Item 1A. Risk Factors
You should carefully consider the following factors, together with all the other information included in this 2025 Form 10-K, in evaluating our company and our business. If any of the following risks actually occur, our business, financial condition and results of operations could be materially and adversely affected, and the value of our stock could decline. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. As such, you should not consider this list to be a complete statement of all potential risks or uncertainties.
Summary Risk Factors
Risks Related to Financing
• Our inability to access funding, our cost of funding or the terms on which such funding is available could have a material adverse effect on our financial condition, liquidity or profitability.
• An increase in our borrowing costs relative to the interest we receive on our assets may materially adversely affect our profitability.
• We may not achieve what we believe to be optimal levels of leverage or we may become overleveraged, which may materially adversely affect our liquidity, results of operations, profitability or financial condition.
• Failure to effectively manage our liquidity could adversely affect our results and financial condition.
• Our financing facilities may contain covenants that restrict our business activities.
• We may have difficulty accessing or be unable to access capital markets.
Risks Associated with Our Investments
• Interest rate fluctuations and changes in the yield curve may have various negative effects on us and may lead to reduced earnings, increased volatility in our earnings, and reduction in our book value.
• The impact of inflation and related monetary policy efforts may adversely affect our financial performance.
• The nature of the mortgage loans we acquire and that underlie the RMBS we acquire exposes us to credit risk that could negatively affect the value of those assets and investments.
• A significant portion of our investments are in the most subordinated first-loss position of the capital structure of Non-Agency RMBS, disproportionately exposing us to credit risk.
• A significant portion of the RMBS we acquire through securitization is subject to the Risk Retention Rules.
• We have a significant amount of investments in Non-Agency RMBS collateralized by mortgage loans that do not meet the prime loan underwriting standards and are subject to increased risk of losses.
• Our investments in mortgage loans and MSRs depend on the performance of third-party mortgage servicers.
• Falling rates may accelerate mortgage prepayments, reducing future servicing income and decreasing MSR valuations.
• We may be required to fund servicing advances on delinquent loans with respect to our MSR investments, which could create liquidity demands, particularly during market downturns or periods of increased borrower distress.
• Changes in prepayment rates could negatively affect the value of our investment portfolio, which could result in reduced earnings, book value impairments, and/or negatively affect the cash available for distribution to our stockholders.
• A significant portion of our Non-Agency RMBS and residential loans are secured by properties in a small number of geographic areas and may be disproportionately affected by adverse events in those markets.
• We may change our investment strategy, adjust our asset allocation, or enter other operating businesses or financing plans without stockholder consent.
• Changes in the fair values of our assets, liabilities, and derivatives can reduce earnings, affect liquidity, increase earnings volatility, and create variability in our book value.
• Our calculations of the fair value of the assets we own or consolidate as well as liabilities related to consolidated securitizations are based upon assumptions that are inherently subjective, and the failure to realize such valuations may have a material adverse effect on our financial condition.
• Any deterioration or uncertainty in market conditions for mortgages and mortgage-related assets, as well as in broader U.S. and global economic and geopolitical conditions, could have a material adverse effect on us.
Risks Related to Our Recent Acquisition and Loan Origination and Acquisition Business
• We may fail to realize the expected benefits of the HomeXpress Acquisition.
• Our loan origination and acquisition volume and ability to sell loans are highly dependent on macroeconomic and U.S. residential real estate market conditions.
• A disruption in the secondary home loan market, our ability to sell the loans that we originate or acquire, or loan compliance issues could have a negative effect on our business.
• Our subsidiary, HomeXpress, relies on warehouse facilities, structured as repurchase agreements, to finance loan originations and acquisitions. These facilities are short-term and subject us to various risks.
• Our business is dependent on our ability to maintain and expand our relationships with our clients, the independent mortgage brokers and bankers.
• Our mortgage loans are primarily initiated by third parties, which exposes us to business and other risks.
Risks Related to Our Investment Management and Advisory Services
• Our investment management and advisory services involve certain risks, which could adversely affect our business, financial condition and results of operations.
• Our failure to appropriately manage or address conflicts of interest could damage our reputation.
• Two of our subsidiaries are currently required to be registered as an investment adviser or a relying adviser, subjecting us to extensive regulation and examination by the SEC.
• Our asset management and advisory services business has significant client concentration. Failure to attract, grow, and retain a diverse and balanced client base could adversely affect our asset management and advisory services business.
Risks Related to Hedging
• Hedging against interest rate exposure may not be successful in mitigating the risks associated with interest rates and may reduce our cash and adversely affect our financial condition and result of operations.
• We may enter into hedging instruments that could expose us to contingent liabilities in the future, which could materially adversely affect our results of operations.
• The characteristics of hedging instruments present various concerns, including illiquidity, enforceability, and counterparty risks, which could adversely affect our business and results of operations.
Risks Associated with Our Operations
• Through certain of our wholly owned subsidiaries we may from time to time engage in securitization transactions relating to residential mortgage loans, which may expose us to potentially material risks.
• Our ability to profitably execute future securitization transactions may be negatively impacted by adverse market conditions.
• Competition may affect our ability to source our target assets at attractive prices and grow our investment management and advisory services, which may have a material adverse effect on our business, financial condition and results of operations.
• Risks related to servicers and other third parties, including their ability to perform their services at a high level and comply with applicable laws, may have an adverse impact on our business.
• Our use of third-party analytical models and data introduce risks related to model accuracy that may have an adverse effect on our execution of investment activities.
• We are dependent on information technology and systems and their failure, including through cyber-attacks, could significantly disrupt our business.
• The development, proliferation and use of artificial intelligence could give rise to legal and/or regulatory action, damage our reputation or otherwise materially impact our business, financial condition, and liquidity.
• The loss of key employee may materially adversely affect our business.
Risks Related to Regulatory Matters, Accounting, and Our 1940 Act Exemption
• Our business is subject to extensive regulation that may subject us to significant costs and compliance requirements, and there can be no assurance that we will satisfactorily comply with such regulations.
• There is no assurance we will be able to obtain various state licenses to purchase mortgage loans.
• Loss of our 1940 Act exemption would negatively affect our share price, our ability to distribute dividends, and us generally.
U.S. Federal Income Tax Risks and Risk Related to Our REIT Status
• Risks related to compliance with REIT requirements, our qualification as a REIT and our election to qualify as a REIT.
• Distributions or gain on sale may be treated as unrelated business taxable income to tax-exempt investors.
• Classification of our securitizations or financing arrangements as a taxable mortgage pool could subject us or certain of our stockholders to increased taxation.
• Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.
Risks Related to Our Organization and Structure
• Certain provisions of Maryland Law, of our charter, and of our bylaws may inhibit potential acquisition bids that stockholders may consider favorable and may affect the market price of our capital stock
Risks Related to Financing
Our inability to access funding, our cost of funding or the terms on which such funding is available could have a material adverse effect on our financial condition, liquidity or profitability, particularly during times of severe market disruption in the financial, mortgage, housing or related sectors.
Our ability to fund our operations, meet financial obligations and finance target asset acquisitions may be impacted by our ability to secure and maintain our financing arrangements, including repurchase agreements, secured financing trusts and warehouse facilities with our counterparties. Because repurchase agreements and warehouse facilities are often short-term commitments of capital, lenders may respond to market conditions by making it more difficult for us to renew or replace on a continuous basis our maturing short-term borrowings and have and may continue to impose more onerous conditions when rolling such financings. For example, times of significant dislocation in the financial markets may result in lenders being unwilling or unable to provide us with financing, which could force us to sell assets at an inopportune time or negatively affect lenders’ valuation of our target assets which may result in margin calls, requiring a pledge of additional collateral or cash to re-establish the required ratio of borrowing to collateral value under our repurchase agreements. In addition, the regulatory capital requirements imposed on our lenders may change, or our lenders may revise their eligibility requirements for the types of assets they are willing to finance or the terms of such financings, including requiring additional collateral in the form of cash, which may affect our ability to fund our operations. If we are not to renew our existing facilities or arrange for new financing on terms acceptable to us, or if we on our covenants or are otherwise to access funds under our financing facilities, or if we are required to post more collateral or face larger haircuts or if we otherwise to effectively manage and maintain our liquidity resources, we may have to our asset acquisition activities and/or of assets at a . In addition, posting additional collateral or cash to support our credit will reduce our liquidity and limit our ability to leverage our assets, which could materially affect our business.
An increase in our borrowing costs relative to the interest income we receive on our assets may materially adversely affect our profitability.
Our earnings are primarily generated from the difference between the interest income we earn on our investment portfolio, less net amortization of purchase premiums and discounts, and the interest expense we pay on our borrowings. During a period of rising or elevated interest rates, our borrowing costs generally will increase at a faster pace than our interest earnings on the leveraged portion of our investment portfolio, which could result in a decline in our net interest spread and net interest margin. We may rely on borrowings under repurchase agreements to finance our investments, which have short-term contractual maturities, or we may use longer-term mark-to-market, non-MTM, and limited MTM financing, which may be more expensive than traditional short-term mark-to-market financing but offers more certainty with respect to funding availability. In general, if the interest expense on our borrowings increases relative to the interest income we earn on our investments, our profitability may be materially adversely affected.
Our business strategy involves the use of leverage. We may not achieve what we believe to be optimal levels of leverage or we may become overleveraged, which may materially adversely affect our liquidity, results of operations, profitability or financial condition.
Our business strategy involves the use of borrowing, or leverage. Pursuant to our leverage strategy, we borrow against a substantial portion of our assets and use the borrowed funds to finance our investment portfolio and the acquisition of additional investment assets. Future increases in the amount by which the collateral value is required to contractually exceed the amount borrowed in such leverage financing transactions, decreases in the market value of our residential mortgage investments, increases in interest rate volatility and changes in the availability of acceptable financing from our existing lenders or alternative sources could cause us to be unable to achieve the amount of leverage we believe to be optimal for achieving our profitability objectives. The return on our assets and cash available for distribution to our stockholders may be reduced to the extent that changes in market conditions prevent us from achieving the desired amount of leverage on our investments or cause the cost of our financing to increase relative to the income earned on our leveraged assets. For certain investments we may evaluate the feasibility of entering into non-MTM financing in order to mitigate liquidity risks related to interest rates and credit market conditions. Non-MTM facilities typically have higher interest rates and deleveraging provisions which reduce the net cash we receive from underlying assets. If the interest income on the investments that we have purchased with borrowed funds to cover the interest expense of the related borrowings, we will experience net interest and may experience net from operations. Such could be significant because of our leveraged structure. The risks associated with leverage are more acute during periods of economic or and may further our ability to what we believe to be optimal levels of leverage or increase our risk of becoming overleveraged. The use of leverage to finance our investments involves many other risks, including, among other things, the following:
• If we or a counterparty to our repurchase transactions defaults on its obligation under the repurchase agreement, we could incur losses. When we engage in repurchase transactions, we generally sell assets to the counterparty to the agreement for cash. Because the cash we receive from the counterparty is less than the value of those securities (this difference is referred to as the “haircut”), if the lender defaults on its obligation to transfer the same securities back to us, we would incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the securities). See Item 7, “Management’s Discussion
and Analysis of Financial Condition and Results of Operations” of this 2025 Form 10-K, for further discussion regarding risks related to exposure to financial institution counterparties. Generally, if we default on a repurchase transaction, the counterparty could liquidate the assets and use the proceeds to repay the amounts it is owed. If the amount received from the sale is equal to or less than the amount owed, we will incur a loss equal to the haircut and the counterparty has recourse to us to repay any remaining deficiency. In addition, if we default on a transaction under any one agreement and fail to honor the related guarantee, the counterparties to our other repurchase agreements could also declare a default under their respective repurchase agreements. Any losses we incur on our repurchase transactions could materially adversely affect our earnings and thus our cash available for distribution to our stockholders and could also adversely affect our liquidity.
• Adverse developments involving major financial institutions or involving one of our lenders could result in a rapid reduction in our ability to borrow and materially adversely affect our business, profitability, and liquidity. As of December 31, 2025, we had amounts outstanding under repurchase agreements with 20 separate lenders, including amounts at risk with Nomura Securities International, Inc. (“Nomura”), of 18% of our equity related to the collateral posted on secured financing agreements. A material adverse development involving one or more major financial institutions or the financial markets, in general, could result in us reducing exposure to certain lenders to mitigate credit risk or our lenders reducing our access to funds available under our repurchase agreements or terminating such repurchase agreements altogether. Because substantially all our repurchase agreements are uncommitted and renewable at our lenders’ discretion, our lenders could determine to reduce or terminate our access to future borrowings at virtually any time, which could materially adversely affect our business and profitability. Furthermore, if a few of our lenders became or to continue to provide us with financing, we could be to sell assets, including assets in unrealized positions, to maintain liquidity. sales, particularly under market conditions, could result in lower sale prices than ordinary market sales made in normal market conditions. If our investments were at prices below our amortized cost of such assets, we would incur , which would affect our earnings.
• Our use of repurchase agreements to borrow money may give our lenders greater rights in the event of bankruptcy. In the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment under the Bankruptcy Code, the effect of which, among other things, would be to allow the creditor under the agreement to avoid the automatic stay provisions of the Bankruptcy Code and take possession of, and liquidate, the collateral under such repurchase agreements without delay.
• A recharacterization of the repurchase agreements as sales for tax purposes rather than as secured lending transactions would adversely affect our ability to maintain our qualification as a REIT and to maintain our 1940 Act exemption. When we enter into a repurchase agreement, we generally sell assets to our counterparty to the agreement for cash. The counterparty is obligated to resell the assets back to us at the end of the transaction term. We believe that for U.S. federal income tax purposes we will be treated as the owner of the assets that are the subject of repurchase agreements and that the repurchase agreements will be treated as secured lending transactions notwithstanding that such agreement may transfer record ownership of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS or the SEC could successfully assert that we did not own these assets during the term of the repurchase agreements, in which case we could fail to qualify as a REIT or fail to maintain our 1940 Act exemption, respectively.
• Our financing facilities may contain covenants that restrict our operations. Certain financing facilities we may enter into contain restrictions, covenants, and representations and warranties that, among other things, require us to satisfy specified financial, asset quality, loan eligibility, and loan performance tests. If we fail to meet or satisfy any of these covenants or representations and warranties, we would be in default under these agreements and our lenders could elect to declare all amounts outstanding under the agreements to be immediately due and payable, enforce their respective rights against collateral pledged under such agreements, and restrict our ability to make additional borrowings. Certain financing agreements may contain cross-default provisions by a guarantor so that if a default occurs under any guaranty agreement, the lenders under our other financing agreements could also declare a default under their respective agreements. Further, under our mark-to-market agreements, we are typically required to pledge additional assets to our lenders in the event the estimated fair value of the existing pledged collateral under such agreements and such lenders demand additional collateral, which may take the form of additional securities, loans or cash. These
restrictions may interfere with our ability to obtain financing or to engage in other business activities, which may have a significant negative impact on our business, financial condition, liquidity and results of operations. A default and resulting repayment acceleration could significantly reduce our liquidity, which could require us to sell our assets to repay amounts due and outstanding whether or not the prices and terms of such sales are favorable to us. A default will also significantly limit our financing alternatives such that we will be unable to pursue our leverage strategy, which could lower our investment returns. This could also significantly harm our business, financial condition, results of operations, and our ability to make distributions, which could cause the value of our stock to decline.
We may have difficulty accessing or be unable to access capital markets.
We may not be able to readily raise capital from external sources in a timely manner or on favorable terms. Many of the same factors that could make the pricing for investments in real estate loans and securities attractive, such as the availability of assets from distressed owners who need to liquidate them at reduced prices, and uncertainty about credit risk, housing, and the economy, may limit investors’ and lenders’ willingness to provide us with additional capital on terms that are favorable to us, if at all. These risks may be more acute during periods of heightened volatility in securities prices in the mortgage sector, making it more difficult to raise capital accretive to our earnings, book value and overall results of operations. There may also be other reasons we are not able to readily raise capital in a timely manner or on favorable terms, and, as a result, may not be able to finance growth in our business and in our portfolio of assets and we could experience other impacts. To the extent we need to raise capital on terms, we may experience dilution of existing shareholders, higher interest costs, or higher transaction costs.
Risks Associated with Our Investments
Interest rate fluctuations, including as a result of the Federal Reserve's monetary policy, may have various negative effects on us and may reduce the market value of our investments and negatively affect our book value, earnings and cash available for distribution, as well as increasing volatility.
Changes in interest rates, the interrelationships between various rates, interest rate volatility, and the shape of the yield curve, including changes to the Federal Reserve’s interest rate policies in response to inflation, labor market conditions and other economic factors, may have negative effects on our earnings, the fair value of our assets and liabilities, loan prepayment rates, and our access to liquidity. For example, interest rate changes, particularly increases in interest rates, could have one more of the following consequences:
• Some of the loans and securities we own or may acquire have adjustable-rate coupons or may be subordinate securities entitled to cash flow only after the more senior securities have been paid. As such, the cash flows and earnings we receive from these assets may vary as a function of interest rates.
• Changes in interest rates may harm the credit performance of our assets and result in costlier financing, which may affect our earnings results, reduce our ability to securitize, re-securitize, or sell our assets, or reduce our liquidity.
• Higher interest rates could reduce mortgage borrowers’ ability to make interest payments or to refinance their loans, reduce property values, lead to increased credit losses, and reduce mortgage originations, thus reducing our opportunities to acquire or originate new assets.
