AAMC 10Q_6.30.2013

 

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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

OR

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

COMMISSION FILE NUMBER: 000-54809
 

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

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

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

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

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

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

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

As of July 18, 2013, 2,345,620 shares of our common stock were outstanding.


Altisource Asset Management Corporation
June 30, 2013
Table of Contents



i

(table of contents)

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

Special note on forward-looking statements

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

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

•
our ability to implement our business strategy and the business strategy of Residential;
•
our ability to retain and maintain our strategic relationships with related parties;
•
the ability of Residential to generate cash available for distribution to its stockholders under our management;
•
our ability to effectively compete with our competitors;
•
our clients' and our future or pending transactions;
•
our projected operating results including receipt of incentive management fees under the terms of the Residential asset management agreement;
•
our ability to retain Residential as a client;
•
Residential's ability to effectively leverage its investments;
•
the failure of Altisource to effectively perform its obligations under various agreements with us;
•
general economic and market conditions; and
•
governmental regulations, taxes and policies.

While forward-looking statements reflect our good faith beliefs, assumptions and expectations, they are not guarantees of future performance. Such forward-looking statements speak only as of their respective dates, and we assume no obligation to update them to reflect changes in underlying assumptions or factors, new information or otherwise. For a further discussion of these and other factors that could cause our future results to differ materially from any forward-looking statements, please see the risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2012 and in our quarterly report on Form 10-Q for the first quarter of 2013.


ii

(table of contents)

Part I
 
Item 1. Financial statements (unaudited)

Certain information contained herein is presented as of July 18, 2013, which we have concluded is the latest practicable date for financial information prior to the filing of this quarterly report.


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(table of contents)

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

 
June 30, 2013
December 31, 2012
Assets:
 
 
Real estate assets:
 
 
Land (from consolidated VIE)
$
4

$
—

Rental residential properties, net (from consolidated VIE)
54

—

Real estate owned (from consolidated VIE)
3,749

—

 
3,807

—

Real estate assets held for sale (from consolidated VIE)
901

—

Mortgage loans (from consolidated VIE)
163,520

—

Cash and cash equivalents (including from consolidated VIE $223,315 and $100,005, respectively)
227,846

105,014

Related party receivables (including from consolidated VIE $2,931 and $0, respectively)
3,220

361

Deferred leasing and financing costs, net (from consolidated VIE)
868

—

Prepaid expenses and other assets (including from consolidated VIE $20,262 and $6, respectively)
20,857

440

Total assets
421,019

105,815

Liabilities:
 
 
Repurchase agreement (from consolidated VIE)
472

—

Accounts payable and accrued liabilities (including from consolidated VIE $1,138 and $46, respectively)
2,113

406

Related party payables (including from consolidated VIE $149 and $5, respectively)
762

528

Total liabilities
3,347

934

Commitments and contingencies (Note 6)




Equity:
 
 
Common stock, $.01 par value, 5,000,000 authorized shares; and 2,345,425 and 2,343,213 shares issued and outstanding, respectively
23

23

Additional paid-in capital
6,289

4,993

Accumulated deficit
(2,385
)
(46
)
Total stockholders' equity
3,927

4,970

Noncontrolling interest in consolidated affiliate
413,745

99,911

Total equity
417,672

104,881

Total liabilities and equity
$
421,019

$
105,815


See accompanying notes to Consolidated Financial Statements.




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(table of contents)

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

 
Three months ended June 30, 2013
 
Six months ended June 30, 2013
 
 
 
 
Net gain on investments:
 
 
 
Net unrealized gain on mortgage loans
$
7,165

 
$
8,293

Net realized gain on mortgage loans
1,719

 
2,106

Total net gain on investments
8,884

 
10,399

Expenses:
 
 
 
Residential rental property operating expenses
84

 
84

Related party mortgage loan servicing costs
1,242

 
1,634

Interest expense
654

 
696

General and administrative
3,369

 
6,067

Related party general and administrative
—

 
207

Total expenses
5,349

 
8,688

Other income
193

 
193

Net income
3,728

 
1,904

Net income attributable to noncontrolling interest in consolidated affiliate
(5,227
)
 
(4,243
)
Net loss attributable to common stockholders
$
(1,499
)
 
$
(2,339
)
 
 
 
 
Loss per share of common stock – basic:
 
 
 
Loss per basic share
$
(0.64
)
 
$
(1.00
)
Weighted average common stock outstanding – basic
2,343,462

 
2,343,338

Loss per share of common stock – diluted:
 
 
 
Loss per diluted share
$
(0.64
)
 
$
(1.00
)
Weighted average common stock outstanding – diluted
2,343,462

 
2,343,338


See accompanying notes to consolidated financial statements.



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(table of contents)


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

 
Common stock
 
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Accumulated deficit
Noncontrolling interest in consolidated affiliate
Total equity
December 31, 2012
2,343,213

$
23

$
4,993

$
(46
)
$
99,911

$
104,881

Issuance of common stock, including option exercises
2,212

—

2

—

—

2

Capital contribution from noncontrolling interest
—

—

—

—

309,591

309,591

Share-based compensation
—

—

1,294

—

—

1,294

Net income/(loss)
—

—

—

(2,339
)
4,243

1,904

June 30, 2013
2,345,425

$
23

$
6,289

$
(2,385
)
$
413,745

$
417,672


 
Common stock
 
 
 
 
 
Number of shares
Amount
Additional paid-in capital
Accumulated deficit
Noncontrolling interest in consolidated affiliate
Total
March 15, 2012 (inception)
—

$
—

$
—

$
—

$
—

$
—

Issuance of common stock, including option exercises
100,000

1

499

—

—

500

Capital contribution from noncontrolling interest
—

—

—

—

500

500

June 30, 2012
100,000

$
1

$
499

$
—

$
500

$
1,000


See accompanying notes to consolidated financial statements.
 




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(table of contents)

Altisource Asset Management Corporation
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
Six months ended June 30, 2013
 
March 15, 2012 (inception) to June 30, 2012
Operating activities:
 
 
 
Net income
$
1,904

 
$
—

Adjustments to reconcile net income to net cash used in operating activities:
 
 
 
Net unrealized gain on mortgage loans
(8,293
)
 
—

Net realized gain on mortgage loans
(2,106
)
 
—

Amortization of deferred financing costs
322

 
—

Share-based compensation
1,294

 
—

Changes in operating assets and liabilities:
 
 
 
Related party receivables
724

 
—

Prepaid expenses and other assets
(280
)
 
—

Accounts payable and accrued liabilities
1,012

 
—

Related party payables
234

 
—

Net cash used in operating activities
(5,189
)
 
—

Investing activities:
 
 
 
Investment in mortgage loans
(168,165
)
 
—

Investment in real estate
(278
)
 
—

Investment in renovations
(22
)
 
—

Acquisition-related deposits
(20,142
)
 
—

Mortgage loan dispositions and repayments
7,062

 
—

Net cash used in investing activities
(181,545
)
 
—

Financing activities:
 
 
 
Issuance of common stock, including stock option exercises
123

 
500

Payment of tax withholdings on exercise of stock options
(121
)
 
—

Capital contribution from noncontrolling interest
310,254

 
500

Proceeds from repurchase agreement
79,761

 
—

Repayments of repurchase agreement
(79,289
)
 
—

Payment of deferred financing costs
(1,162
)
 
—

Net cash provided by financing activities
309,566

 
1,000

Net increase in cash and cash equivalents
122,832

 
1,000

Cash and cash equivalents as of beginning of the period
105,014

 
—

Cash and cash equivalents as of end of the period
$
227,846

 
$
1,000



 

Supplemental disclosure of non-cash investing and financing activity:

 

Transfer of mortgage loans to real estate owned
$
4,399

 
$
—

Changes in Residential's accrued equity issuance costs
$
663

 
$
—

Changes in related party receivable from mortgage loan dispositions and repayments
$
3,583

 
$
—


See accompanying notes to consolidated financial statements.

