MANAGEMENT DISCUSSION OF FUND
PERFORMANCE
For the six-month period ended December 31, 2013, Brookfield Mortgage Opportunity Income Fund Inc. (NYSE: BOI) (the
“Fund”) had a total return based on net asset value of 4.80% and a total return based on market price of -6.04%, which assumes the reinvestment of dividends and is exclusive of brokerage commissions. Based on the NYSE closing price of
$16.57 on December 31, 2013, the Fund’s shares had a distribution yield of 9.20%. The distribution yield is calculated as the annualized amount of the reporting period’s most recent monthly distribution declared, divided by the stated
stock price.
The Fund’s NAV performance over the past six months was positive. The period was punctuated with uncertainties around interest
rates, culminating in the beginning of the end to the Federal Reserve’s Asset Purchase Program. Despite a nearly 0.5% increase in 10-year interest rates, the Fund’s NAV increased, highlighting the lack of interest rate sensitivity of the
Fund’s holdings. Additionally, the Fund’s holdings benefitted from the continued recovery in the housing market, and that story has continued to play out, with year-over-year home price changes at over 12%.1 We expect that as mortgage pool
performance observably improves with the recovery in the housing market, the Fund’s cash flows will also benefit. We have looked to increase our credit-risk exposure, particularly our exposure to the residential recovery and we continue to
utilize our leverage capacity, having used approximately 10% at the end of 2013. We are likely to increase our use of financial leverage, while maintaining a low level of duration, or the sensitivity of the net asset value to a 1% upward shift in
interest rates. We believe that the economy will continue to benefit from the real-estate and consumer recovery, with the potential for better than expected economic outcomes driving interest rates up earlier than market consensus.
MARKET ENVIRONMENT
The Fund is
focused on opportunities available in the residential and commercial mortgage markets. The current emphasis of the Fund is on non-Agency mortgages, which we believe to be undervalued. The Fund seeks investments primarily in non-Agency
Mortgage-Backed Securities (“MBS”), Commercial Mortgage-Backed Securities (“CMBS”) and other mortgage-related investments, including commercial loans. With these assets we expect to generate an attractive income, to maintain low
duration, and to benefit from the recovery in real estate.
2
Brookfield
Investment
Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Over the period from June 30, 2013 to December 31, 2013, the residential real estate market
and the commercial real estate market continued to demonstrate a faster recovery than was anticipated by markets. Commercial real estate prices, as measured by Moody’s Commercial Property Price Index, appreciated 14% year-over-year as of
October 31, 2013. Residential home prices were up 11.8% year-over-year, as measured by Core Logic as of November 30, 2013, which brings us back to levels last seen in June 2008. The recovery is evident, not only in the improvement in the
asset price indices, but in other areas such as the increased financing available in the commercial real estate market. As well, we believe other important metrics for the economy, such as household net worth, have improved dramatically along with
the appreciation in home-owners equity and in the stock market. This economic improvement is likely to begin to have greater impact on other important metrics like payrolls and employment, which also feed back into the consumer and into housing,
retail and real-estate values.
The overhang of all the new regulatory proposals still exists. One of the more critical acronyms in the regulatory
soup-pot is “QM” or the definition of a qualifying mortgage. While there is no limitation on loan-to-value ratio for a qualifying mortgage, there are limitations on debt-to-income ratio, “risky features” like interest only
periods or balloon payments, and restrictions on points and fees. Along with some other regulations, the QM limitations remain a constraint on residential loan originations, given the significant increase in “litigation risk and penalties”
for non-QM loans. We anticipate a longer ramp up of credit expansion, as these regulations are digested. However, we have seen recent indications that banks will be willing to make some non-QM loans, and larger banks are even developing internal
“SWAT teams” of underwriters to help make these loans to be held in the bank’s loan portfolio. Another indicator of credit expansion potential is the new entrants to mortgage insurance (NMI and ESNT), as well as the other players
improving their positions (RDN, MTG). We are seeing more expansion in commercial real-estate credit, given that the private label CMBS market issued more than $85 billion in 2013, nearly double the issuance in 2012. As credit expands, there are
likely to be refinancing benefits to borrowers in some of our discount-priced “seasoned” securities.
Other fundamental underpinnings for
housing continued to show improvement over the period, which include: residential inventory and delinquency rates. The most recent delinquency level reported by the Mortgage Bankers Association was 6.41%, a level last seen in June 2008. This level
was well below peak delinquency levels of 10.06%.
Commercial real estate fundamentals have benefitted from rising rents and falling vacancies, and
in our view, a broader commercial real estate market recovery has begun to develop. More recently, secondary market asset prices have outperformed primary market asset prices as capital continues to flow toward “real assets.”
On a calendar year-to-date basis, non-Agency MBS remained one of the better performing asset classes, on average returning more than 10% over the entire
period. As well, non-Agency MBS were one of the few assets classes that evidenced positive performance from June through year end, as interest rates increased. As we look forward, from a rates perspective, we anticipate more of the same from the
Federal Reserve, i.e. additional reductions in the level of asset purchases until the level is zero. Consensus remains that the declines going forward will approximate the first “bite” at the apple, or $10 billion per meeting. Again, in
our view, the risk is skewed towards faster than expected reduction, resulting in higher than expected longer rates, a steeper yield curve, or an earlier than anticipated shift in short-term rates. This would be particularly true if wage inflation,
or any inflation, reared its “head.”