• Our investment portfolio contains a significant allocation to MBS and residential loans, which are generally sensitive to changes in long-term interest rates. In a rising rate environment, the market value of longer-duration investments typically declines. As interest rates increase, the duration and weighted average life of our target assets may also extend, further magnifying potential declines in value. Decreases in the market value of these investments may reduce our earnings or result in realized losses, which could negatively impact our stockholders by reducing the cash available for distribution and/or book value.
• If both short-term and long-term interest rates rise significantly, we may be subject not only to higher financing costs on our repurchase agreements but also to declining valuations in our portfolio. These combined pressures may reduce our net income, book value, and overall financial performance. If these
conditions persist, they may have a material adverse effect on our results of operations and our ability to make distributions to our stockholders.
We may seek to hedge a majority of, but not all interest rate risks. Our hedging may not work effectively or be successful at all, and we may change our hedging strategies or the degree or type of interest rate risk we assume.
Changes in the yield curve may cause differences in timing between interest rate adjustments on our interest-earning assets and our borrowings, adversely affecting our net interest spread, and may impact our assets and liabilities differently, adversely affecting our book value if our assets are negatively impacted or the value of our liabilities increase.
Our earnings depend, in part, on the difference between the interest income on our interest-earning assets and the interest expense on our borrowings. The relationship between short-term and longer-term interest rates is often referred to as the “yield curve.” In a normal yield curve environment, short-term interest rates are lower than longer-term interest rates. If short-term rates rise disproportionately relative to longer-term rates (often called a “flattening” or “inversion” of the yield curve), our borrowing costs generally increase more rapidly than the interest income we earn, compressing our net interest margin. Because our assets, on average, bear interest based on longer-term rates than our borrowings, a flattening or inversion of the yield curve would tend to decrease our net interest margin, net income, book value, and the market value of our net assets. In the event that short-term rates exceed longer-term rates, we could experience negative net interest spread and incur operating losses.
Additionally, when principal from our investments is returned (either through scheduled or unscheduled payments) and must be reinvested in new assets, the spread between the yields on new investments and our available borrowing rates may narrow. This reinvestment dynamic could further reduce our net income. Changes in the yield curve may also affect the pace and profitability of securitization transactions if the market environment becomes less favorable for issuing or pricing securitized products. In addition, changes in the shape of the yield curve may impact our assets and liabilities differently, and when such changes negatively impact the value of our assets, or increase the value of our liabilities, it may adversely affect our book value.
The impact of inflation and related monetary policy efforts may adversely affect our financial performance.
Certain actions taken by the U.S. government, including the Federal Reserve, may impact our results. In response to concerns about inflation, labor market conditions, or other economic factors, the Federal Reserve may adjust monetary policy. Given our reliance on short-term borrowings to generate interest income, if the yield curve were to flatten or even invert, or if the Federal Reserve finds itself falling behind on inflation and more aggressively tightens monetary policy, our results of operations, financial condition and business could be materially adversely impacted.
The nature of the mortgage loans we acquire and that underlie the RMBS and MSRs we acquire exposes us to credit risk that could negatively affect the value of those assets and investments.
We assume credit risk primarily through the ownership of MSRs and securities backed by residential, multi-family, and commercial real estate loans and through direct investments in residential real estate loans. The substantial majority of our investment assets are subject to various credit risks, as discussed below.
No U.S. Government Guarantee . We acquire residential loans including reperforming loans, nonperforming loans, Non-QMs, jumbo prime loans, and RTLs, which are subject to increased risk of loss. Unlike Agency RMBS, Non-Agency RMBS and residential mortgage loans generally are not guaranteed by the U.S. Government or any GSEs such as Fannie Mae and Freddie Mac. Additionally, by directly acquiring residential loans, we do not receive the structural credit enhancements that benefit senior tranches of RMBS. A residential loan is directly exposed to losses resulting from a borrower default. Therefore, the value of the underlying property, the creditworthiness and financial position of the borrower, and the priority and enforceability of the lien will significantly impact the value of such mortgage loan. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, and any costs or delays involved in the or process may increase . In addition, may be assessed us because of our position as a mortgage holder or property owner, including assignee liability, environmental , and other liabilities. We could also be responsible for property taxes. In some cases, these may lead to exceeding the purchase price of the related mortgage or property. The occurrence of any of these risks could materially impact our results of operations, financial condition, and business.
Non-QM Loan Risks . In addition, we acquire and may retain Non-QMs that will not have the benefit of enhanced legal protections otherwise available to residential mortgage loans originated to a more restrictive credit standard than just determining a borrower’s ability to repay. The ownership of Non-QMs subjects us to legal, regulatory and other risks, including
those arising under federal consumer protection laws and regulations designed to regulate residential mortgage loan underwriting and originators’ lending processes, standards, and disclosures to borrowers. Failure of residential mortgage loan originators or servicers to comply with the CFPB’s Ability-to-Repay Rule could subject us, as an assignee or purchaser of these loans (or as an investor in securities backed by these loans), to monetary penalties assessed by the CFPB through its administrative enforcement authority and by mortgagors through a private right of action against lenders or as a defense to foreclosure, including by recoupment or setoff of finance charges and fees collected, and could result in rescission of the affected residential mortgage loans, which could adversely impact our business and financial results.
Lower Underwriting Standards Risk. A majority of the Non-Agency RMBS we have acquired on the secondary market or retained in our securitizations are backed by collateral pools containing mortgage loans that were originated using underwriting standards that were less strict than those used in underwriting conventional or prime credit quality mortgage loans. These lower standards permitted mortgage loans, often with LTV ratios exceeding 80%, to be made to borrowers having impaired credit histories, lower credit scores, higher debt-to-income ratios or unverified income. Such mortgage loans are likely to experience delinquency, foreclosure, bankruptcy, and other losses at rates that are higher than those experienced by conventional or prime credit quality mortgage loans. Thus, the performance of our Non-Agency RMBS that are backed by these types of loans could be correspondingly worse than those backed by other types of mortgage loan products, especially during times of economic stress, which could materially adversely impact our results of operations, financial condition, and business.
Greater General Credit Risks . In addition, credit losses on residential real estate loans can occur for many reasons (many of which are beyond our control), including, but not limited to: fraud; poor underwriting; poor servicing practices; weak economic conditions; increases in payments required to be made by borrowers; declines in the value of homes; earthquakes, the effects of climate change (including flooding, drought, wildfire and severe weather), and other natural disaster events; uninsured property loss; borrower over-leveraging; costs of remediation of environmental conditions, such as indoor mold; changes in zoning or building codes and the related costs of compliance; acts of war or terrorism; pandemics; changes in legal protections for borrowers and other changes in law or regulation; and personal events affecting borrowers, such as reduction in income and job . Additionally, the amount and timing of credit could be affected by loan modifications, and , reductions in mortgage debt by courts, in the process, documentation , or missing collateral files, and other actions by servicers. in the U.S. economy or the housing market could cause our credit to increase beyond levels that we currently anticipate.
A significant portion of our investments are in Non-Agency RMBS that are the most subordinate securities in securitizations, making us the first-loss security holder, which means these securities are subject to significant credit risk, are illiquid, and are difficult to value.
A significant portion of our Non-Agency RMBS are subordinate classes we have acquired through securitization of mortgage loans. The mortgage loans we have securitized are generally recorded on our balance sheet as “securitized mortgage loans” for GAAP purposes, but in effect we own these assets in the form of securities. A substantial portion of the mortgage loans that we securitize and the subordinate securities that we retain are not newly originated “prime mortgage loans” but rather seasoned reperforming mortgage loans and Non-QM loans that have less strict underwriting standards and are therefore subject to greater risk of loss.
When we securitize mortgage loans, we sell the most senior and mezzanine securities backed by those loans and retain the most subordinate classes of securities, which means we are the first-loss security holder and the securities we own represent a portion of the “securitized mortgage loans” on our balance sheet. Losses on any residential mortgage loan securing our RMBS will be borne first by the owner of the property (i.e., the owner will first lose any equity invested in the property) and, thereafter, by us as the first-loss security holder, and then by holders of more senior securities. If the losses incurred upon loan default exceed any reserve fund, letter of credit, and classes of securities junior to those we own (if any), we may not be able to recover our investment in such securities. Also, if the underlying properties have been overvalued by the originating appraiser or if the values subsequently decline resulting in less collateral available to satisfy interest and principal payments due on the related security, as the first- security holder, we may a total of our investment, followed by on the more senior securities (or other RMBS that we may own). with respect to these investments, which are subject to significant credit risk, could increase or otherwise be higher than anticipated. For a description of the credit risk we are to, see the Risk Factor above captioned “The nature of the mortgage loans we acquire and that underlie the RMBS and MSRs we acquire us to credit risk that could affect the value of those assets and investments.”
In addition, many of our Non-Agency RMBS securities are first loss and subject to the Risk Retention Rules. Pursuant to the Risk Retention Rules, when we sponsor a residential mortgage loan securitization, we are required to retain at least 5% of the fair value of the MBS issued in the securitization. We can retain either an “eligible vertical interest” (which consists of at least 5% of each class of securities issued in the securitization), an “eligible horizontal residual interest” (which is the most
subordinate class of securities with a fair market value of at least 5% of the aggregate credit risk) or a combination of both totaling 5% (the “Required Credit Risk”). We typically own the eligible horizontal residual interest. We are required to hold the Required Credit Risk until the later of (i) the fifth anniversary of the securitization closing date and (ii) the date on which the aggregate unpaid principal balance of the mortgage loans in such securitization has been reduced to 25% of the aggregate unpaid principal balance of the mortgage loans as of the securitization closing date, but no longer than the seventh anniversary of the closing date (the “Sunset Date”). In addition, before the Sunset Date, we may not engage in any hedging transactions if payments on the hedge instrument are materially related to the Required Credit Risk and the hedge position would limit our financial exposure to the Required Credit Risk. Also, we may not pledge our interest in any Required Credit Risk as collateral for any financing unless such financing is full recourse to us. We have financed certain Required Credit Risk positions in full recourse transactions and our ability to refinance the full recourse transactions at maturity on similar or equivalent terms exposes us to certain liquidity and financial risks. Our Required Credit Risk subjects us to the first on our securitizations and is , which may make it more to meet our liquidity needs, each of which may materially and affect our business and financial condition.
The fair value of securities, especially our first loss credit risk retention securities, reperforming mortgage loans (loans that typically were significantly delinquent and subsequently modified), and other investments we make that are not frequently traded may not be readily determinable, and it may be difficult to obtain third-party pricing on such investments. Also, validating third-party pricing for illiquid investments may be more subjective than more liquid investments and may not be reliable. Illiquid investments may also experience greater price volatility because an active market does not exist. We value our investments quarterly based on internally developed processes and valuation models and in accordance with our valuation policy. Because such valuations are inherently uncertain, our fair value determination may differ materially from the values obtained from third parties or the values that would have been used if an active trading market existed for these investments. Our results of operations, financial condition and business could be materially adversely affected if our fair value determinations of the investments were materially different than the values that would exist if a ready market existed for these assets.
The illiquidity of our investments may make it difficult, or impossible for certain assets subject to the Risk Retention Rules, for us to sell these assets. Financing may also be more difficult. Also, if we quickly liquidate all or a portion of our portfolio (for example, to meet a margin call), we may realize significantly less than the value at which we have previously recorded our investments. Thus, our ability to adjust our portfolio in response to changes in economic and other conditions may be relatively limited, which could adversely affect our results of operations, financial condition and the value of our capital stock.
Our interests in MSR financing receivables expose us to risk of loss if the related master servicer is unable to satisfy its obligations to the GSEs and/or to us.
We have interests in MSR financing receivables that expose us to risk of loss. We do not hold the requisite licenses to purchase or hold MSRs directly. Instead, we have entered and, in the future, may enter into purchase agreements with licensed, GSE-approved residential mortgage loan servicers to acquire base and excess servicing compensation rights (known as MSRs) that enable us to garner the economic return of an investment in an MSR purchased by the mortgage servicing counterparty through an MSR financing transaction.
Generally, an MSR financing transaction with a licensed, GSE-approved residential mortgage loan servicer provides that we: (i) purchase an interest in the “excess servicing spread” from such mortgage servicing counterparty, entitling us to monthly distributions of the servicing fees collected by the mortgage servicing counterparty in respect of the underlying MSRs in excess of a base rate (often approximately 12.5 basis points per annum for conventional loans) and (ii) enter into a Reference Spread Agreement for Agency Loans (“RESPA”) with the mortgage loan servicer, or an affiliate thereof, that references the performance of the underlying MSRs. The amount that we pay to enter into a RESPA entitles us to receive an amount generally equivalent to the excess of servicing proceeds (which may include servicing fee revenue, income generated on escrow balances, reimbursements for previously made servicing advances, and proceeds from the sale of the underlying MSRs) over the sum of the excess servicing spread and the actual costs of servicing (including amounts paid for servicing advances, master and subservicing fees, and other costs and expenses). Interests in MSR financing receivables also generally entitle us to distributions of corresponding proceeds upon a sale of the underlying MSRs.
We rely on the mortgage loan servicer to maintain the state licenses required to hold and manage the underlying MSRs, and, when the underlying MSRs related to mortgage loans are guaranteed by a GSE, to maintain the required GSE approvals. If the mortgage loan servicer were to default under its servicing or other obligations to a GSE, such GSE could transfer the related servicing rights to another servicer, in which case we could realize a significant loss on our interests in MSR financing
receivables, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
While our interests in MSR financing receivables involving GSE-guaranteed loans are often subject to an “acknowledgement agreement” with the GSE, which gives us some rights in the event of a mortgage loan servicer default, such rights are not absolute and the underlying MSRs remain subject and subordinate in all respects to the interests of the related GSE.
In addition to being subject to regulations by the GSEs, mortgage servicers are also subject to extensive federal, state and local laws, regulations and administrative decisions. As mortgage servicers, their failures to comply with these laws, regulations and administrative decisions can expose the mortgage loan servicing counterparty to fines, damages and losses. Mortgage loan servicers operate in a highly litigious industry that also subject them to potential lawsuits related to billing and collections practices, modification protocols or foreclosure practices. Furthermore, mortgage loan servicers can often be held responsible for the actions of any subservicers they employ.
Finally, if a mortgage loan servicer becomes insolvent, we may become a general unsecured creditor of such mortgage loan servicer with respect to the related interests in MSR financing receivables, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our interests in MSR financing receivables may expose us to additional financing-related risks, and we may be reliant on acknowledgement agreements with the GSEs and a master servicer's cooperation with its financing sources and its compliance with covenants in its MSR financing facility.
For our current investments in MSR financing receivables, we allow the mortgage loan servicer to apply leverage to the underlying MSRs by pledging them under an MSR financing facility, in which case the lender would have a secured interest in the pledged underlying MSRs. Under a typical MSR financing facility, if the fair value of the pledged underlying MSRs declines and the lender demands additional collateral from the mortgage loan servicer through a margin call, we would be required to provide the mortgage loan servicer with additional funds or other assets to meet such margin call; if we were unable to satisfy such margin call, the lender could declare an event of default. MSR financing facilities typically require the mortgage loan servicer to satisfy various covenants, conditions and tests, the failure of which could lead to an amortization event and/or an event of default, and the satisfaction of which is out of our control. An event of default under an MSR financing facility could result in the by the lender of the pledged underlying MSRs to the loan obligation, which could result in a material on our interests in MSR financing receivables and materially affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Further, our MSR financing facility may also cross-collateralize MSR financing facilities of other investors of the related mortgage loan servicer, whose MSR-related investments (that may or may not be similar to our interests in MSR financing receivables) secure such other investor’s MSR financing facility. Each MSR financing facility requires each of the servicer borrower and the investor borrower to be jointly and severally liable for the obligations of other borrower. Through the servicer borrower, as a common co-borrower on every investor MSR financing facility, each investor borrower may be jointly and severally liable with every other investor borrower. As a result, we may have liability not only for our own obligations under our MSR financing facility, but our MSR financing receivables may also cross-collateralize another investor’s MSR financing facility. In a scenario where those other MSR-related investments decline in value and trigger margin calls under the other investor’s MSR financing facility, if the applicable borrower does not provide funds or additional assets to meet such margin calls, the MSR financing lender could declare a default under the other investor’s MSR financing facility. If that were to occur, we could be required to repay all outstanding obligations under our MSR financing facility on short notice in order to preserve the value of our own investments and avoid an amortization event and/or an event of default under our MSR financing facility. In addition, any to repay all outstanding obligations under our MSR financing facility within the required repayment period, including repayments required due to margin calls made because of in the value of the MSRs, could lead to to the extent our interests in MSR financing receivables were to be applied to outstanding obligations of the other investor’s MSR financing facility before our outstanding obligations under our MSR financing facility.
In addition, the borrowing capacity under any MSR financing is limited, and if the mortgage loan servicer is not successful in upsizing an MSR financing facility or finding a larger replacement facility, we may not be able to achieve our projected leveraged economic returns on our interests in MSR financing receivables. In addition, any new MSR financing facility entered into by a mortgage loan servicer would be subject to approval by the relevant GSE. If the mortgage loan servicer cannot obtain such GSE approval, it may not be able to obtain financing for us on favorable terms or at all.