5

(table of contents)

Altisource Asset Management Corporation
Notes to Consolidated Financial Statements
June 30, 2013
(Unaudited)

1. Organization and basis of presentation

We were incorporated in the United States Virgin Islands on March 15, 2012, which we refer to as "inception." Our primary business is to provide asset management and certain corporate governance services under a 15-year asset management agreement beginning December 21, 2012, which we refer to as the “Residential asset management agreement,” to Altisource Residential Corporation, which we refer to as “Residential,” a Maryland corporation that acquires and manages single-family rental properties by acquiring sub-performing and non-performing mortgages throughout the United States. Subsequent to our separation from Altisource on December 21, 2012, we immediately commenced operations and began to incur costs as a result of becoming an independent publicly traded company.

Residential is currently our primary source of revenue and will drive our potential future growth. The Residential asset management agreement entitles us to incentive fees, which we refer to as our “incentive management fee,” that gives us an increasing share of Residential's cash flow available for distribution to its stockholders as well as reimbursement for certain overhead and operating expenses. Accordingly, our operating results are highly dependent on Residential's ability to achieve positive operating results.

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

On March 22, 2013, Residential's operating partnership entered into a master repurchase agreement with a major financial institution to finance the acquisition and ownership of residential mortgage loans and REO properties. The maximum funding available to Residential under the repurchase agreement is $100.0 million, subject to certain sublimits.

On May 1, 2013, Residential completed a public offering of 17,250,000 shares of its common stock at $18.75 per share and received net proceeds of $309.5 million. Residential has used or intends to use the net proceeds of this offering to purchase additional sub-performing and non-performing residential mortgage loans, pay servicing fees for its mortgage loan portfolios, renovate the single-family rental properties it acquires, pay rental and property management expenses, pay fees and expenses to us under the asset management agreement, fund its investment in NewSource Reinsurance Company, a title insurance and reinsurance company we refer to as "NewSource," and for working capital.

Because we commenced operations on December 21, 2012, we have no comparable results for the three and six months ended June 30, 2012. Accordingly, we have not included the comparative three and six month periods from 2012 in our consolidated statement of operations. Additionally, because Residential's operating partnership was organized on June 7, 2012, our consolidated statement of cash flows and consolidated statement of stockholders' equity for the six months ended June 30, 2012 do not include six full months of operating activities.

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

Basis of presentation and use of estimates

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

The unaudited consolidated financial statements and accompanying unaudited consolidated financial information, in our opinion, contain all adjustments (including normal recurring accruals) necessary for a fair presentation of our financial position,

6
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results of operations and cash flows. We have omitted certain notes and other information from the interim consolidated financial statements presented in this Quarterly Report as permitted by SEC rules and regulations. These consolidated financial statements should be read in conjunction with our 2012 annual report on Form 10-K.

Recently issued accounting standards

In accordance with ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, beginning in the first quarter of 2013 we are required to provide additional disclosures about the nature of our rights of offset and the related arrangements associated with our financial instruments. As a result, we have included additional disclosures pertaining to the collateral arrangement related to our repurchase agreement in this quarterly report.

2. Mortgage loans at fair value

Acquisitions

During the six months ended June 30, 2013, Residential completed the acquisition of the following portfolios of non-performing residential mortgage loans:

•
On February 14, 2013, a portfolio of first lien residential mortgage loans, substantially all of which are non-performing, having aggregate collateral market value of $94.2 million as of the February 1, 2013 cut-off date for the transaction.
•
On March 21, 2013, a portfolio of first lien residential mortgage loans, substantially all of which are non-performing, having aggregate collateral market value of $38.7 million as of the March 18, 2013 cut-off date for the transaction.
•
On April 5, 2013, a portfolio of first lien residential mortgage loans, substantially all of which are non-performing, having aggregate collateral market value of $122.1 million as of the March 28, 2013 cut-off date for the transaction.

During the three and six months ended June 30, 2013, Residential expensed $0.1 million and $0.4 million, respectively, for due diligence costs related to these and other transactions.

Transfer of mortgage loans to real estate owned

During the three and six months ended June 30, 2013, Residential transferred 33 and 34 mortgage loans, respectively, at fair value based on broker price opinion (BPO) of $4.2 million and $4.4 million, respectively, to real estate owned.

Dispositions

During the three and six months ended June 30, 2013, Residential disposed of 28 and 38 mortgage loans, respectively, primarily through short sales and foreclosure sales. As a result, Residential recorded $1.7 million and $2.1 million, respectively, of net realized gains on mortgage loans.

3. Real estate assets, net

Acquisitions

During the six months ended June 30, 2013, Residential acquired six residential properties, or "real estate owned," as part of the loan portfolio acquisitions described above which were converted to properties on foreclosure of the mortgage loans prior to the acquisition closing date. The aggregate purchase price attributable to these properties was $0.3 million. Residential acquired no residential properties in this manner during the three months ended June 30, 2013.

Real estate held for sale

As of June 30, 2013, Residential classified eight properties having carrying value of $0.9 million as real estate held for sale because it intends to sell the properties which do not meet its residential rental property investment criteria. The real estate held for sale balance is composed solely of real estate owned. These properties have had no significant operations, and, therefore, we are not presenting discontinued operations related to these properties.


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4. Fair value of financial instruments

The following table sets forth the financial assets and liabilities that Residential measures at fair value by level within the fair value hierarchy as of June 30, 2013 ($ in thousands):


Level 1
Level 2
Level 3

Quoted prices in active markets
 Observable inputs other than Level 1 prices
 Unobservable inputs
Recurring basis (assets)
 
 
 
Mortgage loans
$
—

$
—

$
163,520

Nonrecurring basis (assets)
 
 
 
Transfer of mortgage loans to real estate owned
$
—

$
—

$
4,399

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

$
472

$
—


There were no corresponding financial assets or liabilities measured at fair value as of December 31, 2012 because Residential did not own any mortgage loans or residential properties at that time. Additionally, there have been no transfers between levels for the three or six months ended June 30, 2013.

The carrying values of our cash and cash equivalents, related party receivables, accounts payable and accrued liabilities and related party payables are equal to or approximate fair value. The fair value of the repurchase agreement that Residential entered into on March 22, 2013 was estimated using the income approach to approximate the price that would be paid in an orderly transaction between market participants on the measurement date for similar floating rate debt.

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

Three months ended June 30, 2013
 
Six months ended June 30, 2013
Mortgage loans
 
 
 
Beginning balance
$
87,670

 
$
—

Investment in mortgage loans
79,908

 
168,165

Net unrealized gain on mortgage loans
7,165

 
8,293

Net realized gain on mortgage loans
1,719

 
2,106

Mortgage loan dispositions and repayments
(8,699
)
 
(10,645
)
Transfer of mortgage loans to real estate owned
(4,243
)
 
(4,399
)
Ending balance
$
163,520

 
$
163,520

 
 
 
 
Net unrealized gain on mortgage loans held
$
7,165

 
$
8,293

Accumulated unrealized gain on mortgage loans still held
$
8,293

 
$
8,293


There was no corresponding activity for level 3 assets for the three and six months ended June 30, 2012 because Residential did not own any such assets at that time.


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The following table sets forth the fair value of Residential's mortgage loans and the related unpaid principal balance and collateral market value by delinquency as of June 30, 2013 ($ in thousands):


Number of loans
Carrying value
Unpaid principal balance
Collateral market value
Current
102

$
10,748

$
22,020

$
18,178

30
33

2,793

6,411

4,560

60
30

4,299

8,093

6,449

90
460

53,905

106,381

81,086

Foreclosure
707

91,775

185,077

134,500

Mortgage loans
1,332

$
163,520

$
327,982

$
244,773


Residential did not hold any corresponding mortgage loans as of December 31, 2012.

