquired the right to receive 50% of the excess mortgage servicing amount on MSR Pool 2 and, subject to certain limitations and pursuant to a loan replacement agreement (the “MSR Pool 2—Recapture Agreement”), 50% of the Excess MSRs on future mortgage loans originated by Freedom Mortgage that represent refinancings of loans in MSR Pool 2 (which loans then become part of MSR Pool 2) for approximately $38.4 million. Freedom Mortgage has co-invested, pari passu with the Company, in 50% of the Excess MSRs. Freedom Mortgage, as servicer, also retains the ancillary income and the servicing obligations and liabilities. If Freedom Mortgage is terminated as the servicer, the Company’s right to receive its portion of the excess mortgage servicing amount is also terminated. To the extent that Freedom Mortgage is terminated as the servicer and receives a termination payment, the Company is entitled to a pro rata share, or 50%, of such termination payment.

Upon completion of the IPO and the concurrent private placement, the Company also entered into a flow and bulk Excess MSR purchase agreement related to future purchases of Excess MSRs from Freedom Mortgage. On February 28, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the first quarter of 2014 with an UPB of approximately $76.8 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $567,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On March 31, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by a third party originator with an aggregate UPB of approximately $159.8 million. Freedom Mortgage purchased the MSRs on these mortgage loans from a third party on January 31, 2014. The Company acquired an approximate 71% interest in the Excess MSRs for approximately $946,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

On June 30, 2014, pursuant to the flow and bulk Excess MSR purchase agreement, the Company purchased from Freedom Mortgage Excess MSRs on mortgage loans originated by Freedom Mortgage during the second quarter of 2014 with an aggregate UPB of approximately $98.1 million. The Company acquired an approximate 85% interest in the Excess MSRs for approximately $661,000. The terms of the purchase include recapture provisions that are the same as those in the Excess MSR acquisition agreements the Company entered into with Freedom Mortgage in October 2013.

The mortgage loans underlying the Excess MSRs purchased in 2014 are collectively referred to as “Pool 2014,” and the recapture provisions, which are identical, are collectively referred to as the “Pool 2014—Recapture Agreement.”

On May 29, 2015, in conjunction with the acquisition of Aurora, we acquired MSRs on conventional mortgage loans with an aggregate UPB of approximately $712.3 million as of June 30, 2015. We have not entered into a recapture agreement covering the MSRs as of June 30, 2015.

On June 10, 2015, the Company agreed to transfer the direct servicing of the MSR portfolio to Freedom Mortgage pursuant to a subservicing agreement between CHMI Solutions and Freedom Mortgage. Due to the requirements of the agencies and the Consumer Financial Protection Bureau, the transfer is scheduled to occur in September 2015. Pending the transfer, the former servicing employees of Aurora, now employees of Freedom Mortgage, will directly service the portfolio for Aurora. The servicing will be provided at cost pursuant to the Management Agreement with the Manager and the Services Agreement between the Manager and Freedom Mortgage. The cost for such services for June 2015 was $45,000 and is included in servicing costs on the consolidated statements of income (loss).

The following is a summary of the Company’s Servicing Related Assets (dollars in thousands):

Servicing Related Assets Summary

As of June 30, 2015


	Unpaid Principal Balance		Amortized Cost Basis^(A)		Carrying Value^(B)		Weighted Average Coupon			Weighted Average Maturity (Years)^(C)		Changes in Fair Value Recorded in Other Income (Loss)^(D)
Pool 1	$	8,033,836	$	43,914	$	48,421		3.51	%		26.5	$	(1,939	)
Pool 1 - Recapture Agreement		—		2,900		634							23
Pool 2		7,860,186		20,098		33,969		2.75	%		27.5		4,220
Pool 2 - Recapture Agreement		—		2,554		785							(477	)
Pool 2014		284,958		1,906		1,711		3.65	%		27.9		238
Pool 2014 - Recapture Agreement		—		—		—							—
MSRs		712,296		7,008		7,046		4.06	%		23.3		38.0

Total	$	16,891,276	$	78,380	$	92,566		3.18	%		26.9	$	2,103

As of December 31, 2014


	Unpaid Principal Balance		Amortized Cost Basis^(A)		Carrying Value^(B)		Weighted Average Coupon			Weighted Average Maturity (Years)^(C)		Changes in Fair Value Recorded in Other Income (Loss)^(D)
Pool 1	$	8,715,747	$	47,741	$	54,187		3.51	%		27.0	$	(2,889	)
Pool 1 - Recapture Agreement		—		2,900		611							(371	)
Pool 2		8,475,975		24,025		33,676		2.77	%		27.8		2,011
Pool 2 - Recapture Agreement		—		2,554		1,262							(1,882	)
Pool 2014		308,562		2,019		1,586		3.71	%		28.4		(433	)
Pool 2014 - Recapture Agreement		—		—		—							—

Total	$	17,500,284	$	79,239	$	91,322		3.16	%		27.4	$	(3,564	)

(A)	The amortized cost basis of the recapture agreements is determined based on the relative fair values of the recapture agreements and related Excess MSRs at the time they were acquired.

(B)	Carrying value represents the fair value of the pools or recapture agreements, as applicable (see Note 9).

(C)	The weighted average maturity represents the weighted average expected timing of the receipt of cash flows of each investment.

(D)	The portion of the change in fair value of the recapture agreement relating to loans recaptured as of June 30, 2015 and December 31, 2014 is reflected in the respective pool.

The tables below summarize the geographic distribution for the states representing 5% or greater of the underlying residential mortgage loans of the Servicing Related Assets:

Geographic Concentration of Servicing Related Assets

As of June 30, 2015


	Percentage of Total Outstanding Unpaid Principal Balance
California		11.9	%
Texas		9.7	%
Florida		6.7	%
Virginia		6.3	%
North Carolina		5.5	%
Georgia		5.2	%
All other		54.7	%

Total		100.0	%

As of December 31, 2014


	Percentage of Total Outstanding Unpaid Principal Balance
California		13.3	%
Texas		10.1	%
Florida		6.9	%
Virginia		6.5	%
North Carolina		5.7	%
Georgia		5.3	%
Washington		5.1	%
All other		47.1	%

Total		100.0	%

Geographic concentrations of investments expose the Company to the risk of economic downturns within the relevant states. Any such downturn in a state where the Company holds significant investments could affect the underlying borrower’s ability to make the mortgage payment and, therefore, could have a meaningful, negative impact on the Company’s Servicing Related Assets.