We may have to fund amounts equal to the servicing advances due under our interests in MSR financing receivables, which could adversely impact our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Pursuant to certain RESPA contracts, to the extent that costs of servicing exceed servicing proceeds, we may be obligated to pay the equivalent of such excess to cover such “servicing advances,” which can include the payment of unpaid principal and interest due to the third-party owners of the loans, property taxes and insurance premiums, legal expenses and other protective advances that have not yet been received from the individual borrowers. Subject to the terms of the relevant servicing agreements, the mortgage loan servicer is generally entitled to reimbursement for servicing advances that are not subsequently collected from the underlying borrowers, and under the RESPA we would in turn be reimbursed by the RESPA counterparty for any servicing advances that we had funded. Our right to such reimbursement is unsecured.
During periods of economic disruption, there is a greater possibility that mortgage loan borrowers could fail to pay principal and interest payments, request forbearance of their monthly mortgage payments altogether, or otherwise miss scheduled payments including property taxes and insurance premium escrows, which could greatly increase the amount of servicing advances we would be required to indirectly fund, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
Our interests in MSR financing receivables may involve complex or novel structures.
Our interests in MSR financing receivables may involve complex or novel structures. Accordingly, the risks associated with the transactions and structures are not fully known. In the case of interests in MSR financing receivables that reference mortgages guaranteed by GSEs, the GSEs may require that we submit to costly or burdensome conditions as a prerequisite to their consent to an investment in, or our financing of, those MSRs. These conditions, which could include large capital requirements, may greatly reduce the potential returns available from these investments.
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, even with respect to a completed investment. A GSE could even impose new conditions on our existing interests in MSR financing receivables, including rights with respect to such MSRs. Such new conditions may be costly or burdensome and could require us to dispose of the interests in MSR financing receivables at an inopportune time.
Moreover, complying with such new conditions could 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, all of which could negatively affect the returns from our investments.
In addition, the novelty and/or complexity of such structures may limit our ability to transfer such interests, including as a result of required GSE consents and/or the unsecured nature of our interest, and the market for investors willing to invest in an asset with such a novel and complex structure may be limited or may not exist at all, which could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
We do not have legal title to the underlying MSRs.
The licensed residential mortgage loan servicer, rather than us, owns legal title to the MSRs and is responsible for performing all servicing activities. While we do purchase the excess servicing spread from the mortgage loan servicer, we do not purchase an interest in the underlying MSRs, and instead rely on the RESPA and True Excess Spread Agreement for FNMA Loans, which entitles us to payments based on the performance of the underlying MSRs but does not give us any security interest or buyer's rights to the underlying MSRs. The validity or priority of our interest in the underlying MSRs, which is not secured, could be challenged in a bankruptcy proceeding of the mortgage servicing counterparty, the parent company of the mortgage loan servicer, or a subservicer, and the related purchase agreement could be rejected in such proceeding. Any of the foregoing events could materially adversely affect our business, financial condition and results of operations, and our ability to pay dividends to our stockholders.
The value of our MSR investments may vary substantially with changes in interest rates.
The values of our MSR investments are highly sensitive to changes in interest rates. The value of MSRs typically increases when interest rates rise and decreases when interest rates decline because of the effect those changes in interest rates have on
prepayment estimates. Changes in interest rates influence a variety of assumptions included in the valuation of MSRs, including prepayment speeds, assumed yields used to discount future cashflows, the value of float income earned on escrow balances and other servicing valuation elements. Subject to qualifying and maintaining our qualification as a REIT, we may pursue various hedging strategies to seek to reduce our exposure to adverse changes in interest rates.
Changes in prepayment rates could negatively affect the value of our investment portfolio, which could result in reduced earnings, losses, book value impairments and/or negatively affect the cash available for distribution to our stockholders.
There are seldom any restrictions on consumer borrowers’ abilities to prepay their residential mortgage loans. Homeowners tend to prepay mortgage loans faster when interest rates decline and not prepay when interest rates increase, resulting in loan owners having to reinvest the money received from prepayments at the lower prevailing rates or being unable to reinvest money that would have been received from prepayments at the higher prevailing interest rates, respectively. In addition, our Agency RMBS are protected from the risk of default on the underlying mortgages by guarantees from the U.S. Government or any GSEs such as Fannie Mae and Freddie Mac. Defaults on mortgage loans underlying Agency MBS typically have the same effect as prepayments because of the underlying Agency guarantee. Volatility in interest rates may increase the likelihood borrower’s may prepay the mortgage loans, and variability in prepayment rates may affect the earnings and value of our portfolio of residential mortgage loans, RMBS and MSRs, and may result in reduced earnings or losses, and negatively affect the cash available for distribution to our stockholders. In addition, if we purchased an investment at a premium, faster than expected prepayments would result in a faster than expected amortization of the premium paid, which would affect our earnings. Conversely, if these investments were purchased at a discount, than expected prepayments would reduce our recognition of the discount, which would affect our earnings.
A significant portion of our investment portfolio is secured by properties in a small number of geographic areas and may be disproportionately affected by economic or housing downturns, natural disasters, including natural disasters exacerbated by climate change, terrorist events, regulatory changes, or other adverse events specific to those markets.
A significant number of the mortgages underlying our Non-Agency RMBS and Loans held for investments are concentrated in certain geographic areas. For example, we have significant exposure in California, New York, Florida, Illinois, and Texas, among others. For further information on the geographic concentration of our investments see Note 3 and Note 4 to the consolidated financial statements within this 2025 Form 10-K. Any event that adversely affects the economy or real estate market (including business layoffs or downsizing, industry slowdowns, changing demographics, over or under building of housing, availability and cost of insurance, oversupply or reduced demand and other factors) in areas of high concentration could have a disproportionately adverse effect on our investments. In general, any material decline in the economy or significant problems in a particular real estate market would likely cause a decline in the value of residential properties securing the mortgages in that market, thereby increasing the risk of , , and of mortgage loans underlying our investments and the risk of upon of these assets. This could have a material effect on our credit experience in the affected market if higher-than-expected rates of or higher-than-expected on such loans were to occur.
In addition, the occurrence of a natural disaster or a terrorist attack may cause a sudden decrease in the value of real estate in the area or areas affected and would likely reduce the value of the properties securing the mortgages collateralizing our investments. Recent years have seen frequent and severe natural disasters in the U.S., including wildfires, hurricanes, high winds, hail, severe flooding and mudslides, the frequency and intensity of which may be indicative of the impact of climate change. The impacts of climate change, which may persist or worsen in the future, could have a more significant localized effect in the areas where our borrowers and real estate are concentrated, resulting in a disproportionate impact on us. Because certain natural disasters such as hurricanes or certain flooding are not typically covered by the standard hazard insurance policies maintained by borrowers, or the proceeds payable under any such policy are not sufficient to cover the related repairs, the affected borrowers may have to pay for any repairs themselves. Under these circumstances, borrowers may decide not to repair their property or may stop paying their mortgages. This would cause and credit to increase. The availability and cost of property and insurance has become increasingly uncertain as insurance carriers reduce coverage or withdraw from certain states, which may limit options for borrowers and would be homeowners and collateral protection. If borrowers are to obtain or afford adequate insurance, the value of our mortgage assets and the performance of the affected loans could and impact our financial results.
Changes in local laws and regulations, fiscal policies, property taxes and zoning ordinances in such states can also have a negative impact on property values, which could result in borrowers deciding to stop paying their mortgages. This circumstance could cause defaults and loss severities to increase, thereby adversely impacting our results of operations.
We may change our investment strategy or asset allocation or enter other operating businesses or financing plans without stockholder consent, which may result in riskier investments or subject us to new or increased regulatory risks and have an adverse effect on our business, results of operations and financial condition.
We may change our investment strategy or asset allocation or enter other operating businesses or financing plans at any time without the consent of our stockholders, which could result in our making investments that are different from, and possibly riskier than, the investments described in this 2025 Form 10-K. For example, we recently expanded our scope of business via the HomeXpress Acquisition. See “Risks Related to Our Recent Acquisition and Loan Origination and Acquisition Business” for further discussion.
A change in our investment strategy or financing plans could increase our exposure to interest rate and default risk and real estate market fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different from those described in this 2025 Form 10-K. Additionally, we may enter other operating businesses that may or may not be closely related to our current business. These new assets or business operations may have new, different or increased risks than what we are currently exposed to, including potential unknown liabilities and disputes associated with these new assets or business operations that could lead to litigation, and we may not be able to manage these risks successfully. Additionally, when investing in new assets or businesses we could be exposed to the risk that those assets, or income generated by those assets or businesses, affects our ability to meet the requirements to maintain our qualification as a REIT or our exemption from registration under the 1940 Act. If we are not able to successfully manage the risks associated with new asset types or businesses, our business, results of operations and financial condition could be affected.
Changes in the fair values of our assets, liabilities, and derivatives can have various negative effects on us, including reduced earnings, less liquidity, increased earnings volatility, and variability in our book value.
Fair values for our assets and liabilities, including derivatives, can be volatile and our revenue and income can be impacted by changes in fair values. Fair values can change rapidly and significantly, and changes can result from changes in interest rates, perceived risk, credit spreads, supply, demand, and actual and projected cash flows, prepayments, and credit performance. A decrease in fair value may not necessarily be the result of deterioration in future cash flows. Fair values for illiquid assets can be difficult to estimate, which could lead to volatility and uncertainty of earnings and book value. For GAAP purposes, we mark-to-market most, but not all, of the assets and liabilities on our Consolidated Statements of Financial Condition. In addition, valuation adjustments on certain consolidated assets and our derivatives are reflected in our Consolidated Statements of Operations. Assets that are funded with certain liabilities and hedges may have different mark-to-market treatment than the liability or hedge. If we sell an asset that has not been marked to market through our Consolidated Statements of Operations at a reduced market price relative to its cost basis, our reported earnings will be reduced. Our loan sale profit margins are generally reflective of gains (or ) over the period from when we identify a loan for purchase until we subsequently sell or securitize the loan. These profit margins may encompass elements of or market valuation adjustments on loans, hedging or associated with related risk management activities, and any other related transaction expenses. However, under GAAP, the different elements may be realized unevenly over the course of one or more quarters for financial reporting purposes, with the result that our financial results may be more and less reflective of the underlying economics of our business activity.
Our calculations of the fair value of the assets we own or consolidate are based upon assumptions that are inherently subjective and involve a high degree of management judgment, and such assumptions may be more difficult to calculate during times of severe market disruption in the mortgage, housing, rates or other financial market related sectors.
We report the fair values of securities, loans, derivatives, and certain other assets on our Consolidated Statements of Financial Condition. In computing the fair values for these assets, we may make several market-based assumptions, including assumptions regarding future interest rates, prepayment rates, discount rates, credit loss rates, and the timing of credit losses. These assumptions are inherently subjective and involve a high degree of management judgment, particularly for illiquid securities and other assets for which market prices are not readily determinable. These assumptions may be more difficult to calculate during times of severe market disruption in the mortgage, housing, rates or other financial market related sectors. For further information regarding our assets recorded at fair value see Note 6 to the consolidated financial statements within this 2025 Form 10-K. Use of different assumptions could materially affect our fair value calculations and our financial results and our actual experience may cause us to substantially revise our assumptions. Further discussion of the risk of our ownership and valuation of illiquid securities is set forth in the Risk Factors above and in this 2025 Form 10-K.
Any deterioration or uncertainty in broader U.S. and global economic conditions could materially adversely affect our business and financial condition.
Our results of operations are materially affected by conditions in the broader financial markets and the economy generally. Concerns over actual or anticipated low economic growth rates, higher levels of unemployment, a reduction in housing market
activity, inability of the U.S. government to address debt ceiling crises, increases in the supply of or decreases in demand for U.S. government issued securities, uncertainty over tariffs and potential international trade disputes, uncertainty regarding future U.S. monetary policy, potential prolonged shutdowns of the federal government, or geopolitical conflicts may contribute to increased financial market volatility and a decline in business volume. A reduction in our business volume can reduce our net interest income and adversely affect our financial results. Global economic conditions can also adversely affect our business and financial results. Changes or volatility in market conditions resulting from deterioration in or uncertainty regarding global economic conditions can adversely affect the value of our assets, which could materially affect our results of operations, net worth and financial condition. To the extent global economic conditions affect the U.S. economy, they also could affect the credit performance of the loans in our investment portfolio. or uncertainty in global or domestic political conditions also can significantly affect economic conditions and financial markets. Global or domestic political could affect economic conditions and financial markets. Such events may contribute to heightened inflationary pressures, increased interest rates, market , reduced liquidity, and in capital markets, any of which could impact economic growth, the value of our investments, our access to financing, and our overall financial condition and results of operations.
Risks Related to Our Recent Acquisition and Loan Origination and Acquisition Business
We may fail to realize the expected benefits of the HomeXpress Acquisition.
We will be required to devote significant management attention and resources to the integration of HomeXpress’ business in order to realize the anticipated benefits and synergies of the HomeXpress Acquisition. The potential difficulties we may encounter in combining the companies include, but are not limited to, the following:
• the inability to successfully integrate HomeXpress businesses in a manner that permits us to achieve the anticipated benefits and synergies expected to result from the HomeXpress Acquisition in the timeframe currently anticipated or at all;
• the diversion of management’s attention from our ongoing business as a result of the devotion of time and resources to integration of the HomeXpress Acquisition;
• addressing possible differences in business backgrounds, corporate cultures and management philosophies;
• maintaining employee morale and attracting, motivating and retaining management personnel and other key employees;
• complying with an expanded regulatory framework, including the wide array of laws, rules and regulation, including federal and state consumer lending regulations, related to our loan origination and acquisition business;
• the possibility of faulty assumptions underlying expectations regarding the HomeXpress Acquisition;
• potential unknown liabilities and unforeseen increased expenses, delays or conditions associated with the HomeXpress Acquisition and HomeXpress’ operations;
• performance shortfalls as a result of the diversion of management’s attention caused by integrating HomeXpress’ operations;
• consolidating corporate and administrative infrastructures and eliminating duplicative operations;
• unanticipated issues and costs in integrating information technology, communications and other systems; and
• unanticipated changes in federal or state laws or regulations.
The operations acquired through the HomeXpress Acquisition are subject to certain of the same risks as our existing business. Due to the HomeXpress Acquisition, we are, however, subject to additional risks due to the heavily regulated nature of the mortgage industry and are required to comply with a wide array of laws, rules and regulations, including federal and state consumer lending regulations, that concern, among other things, the manner in which we conduct our loan origination and acquisition business, as well as other risks described in “Risks Related to Our Recent Acquisition and Loan Origination and Acquisition Business.”
It is possible that the integration process could take longer than anticipated or that the management of the combined organizations and achievement of anticipated benefits and synergies could be more difficult than expected. The integration of HomeXpress into Chimera could also result in the disruption of ongoing businesses, processes, systems and business relationships or inconsistencies in standards, controls, procedures, practices, policies and compensation arrangements, any of which could adversely affect our ability to achieve the anticipated benefits of the HomeXpress Acquisition. The integration process is subject to a number of risks and uncertainties, and no assurance can be given that the anticipated benefits of the HomeXpress Acquisition will be realized or, if realized, the timing of its realization. Failure to achieve these anticipated benefits could adversely affect our business, financial condition and results of operations.
Our loan origination and acquisition volume and ability to sell loans are highly dependent on macroeconomic and U.S. residential real estate market conditions which are outside of our control, and which may impact our ability to originate or acquire quality and profitable loans at an appropriate and consistent cost.
As a result of the HomeXpress Acquisition, we originate and sell consumer Non-QM and investor business purpose mortgage loans secured primarily by residential real estate properties with up to eight units, which are substantially all Non-QM loans sourced primarily on a wholesale basis through independent mortgage brokers and bankers. We also have a non-delegated correspondent channel, and may expand to include a delegated correspondent channel, in which we acquire and sell the same type of mortgage loans which are originated by correspondent lenders, with whom we partner. We refer to our network of independent mortgage brokers and correspondent lenders collectively as our “HomeXpress clients.” The HomeXpress business has been, and may continue to be, affected by a number of factors that are beyond our control, including the health of the U.S. residential real estate industry, changes in general economic and capital market conditions, including increases and decreases in interest rates, inflation, credit spreads, competition from competitors who may have greater financial and other resources than we have (including access to capital), changes in the costs to originate our loans, and the ability of borrowers to buy homes and make mortgage payments. In addition, the consumer Non-QM and investor business purpose mortgage loan market is highly sensitive to interest-rate volatility, securitization execution, and investor demand, and disruptions in these markets may limit our ability to sell or finance loans on acceptable terms and such conditions could reduce origination volumes, compress margins, or require us to retain assets longer than anticipated. The majority of the properties securing HomeXpress’ loans that are originated and held for sale are located in California, Florida, and Texas, and conditions in these regions’ real estate markets could have an outsized impact on the HomeXpress business.
Our consumer Non-QM loans are designed for borrowers who do not meet traditional qualified mortgage standards and documentation requirements and typically carry higher interest rates than traditional qualified mortgages. The business purpose loans that we originate are for investors in 1-to-8-unit investment rental properties and rely on the income from the property to service the debt. Loans made to borrowers who are self-employed borrowers or have a credit profile that does not meet qualified mortgage standards or are based on rental properties and their debt service coverage typically have a higher risk of default. Our underwriting guidelines strive to account for these characteristics, but our risk management and procedures may not be effective in assessing the likelihood of default and identifying potential valuation issues.