The significant unobservable inputs used in the fair value measurement of Residential's mortgage loans are discount rates, home prices, gross rental rates, alternate loan resolution probabilities and timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. A decline in the discount rate in isolation would increase the fair value of an asset. A decrease in the housing pricing index or gross rental rates in isolation would decrease the fair value. Individual loan characteristics such as location and value of underlying collateral affect the loan resolution probabilities and timelines. An increase in the loan resolution timeline in isolation would decrease the fair value. The following table sets forth quantitative information about the significant unobservable inputs used to measure the fair value of our mortgage loans as of June 30, 2013:
Input
Range
Discount rate
15.0%
Gross monthly rental rate
$480 to $5,030
Home pricing index range       
-1.8% to 4.6%
Loan resolution probabilities - modification
0% to 22.3%
Loan resolution probabilities - rental
0% to 100.0%
Loan resolution probabilities - liquidation
0% to 100.0%
Loan resolution timelines
1 to 67 months

There were no corresponding fair value measurements which required significant unobservable inputs as of December 31, 2012 because Residential did not own any such assets at that time.

5. Repurchase agreement

On March 22, 2013, Residential's operating partnership entered into a master repurchase agreement with a major financial institution. The purpose of the repurchase agreement is to finance the purchase and beneficial ownership of mortgage loans and REO properties in its portfolio. Residential has effective control of the assets associated with this agreement and therefore we have concluded this is a financing arrangement. The maximum funding amount available to Residential under the repurchase agreement is $100.0 million, subject to certain sublimits. As of June 30, 2013, an aggregate of $0.5 million was outstanding under the repurchase agreement which was collateralized by mortgage loans and real estate owned with a carrying value of $1.0 million. As of June 30, 2013 the cost of funds for amounts borrowed under the repurchase agreement was approximately 3.5%. As of July 18, 2013, an aggregate of $0.5 million was outstanding under the repurchase agreement. The obligations under the repurchase agreement are fully guaranteed by Residential. The repurchase agreement matures on March 21, 2014.

Under the terms of the repurchase agreement, as collateral for the funds Residential draws thereunder, Residential's operating partnership will sell to the lender equity interests in its Delaware statutory trust subsidiary that owns the underlying mortgage assets on its behalf. In the event the lender determines the value of the collateral has decreased, it has the right to initiate a margin call and require Residential to post additional collateral or to repay a portion of the outstanding borrowings. The price paid by the lender for each underlying mortgage asset Residential finances under the repurchase agreement is based on a percentage of the market value of the underlying mortgage asset and depends on its delinquency status. With respect to funds drawn under the repurchase agreement, Residential's operating partnership is required to pay the lender interest at the lender's

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(table of contents)

cost of funds plus a spread calculated based on the type of applicable underlying mortgage assets collateralizing the funding, as well as certain other customary fees, administrative costs and expenses to maintain and administer the repurchase agreement.

The repurchase agreement requires Residential to maintain various financial and other covenants, including maintaining a minimum adjusted tangible net worth, a maximum ratio of indebtedness to adjusted tangible net worth and specified levels of unrestricted cash as well as restrictions on net losses in excess of specified amounts. In addition, the repurchase agreement contains customary events of default.

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

6. Commitments and contingencies

On December 21, 2012, we entered into a subscription agreement to invest $2.0 million to acquire 100% of the common stock and voting rights of NewSource Reinsurance Company Ltd., a title insurance and reinsurance company. In addition, Residential entered into a subscription agreement to invest $18.0 million in the non-voting preferred stock of NewSource Reinsurance Company Ltd. No amounts have been invested as of June 30, 2013 and therefore the commitments remain $2.0 million and $18.0 million, respectively, as of June 30, 2013.

Litigation, claims and assessments

We are not currently the subject of any material legal or regulatory proceedings, and no legal or regulatory proceedings have been threatened against us. We may be involved, from time to time, in legal proceedings that arise in the ordinary course of business.

7. Related party transactions

During the six months ended June 30, 2013, Residential acquired a portfolio from Ocwen of non-performing first lien residential mortgage loans having aggregate collateral market value of $94.2 million as of the February 1, 2013 cut-off date for the transaction. The aggregate purchase price for this portfolio was $64.4 million.

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

Three months ended June 30, 2013
Six months ended June 30, 2013
Counter-party
Consolidated Statements of Operations location
Related party mortgage loan servicing costs
$
1,242

$
1,634

Ocwen
Mortgage loan servicing costs paid by Residential
Due diligence costs
$
—

$
183

Altisource
Related party general and administrative expenses
Sublease and related occupancy costs
$
55

$
79

Ocwen
Related party general and administrative expenses
Expense reimbursements
$
1,156

$
2,057

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

There were no corresponding related party transactions from March 15, 2012 (inception) to June 30, 2012.

8. Share-based payments

During the six months ended June 30, 2013, we granted 32,197 shares of stock to certain members of executive management with weighted average grant date fair value per share of $63.98. Additionally, we granted 1,470 shares of stock pursuant to our 2013 Director Equity Plan with weighted average grant date fair value per share of $205.27. Of these shares, 660 were issued in connection with our directors' service on the board from January 24, 2013 to our 2013 annual meeting of stockholders and the remaining 810 are expected to be issued for their service from the 2013 annual meeting to the 2014 annual meeting of stockholders. As of June 30, 2013, we had an aggregate of $9.5 million of total unrecognized stock-based compensation costs which will be recognized over a weighted average remaining estimated term of 3.50 years.


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9. Income taxes

We are domiciled in the United States Virgin Islands and under current United States Virgin Islands law are obligated to pay taxes in the United States Virgin Islands on income and/or capital gains. As of February 1, 2013, we were granted status as an economic development company by the United States Virgin Islands Economic Development Commission. Under this designation, we receive tax benefits that allow for our taxable income to be taxed at an effective tax rate of 3.85%. For the three months ended March 31, 2013 we had future taxable income deductions (deferred tax assets) related to initial year expenditures including a cumulative net loss. We have recorded a valuation allowance equal to the resulting gross deferred tax asset because we do not believe it is more likely than not that the deferred tax asset will be realized.

In addition, Residential intends to be taxed as a REIT beginning in the year ending December 31, 2013 and will make an election in 2014 upon filing its 2013 income tax return. Accordingly, Residential believes it will not be subject to federal income tax beginning in 2013 on that portion of its REIT taxable income that is distributed to its shareholders as long as certain asset, income and share ownership tests are met. As a REIT, Residential generally will not be subject to federal income tax to the extent it distributes its REIT taxable income to its shareholders.

As of June 30, 2013, we did not have any unrecognized tax benefits. Additionally, we did not accrue interest or penalties associated with any unrecognized tax benefits, nor was any interest expense or penalty recognized during the year. Our subsidiaries and we remain subject to tax examination for the period from inception to December 31, 2012.

10. Earnings per share

Because we incurred a net loss attributable to common stockholders for the three and six months ended June 30, 2013, basic and diluted earnings per share are equivalent for the periods. For the three and six months ended June 30, 2013, there were 293,760 stock options and 224,944 units of restricted stock excluded from the calculation of diluted earnings per share because inclusion would have been anti-dilutive.

11. Segment information

Our primary business is to provide asset management and certain corporate governance services to Residential. Residential's primary business is the acquisition and ownership of single-family rental assets. Residential's primary sourcing strategy is to acquire these assets by purchasing sub-performing and non-performing mortgages. As a result, we operate in a single segment focused on the management of Residential's resolution of sub-performing and non-performing mortgages with the intent to modify as many loans as possible to keep borrowers in their homes or own the collateral which is suitable as long-term rental properties.

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

Overview

Our primary business is to provide asset management and certain corporate governance services under a 15-year asset management agreement with Residential, which we refer to as the “Residential asset management agreement." Residential is a corporation formed under the laws of the state of Maryland that acquires and manages single-family rental properties by acquiring sub-performing and non-performing mortgages throughout the United States. Residential intends to elect to qualify as a REIT beginning in the year ending December 31, 2013.

We have a capital light operating strategy and will consider using any future profits for share repurchases and dividends, although we have no current plans to repurchase shares or pay dividends. Residential is currently our primary source of revenue and will drive our potential future growth. The Residential asset management agreement entitles us to incentive fees, which we refer to as our “incentive management fees,” that will give us an increasing share of Residential's cash flow available for distribution to its stockholders as well as reimbursement for certain overhead and operating expenses. Accordingly, our operating results are highly dependent on Residential's ability to achieve positive operating results.

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

11
(table of contents)


During the quarter we completed the acquisition of a portfolio of NPLs for Residential consisting of 720 loans with approximately $172 million of UPB and $122 million of market value of underlying properties. In addition, we agreed to acquire two separate portfolios for Residential with an aggregate of 2,698 mortgage loans, substantially all of which were NPLs, with approximately $470 million of UPB and $370 million in market value of underlying properties. We currently expect to complete these acquisitions during the third quarter although there can be no assurance that we will be able to complete them on a timely basis or at all.

Operation of our business model

We believe Residential's business model provides it with operating capabilities that are difficult to replicate and positions it to capitalize on substantial market opportunities. Our success will be dependent on our ability to acquire single-family properties for Residential at attractive acquisition basis, effectively manage properties in Residential's rental portfolio and raise capital for Residential at accretive rates, which we believe will help it achieve its business objective of generating attractive risk-adjusted returns for its stockholders through dividends and capital appreciation and incentive management fees for us. As more fully described below, during the quarter we delivered on each of these objectives:
 
•
As described earlier, we have agreed to acquire non-performing loan portfolios for Residential with a total of $470 million in UPB that we believe meet Residential's return targets and other investment criteria. With the closing of these acquisitions, Residential's NPL portfolio will represent approximately 4,100 loans with $820 million in UPB and $625 million in market value of underlying properties;
•
We are meeting our initial targets for loan resolutions. While loan resolutions are long lead-time activities, we are to date hitting the targets that we set for Residential's portfolio; and
•
We successfully raised $309.5 million in new equity capital for Residential.

Factors affecting our consolidated results

As described above, our operating results depend heavily on Residential's operating results. We expect Residential's operating results to be affected by various factors, many of which are beyond its control, including the following:
 
Acquisitions

Residential's and our operating results will depend heavily on sourcing sub-performing and non-performing loans. Our results will depend on Residential's success in growing its portfolio of assets. As a result of the economic crisis in 2008, we believe that there is currently a large supply of sub-performing and non-performing loans available to Residential for acquisition. We believe the available supply provides for a steady acquisition pipeline of assets since Residential plans on targeting just a small percentage of the population. We further believe that Residential will be able to purchase residential mortgage loans at lower prices than REO properties because sellers of such loans will be able to avoid paying the costs typically associated with home sales, such as broker commissions and closing costs of up to 10% of gross proceeds of the sale.

Similar to Residential's previous acquisitions described under "– Portfolio size," we expect Residential to acquire single-family rental properties primarily through its acquisition of sub-performing and non-performing loan portfolios. We believe there are fewer participants in the sub-performing and non-performing loan marketplace than in the foreclosure auction and other REO acquisition channels due to the large size of portfolios offered for sale on an “all or none” basis and the required operational infrastructure involved in servicing loans and managing single-family rental properties across various states. We believe the relatively lower level of competition for sub-performing and non-performing loans, combined with a growing supply, provide buyers with the opportunity for a higher discount rate relative to the foreclosure auction and other REO acquisition channels and therefore a relatively lower cost to ultimately acquire single-family rental properties.

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

Financing

Residential's ability to grow its business by acquiring sub-performing and non-performing loans is dependent on the availability of adequate financing including additional equity financing, debt financing or both in order to meet its objectives. Residential intends to leverage its investments with debt, the level of which may vary based upon the particular characteristics of its

12

(table of contents)

portfolio and on market conditions. To the extent available at the relevant time Residential's financing sources may include bank credit facilities, warehouse lines of credit, structured financing arrangements and repurchase agreements, among others. Residential may also seek to raise additional capital through public or private offerings of debt or equity securities, depending upon market conditions. Accordingly, our ability to grow our incentive management fee income will be dependent on Residential's access to adequate financing. To qualify as a REIT under the federal income tax code, Residential generally will need to distribute at least 90% of its taxable income each year (subject to certain adjustments) to its stockholders. This distribution requirement limits Residential's ability to retain earnings and thereby replenish or increase capital to support its activities.

Conversions

We currently expect that a majority of Residential's acquired loans will be converted into rental property. As a result, we believe the key components that will affect Residential's residential rental revenues over the long-term will be average occupancy and rental rates. We expect Residential's timeline to convert acquired loans into single-family rental properties will vary significantly by loan, which could result in variations in our revenue recognition and Residential's operating performance from period to period. There are a variety of factors that may inhibit Residential's ability, through Ocwen, to foreclose upon a residential mortgage loan and get access to the real property within the time frames we model as part of our valuation process. These factors include, without limitation: state foreclosure timelines and deferrals associated therewith (including with respect to litigation); unauthorized occupants living in the property; federal, state or local legislative action or initiatives designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures that may delay the foreclosure process; federal government programs that require specific procedures to be followed to explore the non-foreclosure outcome of a residential mortgage loan prior to the commencement of a foreclosure proceeding; and continued declines in real estate values and sustained high levels of unemployment that increase the number of foreclosures and place additional pressure on the already overburdened judicial and administrative systems.

Expenses

Our expenses will consist of largely compensation expense and general and administrative expenses. The general and administrative expenses consist of those costs related to the general operation and overall administration of the business.
Residential reimburses us for the costs we incurred for the services we perform for Residential based on the percentage of time spent for the benefit of Residential. Residential's expenses primarily will consist of loan servicing fees, rental property operating expenses, depreciation and amortization, general and administrative expenses and interest expense. From time to time, expenses also may include impairments of assets. Loan servicing fees are expenses paid to Ocwen to service Residential's acquired loans. Rental property operating expenses are expenses associated with Residential's ownership and operation of rental properties and include expenses that are either impacted by occupancy levels or renovation expenses, such as Altisource's inspection, property preservation and renovation fees, property management fees and turnover costs, and expenses that do not vary based on occupancy, such as property taxes, insurance and HOA dues. Depreciation and amortization is a non-cash expense associated with the ownership of real estate and generally remains relatively consistent each year at an asset level since Residential depreciates its properties on a straight-line basis over a fixed life. The interest expense consists of the costs to borrow money.

Resolution methodologies

Residential employs various loan resolution methodologies with respect to its residential mortgage loans, including loan modification, collateral resolution and collateral disposition. The manner in which a sub-performing or non-performing loan is resolved will impact the amount and timing of revenue Residential will receive. We expect that a portion of our sub-performing and non-performing loans will be returned to performing status primarily through loan modifications. Once successfully modified, we expect that borrowers will typically refinance these loans with other lenders at or near the estimated value of the underlying property or we may also consider selling these modified loans. We believe that a majority of these residential mortgage loans may enter into foreclosure or similar proceedings, ultimately becoming REO. REO property can be converted into single-family rental properties and added to Residential's portfolio if they meet its investment criteria, or they may be sold through REO liquidation and short sale processes. We expect the timelines for each of the different processes to vary significantly, and final resolution could take up to 24 months or longer from the loan acquisition date.

The exact nature of resolution will be dependent on a number of factors that are beyond Residential's control, including borrower willingness, property value, availability of refinancing, interest rates, conditions in the financial markets, regulatory environment and other factors. In addition, we expect that Residential's real estate assets would decline in value in a rising

13

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interest rate environment and that its net income could decline in a rising interest rate environment to the extent such real estate assets are financed with floating rate debt and there is no accompanying increase in rental yield.

The state of the real estate market and home prices will determine proceeds from any sale of real estate. Although Residential generally intends to own as rental properties the assets it acquires upon foreclosure, Residential may determine to sell such assets if they do not meet its investment criteria. In addition, while we seek to track real estate price trends and estimate the effects of those trends on the valuations of Residential's portfolios of residential mortgage loans, future real estate values are subject to influences beyond our control. Generally, rising home prices are expected to positively affect Residential's results. Conversely, declining real estate prices are expected to negatively affect Residential's results of real estate.

Portfolio size

The size of Residential's investment portfolio will also be a key revenue driver. Generally, as the size of Residential's investment portfolio grows, the amount of revenue we expect Residential to generate will increase and we believe that the amount of incentive management fees that Residential will pay to us will grow as well. The larger investment portfolio, however, will drive increased expenses including servicing fees to Ocwen, property management fees to Altisource and related fees payable to us. Residential may also incur additional interest expense to finance the purchase of its assets.