A disruption in the secondary home loan market, our ability to sell the loans that we originate or acquire, or loan compliance issues could have a negative effect on our business.
Our subsidiary, HomeXpress, sells mortgage loans to a variety of aggregators, insurance companies, banks, and other institutional investors who either hold such loans for investment or securitize such loans, which we currently sell on a servicing-released basis. Demand in the secondary market for the purchase of such loans and our ability to sell the mortgage loans that we originate or acquire depend on many factors that are beyond our control, including general economic conditions, the willingness of investors to provide funding for and to purchase mortgage loans, and changes in regulatory requirements. The gain recognized from sales represents a significant portion of HomeXpress’ revenues and earnings. If it is not possible or economical for us to continue selling mortgages to such investors or other loan purchasers, our business could be materially and adversely affected. Similarly, if we choose to retain a portion of HomeXpress’ loan originations in lieu of selling to investors, we may forgo current gain-on-sale earnings in favor of longer-term investment income, which could materially alter the timing of our earnings and adversely impact our financial condition.
Furthermore, non-GSE sales typically take longer to execute which can increase the amount of time that a mortgage loan is held by us, exposing us to additional market and interest rate risk, including prepayment risk where a mortgage loan has no prepayment penalty or such penalty is waived, and increased liquidity requirements.
Additionally, if a mortgage loan does not comply with the representations and warranties that we made with respect to it at the time of our sale, we may be required to either repurchase the loan with the identified defects or indemnify the investor or insurer for any loss. In addition, we may be required to repay all, or a portion of, the premium initially paid by an investor in the case of an early loan payoff or early default on certain loans. We may also be required to repurchase loans as a result of borrower fraud or if a payment default occurs on a loan shortly after its sale. Actual repurchase, premium recapture and indemnification obligations could materially exceed the reserves recorded in our consolidated financial statements. Any significant repurchases, premium recapture, or indemnifications could be detrimental to our business.
Our subsidiary, HomeXpress, relies on warehouse facilities, structured as repurchase agreements, to finance its loan originations and acquisitions. These facilities are short-term and subject us to various risks different from other types of credit facilities.
We fund substantially all of the mortgage loans we originate or acquire from our HomeXpress clients under HomeXpress’ short-term warehouse facilities and funds generated by HomeXpress’ operations. These borrowings are in turn generally repaid
with the proceeds we receive from mortgage loan sales. We depend upon several financial institutions to provide the warehouse lines of credit for these loans. Our ability to fund loan originations may be impacted by the ability of HomeXpress to secure further such borrowings on acceptable terms and the ability of our counterparties to continue to provide financing. HomeXpress’ warehouse facilities are uncommitted and can generally be terminated by the applicable lender at any time. In addition, these warehouse facilities contain restrictions, covenants and conditions that require HomeXpress to satisfy, among other things, specified financial and loan eligibility tests. The failure to satisfy such conditions could result in such warehouse facility being made unavailable to us, an event of default or other negative consequences. In the event that a significant number of these loan funding facilities become unavailable or are terminated or are not renewed, or if the aggregate principal amount that may be drawn under our funding agreements were to decrease significantly, we may be to find replacement financing on commercially terms, or at all. Our liquidity with respect to the HomeXpress entity may be further constrained as there may be less demand from investors to acquire our mortgage loans in the secondary market. Further, if we are to refinance or obtain additional liquidity for borrowing, our ability to maintain or grow our loan origination business could be limited. If the refinancing or borrowing guidelines under these facilities become more and those changes result in increased costs to comply or decreased origination volume, those changes could be to our liquidity and business operations.
Our business is dependent on our ability to maintain and expand our relationships with our clients, the independent mortgage brokers and bankers.
Our clients are independent mortgage brokers and bankers who refer or sell us mortgage loans to originate or fund. Consequently, our results of operations are dependent, in large part, on our ability to maintain and expand our relationships with these clients. If we are unable to attract these clients to join our network and to provide a level of service such that our clients remain with the network or refer or sell a greater number of their mortgage loans to us, our ability to originate loans will be significantly impaired. The willingness of independent mortgage brokers and bankers to originate mortgage loans with us is dependent on (i) the rates that we are able to offer our clients’ borrowers for mortgage loans, (ii) our customer service, (iii) products and (iv) compensation. In determining with whom to partner, our clients are also focused on the technological services and platforms we can provide so that they can best attract and serve their customers. If our clients are dissatisfied with our services or our platform or technological capabilities, or if they cannot offer prospective borrowers competitive products and rates, we could lose a number of clients, which would have a impact on our business, operating results and financial condition.
Our mortgage loans are primarily initiated by third parties, which exposes us to business, competitive and underwriting risks.
We market, originate and, acquire mortgage loans primarily through independent third parties, comprised of independent mortgage brokers and bankers. While we believe using independent mortgage brokers and bankers best serves mortgage loan consumers, our reliance on third parties presents risks and challenges, including the following:
• Our business depends in large part on the marketing efforts of our clients and on our ability to offer loan products and services that meet the requirements of our clients and their borrowers. However, loan officers are not obligated to sell or promote our products and many sell or promote competitors’ loan products in addition to our products. Some of our competitors may have higher financial strength ratings, may offer a larger variety of products, and/or may offer higher incentives than we do. Therefore, we may not be able to continue to attract and retain clients to source loans for us. The failure or inability of our clients to successfully market our mortgage products to prospective borrowers could, in turn, have a material adverse impact on our business, financial condition and results of operations.
• Communication with prospective borrowers is made through loan officers employed by third parties. Consequently, we rely on our clients and their loan officers to provide us with accurate information on behalf of borrowers, including financial statements and other financial information, for us to use in deciding whether to approve loans. While we have procedures in place to independently verify certain borrower information that we use in our lending decisions, if any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the fair value of the loan may be significantly lower than expected. Whether a misrepresentation is made by the borrower, the loan officer or one of our team members, we generally bear the risk of loss associated with the misrepresentation and may be exposed to repurchase obligations or regulatory violations. Our controls and processes may not detect or may not have detected all misrepresented information in our loan originations. Likewise, our clients may also sufficient controls and processes. Any such information could have a material effect on our business and results of operations.
• Wholesale mortgage lending presents some unique reputational and brand recognition risks. We attempt to provide high quality and transparent service to our clients so that our clients and prospective clients have confidence in our
ability to deliver our services in a timely and effective manner. To maintain good client relations, we attempt to do business with mortgage brokers and bankers that have a good reputation. Clients are monitored and those with excessive borrower complaints or misrepresented information are generally terminated. Our reputation and brand may suffer if we lose our clients’ confidence, which could have a material adverse impact on our results of operations and profitability.
• Growth in our market share is principally dependent on growth in the market share controlled by us within the wholesale and correspondent chann els. Co ntinued advancements or the perception of efficiency in “direct-to-the-consumer” distribution models may impact the overall market share controlled by our clients and make it more difficult for us to grow or require us to establish new, or modify existing, client relationships.
The conduct of the independent mortgage brokers and bankers through whom we originate mortgage loans could subject us to fines or other penalties.
We depend primarily on independent mortgage brokers and bankers for our loan originations and acquisitions. These clients are subject to parallel and separate legal obligations. While these laws may not explicitly hold the originating lenders responsible for the legal violations of such entities, U.S. federal and state agencies increasingly have sought to impose such liability. For example, the U.S. Department of Justice (“DOJ”), through its use of a disparate impact theory under the Fair Housing Act, has held originating lenders responsible for the pricing practices of third parties, alleging that the lender is directly responsible for the total fees and charges paid by the borrower even if the lender neither dictated what the third party could charge nor kept the money for its own account. In the past few years, there were a number of actions brought by the DOJ and other federal and state agencies under the Equal Credit Opportunity Act that allege that lenders have engaged in “redlining” by engaging in acts or practices directed at discouraging potential loan applicants from seeking financing. Even though we do not market directly to consumers, the failure or inability of our clients and their loan officers to attract certain classes of borrowers could result in actions being brought us. In addition, under the TILA-RESPA Integrated Disclosure rule, we may be held responsible for disclosures made to borrowers by our clients. While the current presidential administration has suggested that these types of will not be pursued by the DOJ or federal agencies to the same degree, there is no assurance that state or private parties will not pursue similar . While we seek to use technology, and other means to monitor whether these clients and their loan officers are complying with their obligations, our ability to enforce such compliance is extremely limited. Consequently, we may be subject to for or other based upon the conduct of our clients and their loan officers with whom we do business, which could have a material effect on our operating results and financial condition.
The mortgage lending industry can be very cyclical, with loan origination volumes varying materially based on macroeconomic conditions. If we are unable to effectively manage our team members during periods of volatility, it could adversely affect our current business operations and our growth.
The mortgage lending industry can be very cyclical, with loan origination volumes varying materially based largely on macroeconomic conditions. Our ability to effectively manage the volatility from significant increases and decreases in loan origination and acquisition volume will depend on our ability to hire, integrate, train and retain highly qualified personnel for all areas of our organization during these periods of changing volume. Any talent acquisition and retention challenges or mismanagement of our personnel needs in these situations could reduce our operating efficiency, increase our costs of operations and harm our overall financial condition. As the pool of qualified candidates has continued to be limited and there continues to be significant competition for talent, we may face challenges in hiring and retaining such highly qualified personnel in changing environments. Additionally, we invest heavily in training our team members, which increases their value to competitors who may seek to recruit them. If we do not effectively manage our pool of team members in times of volatility, it could disrupt our business operations and have a impact on our long-term growth.
We operate in a heavily regulated industry, and our mortgage loan origination activities as a result of our acquisition of HomeXpress, exposes us to risks of noncompliance with an increasing and inconsistent body of complex laws and regulations, including federal and state consumer lending regulations.
Due to the heavily regulated nature of the mortgage industry, we and our HomeXpress clients are required to comply with a wide array of laws, rules and regulations, including federal and state consumer lending regulations, that concern, among other things, the manner in which we conduct our loan origination and acquisition business and the fees that we may charge, and the collection, use, retention, protection, disclosure, transfer and processing of personal information by us and our clients. Governmental authorities and various U.S. federal and state agencies, including the CFPB, have broad oversight and supervisory authority over our HomeXpress business.
Because we originate and acquire mortgage loans in 46 states and the District of Columbia, we must be licensed in all relevant jurisdictions that require licensure for the type of mortgages we originate or acquire, and we are required to comply with each such jurisdiction’s respective laws and regulations, as well as with judicial and administrative decisions applicable to us. Such
licensing requirements also generally require the submission of information regarding any person who has 10% or more of the combined voting power of our outstanding equity interests. In addition, we and our clients are currently subject to a variety of, and may in the future become subject to additional, U.S. federal, state and local laws that are continuously evolving and developing.
We expect more states to enact legislation similar to the California Consumer Privacy Act and California Privacy Rights Act, which increase the privacy and security obligations of entities handling certain personal information of such consumers and could require us to provide consumers with privacy rights, such as the right to request deletion of their data, the right to receive data on record for them and the right to know what categories of data (generally) are maintained about them. These regulations directly impact our business and require ongoing compliance, monitoring and internal and external compliance audits as they continue to evolve and may result in ever-increasing public scrutiny with escalating levels of enforcement and sanctions. Subsequent changes to data protection and privacy laws could also impact how we process personal information and therefore limit the effectiveness of our products or services or our ability to operate or expand our business, including limiting strategic partnerships that may involve the sharing of personal information. Additionally, the interpretation of such data protection and privacy laws is rapidly evolving, making implementation and enforcement, and thus compliance requirements, ambiguous, uncertain, and potentially inconsistent. Although we make reasonable efforts to comply with all applicable data protection laws and regulations, our interpretations and such measures may have been or may prove to be insufficient or .
We and our HomeXpress clients must also comply with a number of federal, state and local consumer financial services, laws and regulations including, among others, the TILA, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Telephone Consumer Protection Act, the Gramm-Leach-Bliley Act, the Servicemembers Civil Relief Act, the Homeowners Protection Act, the Home Mortgage Disclosure Act, the SAFE Act, the Federal Trade Commission Act, the TILA-RESPA Integrated Disclosure rule rules, the Dodd-Frank Act, the Appraisal Independence Rule, the Bank Secrecy Act, U.S. federal and state laws prohibiting unfair, deceptive, or abusive acts or practices, and state foreclosure laws. These laws and regulations mandate certain disclosures and notices to borrowers and apply to loan origination, home appraisal, marketing, use of credit reports, safeguarding of non-public, personally identifiable information about borrowers, foreclosure and claims handling, investment of and interest payments on escrow balances and escrow payment features. The Appraisal Independence Rule requires that there be a separation of duties to ensure no of interest. While we believe that our programs meet all of the regulatory and legal requirements, there is a risk that a regulatory agency could decide that our programs do not meet all of the regulatory and legal requirements, or that our programs will not be accepted by other market participants, which could us to additional liability, or subject us to repurchase obligations.
Our Non-QM loans have more flexibility in underwriting guidelines than traditional qualified mortgage loan standards and are subject to increased credit risk compared to QM loans. These loans are also subject to relatively more litigation potential due to the subjectivity of the regulations and because they do not benefit from compliance with safe harbors. The underwriting guidelines for our Non-QM loans may be more permissive as to the borrower’s debt to income ratio, credit history, and/or income documentation than QM loans. Loans that are underwritten pursuant to less stringent underwriting guidelines could experience substantially higher rates of delinquencies, defaults and foreclosures than those experienced by loans underwritten to more stringent underwriting guidelines. If our Non-QM loans are underwritten to more flexible guidelines which have increased risk and may cause higher delinquency, default, or foreclosure rates given economic stress, the performance of the Non-QM loans we originate or acquire for resale could be correspondingly affected, which could materially and affect us.
Various federal, state and local laws have been enacted that are designed to discourage predatory lending practices. The Home Ownership and Equity Protection Act of 1994 (“HOEPA”) prohibits inclusion of certain provisions in consumer-purpose residential loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain disclosures prior to origination. Some states have enacted, or may enact, similar laws or regulations, which in some cases impose restrictions and requirements greater than those in HOEPA. In addition, under the anti-predatory lending laws of some states, the origination of certain residential loans, including loans that are not classified as “high cost” loans under applicable law, must satisfy a net tangible benefits test with respect to the related borrower. This test may be highly subjective and open to interpretation. As a result, a court may determine that a residential loan, for example, does not meet the test even if the related originator reasonably believed that the test was satisfied. Our failure to comply with these laws, or the failure of residential loan originators to comply with these laws, to the extent any of their residential loans are or become part of our mortgage-related assets, could subject us, as an originator, or, in the case of acquired loans, as an assignee or purchaser, to monetary and could result in the borrowers rescinding the affected loans. Lawsuits have been brought in various states making originators, assignees and purchasers of high-cost loans for of state law. Named in these cases have included numerous participants within the secondary mortgage market. If our loans are found to have been originated in of or lending laws, we could be subject to lawsuits or governmental actions, and we could be or incur .
Both the scope of the laws, rules and regulations and the intensity of the regulatory oversight to which our business is subject has increased over time. In the past years, regulatory enforcement and fines have become more significant across the financial
services sector. For example, various federal regulatory agencies and departments, including the DOJ and CFPB, have historically taken the position that antidiscrimination statutes, such as the Fair Housing Act and the ECOA, that prohibit creditors from discriminating against loan applicants and borrowers based on certain characteristics, such as race, ethnicity, sex, religion and national origin apply not only to intentional discrimination, but also to neutral practices that have a disparate impact on a group that shares a characteristic that a creditor may not consider in making credit decisions (i.e., creditor practices that have a disproportionate negative effect on a protected class of individuals). While there is a perception that the enforcement agenda of the federal regulatory agencies may be curtailed under the current presidential administration, state regulators may fill the gap, and it is not clear the scope of such future limitations or the timing for implementation. Furthermore, it is not clear what effect those changes will have, or whether as a result of lesser oversight by the federal authorities, states will increase their regulatory oversight. Moreover, subsequent changes in various government administrations may result in yet other changes in regulatory oversight and enforcement. As these U.S. federal, state and local laws evolve, it may be more for us to identify these developments comprehensively, to interpret changes accurately and to train our team members effectively with respect to these laws and regulations. These potentially increase our exposure to the risks of with these laws and regulations, including of our licenses and approvals to engage in our lending businesses, costs associated with ourselves from and enforcement actions or resulting administrative and and civil and liability, including class action lawsuits, which could be to our business.
The laws and regulations applicable to us are subject to administrative or judicial interpretation. Furthermore, state and federal agencies may differ in their interpretations as may private plaintiffs. Litigation amongst these various agencies and between private plaintiffs, including participants in the mortgage industry, and these agencies have added complexity and ambiguity in interpreting these regulations. Ambiguities in applicable laws and regulations may leave uncertainty with respect to permitted or restricted conduct and may make compliance with laws, and risk assessment decisions with respect to compliance with laws difficult, uncertain and costly. The adoption by industry participants of different interpretations of these statutes and regulations has added uncertainty and complexity to compliance and may result in them having a short- or long-term competitive advantage. If we are deemed to have violated applicable statutes or regulations, it could result in regulatory investigations, state or federal governmental actions or private civil claims, including class actions, being brought us. Such would cause us to incur costs, and legal expenses in connection with these matters, regardless of any eventual ruling in our favor, and could also the reputation of our brand, any of which could have a material effect on our business, financial condition or results of operations.