14

(table of contents)

As of June 30, 2013, our portfolio of mortgage loans consisted of the following ($ in thousands):
Location
Loan count
Carrying value (1)
Unpaid principal balance
Collateral market value (2)
Weighted Average LTV (3)
Alabama
4

$
399

$
713

$
619

122.1
%
Arkansas
4

458

744

746

100.7
%
Arizona
35

4,010

8,135

5,981

157.5
%
California
202

43,955

78,392

62,008

144.6
%
Colorado
11

1,990

2,413

2,838

92.9
%
Connecticut
18

2,339

4,724

3,408

170.5
%
Delaware
6

963

1,780

1,513

120.6
%
Florida
359

34,696

77,465

49,765

183.2
%
Georgia
52

3,749

8,507

5,297

187.0
%
Hawaii
2

554

954

980

100.5
%
Iowa
2

97

178

158

113.8
%
Idaho
2

250

515

322

160.6
%
Illinois
81

8,569

19,556

13,554

164.4
%
Indiana
12

971

1,914

1,392

184.4
%
Kansas
2

109

220

155

144.5
%
Kentucky
4

193

366

288

140.0
%
Louisiana
10

1,179

1,912

1,801

111.1
%
Massachusetts
25

4,059

8,299

6,839

133.4
%
Maryland
68

7,984

18,530

12,786

162.6
%
Maine
6

593

1,088

944

120.9
%
Michigan
7

317

915

491

212.6
%
Minnesota
2

250

644

420

157.1
%
Missouri
6

455

774

723

117.1
%
Mississippi
5

225

504

334

182.4
%
North Carolina
18

2,252

4,039

3,350

123.6
%
Nebraska
3

136

311

231

138.7
%
New Jersey
79

8,301

21,882

14,314

174.2
%
New Mexico
3

290

396

407

98.7
%
Nevada
33

3,221

8,189

4,529

192.3
%
New York
22

2,414

5,897

5,392

125.4
%
Ohio
21

2,004

3,551

3,208

119.9
%
Oklahoma
4

404

571

572

100.2
%
Oregon
15

2,551

4,252

3,724

119.8
%
Pennsylvania
43

4,935

8,256

7,593

117.8
%
Puerto Rico
3

70

278

322

88.2
%
Rhode Island
1

107

266

190

139.9
%
South Carolina
13

1,594

2,849

2,317

134.0
%
South Dakota
1

75

141

130

108.7
%
Tennessee
11

755

1,519

1,069

167.0
%
Texas
73

7,460

10,737

11,127

112.8
%
Utah
5

670

976

855

116.2
%
Virginia
27

4,531

7,744

6,928

123.3
%
Vermont
2

132

309

340

91.1
%
Washington
25

3,004

5,992

4,351

156.8
%
Wisconsin
5

250

585

462

145.6
%
Total mortgage loans
1,332

$
163,520

$
327,982

$
244,773

156.5
%

15

(table of contents)

_____________
(1)
The carrying value of an asset is based on our fair value model. The significant unobservable inputs used in the fair value measurement of our mortgage loans are discount rates, forecasts of future home prices, gross rental rates, alternate resolution probabilities and timelines. Significant changes in any of these inputs in isolation could result in a significant change to the fair value measurement. For a more complete description of the fair value measurements and the factors that may significantly affect the Carrying Value of our assets, please see Note 4 to our consolidated financial statements.
(2)
Collateral market value is based on the most recent BPO provided to us within 180 days of the balance sheet date or provided to us by the applicable sellers as of the respective cut-off dates for each transaction if the transaction was consummated within the last 180 days. Although we performed diligence on a representative sample of the properties in each portfolio to confirm the accuracy of the BPOs provided to us by the sellers, we cannot assure you that the BPOs set forth in this table accurately reflected the actual market value of the related property at the purported time or accurately reflect such market value today.
(3)
Weighted average loan to value (LTV) is based on the loan to value weighted by unpaid principal balance for each state.

Summary Management Reporting Information

In addition to evaluating our consolidated financial performance, we also evaluate the operations of AAMC on a stand-alone basis because our financial statements consolidate the results of Residential under U.S. GAAP. We also look at our stand-alone results because the effect of amounts received from Residential are still recognized in net income attributable to our stockholders through the adjustment for earnings attributable to our noncontrolling interest in Residential.

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

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

16

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Altisource Asset Management Corporation
Consolidating Statement of Operations
Three months ended June 30, 2013
(In thousands)

 
 Residential (GAAP)
 AAMC Stand-alone (Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
Net gain on investments:
 
 
 
 
Net unrealized gain on mortgage loans
$
7,165

$
—

$
—

$
7,165

Net realized gain on mortgage loans
1,719

—

—

1,719

Expense reimbursements
—

1,156

(1,156
)
—

Total net gain on investments
8,884

1,156

(1,156
)
8,884

Expenses:
 




 
Residential rental property operating expenses
84

—

—

84

Related party mortgage loan servicing costs
1,242

—

—

1,242

Interest expense
654

—

—

654

General and administrative
714

2,655

—

3,369

Related party general and administrative
1,156

—

(1,156
)
—

Total expenses
3,850

2,655

(1,156
)
5,349

Other income
193

—

—

193

Net income (loss)
5,227

(1,499
)
—

3,728

Net income attributable to noncontrolling interest in consolidated affiliate
—

—

(5,227
)
(5,227
)
Net income (loss) attributable to common stockholders
$
5,227

$
(1,499
)
$
(5,227
)
$
(1,499
)


17

(table of contents)

Altisource Asset Management Corporation
Consolidating Statement of Operations
Six months ended June 30, 2013
(In thousands)

 
 Residential (GAAP)
 AAMC Stand-alone (Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
Net gain on investments:
 
 
 
 
Net unrealized gain on mortgage loans
$
8,293

$
—

$
—

$
8,293

Net realized gain on mortgage loans
2,106

—

—

2,106

Expense reimbursements
—

2,057

(2,057
)
—

Total net gain on investments
10,399

2,057

(2,057
)
10,399

Expenses:
 
 
 
 
Residential rental property operating expenses
84

—

—

84

Related party mortgage loan servicing costs
1,634

—

—

1,634

Interest expense
696

—

—

696

General and administrative
1,701

4,366

—

6,067

Related party general and administrative
2,234

30

(2,057
)
207

Total expenses
6,349

4,396

(2,057
)
8,688

Other income
193

—

—

193

Net income (loss)
4,243

(2,339
)
—

1,904

Net income attributable to noncontrolling interest in consolidated affiliate
—

—

(4,243
)
(4,243
)
Net income (loss) attributable to common stockholders
4,243

(2,339
)
(4,243
)
(2,339
)


18

(table of contents)

Altisource Asset Management Corporation
Consolidating Balance Sheet
June 30, 2013
(In thousands)

 
 Residential (GAAP)
 AAMC Stand-alone (Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
 
 
 
 
 
Assets:
 
 
 
 
Real estate assets, net:
 
 
 
 
Land
$
4

$
—

$
—

$
4

Rental residential properties, net
54

—

—

54

Real estate owned
3,749

—

—

3,749

 
3,807

—

—

3,807

Real estate assets held for sale
901

—

—

901

Mortgage loans
163,520

—

—

163,520

Cash and cash equivalents
223,315

4,531

—

227,846

Related party receivables
3,183

389

(352
)
3,220

Deferred leasing and financing costs, net
868

—

—

868

Prepaid expenses and other assets
20,262

595

—

20,857

Total assets
415,856

5,515

(352
)
421,019

Liabilities:
 
 
 
 
Repurchase agreement
472

—

—

472

Accounts payable and accrued liabilities
1,138

975

—

2,113

Related party payables
501

613

(352
)
762

Total liabilities
2,111

1,588

(352
)
3,347

Commitments and contingencies
 
 
 
 
Equity:
 
 
 
 
Common stock
251

23

(251
)
23

Additional paid-in capital
409,340

6,289

(409,340
)
6,289

Accumulated deficit
4,154

(2,385
)
(4,154
)
(2,385
)
Total stockholders' equity
413,745

3,927

(413,745
)
3,927

Noncontrolling interest in consolidated affiliate
—

—

413,745

413,745

Total equity
413,745

3,927

—

417,672

Total liabilities and equity
$
415,856

$
5,515

$
(352
)
$
421,019


19

(table of contents)