To resolve issues raised in examinations or other governmental actions, we may be required to take various corrective actions, including changing certain business practices, making refunds and/or taking other actions that could be financially or competitively detrimental to us. We expect to continue to incur costs to comply with governmental regulations. In addition, certain legislative actions and judicial decisions can give rise to the initiation of lawsuits against us for activities we conducted in the past. Furthermore, provisions in our mortgage loan documentation, including but not limited to the mortgage and promissory notes we use in loan originations, could be construed as unenforceable by a court.
Although we have compliance management systems and procedures to comply with these legal and regulatory requirements, we cannot be assured that more restrictive laws and regulations will not be adopted in the future, or that governmental bodies or courts will not interpret existing laws or regulations in a more restrictive manner, which could render our current business practices non-compliant or which could make compliance more difficult or expensive. Any of these, or other, changes in laws or regulations could have a detrimental effect on our business.
Risks Related to Our Investment Management and Advisory Services
Our investment management and advisory services involve certain risks, which could adversely affect our business, financial condition and results of operations.
On December 2, 2024, we acquired TPG, PAS, Palisades Technology Holdings, LLC, and their respective subsidiaries (the “Palisades Acquisition”). As a result of the Palisades Acquisition, we began providing investment management and advisory services primarily through TPG and PAS (together with TPG, “Palisades”). TPG is registered with the SEC as an investment adviser under the Advisers Act, and PAS is a relying adviser with respect to TPG’s investment adviser registration.
Our investment management and advisory services are provided on a discretionary basis through investment funds that we manage and on a non-discretionary basis with respect to assets acquired and owned by third-party institutions, including insurance companies, credit funds, and other institutional investors. We do not own an interest in the Discretionary Funds other than any capital commitment that we may make in the future on a direct or indirect basis, including through co-investments. The Company did not acquire the general partners of the existing Discretionary Funds, for which the investment period has ended, as part of the Palisades Acquisition. Our subsidiary, however, is the non-member manager of the general partners of the existing Discretionary Funds and serves as the investment manager of the existing Discretionary Funds. Accordingly, we have certain obligations and responsibilities with respect to the existing Discretionary Funds and other third-party clients of our non-discretionary investment management and advisory services. In the future, we may form and manage new Discretionary Funds
for which we may act as the general partner and investment manager. Accordingly, our role as investment manager and advisor is subject to certain risks including, but not limited to:
• the possibility that investors in a Discretionary Fund or a managed account might become bankrupt or otherwise be unable to meet their capital commitment obligations;
• to the extent we were to become a general partner or limited partner in a new Discretionary Fund, the possibility that operating and/or management agreements applicable to such Discretionary Fund or a managed account may restrict our ability to transfer or liquidate our interest when we desire or on advantageous terms;
• that our relationships with clients of our non-discretionary investment management and advisory services are concentrated with certain clients and are generally contractual in nature and may be terminated (with or without cause) under the terms of the applicable agreements;
• that our role as investment manager and advisor of a Discretionary Fund or a managed account is generally contractual in nature and may be terminated or dissolved under the terms of the applicable agreements, or we may be removed as the non-member manager of the general partner of the existing Discretionary Funds;
• that our role as the general partner of any new Discretionary Fund is generally contractual in nature, and we may be removed as the general partner of any new Discretionary Fund under the terms of the applicable agreements;
• that we may fail to manage conflicts of interests among the general partner and limited partners of Discretionary Funds, and their respective principals, officers, employees, members and affiliates, as well as any conflicts of interests involving our business outside of the Discretionary Funds or managed accounts;
• that disputes between us and the investors in a Discretionary Fund or a managed account may result in litigation or arbitration that would increase our expenses and prevent our officers and directors from focusing their time and effort on our business and result in subjecting the investments owned by such Discretionary Fund or managed account to additional risk;
• that by reason of being the general partner for new Discretionary Funds, non-member manager of the general partner for existing Discretionary Funds, or investment manager, we will be required to make various decisions and perform various tasks, including preparing disclosures, tax filings and financial reports, that could expose us to liability, including for claimed breaches of fiduciary duties;
• that difficult market conditions could adversely affect a Discretionary Fund in many ways, including by negatively impacting its performance and reducing the ability of new Discretionary Funds to raise or deploy capital, thereby reducing assets under management and lowering management fee income and incentive-based income;
• that SEC examination of one or more of our subsidiaries currently required to be registered as an investment adviser or relying adviser may uncover deficiencies and potentially subject us to enforcement proceedings and sanctions for violations, including censure or termination of SEC registration, litigation and reputational harm; and
• that our business and financial condition may be materially adversely impacted by the loss of any of our key executives or other investment professionals.
Many of these factors are outside of our control and any one of them could adversely affect our business, financial condition and results of operations. Any incentive-based income that we may be entitled to with respect to future Discretionary Funds may be affected by changes in the market value of securities held in client accounts due to fluctuations in the securities markets and is highly variable. Such income may also be delayed due to the nature of a fund’s investment cycle.
Under the Advisers Act, the investment advisory contracts entered into by our investment adviser subsidiary may not be assigned without the client’s consent. A deemed “change of control” of our company could require us to obtain the consent of our clients, and a failure to do so properly could adversely affect our operations, financial conditions or business.
Our registered investment adviser and relying adviser subsidiaries are regulated and subject to examination by the SEC. The Advisers Act imposes numerous obligations, on registered investment advisers, including fiduciary duties, disclosure obligations recordkeeping and reporting requirements, marketing restrictions and general anti-fraud prohibitions. The failure to comply with the Advisers Act and other securities laws and regulations could cause the SEC to institute proceedings and impose sanctions for violations, including censure or terminating our registered investment adviser’s SEC registration, and could also result in litigation or reputational harm.
Our failure to appropriately manage or address conflicts of interest could damage our reputation and adversely affect our business, financial condition and results of operations.
As we expand the number of funds and scope of our business, we may confront potential conflicts of interest relating to our investment activities and the Discretionary Funds’ investment activities. With respect to each of the existing Discretionary Funds, the investment period has ended, and investments made on behalf of any future Discretionary Funds will be subject to a comprehensive policy regarding the allocation of investment opportunities between such future Discretionary Funds and our own account. Nevertheless, Discretionary Funds could have overlapping investment objectives, and such investment objectives could additionally overlap with our own investment objectives. Potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities among us and the Discretionary Funds. For example, we may allocate an investment opportunity that is appropriate for two or more Discretionary Funds in a manner that excludes one or more Discretionary Funds or results in a disproportionate allocation based on factors or criteria that we determine, such as sourcing of the transaction, the specific nature of the investment or size and type of the investment, amount of capital available to invest in a related investment by a fund, among other factors. The Discretionary Fund investors and our public stockholders may perceive of interest regarding investment decisions and will have very limited ability to those decisions.
In addition, the challenge of allocating investment opportunities to certain Discretionary Funds may be exacerbated if we expand our business to include more lines of business. Allocating investment opportunities appropriately frequently involves significant and subjective judgments. In addition, the perception of noncompliance with such requirements or policies could harm our reputation with Fund investors and our public stockholders.
In the event we were to acquire new businesses or service providers, these newly acquired affiliates could become service providers or counterparties to the Discretionary Funds and receive fees or other compensation for services that are not shared with the Discretionary Fund investors. In such instances, we may be incentivized to cause the Discretionary Funds or portfolio companies to purchase such services from our affiliates rather than an unaffiliated service provider despite the fact that a third-party service provider could potentially provide higher quality services or offer them at a lower cost.
It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction or litigation or regulatory enforcement actions. While we believe we have appropriate policies and procedures in place to manage conflicts of interest, this process 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 or actual conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest would have a material adverse effect on our reputation, which would materially adversely affect our business, financial condition or results of operations in a number of ways, including an to raise additional Discretionary Funds and a of counterparties to do business with us.
Two of our subsidiaries are currently required to be registered as an investment adviser or a relying adviser, subjecting us to extensive regulation and examination by the SEC that could adversely affect our ability to manage our business.
While Chimera Investment Corporation is currently not registered as an investment adviser under the Advisers Act, two of our subsidiaries are currently required to be registered as an investment adviser or relying adviser, and other subsidiaries may be required to register as such in the future. As a result, we and/or our subsidiaries are subject to extensive regulation which could adversely affect our ability to manage our business. Investment advisers are subject to various requirements under the Advisers Act such as fiduciary duties to clients, anti-fraud provisions, substantive prohibitions and requirements, contractual and record-keeping requirements and administrative oversight by the SEC (primarily by inspection). In addition, investment advisers must continually address potential conflicts between their interests and those of clients. 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. If we are deemed to be out of compliance with any such rules and regulations, we may be subject to civil liability, liability and/or regulatory sanctions.
Our asset management and advisory services business has significant client concentration, with a limited number of clients accounting for a significant portion of fees. Failure to attract, grow, and retain a diverse and balanced client base could adversely affect our asset management and advisory services business.
Our asset management and advisory services business has a limited number of clients that account for a substantial portion of its fees. Revenues from these clients may fluctuate from time to time based on these clients’ business needs and client experience, the timing of which may be affected by market conditions or other factors outside of our control. Competitive pressures may also cause us to reduce the prices we charge, which could have an adverse effect on our margins and financial position and could negatively affect our revenues. If any of our large clients terminates its relationship with us or materially reduces the services they acquire from us, such termination or reduction could materially reduce the revenues we derive from our asset management and advisory services business. Because our operating costs may not decline proportionately with any such reductions, any client redemption or mandate termination could negatively impact our profitability.
Our ability to attract, grow, and retain a diverse and balanced client base may affect our ability to grow our revenues. Our ability to attract clients depends on a variety of factors, including our service offerings. If we are unable to expand or improve our service offerings, we may fail to develop, grow, and retain a diverse and balanced client base, which could adversely affect our asset management and advisory services business and the revenues derived therefrom.
Risks Related to Hedging
Hedging interest rate exposure may not be successful in mitigating the risks associated with interest rates and may reduce our cash available for distribution to our stockholders and adversely affect our financial condition and result of operations.
Subject to maintaining our qualification as a REIT, we use various hedging strategies to reduce our exposure to losses from rising interest rates in the current market. Hedging activity varies in scope based on the level and volatility of interest rates, the type of assets held, financing used, and other changing market conditions. There are no perfect hedging strategies, and interest rate hedging may fail to protect us from loss. Alternatively, we may fail to properly assess a risk to our investment portfolio or may fail to recognize a risk entirely, leaving us exposed to losses without the benefit of any offsetting hedging activities. The derivative financial instruments we may use, including interest rate caps, options, futures, and swap futures, to hedge our interest rate exposure, may not fully protect us from adverse market movements and could expose us to additional risks such as basis risk, margin calls, and liquidity constraints. Our hedging instruments can be traded on an exchange, or administered through a clearing house or under bilateral agreements between us and a counterparty. Bilateral agreements us to increased counterparty risk, and we may be at risk of any collateral held by a hedging counterparty if the counterparty becomes or files for .
The nature and timing of hedging transactions may influence the effectiveness of these strategies. Poorly designed strategies or improperly executed transactions could also increase our risk and losses. Our hedging strategies rely on models, assumptions, and historical correlations that may prove inaccurate, particularly in periods of market disruption. If these relationships break down or our models fail to capture relevant risk drivers, our hedges may underperform and result in financial losses. In addition, our hedging activities could result in losses if the anticipated market movements do not occur or if the hedging instruments do not effectively match the duration, timing, or other characteristics of the related assets or liabilities, or otherwise fail to correlate as intended with the risks being hedged. Regulatory changes that alter margin or clearing requirements could increase our costs and limit our hedging flexibility. Lastly, the amount of income that we may earn from hedging transactions to offset interest rate may be limited by U.S. federal tax provisions governing REITs.
The hedging transactions we undertake, which are intended to limit losses, may limit gains and increase our exposure to losses. Thus, if our hedging strategies fail or market conditions change unexpectedly, it may result in a reduction of our cash available for distribution and we could incur losses that adversely affect our financial condition and results of operations.
We may enter into hedging instruments that could expose us to contingent liabilities in the future, which could materially adversely affect our results of operations.
Subject to maintaining our qualification as a REIT, part of our financing strategy involves entering into hedging instruments that could require us to fund cash payments in certain circumstances (e.g., the early termination of a hedging instrument caused by an event of default or other voluntary or involuntary termination event or the decision by a hedging counterparty to request the posting of collateral that it is contractually owed under the terms of a hedging instrument). With respect to the termination of an existing derivative or hedge instrument, the amount due would generally be equal to the unrealized loss of the open position with the hedging counterparty and could also include other fees and charges. These economic losses will be reflected in our financial results of operations and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. Any losses we incur on our hedging instruments could materially adversely affect our earnings and thus our cash available for distribution to our stockholders.
The characteristics of hedging instruments present various concerns, including illiquidity, enforceability, and counterparty risks, which could adversely affect our business and results of operations.
As indicated above, from time to time we enter into various forms of hedge instruments. Entities entering into derivatives are exposed to credit losses in the event of non-performance by counterparties to these transactions. Rules issued by the Commodity Futures Trading Commission (the “CFTC”) that became effective in October 2012 require, with limited exceptions, the clearing of all standardized swap transactions through registered derivatives clearing organizations, or swap execution facilities, through standardized documents under which each swap counterparty transfers its position to another entity whereby the centralized clearinghouse effectively becomes the counterparty to each side of the swap. In addition to greater initial and
periodic margin (collateral) requirements and additional transaction fees both by the swap execution facility and the clearinghouse, the swap transactions are now subjected to greater regulation by both the CFTC and the SEC. In response to events having or expected to have adverse economic consequences or which create market uncertainty, clearing facilities or exchanges upon which some of our hedging instruments (i.e., interest rate swaps) are traded may also require us to post additional collateral against our hedging instruments. These additional fees, costs, margin requirements, documentation requirements, and regulations could adversely affect our business and results of operations.
Risks Associated with Our Operations
Through certain of our wholly owned subsidiaries, we have engaged in the past, and expect to continue to engage in, securitization transactions relating to residential mortgage loans. These types of transactions and investments expose us to potentially material risks.
A significant part of our business and growth strategy is to engage in various securitization transactions related to mortgage assets, and such transactions expose us to potentially material risks, including without limitation:
• Financing at Unfavorable Terms Risk: Engaging in securitization transactions and other similar transactions generally require us to incur short-term debt on a recourse basis to finance the accumulation of residential mortgage loans. If investor demand for securitization transactions weakens sufficiently, we may be unable to complete the securitization of loans accumulated for that purpose on favorable terms, or at all, which may hurt our business or financial results. We have a limited capacity to hold loans on our balance sheet as investments, and many of our financings are not structured as buy-and-hold facilities. If demand for securitized securities weakens, we may be forced to incur additional debt on unfavorable terms or may be unable to borrow to finance these assets, which may in turn impact our ability to continue acquiring loans over the short or long term.
• Diligence Risk: We engage in due diligence with respect to the loans or other assets we are securitizing and make representations and warranties relating to those loans and assets. When conducting due diligence, we rely on resources and data available to us and on a review of the collateral by third parties, each of which may be limited. We may also only conduct due diligence on a sample of a pool of loans or assets we are acquiring and assume that the sample is representative of the entire pool. Our due diligence efforts may not reveal matters which could lead to losses. If our due diligence process is not robust enough, or the scope of our due diligence is limited, we may incur losses. Losses could occur because a counterparty that sold us a loan or other asset refuses or is unable (e.g., due to its financial condition) to repurchase that loan or asset or pay damages to us if we determine after purchase that one or more of the representations or warranties made to us was inaccurate or because we do not get a representation or warranty that covers a discovered defect or . In addition, with respect to such loans will generally be borne by us as the holder of the “first-” securities in our securitizations.
• Disclosure and Indemnity Risk: When engaging in securitization transactions, we also prepare marketing and disclosure documentation, including term sheets and prospectuses, that include disclosures regarding the securitization transactions, the securitization transaction agreements and the assets being securitized. If our marketing and disclosure documentation are alleged or found to contain inaccuracies or omissions, we may be liable under federal and state securities laws (or under other laws) for damages to third parties that invest in these securitization transactions, including in circumstances where we relied on a third party in preparing accurate disclosures, or we may incur other expenses and costs disputing these allegations or settling claims. Additionally, we typically retain various third-party service providers when we engage in securitization transactions, including underwriters, trustees, administrative and paying agents, servicers and custodians, among others. We frequently contractually agree to indemnify these service providers against various claims and losses they may from providing these services to us or the securitization trust. If any of these service providers are liable for to third parties that have invested in these securitization transactions, we may incur costs and expenses because of these indemnities.
• Call Right Risk : We often retain call rights with respect to certain sponsored securitizations that permit us to redeem securities at par, and because these securitizations are generally consolidated, exercising such rights may affect our GAAP book value. Specifically, if the redeemed securities are carried below par at the time of redemption, our GAAP book value may decline.
• Documentation Defects : If there are problems with the establishment of title to underlying mortgaged property and lien priority rights are transferred, securitization transactions that we sponsored and third-party sponsored securitizations that we hold investments in may experience losses, which could expose us to losses and could damage our ability to engage in future securitization transactions.
Our ability to profitably execute or participate in future securitization transactions depends, in part, on our ability to compete with other purchasers of residential mortgage loans and the cost and availability of short-term debt, which may be negatively impacted by adverse market conditions beyond our control.