Altisource Asset Management Corporation
Consolidating Balance Sheet
December 31, 2012
(In thousands)

 
 Residential (GAAP)
 AAMC Stand-alone (Non-GAAP)
 Consolidating Entries
 AAMC Consolidated (GAAP)
Assets:
 
 
 
 
Cash and cash equivalents
$
100,005

$
5,009

$
—

$
105,014

Related party receivables
—

410

(49
)
361

Prepaid expenses and other assets
6

434

—

440

Total assets
100,011

5,853

(49
)
105,815

Liabilities:
 
 
 
 
Accounts payable and accrued liabilities
46

360

—

406

Related party payables
54

523

(49
)
528

Total liabilities
100

883

(49
)
934

Commitments and contingencies
 
 
 
 
Equity:
 
 
 
 
Common stock
78

23

(78
)
23

Additional paid-in capital
99,922

4,993

(99,922
)
4,993

Deficit accumulated during the development stage
(89
)
(46
)
89

(46
)
Total stockholders' equity
99,911

4,970

(99,911
)
4,970

Noncontrolling interest in consolidated affiliate
—

—

99,911

99,911

Total equity
99,911

4,970

—

104,881

Total liabilities and equity
$
100,011

$
5,853

$
(49
)
$
105,815


Primary driver of our stand-alone operating results

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

Results of operations

The following sets forth discussion of our results of operations for the three and six months ended June 30, 2013. There were no corresponding results for March 15, 2012 (inception) to June 30, 2012. Because the results of Residential are consolidated into our financial statements, the results of operations disclosures set forth below include the results of Residential. We eliminate all intercompany amounts in our consolidated financial statements, including the expense reimbursement and incentive management fees, if any, paid or owed to us by Residential. However, the effect of such amounts received from Residential is still recognized in net income attributable to our stockholders through the adjustment for earnings attributable to noncontrolling interest.


20

(table of contents)

Three and six months ended June 30, 2013

Residential rental revenues

Residential generated a nominal amount of residential rental revenues for the three and six months ended June 30, 2013. Residential expects to generate increasing residential rental revenues for the remainder of 2013 upon renovating, listing and renting additional residential rental properties. Residential's residential rental revenues will be dependent primarily on occupancy levels and rental rates for our residential rental properties. Because Residential's lease terms generally are expected to be one to two years, Residential's occupancy levels and rental rates will be highly dependent on localized residential rental markets.

Net unrealized gain on mortgage loans

Residential generated $7.2 million and $8.3 million of net unrealized gains on mortgage loans for the three and six months ended June 30, 2013, respectively, which can be broken down into the following components.

•
First, Residential recognized $1.4 million and $1.6 million for the three and six months ended June 30, 2013, respectively, in unrealized gains driven by a material change in loan status. During the three and six months ended June 30, 2013, Residential converted 33 and 34 loans to REO status, respectively. Upon conversion of these loans to REO, Residential marked these properties to the most recent market value (less estimated selling costs in the case of REO held for sale);
•
Second, Residential accreted $5.8 million and $6.7 million in unrealized gains for the three and six months ended June 30, 2013, respectively, relating to discounts and expenses which were priced into the acquisitions. These amounts represent the time value of money and servicing expenses incurred as a property proceeds through the foreclosure process. The judgment embedded in this value is the estimated time that it takes to foreclose on a loan in various jurisdictions.

Through Residential's acquisitions, Residential's loan portfolio has grown from 673 loans at March 31, 2013 to 1332 loans at June 30, 2013. The fair value of mortgage loans is based on a number of factors which are difficult to predict and may be subject to adverse changes in value depending on the financial condition of borrowers and renters, as well as geographic, economic, market and other conditions. Therefore, Residential may experience unrealized losses on our mortgage loans in the future.

Net realized gain on mortgage loans

Residential generated $1.7 million and $2.1 million of net realized gains on mortgage loans for the three and six months ended June 30, 2013, respectively, from 28 and 38 loan dispositions, respectively, primarily from short sales and foreclosure sales.

Residential rental property operating expenses

Residential incurred a nominal amount of rental property operating expenses for the three and six months ended June 30, 2013. Residential expects to incur increasing residential rental property operating expenses in the remainder of 2013 upon converting its mortgage loans to, and owning, residential rental properties. Residential's residential rental property operating expenses will be dependent primarily on residential property taxes and insurance, property management fees and repair and maintenance expenditures.

Real estate depreciation and amortization

Residential incurred a nominal amount of real estate depreciation and amortization for the three and six months ended June 30, 2013. Residential expects to incur increasing real estate depreciation and amortization in 2013 upon converting its mortgage loans to, and owning, residential rental properties. Real estate depreciation and amortization are non-cash expenditures which generally are not expected to be indicative of the market value or condition of Residential's residential rental properties.

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Related party mortgage loan servicing costs

Residential incurred $1.2 million and $1.6 million of mortgage loan servicing costs primarily from advances of residential property taxes and insurance and servicer fees for the three and six months ended June 30, 2013, respectively. Residential expects to incur additional mortgage loan servicing costs in the remainder of 2013 to protect its investment in mortgage loans and to continue to service acquired loans. Generally the ownership of non-performing and sub-performing mortgage loans will require Residential to fund the related property taxes and insurance on the properties collateralizing its acquired mortgage loans to avoid tax liens and protect the underlying residential real estate. Therefore, Residential's loan servicing costs could be higher than expected in a given period if the number of unconverted non-performing mortgage loans exceeds expected levels.

Interest expense

Residential incurred $0.7 million of interest expense due to borrowings under its repurchase agreement for both the three and six months ended June 30, 2013. Residential repaid the majority of our borrowings under our repurchase agreement as of June 30, 2013. Residential expects to incur additional interest expense in the remainder of 2013 as its average financing and/or securitization levels increase to fund and leverage additional purchases and its ownership of non-performing and sub-performing loan portfolios. The interest rate on Residential's initial funding under the repurchase agreement is subject to changes in cost of funds. Cost of funds currently is at historically low levels and any increase in cost of funds will cause our contractual interest expense to increase.

General and administrative expenses

Residential and we incurred $3.4 million and $6.1 million of general and administrative expenses for the three and six months ended June 30, 2013 primarily consisting of salaries and benefits, professional fees and acquisition costs. Additionally, Residential and we incurred certain other organizational costs in the first three months of 2013 related to the commencement of our businesses and being new public companies.

Net income attributable to noncontrolling interest in consolidated affiliate

We have recorded $5.2 million and $4.2 million of net income attributable to noncontrolling interest in consolidated affiliate which is equivalent to Residential's net income for the three and six months ended June 30, 2013, respectively, because although we consolidate Residential we have no ownership in Residential.

Incentive management fees and expense reimbursements

We did not generate any incentive management fees for the three and six months ended June 30, 2013. We generated $1.2 million and $2.1 million of expense reimbursements from Residential that have been eliminated in consolidation for the three and six months ended June 30, 2013, respectively. We are not reimbursed by Residential for certain general and administrative expenses pertaining to stock-based compensation and our expenditures that are not for the benefit of Residential. We expect to generate incentive management fees to the extent Residential generates cash available for distribution to its shareholders as contractually defined in the future.

Liquidity and capital resources

As of July 18, 2013, we had cash and cash equivalents of $4.5 million. We believe this cash is sufficient to fund our operations and investment in NewSource until Residential begins paying the incentive management fee to us as a result of generating cash available for distribution to its stockholders since our only expenses to date are general and administrative expenses.

Residential's liquidity reflects its ability to meet its current obligations (including the purchase of residential mortgage loans, its operating expenses and, when applicable, retirement of, and margin calls relating to, its financing arrangements), purchase additional portfolios of sub-performing and non-performing mortgage loans when we identify them and make distributions to its stockholders. Residential generally needs to distribute at least 90% of its taxable income each year (subject to certain adjustments) to its stockholders to qualify as a REIT under the Internal Revenue Code. This distribution requirement limits Residential's ability to retain earnings and thereby replenish or increase capital to support its activities.

Residential expects its primary sources of liquidity to be proceeds from its investments and proceeds from borrowings and/or additional equity offerings.

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Residential was initially funded with the $100 million it received from Altisource in connection with its separation on December 21, 2012. In addition, on May 1, 2013, Residential completed a public offering of 17,250,000 shares of common stock at $18.75 per share and received net proceeds of $309.5 million. Residential used a portion of the proceeds of the offering to pay down its existing repurchase facility. However, Residential intends to re-leverage its existing portfolio and to use the net proceeds of the offering to purchase additional sub-performing and non-performing residential mortgage loans, pay servicing fees for its mortgage loan portfolios, renovate the single-family rental properties it acquires, pay rental and property management expenses, pay fees and expenses to us under the asset management agreement, fund its subscription agreement in NewSource and for working capital.
 
Residential's current leverage strategy is to finance its assets where it believe such borrowing is prudent and appropriate. To date, Residential has completed one borrowing pursuant to a master repurchase agreement that its operating partnership entered with a large money center bank on March 22, 2013. The purpose of the repurchase agreement is to finance the acquisition and ownership of residential mortgage loans and REO properties. The maximum funding available to Residential under the repurchase agreement is $100 million, subject to certain sublimits. As of July 18, 2013, an aggregate of $0.5 million was outstanding under the repurchase agreement. The obligations under the repurchase agreement are fully guaranteed by Residential. The repurchase agreement matures on March 21, 2014.

Because Residential's current debt facility and anticipated additional debt financings, at least near term, are expected to consist solely of short-term borrowings, Residential expects to renew these facilities in advance of maturity in order to ensure its ongoing liquidity and access to capital.

Under the terms of the repurchase agreement, as collateral for the funds Residential draws thereunder, the operating partnership will sell to the lender equity interests in Residential's Delaware statutory trust subsidiary that owns the underlying mortgage assets on its behalf. In the event the lender determines the value of the collateral has decreased, it has the right to initiate a margin call and require Residential to post additional collateral or to repay a portion of the outstanding borrowings. The price paid by the lender for each underlying mortgage asset Residential financed under the repurchase agreement is based on a percentage of the market value of the underlying mortgage asset and depends on its delinquency status. With respect to funds drawn under the repurchase agreement, the operating partnership is required to pay the lender interest at the lender's cost of funds plus a spread calculated based on the type of applicable underlying mortgage assets collateralizing the funding, as well as certain other customary fees, administrative costs and expenses to maintain and administer the repurchase agreement.

The repurchase agreement requires Residential to maintain various financial and other covenants, including maintaining a minimum adjusted tangible net worth, a maximum ratio of indebtedness to adjusted tangible net worth and specified levels of unrestricted cash as well as restrictions on net losses in excess of specified amounts. In addition, the repurchase agreement contains customary events of default. Residential is restricted by the terms of its repurchase agreement from paying dividends greater than its REIT taxable income in a calendar year.

Residential is currently in compliance with the covenants and other requirements with respect to the repurchase agreement. Residential monitors its banking partner's ability to perform under the repurchase agreement and has concluded there is currently no reason to doubt that its banking partner will continue to perform under the repurchase agreement as contractually obligated.

Based on its current portfolio and leverage ratio, Residential's believes that these sources of liquidity will be sufficient to enable it to meet anticipated short-term (one year or less) liquidity requirements, which include funding our current investment opportunities, paying expenses on our existing loan portfolio, funding distributions to our stockholders, paying fees to us under the asset management agreement and general corporate expenses. To the extent Residential has significant opportunities to purchase additional portfolios of sub-performing and non-performing residential mortgage loans, it may seek to obtain additional debt and/or equity financing.

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


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Cash flows

We report and analyze our cash flows based on operating activities, investing activities and financing activities. The following table sets forth the changes in cash flows ($ in thousands):

 
Three months ended June 30, 2013
March 15, 2012 (inception) to June 30, 2012
Change
Net cash used in operating activities
$
(5,189
)
$
—

$
(5,189
)
Net cash used in investing activities
(181,545
)
—

(181,545
)
Net cash provided by financing activities
309,566

1,000

308,566

Total cash flows
$
122,832

$
1,000

$
121,832


Net cash used in operating activities for the six months ended June 30, 2013 by Residential and us consisted primarily of related party mortgage servicing costs including net advances of taxes and insurance on delinquent loans, interest expense, professional fees, organization costs, acquisition costs and salaries and benefits.

Net cash used in investing activities for the six months ended June 30, 2013 consisted primarily of Residential's $188.6 million of investments in non-performing and sub-performing loan pools partly offset by $7.1 million of proceeds from the disposition of loans. During periods in which Residential purchases a significant number of mortgage loans and conducts substantial renovations of residential real estate, its cash used in investing activities is generally expected to exceed cash provided by investing activities, which will typically consist of proceeds from the disposition of loans.

Net cash provided by financing activities consisted primarily of Residential's net proceeds from the issuance of common stock. Net cash related to financing activities will generally consist of the incurrence by Residential of debt, repayment of debt previously incurred by Residential and Residential's issuance of common stock.

Off-balance sheet arrangements

Residential and we have no off-balance sheet arrangements as of June 30, 2013.

Recent accounting pronouncements

In accordance with ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, beginning in the first quarter of 2013 we are required to provide additional disclosures about the nature of our rights of offset and the related arrangements associated with our financial instruments. As a result, we have included additional disclosures pertaining to the collateral arrangement related to Residential's repurchase agreement in this quarterly report.

Critical accounting judgments
    
Accounting standards require information in financial statements about the risks and uncertainties inherent in significant estimates, and the application of generally accepted accounting principles involves the exercise of varying degrees of judgment. Certain amounts included in or affecting our financial statements and related disclosures must be estimated requiring us to make certain assumptions with respect to values or conditions that cannot be known with certainty at the time our consolidated financial statements are prepared. These estimates and assumptions affect the amounts we report for our assets and liabilities and our revenues and expenses during the reporting period and our disclosure of contingent assets and liabilities at the date of our consolidated financial statements. We routinely evaluate these estimates utilizing historical experience, consultation with experts and other methods we consider reasonable in the particular circumstances. Nevertheless, actual results may differ significantly from our estimates and any effects on our business, financial position or results of operations resulting from revisions to these estimates are recorded in the period in which the facts that give rise to the revision become known.

We consider our critical accounting judgments to be those used in the determination of the reported amounts and disclosure related to the following:

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Consolidations

The consolidated financial statements include wholly owned subsidiaries and would include those subsidiaries in which we own a majority voting interest with the ability to control operations of the subsidiaries and where no substantive participating rights or substantive kick out rights have been granted to the noncontrolling interests. Additionally, we consolidate partnerships, joint ventures and limited liability companies when we control the major operating and financial policies of the entity through majority ownership, in our capacity as general partner or managing member or by contract. Lastly, we consolidate those entities deemed to be variable interest entities in which we are determined to be the primary beneficiary.

While the results of operations of consolidated entities are included in net loss in our consolidated financial statements, net loss attributable to common stockholders does not include the portion attributable to noncontrolling interests. Additionally, noncontrolling interest in consolidated affiliate is recorded in our Consolidated Balance Sheets and our Consolidated Statements of Equity within the equity section but separate from our equity.

Income taxes

Income taxes are provided for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which management expects those temporary differences to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period in which the change occurs. Subject to our judgment, we reduce a deferred tax asset by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax asset will not be realized. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in evaluating tax positions, and we recognize tax benefits only if it is more likely than not that a tax position will be sustained upon examination by the appropriate taxing authority.

Residential believes it will comply with the provisions of the federal income tax code applicable to REITs beginning for the year ending December 31, 2013 and intends to elect REIT status upon the filing of its 2013 income tax return. Accordingly, Residential believes it will not be subject to federal income tax beginning in the year ending December 31, 2013 on that portion of its REIT taxable income that is distributed to its shareholders as long as certain asset, income and share ownership tests are met. If Residential fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its REIT taxable income at regular corporate income tax rates. If after electing to be taxed as a REIT, Residential subsequently fails to qualify as a REIT in any taxable year, it generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the IRS grants relief under certain statutory provisions. Such an event could materially adversely affect Residential's net income and net cash available for distribution to its shareholders. However, Residential has been organized and operates in such a manner as to qualify for treatment as a REIT. Residential's taxable REIT subsidiary is subject to federal and state income taxes.