A significant part of our business and growth strategy is to engage in various securitization transactions related to residential mortgage loans. There are many factors that can have a significant impact on whether a securitization transaction is profitable to us or result in a loss. One of these factors is the price we pay for the mortgage loans that we securitize, which, in the case of residential mortgage loans, is impacted by the level of competition in the marketplace for acquiring residential mortgage loans and the relative desirability to originators or other financial institutions of retaining residential mortgage loans as investments or selling them to third parties such as us. The cost and availability of the short-term debt we use to finance our mortgage loans before securitization impacts our profitability. This short-term debt cost is affected by several factors including its availability to us, its interest rate, its duration, and the percentage of our mortgage loans for which third parties are willing to provide short-term financing.
After we acquire mortgage loans that we intend to securitize, we can also suffer losses if the value of those loans declines before securitization. Declines in the value of a residential mortgage loan, for example, can be due to, among other things, changes in interest rates, changes in the credit quality of the loan, changes in the projected yields required by investors to invest in securitization transactions, and increased delinquencies. Hedging against a decline in loan value due to changes in interest rates may impact the profitability of a securitization.
The price that investors in MBS will pay for securities issued in our securitization transactions also has a significant impact on the profitability of the transactions to us, and these prices are impacted by numerous market forces and factors including the uncertainty, potential delinquencies, and lack of liquidity. In addition, the underwriter(s) or placement agent(s) we select for securitization transactions, the terms of their engagement and the transaction costs incurred in such securitizations can also impact the profitability of our securitizations. Also, any liability that we may incur, or may be required to reserve for when executing a transaction can cause a loss to us. To the extent that we are not able to profitably execute future securitizations of residential mortgage loans or other assets, including for the reasons described above or for other reasons, it could have a material adverse impact on our business and financial results.
Competition may affect our ability to source our target assets at attractive prices and grow our investment management and advisory services, which may have a material adverse effect on our business, financial condition and results of operations.
We operate in a highly competitive market for investment opportunities. In acquiring real estate-related assets for ourselves or for any new Discretionary Fund in our capacity as investment manager, we compete with other mortgage REITs, investment management firms, specialty finance companies, savings and loan associations, banks, mortgage bankers, insurance companies, exchange traded funds, mutual funds, institutional investors, investment banking firms, financial institutions, private equity funds, hedge funds, governmental bodies (including the Federal Reserve) and other entities. Many of our competitors are significantly larger than we are, have access to greater capital, technical, technological, marketing and other resources, and may have other advantages over us. In addition, some of our competitors may have higher risk tolerances, different risk assessments, or fewer regulatory burdens and restrictions, which could allow them to consider a wider variety of investments and establish more favorable relationships than we can. The existence of these entities, as well as the possibility of additional entities forming in the future, may increase the competition for the acquisition of residential mortgage assets, resulting in higher prices and lower yields on such assets, as well as limiting our ability to raise third-party funds for, and therefore earn fees and incentive-based income from, any new Discretionary Funds.
We also provide investment management and advisory services on a non-discretionary basis. In that regard, we compete with investment management firms and similar entities for clients. Our clients may also choose to perform these functions internally and discontinue their relationships with us. Many of our competitors are significantly larger than we are, have access to greater capital and other resources, and may have other advantages over us. The existence of these entities, as well as the possibility of additional entities forming in the future, may limit our ability to grow fees from our non-discretionary investment management and advisory services or our ability to obtain new third-party non-discretionary accounts. The competitive pressures we face may have a material adverse effect on our business, financial condition and results of operations.
We rely on third parties to perform certain services particularly as it relates to loan servicing, comply with applicable laws and regulations, and carry out contractual covenants and terms, the failure of which by any of these third parties may adversely impact our business and financial results.
To conduct our business of acquiring loans, engaging in securitization transactions, and investing in third-party issued securities and other assets, we rely on third-party service providers to perform certain services, comply with applicable laws and regulations, and carry out contractual covenants and terms. Thus, we are subject to the risks associated with a third party’s failure to perform, including failure to perform due to reasons such as fraud, negligence, errors, miscalculations, or insolvency.
We rely on third-party loan servicers to service and manage the mortgage loans we beneficially own and that underlie our RMBS. Third-party servicers also service and manage the mortgage loans underlying MSRs that we may invest in. The ultimate returns generated by our investments may depend on the quality of the service providers, the selection of which we may not always have control. For example, servicers not vigilantly monitoring required monthly payments or taking longer than expected to resolve non-performing loans or liquidate related real properties may adversely impact the value of these investments and our financial performance. In addition, while we have contracted with third-party servicers to carry out the actual servicing of the loans we beneficially own, other than our securitized loans (including all direct interface with the borrowers) we are nevertheless ultimately responsible, vis-à-vis the borrowers and state and federal regulators, for ensuring that the loans are serviced in accordance with the terms of the related notes and mortgages and applicable law and regulation. See “Risks Related to Regulatory Matters, Accounting, and Our 1940 Act Exemption” for further discussion. Considering the current regulatory environment, such exposure could be significant even though we might have contractual claims our servicers for any to service the loans to the required standard.
For a majority of the loans that we beneficially own (other than securitized loans), we also beneficially own the right to service those loans, and we retain a sub-servicer to service those loans. In these circumstances, we are exposed to certain risks, including, without limitation, that we may not be able to enter into sub-servicing agreements on favorable terms to us or at all, or that the sub-servicer may not properly service the loan in compliance with applicable laws and regulations or the contractual provisions governing their sub-servicing role, and that we would be held liable for the sub-servicer’s improper acts or omissions. Additionally, in its capacity as a servicer of residential mortgage loans, a sub-servicer will have access to borrowers’ non-public personal information, and we could incur liability for a data breach relating to a sub-servicer or misuse or mismanagement of data by a sub-servicer. In the past, one of our sub-servicers experienced a data of personal information requiring notifications to borrowers and remedial actions. We also rely on technology infrastructure and systems of third parties who provide services to us and with whom we transact business. To the extent any one sub-servicer counterparty services a significant percentage of the loans with respect to which we own the servicing rights, the risks associated with our use of that sub-servicer are concentrated around this single sub-servicer counterparty. To the extent that there are significant amounts of that need to be funded in respect of loans where we own the servicing right, it could have a material effect on our business and financial results.
We also rely on corporate trustees to act on behalf of us in enforcing our rights as security holders. Under the terms of most RMBS we hold, we do not have the right to directly enforce remedies against the issuer of the security but instead must rely on a trustee to act on behalf of us and other security holders. Should a trustee not be required to act under the terms of the securities, or fail to act, we could experience losses.
The expanding body of federal, state and local regulations and the investigations of servicers may increase their cost of compliance and the risks of noncompliance and may adversely affect their ability to perform their servicing obligations.
We rely on third-party servicers to service the residential mortgage loans that we acquire through consolidated trusts and that underlie the RMBS that we acquire. The mortgage servicing business is subject to extensive regulation by federal, state and local governmental authorities and various laws and judicial and administrative decisions imposing requirements and restrictions and increased compliance costs on a substantial portion of their operations. The volume of new or modified laws and regulations has increased in recent years. Some jurisdictions and municipalities have enacted laws that restrict loan servicing activities, including delaying or preventing prompt foreclosures, forcing the modification of certain mortgages, or preventing the collection of interest or other charges from borrowers under certain circumstances. Certain mortgage lenders and third-party servicers may also voluntarily, or as part of settlements with law enforcement authorities, establish loan modification programs relating to loans they hold or service, even if such loan modifications and other actions are not in the best interests of the beneficial owners of the mortgages. These federal, state and local legislative or regulatory actions that result in modifications of our outstanding mortgages, or interests in mortgages acquired by us either directly through consolidated trusts or through our investments in RMBS, may affect the value of, and returns on, such investments. The foregoing matters may cause our business, financial condition, results of operations and ability to pay dividends to be affected.
We utilize third-party analytical models and data to value our investments, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks.
Given the complexity of our investments and strategies, we rely heavily on analytical models and information and data supplied by third parties, (“Third-Party Data”). Third-Party Data is used to value investments or potential investments and to hedge our investments. When we rely on Third-Party Data that proves to be incorrect, misleading or incomplete, our decisions expose us to potential risks. For example, by relying on Third-Party Data, especially valuation models, we may be induced to buy certain investments at prices that are too high, to sell certain other investments at prices that are too low, or to miss favorable opportunities altogether. Similarly, any hedging based on faulty Third-Party Data may prove to be unsuccessful. Furthermore, any valuations of our investments that are based on valuation models may prove to be incorrect.
These risks include the following: (i) collateral cash flows and/or liability structures may be incorrectly modeled in all or only certain scenarios, or may be modeled based on simplifying assumptions that lead to errors; (ii) information about collateral may be incorrect, incomplete, or misleading; (iii) collateral or bond historical performance (such as historical prepayments, defaults, cash flows, etc.) may be incorrectly reported, or subject to interpretation (e.g., different issuers may report delinquency statistics based on different definitions of what constitutes a delinquent loan); or (iv) collateral or bond information may be outdated, in which case the models may contain incorrect assumptions as to what has occurred since the date information was last updated.
Some of the Third-Party Data we use, such as mortgage prepayment models or mortgage default models, are predictive in nature. The use of predictive models has inherent risks. For example, such models may incorrectly forecast future behavior, leading to potential losses on a cash flow and/or a mark-to-market basis. In addition, the predictive models we use may differ substantially from those models used by other market participants, with the result that valuations based on these predictive models may be substantially higher or lower for certain investments than actual market prices. Furthermore, since predictive models are usually constructed based on historical data supplied by third parties, the success of relying on such models may depend heavily on the accuracy and reliability of the supplied historical data and the ability of these historical models to accurately reflect future periods.
All valuation models rely on correct market data inputs. Certain assumptions used as inputs to the models may be based on historical trends and these trends may not be indicative of future results. If incorrect market data is used, even a well-designed valuation model may result in incorrect valuations. Even if market data is appropriately captured in the model, the resulting “model prices” will often differ substantially from market prices, especially for securities with complex characteristics, such as derivative securities. Volatility in any asset class, including real estate and mortgage-related assets, increases the likelihood of Third-Party Data being inaccurate as market participants attempt to value assets that have frequent, significant swings in pricing.
We are dependent on information technology and systems, including those of third parties, and their failure, including through a cyber-attack, could significantly disrupt our business or result in the disclosure or misuse of confidential or other information, including personal information, which could damage our reputation, result in regulatory sanctions, subject us to litigation and/or increase our costs and cause losses that have a material adverse impact on our business, financial results and financial condition.
Our business is highly dependent on our information and communications systems. These information and communications systems include hardware, software and cloud-based solutions. Our business is also highly dependent on the information and communications systems of third parties with whom we do business or that facilitate our business activities, including clearing agents, mortgage servicers, trustees, business counterparties, technology service providers and financial intermediaries. Our relationships with certain of these third parties allow for the external storage and processing of our information, including personal information, and counterparty and borrower information, including on cloud-based systems. In addition, third parties to whom we provide investment management and advisory services and a few customers who license two of our internally developed data analytics technologies, may also share their confidential information, including personal information, with us, which information may be processed and stored in, and transmitted through, our computer systems and networks.
We may not be able to anticipate, detect or recognize threats to our systems and assets, or to implement effective preventive measures against all cyber threats, especially because the techniques used in cyber-attacks are increasingly sophisticated, change frequently, are complex, and are often not recognized until launched. Cyber-attacks can occur and persist for an extended period of time without detection. Investigations of cyber-attacks are inherently unpredictable, and it takes time to complete an investigation and have full and reliable information. These and other challenges could further increase the costs and consequences of a cyber-attack and may inhibit our ability to provide rapid, complete and reliable information about a cyber-attack to our business partners, counterparties and regulators, as well as the public.
Any failure, interruption, attack or security breach of our networks or systems or those of key third parties could cause delays or other problems in our business or result in the disclosure or misuse of confidential or other information, including personal information, that belongs to us, to third parties to whom we provide investment management and advisory services, or to a few customers who license two of our internally developed data analytics technologies. Such delays, problems or unintentional
disclosures could damage our reputation, result in regulatory sanctions or liability to third parties and/or increase our costs and cause losses that have a material adverse impact on our business, financial results and financial condition. Cyber criminals are now deploying sophisticated techniques to conduct more advanced and persistent attacks. We have been and continue to be the target of such attacks. From time to time, third parties with whom we do business, including servicers and due diligence and third-party data providers, have experienced data breaches or other cybersecurity incidents. Such attacks, as well as an actual or perceived failure by us or third parties to comply with privacy, data protection and information security laws, regulations, standards, policies and contractual obligations could result in legal liabilities, fines, regulatory action and reputational harm that have a material adverse impact on our business, financial results and financial condition. We cannot you that our cybersecurity control and response plans will be sufficient to prevent or mitigate all potential risks of cybersecurity and . Especially due to the current hybrid working environments, where our personnel are spending some time working from home, there is an elevated risk of such events occurring.
The development, proliferation, and use of artificial intelligence could give rise to legal and/or regulatory action, damage our reputation or otherwise materially impact our business, financial condition, and liquidity.
We currently use artificial intelligence in certain aspects of our operations, and we believe the development and proliferation of artificial intelligence will have a significant impact in our industry; however, the emerging and rapidly evolving nature of artificial intelligence presents risks, challenges, and unintended consequences, including potential defects in the design and development of the technologies used to automate processes, misapplication of artificial intelligence-enabled technologies, the reliance on data, rules or assumptions that may prove incomplete or inaccurate, information security vulnerabilities and operational failures to meet internal or external expectations for reliability, accuracy, fairness, and among others. This risk affects the adoption and use of this technology to the extent artificial intelligence algorithms and machine learning methods are flawed or insufficiently tested. For example, the use of artificial intelligence may raise ethical and legal issues in the origination of mortgage loans. While we aim to use artificial intelligence responsibly, we may be in identifying or resolving issues before they arise. Artificial intelligence-related issues, including potential government regulation of artificial intelligence, or could give rise to legal and regulatory actions, our reputation or otherwise materially impact our business, financial condition, and liquidity.
Laws and regulations related to artificial intelligence are developing rapidly, and there is significant uncertainty as to the potential adoption of new laws and regulations, which may vary amongst various states, that may restrict or impose burdensome and costly requirements on our ability to use artificial intelligence. We may receive claims from third parties, including our competitors, alleging that the use of artificial intelligence technology infringes on or violates such third party’s intellectual property rights. Adverse consequences of these risks related to artificial intelligence could undermine the decisions, predictions or analyses such technologies produce and subject us to competitive harm, legal liability, heightened regulatory scrutiny and brand or reputational harm. We could face competitive pressure to adopt AI at a pace consistent with technological advancements across our industry. If we are to implement AI capabilities as quickly or effectively as our competitors, our relative market position could be affected.
Our executive officers and other key personnel are critical to our success and the loss of any executive officer or key employee may materially adversely affect our business.
Our success and our ability to manage anticipated future growth depend, in large part, upon the efforts of our highly skilled employees, and particularly on our key personnel, including our executive officers. Our executive officers have extensive experience and strong reputations in our industry and have been instrumental in setting our strategic direction, operating our business, identifying, recruiting, and training our other key personnel, and arranging necessary financing. Retention and motivation of certain key employees is particularly important to our business in light of the recent HomeXpress Acquisitions due to the uncertainty and difficulty of integration, as well as the time and attention required by our management team. See the Risk Factor above captioned “We may fail to realize the expected benefits of the HomeXpress Acquisition ”. In addition, the governing agreements of the Discretionary Funds typically require the suspension or termination of the investment period if certain members of our senior management team or key personnel cease to devote sufficient professional time to or cease to be employed by the Company, often called a “key person event,” or in connection with certain other events. The departure of any of our executive officers or other key personnel, or our to attract, motivate and retain highly qu alified employees at all levels of the firm in light of the intense competition for talent, could affect our business, operating results or financial condition, our investment , or our relationships with lenders, counterparties and other parties important to our business and strategy.
Risks Related to Regulatory Matters, Accounting, and Our 1940 Act Exemption
Our business is subject to extensive regulation that may subject us to significant costs and compliance requirements, and there can be no assurance that we will satisfactorily comply with such regulations. A ny changes in regulatory and
legal requirements, including changes in their interpretation and enforcement by lawmakers and regulators, could materially and adversely affect our business and our financial condition, liquidity, and results of operations.
Our business is subject to extensive regulation by federal and state governmental authorities, self-regulatory organizations, and securities exchanges. We are required to comply with numerous federal and state laws. The laws, rules and regulations comprising this regulatory framework change frequently, as can the interpretation and enforcement of existing laws, rules, and regulations. We incur significant ongoing costs to comply with these government regulations.
Our portfolio includes or may include investments in mortgage pass-through certificates issued or guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac. The FHFA and Congress have considered various measures that would significantly reform the country’s mortgage finance system, including, among other things, eliminating Freddie Mac and Fannie Mae and replacing them with a single new MBS insurance agency. While the likelihood that major mortgage finance system reform will be enacted in the short term or through administrative action remains uncertain, it is possible that the adoption of any such reforms could adversely affect the types of assets we can buy, the costs of these assets and our business operations. A reduction in the ability of mortgage loan originators to access Fannie Mae and Freddie Mac to sell their mortgage loans may adversely affect the mortgage markets generally and adversely affect the ability of mortgagors to refinance their mortgage loans. In addition, any decline in the value of securities issued by Fannie Mae and Freddie Mac may affect the value of MBS in general.
Although we do not currently directly service residential mortgage loans, where this activity is subject to separate state and federal regulatory requirements, we may do so in the future. We and our HomeXpress clients are required to comply with a wide array of laws, rules and regulations, including federal and state consumer lending regulations, that concern, among other things, the manner in which we conduct our loan origination and acquisition business and the fees that we may charge, and the collection, use, retention, protection, disclosure, transfer and processing of personal information by us and our clients. Governmental authorities and various U.S. federal and state agencies, including the CFPB, have broad oversight and supervisory authority over our HomeXpress business. See “Risks Related to Our Recent Acquisition and Loan Origination and Acquisition Business” for further discussion. We are also subject to various federal and state laws, rules, and regulations because we purchase residential mortgage loans, including rules promulgated under the Dodd-Frank Act and the Gramm-Leach-Bliley Financial Modernization Act of 1999. The CFPB, has broad authority over a wide range of consumer financial products and services, including mortgage lending and servicing. One portion of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act (or Mortgage Reform Act), contains underwriting and servicing standards for the mortgage industry and various other requirements related to mortgage origination and servicing. In addition, the Dodd-Frank Act grants enforcement authority and broad discretionary regulatory authority to the CFPB to prohibit or condition terms, acts or practices relating to residential mortgage loans that the CFPB finds , , or , as well as to take other actions that the CFPB finds are necessary or proper to ensure responsible affordable mortgage credit remains available to consumers. The Dodd-Frank Act also affects the securitization of mortgages (and other assets) with requirements for risk retention by securitizers and requirements for regulating rating agencies.
Numerous regulations have been issued pursuant to the Dodd-Frank Act, including regulations regarding mortgage loan servicing, underwriting and loan originator compensation and others could be issued in the future. These requirements can and do change, and the recent trends among federal and state lawmakers and regulators have been toward increasing laws, regulations, and investigative proceedings concerning the mortgage industry generally. As a result, we are unable to predict how the Dodd-Frank Act, as well as future laws or regulations, will affect our business, results of operations and financial condition, or the environment for financing or investing. We believe that the Dodd-Frank Act and the regulations promulgated thereunder are likely to continue to increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.
In 2020, in response to the COVID-19 pandemic, wide-ranging legal protections for homeowners, including foreclosure moratoria and forbearance provisions, were enacted and extended multiple times including through the Coronavirus Aid, Relief, and Economic Security Act (or CARES Act), which was signed into law on March 27, 2020, and rules and letters issued by the Federal Housing Agency and the CFPB. If the COVID-19 pandemic resurges or another public health crisis breaks out in the future, similar measures may be reenacted, which could adversely affect our business, results of operations and financial condition.
Although we believe that we have structured our operations and investments to comply with existing legal and regulatory requirements and interpretations, changes in regulatory and legal requirements, including changes in their interpretation and enforcement by lawmakers and regulators, could materially and adversely affect our business and our financial condition, liquidity, and results of operations.
The need to operate within the parameters that allow us to be excluded from regulation as a commodity pool operator could limit the use of swaps by us below the level we would otherwise consider optimal or may lead to the registration of us or our directors as commodity pool operators, which will subject us to additional regulatory oversight, compliance and costs.
The Dodd-Frank Act established a comprehensive regulatory framework for derivative contracts commonly referred to as “swaps.” Under the Dodd-Frank Act, any investment fund that trades in swaps may be considered a “commodity pool,” which would cause its operators to be regulated as a commodity pool operator (“CPO”). In December 2012, the CFTC issued a no-action letter, giving relief to operators of mortgage REITs from the requirement to register as a CPO. In order to qualify, we must, among other non-operation requirements: (1) limit our initial margin and premiums required to establish our swap or futures positions to no more than 5% of the fair market value of our total assets; and (2) limit our net income derived annually from our swaps and futures positions that are not “qualifying hedging transactions” to less than 5% of our gross income. The need to operate within these parameters could limit the use of swaps by us below the level that we would otherwise consider optimal or may lead to the registration of us or our directors as commodity pool operators, which will subject us to additional regulatory oversight, compliance and costs.
We may be required to obtain various state licenses to purchase mortgage loans in the secondary market and there is no assurance we will be able to obtain or maintain those licenses.
While we are not required to obtain licenses to purchase MBS, the purchase of residential mortgage loans in the secondary market may, in some circumstances, require us, or the entities, including securitization trusts, we use to conduct our business, to maintain various state licenses. Acquiring the right to service residential mortgage loans may also, in some circumstances, require us to maintain various state licenses even though we currently do not expect to directly engage in loan servicing ourselves. Thus, we could be delayed in conducting certain business if we were first required to obtain a state license. We cannot assure you that we will be able to obtain all the licenses we need or that we would not experience significant delays in obtaining these licenses. Furthermore, once licenses are issued, we are required to comply with various information reporting and other regulatory requirements to maintain those licenses, and there is no assurance that we will be able to satisfy those requirements or other regulatory requirements applicable to our business of acquiring residential mortgage loans on an ongoing basis. Our failure to obtain or maintain required licenses or our to comply with regulatory requirements that are applicable to our business of acquiring residential mortgage loans may restrict our business and investment options and could our business and us to or other .
Our GAAP financial results may not be an accurate indicator of taxable income and dividend distributions.
Generally, the cumulative net income we report over the life of an asset will be the same for GAAP and tax purposes, although the timing of this income recognition over the life of the asset could be materially different. Differences exist in the accounting for GAAP net income and REIT taxable income, which can lead to significant variances in the amount and timing of when income and losses are recognized under these two measures. Due to these differences, our reported GAAP financial results could materially differ from our determination of taxable income, which impacts our dividend distribution requirements, and, therefore, our GAAP results may not be an accurate indicator of future taxable income and dividend distributions.
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.
The Financial Accounting Standards Board, or 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 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, directly or through their impact on our business partners or counterparties.
Loss of our 1940 Act exemption would adversely affect us and negatively affect the market price of shares of our capital stock and our ability to distribute dividends.
We conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the 1940 Act. Section 3(a)(1)(A) of the 1940 Act defines an investment company as any issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting, or trading in securities. Section 3(a)(1)(C) of the 1940 Act defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. Excluded from the term “investment securities,” among other things, are U.S. Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and are not
relying on the exclusion from the definition of investment company set forth in Section 3(c)(1) or Section 3(c)(7) of the 1940 Act.
Because we are a holding company that conducts its businesses primarily through wholly owned subsidiaries and majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities we may own, may not have a combined value in excess of 40% of the value of our adjusted total assets on an unconsolidated basis. This requirement limits the types of businesses in which we may engage through our subsidiaries. In addition, the assets we and our subsidiaries may acquire are limited by the provisions of the 1940 Act, the rules and regulations promulgated under the 1940 Act and SEC staff interpretative guidance, which may adversely affect our performance.
Certain of our subsidiaries may rely on Section 3(c)(7) for their 1940 Act exemption and, therefore, our interest in each of these subsidiaries would constitute an “investment security” for purposes of determining whether we pass the 40% test.
Certain of our subsidiaries rely on the exemption from registration provided by Section 3(c)(5)(C) of the 1940 Act. Section 3(c)(5)(C) as interpreted by the staff of the SEC, requires us to invest at least 55% of our assets in “mortgages and other liens on and interest in real estate” (“Qualifying Real Estate Assets”) and at least 80% of our assets in Qualifying Real Estate Assets plus real estate-related assets. The assets that we acquire, therefore, are limited by the provisions of the 1940 Act and the rules and regulations promulgated under the 1940 Act. If the SEC determines that any of our subsidiaries’ securities are not Qualifying Real Estate Assets or real estate-related assets or otherwise believes such subsidiary does not satisfy the exemption under Section 3(c)(5)(C) of the 1940 Act, we could be required to restructure our activities or sell certain of our assets. The net effect of these factors will be to lower our net interest income. If we fail to qualify for exemption from registration as an investment company, our ability to use leverage would be substantially reduced, and we would not be able to conduct our business as described.
Certain of our subsidiaries may rely on Rule 3a-7, which exempts certain securitization vehicles. There are numerous requirements that must be met to exclude such subsidiaries from the definition of an investment company. Our ability to manage assets held in a special purpose subsidiary that complies with Rule 3a-7 will be limited and we may not be able to purchase or sell assets owned by that subsidiary when we would otherwise desire to do so, which could lead to losses.
The determination of whether an entity is a majority-owned subsidiary of our company is made by us. The 1940 Act defines a majority-owned subsidiary of a person as a company of which 50% or more of the outstanding voting securities are owned by such person, or by another company which is a majority-owned subsidiary of such person. The 1940 Act further defines voting securities as any security presently entitling the owner or holder thereof to vote for the election of directors of a company. We treat companies in which we own at least a majority of the outstanding voting securities as majority-owned subsidiaries for purposes of the 40% test. We have not requested the SEC to approve our treatment of any company as a majority-owned subsidiary, and the SEC has not done so. If the SEC were to disagree with our treatment of one or more companies as majority-owned subsidiaries, we may need to adjust our strategy and our assets to continue to pass the 40% test. Any such adjustment in our strategy could have a material adverse effect on us.
There can be no assurance that the laws and regulations governing the 1940 Act status of REITs, including guidance from the Division of Investment Management of the SEC regarding these exemptions, will not change in a manner that adversely affects our operations. If we or our subsidiaries fail to maintain an exception or exemption from the 1940 Act, we could, among other things, be required either to (a) substantially change the manner in which we conduct our operations to avoid being required to register 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 negatively affect the value of our capital stock, the sustainability of our business model, and our ability to make distributions, which could have an adverse effect on our business and the market price for our shares of capital stock.
U.S. Federal Income Tax Risks and Risks Related to Our REIT Status
Complying with REIT requirements may cause us to forego otherwise attractive opportunities or to liquidate otherwise attractive investments.
To maintain our qualification as a REIT, we must continually satisfy various tests regarding the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. To meet these tests, we may be required to forego investments we might otherwise make. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our investment performance. In particular, we generally must ensure that at the end of each calendar quarter at least 75% of the value of our total assets consists of cash, cash items, government securities and qualifying
real estate assets, including certain mortgage loans and MBS. The remainder of our investments in securities (other than government securities and qualifying real estate assets) generally cannot include more than 10% of the outstanding voting securities of any one issuer or more than 10% of the total value of the outstanding securities of any one issuer. In addition, in general, no more than 5% of the value of our assets (other than government securities, qualifying real estate assets, and stock in one or more TRSs) can consist of the securities of any one issuer, and no more than 25% of the value of our total assets can be represented by securities of one or more TRSs (20% for taxable years beginning before January 1, 2026). If we fail to comply with these requirements at the end of any quarter, we must correct the failure within 30 days after the end of such calendar quarter or qualify for certain statutory relief provisions to avoid losing our REIT status and suffering adverse tax consequences. Thus, we may be required to liquidate from our portfolio otherwise attractive investments. These actions could have the effect of reducing our income and amounts available for distribution to our stockholders.
Complying with REIT requirements may limit our ability to hedge effectively.
The REIT provisions of the Internal Revenue Code of 1986, as amended (the “Code”), substantially limit our ability to hedge our assets and related borrowings. Under these provisions, any income that we generate from transactions intended to hedge our interest rate, inflation and/or currency risks will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges (1) interest rate risk on liabilities incurred to carry or acquire real estate or (2) risk of currency fluctuations with respect to any item of income or gain that would be qualifying income under the REIT 75% or 95% gross income tests, and such instrument is properly identified under applicable Treasury Department regulations. Our annual gross income from non-qualifying hedges, together with any other income not generated from qualifying real estate assets, cannot exceed 25% of our annual gross income. In addition, our aggregate gross income from non-qualifying hedges, fees, and certain other non-qualifying sources cannot exceed 5% of our annual gross income. As a result, we might have to limit our use of advantageous hedging techniques or implement certain hedges through a TRS. This could increase the cost of our hedging activities or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear.
We may invest in TBAs, which have some uncertainty in their treatment under the REIT asset and income tests.
We may in the future purchase and sell Agency 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. While 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 REIT 75% asset test or the qualification of income or gains from dispositions of TBAs as gains from the sale of real property or other qualifying income for purposes of the REIT 75% gross income test, we intend to treat the GAAP value of our TBAs under which we contract to purchase to-be-announced Agency RMBS as qualifying assets for purposes of the REIT 75% asset test, and we treat income and gains from our TBAs as qualifying income for purposes of the REIT 75% gross income test. 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 our position, we could be subject to a penalty tax or we could fail to remain qualified as a REIT if a sufficient portion of our assets consists of TBAs or a sufficient portion of our income consists of income or from the disposition of TBAs.
Failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce the cash available for distribution to our stockholders.
We have elected to be treated as a REIT for U.S. federal income tax purposes and intend to operate so that we will qualify as a REIT. However, the U.S. federal income tax laws governing REITs are extremely complex, and interpretations of the U.S. federal income tax laws governing qualification as a REIT are limited. Qualifying as a REIT requires us to meet various tests regarding the nature of our assets and our income, the ownership of our outstanding stock, and the amount of our distributions on an ongoing basis. While we intend to operate so as to maintain our qualification as a REIT, given the highly complex nature of the rules governing REITs, the ongoing importance of factual determinations, including the tax treatment of certain investments we may make, and the possibility of future changes in our circumstances, no assurance can be given that we will so qualify for any particular year.
We also indirectly own an entity that has elected to be taxed as a REIT under the U.S. federal income tax laws (the “Subsidiary REIT”). Our Subsidiary REIT is subject to the same REIT qualification requirements that are applicable to us. If our Subsidiary REIT were to fail to qualify as a REIT, then (i) that Subsidiary REIT would become subject to regular U.S. federal, state and local corporate income tax, (ii) our interest in such Subsidiary REIT would cease to be a qualifying asset for purposes of the REIT asset tests, and (iii) it is possible that we would fail certain of the REIT asset tests, in which event we also would fail to qualify as a REIT unless we could avail ourselves of certain relief provisions. While we believe that the Subsidiary REIT has qualified as a REIT under the Code, we have joined the Subsidiary REIT in filing a “protective” TRS election under Section 856(l) of the Code for each taxable year in which we have owned an interest in the Subsidiary REIT. We cannot assure you that such "protective" TRS election would be effective to avoid adverse consequences to us. Moreover, even if the “protective” election were to be , the Subsidiary REIT would be subject to regular corporate income tax, and we cannot you
that we would not fail to satisfy the requirement that not more than 25% (20% for taxable years beginning before January 1, 2026) of the value of our total assets may be represented by the securities of one or more TRSs. See “Our ownership of and relationship with our TRSs will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.” below.
If we fail to qualify as a REIT in any calendar year and we do not qualify for certain statutory relief provisions, we would be required to pay U.S. federal income tax on our taxable income at regular corporate income tax rates. We might need to borrow money or sell assets to pay any such tax. Our payment of income tax would decrease the amount of our income available for distribution to our stockholders. Furthermore, if we fail to maintain our qualification as a REIT and we do not qualify for certain statutory relief provisions, we no longer would be required to distribute substantially all our REIT taxable income to our stockholders. Unless our failure to qualify as a REIT was excused under U.S. federal tax laws, we would be disqualified from taxation as a REIT for the four taxable years following the year during which qualification was lost.
The ability of our Board of Directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides that our Board of Directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if our Board of Directors determines that it is no longer in our best interest to attempt to, or continue to, qualify as a REIT. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our net taxable income and we generally would no longer be required to distribute any of our net taxable income to our stockholders, which may have adverse consequences on the total return to our stockholders.
Distributions may be treated as unrelated business taxable income to tax-exempt investors.
If (1) all or a portion of our assets are subject to the rules relating to taxable mortgage pools, (2) we are a ‘‘pension-held REIT,’’ (3) a tax-exempt stockholder has incurred debt to purchase or hold our capital stock, or (4) the residual REMIC interests, we buy (if any) generate “excess inclusion income,” then a portion of the distributions to and, in the case of a stockholder described in clause (3), gains realized on the sale of capital stock by such tax-exempt stockholder may be subject to U.S. federal income tax as unrelated business taxable income under the Code.
Classification of our securitizations or financing arrangements as a taxable mortgage pool could subject us or certain of our stockholders to increased taxation.
We intend to structure our securitization and financing arrangements so as to not allocate “excess inclusion income” to our stockholders. However, if we have borrowings with two or more maturities and, (1) those borrowings are secured by mortgages or MBS and (2) the payments made on the borrowings are related to the payments received on the underlying assets, then the borrowings and the pool of mortgages or MBS to which such borrowings relate may be classified as a taxable mortgage pool under the Code. If any part of our investments were to be treated as a taxable mortgage pool, then our REIT status would not be impaired, but a portion of the taxable income we recognize may, under regulations to be issued by the Treasury Department, be characterized as excess inclusion income and allocated among our stockholders to the extent of and generally in proportion to the distributions we make to each stockholder. Any excess inclusion income would:
• not be allowed to be offset by a stockholder’s net operating losses;
• be subject to a tax as unrelated business income if a stockholder were a tax-exempt stockholder;
• be subject to the application of U.S. federal withholding tax at the maximum rate (without reduction for any otherwise applicable income tax treaty) with respect to amounts allocable to foreign stockholders; and
• be taxable (at the highest corporate tax rate) to us, rather than to our stockholders, to the extent the excess inclusion income relates to stock held by disqualified organizations (generally, tax-exempt organizations not subject to tax on unrelated business income, including governmental organizations).