Mortgage loans at fair value

Upon the acquisition of mortgage loans, Residential records the assets at fair value which is generally the purchase price as of the acquisition date. Related acquisition costs are expensed as incurred as components of general and administrative expense. Mortgage loans are subsequently accounted for at fair value under the fair value option election with unrealized gains and losses recorded in current period earnings. Residential does not separately accrue interest income. Carrying costs such as advances of taxes and insurance and mortgage servicing fees are expensed as incurred as components of mortgage loan servicing costs. We have concluded that mortgage loans accounted for at fair value timely reflect the results of Residential's investment performance. The fair value of mortgage loans is measured on a recurring basis using a discounted cash flow valuation model and considering alternate loan resolution probabilities. Observable inputs to the model include current interest rates, loan amount, payment status and property type. Unobservable inputs to the model include discount rates and forecasts of future home prices, gross rental rates, alternate loan resolution probabilities and timelines. Additionally, for performing loans, Residential considers the risk of nonperformance when determining fair value.
The capital markets group determines the fair value of mortgage loans monthly and has developed procedures and controls governing the valuation process relating to these assets. The capital markets group reports to our Investment Committee, a committee of our Chief Executive Officer and our Chairman that oversees and approves the valuations. The capital markets group also monitors the valuation model for performance against actual results which is reported to the Investment Committee and used to continuously improve the model.

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Real estate impairment

With respect to residential rental properties classified as held for use, Residential performs an impairment analysis using estimated cash flows if events or changes in circumstances indicate that the carrying value may be impaired, such as prolonged vacancy, identification of materially adverse legal or environmental factors, changes in expected ownership period or a decline in market value to an amount less than cost. This analysis is performed at the property level. These cash flows are estimated based on a number of assumptions that are subject to economic and market uncertainties including, among others, demand for rental properties, competition for customers, changes in market rental rates, costs to operate each property and expected ownership periods.

If the carrying amount of a held for use asset exceeds the sum of its undiscounted future operating and residual cash flows, an impairment loss is recorded for the difference between estimated fair value of the asset and the carrying amount. Residential generally estimates the fair value of assets held for use by using broker price opinions. In some instances, appraisal information may be available and is used in addition to broker price opinions. As the factors used in generating these cash flows are difficult to predict and are subject to future events that may alter our assumptions, the discounted and/or undiscounted future operating and residual cash flows estimated by Residential in its impairment analyses or those estimated by appraisal may not be achieved, and Residential may be required to recognize future impairment losses on its properties held for use.

Rental residential properties, net

Upon the acquisition of real estate, Residential records the assets at fair value as of the acquisition date as a component of real estate owned based on information obtained from a broker's price opinion, a full appraisal or the price given in a current contract of sale of the property. After a short evaluation period, Residential performs property renovations to maximize the value of the property for its rental strategy. Such expenditures are part of Residential's initial investment in a property and, therefore, will be classified as investing activities in our Consolidated Statement of Cash Flows. Subsequently, the real estate plus any renovations that improve or extend the life of the asset are accounted for at cost. The cost basis is depreciated using the straight-line method over an estimated useful life of 3 to 27.5 years based on the nature of the components. Interest and other carrying costs incurred during the renovation period are capitalized until the property is ready for its intended use. Expenditures for ordinary maintenance and repairs are charged to expense as incurred.

Expenditures directly related to successful leasing efforts such as lease commissions will be included in deferred leasing and financing costs, net and will be stated at amortized cost. Such expenditures are part of Residential's operations and, therefore, will be classified as operating activities in our Consolidated Statement of Cash Flows. Capitalized leasing costs will be amortized on a straight-line basis over the lease term of the respective leases which generally are from one to two years.

Residential rental properties are classified either as held for use or held for sale. Residential rental properties will be classified as real estate and related assets held for sale when sale of the assets has been formally approved and the sale is expected to occur in the next twelve months. We will record residential rental properties held for sale at the lower of the carrying amount or estimated fair value. Fair value of assets held for sale is equal to the estimated or contracted sales price with a potential buyer less costs to sell. The impairment loss is the amount by which the carrying amount exceeds the estimated fair value.

Residential rental revenues

Minimum contractual rents from leases will be recognized on a straight-line basis over the terms of the leases in residential rental revenues. This means that, with respect to a particular lease, actual amounts billed in accordance with the lease during any given period may be higher or lower than the amount of rental revenue recognized for the period. Straight-line rental revenue is commenced when the customer takes control of the leased premises. Deferred rents receivable, net will represent the amount by which straight-line rental revenue exceeds rents currently billed in accordance with lease agreements. Contingent rental revenue is accrued when the contingency is removed. Termination fee income is recognized when the customer has vacated the asset, the amount of the fee is determinable and collectability is reasonably assured.

Rents receivable, net and deferred rents receivable, net will be reduced by an allowance for amounts that may become uncollectible in the future. Residential will regularly evaluate the adequacy of its allowance for doubtful accounts. The evaluation primarily will consist of reviewing past due account balances and considering such factors as the credit quality of our customer and historical trends of the customer payment. If Residential's assumptions regarding the collectability of receivables prove incorrect, it could experience losses in excess of its allowance for doubtful accounts. Rents receivable, net and deferred rents receivable, net will be written-off when we have concluded there is a low probability of collection.


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Item 3. Quantitative and qualitative disclosures about market risk

For information regarding our market risk as of June 30, 2013, see "Item 7A. Quantitative and qualitative disclosures about market risk" in our 2012 annual report on Form 10-K.

Item 4. Controls and procedures

SEC rules require us to maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our annual and periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Our CEO and CFO have concluded that the disclosure controls and procedures were effective at the end of the period covered by this quarterly report.

SEC rules also require us to establish and maintain internal control over financial reporting designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepting accounting principles. There were no changes in internal control over financial reporting during the three months ended June 30, 2013 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


Part II

Item 1A. Risk factors

There have been no material changes in our market risk since December 31, 2012. For information regarding our risk factors as of June 30, 2013, you should carefully consider the risk factors discussed in "Item 1A. Risk factors" in our quarterly report on Form 10-Q for the first quarter of 2013 and the other risk factors discussed in our 2012 Form 10-K and Residential's quarterly report on Form 10-Q for the first quarter of 2013.

Item 4. Mine safety disclosures
    
Not applicable.


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Item 6. Exhibits

Exhibits
Exhibit Number
 
Description
 
2.1
 
Separation Agreement, dated as of December 21, 2012, between Altisource Asset Management Corporation and Altisource Portfolio Solutions S.A. (incorporated by reference to Exhibit 2.1 of the Registrant's Current Report on Form 8-K filed with the Commission on December 28, 2012).
 
3.1
 
Amended and Restated Articles of Incorporation of Altisource Asset Management Corporation (incorporated by reference to Exhibit 3.1 of the Registrant's Registration Statement on Form 10 filed with the Commission on December 5, 2012).
 
3.2
 
First Amended and Restated Bylaws of Altisource Asset Management Corporation (incorporated by reference to Exhibit 3.2 of the Registrant's Registration Statement on Form 10 filed with the Commission on December 5, 2012).
 
31.1*
 
Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act
 
31.2*
 
Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act
 
32.1*
 
Certification of CEO Pursuant to Section 906 of the Sarbanes-Oxley Act
 
32.2*
 
Certification of CFO Pursuant to Section 906 of the Sarbanes-Oxley Act
 
101.INS*
 
XBRL Instance Document
 
101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB*
 
XBRL Extension Labels Linkbase
 
101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
__________

* Filed herewith.


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Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
 
 
Altisource Asset Management Corporation
Date: 
July 23, 2013
By:
/s/
Kenneth D. Najour
 
 
 
 
Kenneth D. Najour
 
 
 
 
Chief Financial Officer



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