Failure to make required distributions would subject us to tax, which would reduce the cash available for distribution to our stockholders.
To maintain our qualification as a REIT, we must distribute to our stockholders each calendar year at least 90% of our REIT taxable income (excluding certain items of non-cash income in excess of a specified threshold), determined without regard to the deduction for dividends paid and excluding net capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible excise tax on the amount, if any, by which our distributions in any calendar year are less than the sum of:
• 85% of our REIT ordinary income for that year;
• 95% of our REIT capital gain net income for that year; and
• any undistributed taxable income from prior years.
We intend to distribute all of our REIT taxable income to our stockholders so as to satisfy the 90% distribution requirement and to avoid both corporate income tax and the 4% nondeductible excise tax.
Our taxable income may substantially exceed our net income as determined by GAAP. As an example, realized capital losses may be included in our GAAP net income, but may not be deductible in computing our taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets. Also, our ability, or the ability of our subsidiaries, to deduct interest may be limited under Section 163(j) of the Code. To the extent that we generate such non-cash taxable income or have limitations on our deductions in a taxable year, we may incur corporate income tax and the 4% nondeductible excise tax on that income if we do not distribute such income to stockholders in that year. In that event, we may be required to use cash reserves, incur debt, or liquidate non-cash assets at rates or at times that we regard as unfavorable to satisfy the distribution requirement and to avoid corporate income tax and the 4% nondeductible excise tax in that year. Moreover, our ability to distribute cash may be limited by available financing facilities. Therefore, our dividend payment level may fluctuate significantly, and, under some circumstances, we may not pay dividends at all.
Our ownership of and relationship with our TRSs will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the equity of one or more TRSs. A TRS may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. Overall, no more than 25% (20% for taxable years beginning before January 1, 2026) of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. A TRS will pay U.S. federal, state and local income tax at regular corporate rates on any taxable income that it earns and could be subject to the 15% corporate alternative minimum tax on its adjusted financial statement income if certain income thresholds are met. In addition, the TRS rules impose a 100% excise tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis. Our TRS after-tax net income would be available for distribution to us but would not be required to be distributed to us. We expect to satisfy the 25% limitation discussed above and conduct transactions with any TRS on an arm's length basis. There can be no assurance, however, that we will be able to comply with the 25% limitation or to avoid application of the 100% excise tax.
The tax on prohibited transactions will limit our ability to engage in transactions, including certain methods of securitizing mortgage loans, that would be treated as sales for U.S. federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we sold or securitized our assets in a manner that was treated as a sale for U.S. federal income tax purposes. Therefore, to avoid the prohibited transactions tax, we may choose not to engage in certain sales of assets at the REIT level and may securitize assets in transactions that are treated as financing transactions and not as sales for tax purposes even though such transactions may not be the optimal execution on a pre-tax basis. We could avoid any prohibited transactions tax concerns by engaging in securitization transactions or sales of loans, including loans originated by HomeXpress , through a TRS, subject to certain limitations described above. To the extent that we engage in such activities through domestic TRSs, the income associated with such activities will be subject to U.S. federal (and applicable state and local) corporate income tax. There can be no assurance, however, that we will avoid the application of the 100% tax on net income from prohibited transactions described above.
The interest apportionment rules may affect our ability to comply with the REIT asset and gross income tests.
The mortgage loans we acquire may be subject to the interest apportionment rules under Treasury Regulations Section 1.856-5(c) (the “Interest Apportionment Regulation”), which generally provides that if a mortgage is secured by both real property and other property, a REIT is required to apportion its annual interest income for purposes of the REIT 75% gross income test. If a mortgage is secured by both real property and personal property and the value of the personal property does not exceed 15% of the aggregate value of the property securing the mortgage, the mortgage is treated as secured solely by real property for this purpose.
For purposes of the asset tests applicable to REITs, Revenue Procedure 2014-51 provides a safe harbor under which the IRS will generally not challenge a REIT’s treatment of a loan as being in part a real estate asset in an amount equal to the lesser of the fair market value of the loan or the fair market value of the real property securing the loan at certain relevant testing dates. We believe that all of the mortgage loans that we acquire are secured only by real property. Therefore, we believe that the Interest Apportionment Regulation does not apply to our portfolio.
Nevertheless, if the IRS were to assert successfully that our mortgage loans were secured by property other than real estate, that the Interest Apportionment Regulation applied for purposes of our REIT testing, and that the position taken in Revenue Procedure 2014-51 should be applied to our portfolio, then we might not be able to meet the REIT 75% gross income test, and possibly the asset tests applicable to REITs. If we did not meet these tests, we could lose our REIT status or be required to pay a tax penalty to the IRS.
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 U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted because of a foreclosure, excise taxes, state or local income, property and transfer taxes, such as mortgage recording taxes, and other taxes. In addition, to meet the REIT qualification requirements, prevent the recognition of certain types of non-cash income, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we may originate or hold some of our assets through our TRSs or other subsidiary corporations that will be subject to corporate-level income tax at regular corporate rates. In certain circumstances, the ability of our TRSs to deduct net interest expense may be limited. Any of these taxes would decrease cash available for distribution to our stockholders.
The failure of excess MSRs held by us to qualify as real estate assets, or the failure of the income from excess MSRs to qualify as interest from mortgages, could adversely affect our ability to qualify as a REIT.
We may hold excess MSRs. In certain private letter rulings, the IRS ruled that excess MSRs meeting certain requirements would be treated as an interest in mortgages on real property and thus a real estate asset for purposes of the 75% REIT asset test, and interest received by a REIT from such excess MSRs will be considered interest on obligations secured by mortgages on real property for purposes of the 75% gross income test. A private letter ruling may be relied upon only by the taxpayer to whom it is issued, and the IRS may revoke a private letter ruling. We intend to treat any excess MSRs that we acquire that are consistent with the requirements provided in the private letter rulings as qualifying assets for purposes of the 75% gross asset test, and we intend to treat income from such excess MSRs as qualifying income for purposes of the 75% and 95% gross income tests. Notwithstanding the IRS's determination in the private letter rulings described above, it is possible that the IRS could successfully assert that any excess MSRs that we acquire do not qualify for purposes of the 75% REIT asset test and income from such MSRs does not qualify for purposes of the 75% and/or 95% gross income tests, which could cause us to be subject to a penalty tax and could adversely impact our ability to qualify as a REIT.
We may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our capital stock and our business in general.
At any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws or regulations may be amended. We cannot predict when or if any new U.S. federal income tax law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or administrative interpretation, will be adopted, promulgated or become effective and any such law, regulation or interpretation may take effect retroactively. We and our stockholders could be adversely affected by any such change in, or any new, U.S. federal income tax law, regulation or administrative interpretation.
Risks Related to Our Organization and Structure
Certain provisions of Maryland Law, of our charter, and of our bylaws contain provisions that may inhibit potential acquisition bids that stockholders may consider favorable, and the market price of our capital stock may be lower as a result.
• There are ownership limits and restrictions on transferability and ownership in our charter . To qualify as a REIT, not more than 50% of the value of our outstanding stock may be owned, directly or constructively, by five or fewer individuals during the second half of any calendar year. To assist us in satisfying this test, among other things, our charter generally prohibits any person or entity from beneficially or constructively owning more than 9.8% in value or number of shares, whichever is more restrictive, of any class or series of our outstanding capital stock. This restriction
may discourage a tender offer or other transactions or a change in the composition of our Board of Directors or control that might involve a premium price for our shares or otherwise be in the best interests of our stockholders and any shares issued or transferred in violation of such restrictions being automatically transferred to a trust for a charitable beneficiary, thereby resulting in a forfeiture of the additional shares.
• Our charter permits our Board of Directors to issue stock with terms that may discourage a third party from acquiring us. Our charter permits our Board of Directors to amend the charter without stockholder approval to increase the total number of authorized shares of stock or the number of shares of any class or series and to issue common or preferred stock, having preferences, conversion or other rights, voting powers, restrictions, limitations as to dividends or other distributions, qualifications, and terms or conditions of redemption as determined by our Board of Directors. Thus, our Board of Directors could authorize the issuance of stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders of some or a majority of our shares might receive a premium for their shares over the then-prevailing market price of our shares.
• Maryland Control Share Acquisition Act. Maryland law provides that holders of ‘‘control shares’’ of our company (defined as voting shares of stock which, when aggregated with all other shares controlled by the acquiring stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares. Our bylaws provide that we are not subject to the “control share” provisions of Maryland law. Our Board of Directors, however, may elect to make the “control share” statute applicable to us at any time and may do so without stockholder approval.
• Business Combinations. We are subject to the “business combination” provisions of Maryland law that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting capital stock or an affiliate or associate of ours who, at any time within the two‑year period before the date in question, was the beneficial owner of 10% or more of our then outstanding voting capital stock) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five‑year prohibition, any business combination between us and an interested stockholder generally must be recommended by our Board of Directors and approved by the affirmative vote of at least (i) 80% of the votes entitled to be cast by holders of outstanding shares of our voting capital stock and (ii) two‑thirds of the votes entitled to be cast by holders of voting capital stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super‑majority voting requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of Maryland law also do not apply to business combinations that are approved or exempted by a Board of Directors before the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our Board of Directors has by resolution exempted business combinations between us and any other person, provided, that such business combination is first approved by our Board of Directors (including a majority of our directors who are not affiliates or associates of such person).
• Unsolicited Takeovers : The “unsolicited takeover” provisions of Maryland law, permit our Board of Directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to elect to be subject to any or all of five provisions, including a classified board, a two-thirds vote requirement for removing a director, a requirement that the number of directors be fixed only by vote of the directors, a requirement that a vacancy on the board be filled only by the remaining directors and for the remainder of the full term of the class of directors in which the vacancy occurred, and majority requirement for the calling of a special meeting of stockholders. Through provisions in our charter and bylaws unrelated to this statute, we (i) require, unless called by the chairman of our Board of Directors, our chief executive officer, our president or our Board of Directors, the request of stockholders entitled to cast not less than a majority of all the votes entitled to be cast at the meeting to call a special meeting of
stockholders, (ii) require that the number of directors be fixed only by our Board of Directors, (iii) have a classified board and (iv) have a two-thirds vote requirement for the removal of a director. We have elected in our charter to be subject to the provision whereby any vacancy on the board is filled only by a vote of the remaining directors (whether or not they constitute a quorum) for the remainder of the full term of the directorship in which the vacancy occurred and until a successor is duly elected and qualifies. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring, or preventing a change in control of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price.
• Classified Board. Our Board of Directors is divided into three classes of directors. Directors of each class are chosen for terms expiring at the annual meeting of stockholders held in the third year following the year of their election, and each year one class of directors is elected by the stockholders. The classified terms of our directors may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interests of our stockholders.
Our rights and the rights of our stockholders to take action against our directors and officers are limited, which could limit stockholders’ recourse in the event of actions not in their best interests.
Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
• actual receipt of an improper benefit or profit in money, property or services; or
• a judgment or other final adjudication adverse to the director or officer based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated in the proceeding.
In addition, our charter authorizes us to obligate our company to indemnify, and to pay or reimburse reasonable expenses in advance of final disposition of a proceeding to our present and former directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify and, without requiring a preliminary determination of the ultimate entitlement to indemnification, pay or reimburse reasonable expenses in advance of final disposition of a proceeding, each present or former director or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made or threatened to be made, a party because of his or her service to us.
Risks Related to Our Securities
The market price and trading volume of shares of our capital stock may be volatile.
The market price of shares of our capital stock, including our common and preferred stock, may be highly volatile and could be subject to wide fluctuations. A variety of factors may influence the price of our common and preferred stock in the public trading markets. For example, some investors may perceive REITs as yield-driven investments and compare the annual yield from dividends by REITs with yields on various other types of financial instruments. An increase in market interest rates may lead purchasers of stock to seek a higher annual dividend rate from other investments, which could adversely affect the market price of the stock. Also, the trading volume in shares of our capital stock may fluctuate and cause significant price variations to occur. We cannot assure you that the market price of shares of our capital stock will not fluctuate or decline significantly in the future. Some of the factors that could negatively affect our share price or result in fluctuations in the price or trading volume of our shares of common and preferred stock include those set forth in this Item 1A. “Risk Factors” section.
We may not be able to pay dividends or other distributions on our capital stock.
Under Maryland law, no distributions on stock may be made if, after giving effect to the distribution, (i) the corporation would not be able to pay the indebtedness of the corporation as such indebtedness becomes due in the usual course of business or (ii) except in certain limited circumstances when distributions are made from net earnings, the corporation’s total assets would be less than the sum of the corporation’s total liabilities plus, unless the charter provides otherwise (which our charter does, with respect to any outstanding series of preferred stock), the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution. There can be no guarantee that we will have sufficient cash to pay dividends on any series of our capital stock. Our ability to pay dividends may be impaired if any of the risks described in this
Item 1A “Risk Factors” section were to occur. In addition, payment of our dividends depends upon our earnings, our financial condition, maintenance of our REIT qualification and other factors as our Board of Directors may deem relevant from time to time. The payment of dividends may be more uncertain during disruptions in the mortgage, housing or related sectors, such as the current elevated interest rate environment. We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to make distributions on our common stock or any series of our preferred stock.
Interests of holders of our securities are structurally subordinated to the liabilities and obligations of our subsidiaries and may also be adversely affected by future offerings of securities.
We are a holding company that conduct our businesses primarily through our subsidiaries. Accordingly, claims of holders of our capital stock and debt securities are structurally subordinated to all existing and future liabilities and obligations of our subsidiaries. In the future, we may also attempt to increase our capital resources by making offerings of debt or additional offerings of equity or equity-linked securities, including commercial paper, warrants, senior or subordinated notes and series or classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and shares of preferred stock, if any, and lenders with respect to other borrowings will receive a distribution of our available assets before the holders of our common stock. With certain limited exceptions related to some financing facilities, we are not required to offer any such shares to existing shareholders on a pre-emptive basis; therefore, additional offerings of equity securities, including securities that may be converted into or exchanged for equity securities, may dilute the holdings of our existing stockholders or reduce the market price of our capital stock, or both. Preferred stock, including our Series A, Series B, Series C, and Series D Preferred Stock, will have a preference on liquidating distributions or a preference on dividend payments or both that could limit our ability to make a dividend distribution to the holders of our capital stock, including our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our securities bear the risk of our future offerings reducing the market price of our securities and diluting their holdings in us.
Changes in the amount of dividend distributions we pay or in the tax characterization of dividend distributions we pay may adversely affect the market price of our common stock or may result in holders of our common stock being taxed on dividend distributions at a higher rate than initially expected.
Our dividend distributions are driven by a variety of factors, including our minimum dividend distribution requirements under the REIT tax laws and our REIT taxable income as calculated for tax purposes pursuant to the Code. We generally intend to distribute to our common shareholders at least 90% of our REIT taxable income, although our reported financial results for GAAP purposes may differ materially from our REIT taxable income.
Our ability to pay a dividend per common share per quarter and the dividend on each series of our preferred stock at the stated dividend rate may be adversely affected by many factors, including the risk factors described herein. These same factors may affect our ability to pay other future dividends. In addition, to the extent we determine that future dividends would represent a return of capital to investors, rather than the distribution of income, we may determine to discontinue dividend payments until such time that dividends would again represent a distribution of income. Any reduction or elimination of our payment of dividend distributions would not only reduce the number of dividends you would receive as a holder of our common stock but could also have the effect of reducing the market price of our common stock.
Dividends payable by REITs generally do not qualify for the reduced tax rates available for some dividends.
Qualified dividend income payable to U.S. investors that are individuals, trusts, and estates is subject to the reduced maximum tax rate applicable to long-term capital gains. Dividends payable by REITs, however, generally are not eligible for the reduced qualified dividend rates. Non-corporate taxpayers may deduct up to 20% of certain pass-through business income, including “qualified REIT dividends” (generally, dividends received by a REIT shareholder that are not designated as capital gain dividends or qualified dividend income), subject to certain limitations. Although the reduced U.S. federal income tax rate applicable to qualified dividend income does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable rates applicable to regular corporate qualified dividends and the reduced corporate tax rate could cause certain non-corporate investors 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 shares of REITs, including our stock.
We cannot guarantee that any share repurchase program will be fully consummated or will enhance long-term stockholder value, and share repurchases could increase the volatility of our stock prices and could diminish our cash reserves.
We may engage in share repurchases of our common stock and preferred stock from time to time in accordance with authorizations from the Board of Directors. Our repurchase program does not have an expiration date and does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares. Further, our share repurchases could affect our share trading prices, increase their volatility, reduce our cash reserves and may be suspended or terminated at any time, which may result in a decrease in the trading prices of our stock.
Holders of our preferred stock have limited voting rights.
The voting rights of holders of any series of our outstanding preferred stock are limited. Our common stock is the only class of our securities that currently carries full voting rights. Holders of any series of our preferred stock may vote only (i) to elect, voting together as a single class, with holders of parity stock having similar voting rights two additional directors to our Board of Directors if six full quarterly dividends (whether or not consecutive) payable on any series of our preferred stock are in arrears, (ii) on amendments to our charter, including the articles supplementary designating any series of our outstanding preferred stock, that materially and adversely affect the rights of the holders of such series or (iii) to authorize or create, or increase the authorized or issued amount of, additional classes or series of stock ranking senior to our outstanding preferred stock.