Finally, we have the confirmation of a non-interim Director of the Federal Housing Finance Agency
(“FHFA”) in Mel Watt. Based on his history, Mr. Watt has supported credit expansion, and at the margin, may be biased toward a slower reduction in the GSE footprint. Mr. Watt’s bias is evident even in his first move, which
was to postpone an announced increase in guarantee fee. That being said, we believe banks to be a large buyer of the “super clean” mortgage loans, and given this, it would not be out of the realm of expectations to see the FHFA allow the
conforming balance to decline from the current levels left in place since the crisis. The overwhelming change in the Agency mortgage market has not only been the increased share of that market owned by the Federal Reserve and the U.S. Treasury, but
the increase in the Agency market as a share of the total mortgage market. The Agency share has increased from roughly $3.75 billion to $5.5 billion. While we expect the Federal Reserve and U.S. Treasury to allow their holdings to run-off through
prepayments, the Agency “share” of the new loan market should
2013 Semi-Annual
Report
3
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
return to the 50% level seen in the early 2000s, which means there will need to be more involvement from banks (buying whole loans) or a growing private label market – which we expect to
play out slowly given the regulatory overhang. As well, the Government Sponsored Enterprises (“GSEs”) have completed risk transfer on the last few quarters of production, either through credit linked notes, through which they bought
protection as well as through deals with insurers.
We have seen some compression in yields available through year end 2013, as volatility remained
contained, fundamentals improved and supply remained low. While headline non-Agency yields, in our view, are biased to decline, the cash flows anticipated by the Internal Rate of Return (“IRR”) calculations are also likely to improve as
the improving fundamentals generate better recoveries, fewer defaults and higher prepayments (on discount securities). We are targeting securities that benefit more from these potential performance improvements, as we see the benefits accruing as
the housing and real-estate recovery plays out.
Forward-Looking Information
This management discussion contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements that are based on various assumptions (some of which are beyond our control) may be identified by reference to a future period or periods or by the
use of forward-looking terminology, such as “may,” “will,” “believe,” “expect,” “anticipate,” “continue,” “should,” “intend,” or similar terms or variations on those
terms or the negative of those terms. Although we believe that the expectations contained in any forward-looking statement are based on reasonable assumptions, we can give no assurance that our expectations will be attained. We do not undertake, and
specifically disclaim any obligation, to publicly release any update or supplement to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
Disclosure
The Fund’s
portfolio holdings are subject to change without notice. The mention of specific securities is not a recommendation or solicitation for any person to buy, sell or hold any particular security. There is no assurance that the Fund currently holds
these securities.
The Fund may utilize leverage to seek to enhance the yield and net asset value of its common stock, through bank borrowings,
issuance of short-term debt securities or shares of preferred stock, or a combination thereof. However, these objectives cannot be achieved in all interest rate environments. While leverage may result in a higher yield for the Fund, the use of
leverage involves risk, including the potential for higher volatility of the NAV, fluctuations of dividends and other distributions paid by the Fund and the market price of the Fund’s common stock, among others. The Fund may invest assets in
securities of issuers domiciled outside the United States, including issuers from emerging markets. Foreign investing involves special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political,
economic or other developments. Performance data quoted represents past performance results and does not guarantee future results. Current performance may be lower or higher than the performance data quoted.
This may contain information obtained from third parties, including ratings from credit ratings agencies such as Standard & Poor’s.
Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability
of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the case, of the results obtained from the use of such content.
THIRD PARTY CONTENT PROVIDERS GIVE NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE. THIRD PARTY CONTENT PROVIDERS SHALL NOT BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, EXEMPLARY, COMPENSATORY, PUNITIVE, SPECIAL OR CONSEQUENTIAL DAMAGES, COSTS, EXPENSES, LEGAL FEES, OR LOSSES (INCLUDING LOST INCOME OR
PROFITS AND
4
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
OPPORTUNITY COSTS OR LOSSES CAUSED BY NEGLIGENCE) IN CONNECTION WITH ANY USE OF THEIR CONTENT, INCLUDING RATINGS. Credit ratings are statements of opinions and are not statements of fact or
recommendations to purchase, hold or sell securities. They do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice.
Performance data quoted represents past performance results and does not guarantee future results. Current performance may be lower or higher than the
performance data quoted.
These views represent the opinions of Brookfield Investment Management Inc. and are not intended to predict or depict the
performance of any investment. These views are as of the close of business on December 31, 2013 and subject to change based on subsequent developments.
|
1
|
Core Logic, November 2013
|
2013 Semi-Annual
Report
5
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Portfolio Characteristics (Unaudited)
December 31, 2013
|
|
|
|
|
|
|
PORTFOLIO STATISTICS
|
|
|
|
|
|
|
|
|
Annualized dividend yield
1
|
|
|
9.20
|
%
|
|
Weighted average coupon
|
|
|
3.33
|
%
|
|
Weighted average life
|
|
|
3.59 years
|
|
|
Percentage of leveraged assets
|
|
|
10.10
|
%
|
|
Total number of holdings
|
|
|
148
|
|
|
|
|
|
|
|
|
|
|
|
ASSET BY COUPON TYPE DISTRIBUTION
2,3
|
|
|
|
|
|
Residential Mortgage Related Holdings - Fixed Rate
|
|
|
6.3
|
%
|
|
Residential Mortgage Related Holdings - Floating Rate
|
|
|
44.4
|
%
|
|
Commercial Mortgage Related Holdings - Fixed Rate
|
|
|
21.2
|
%
|
|
Commercial Mortgage Related Holdings - Floating Rate
|
|
|
3.4
|
%
|
|
High Yield Corporate Bonds - Fixed Rate
|
|
|
12.2
|
%
|
|
Loans - Fixed Rate
|
|
|
1.7
|
%
|
|
Loans - Floating Rate
|
|
|
5.3
|
%
|
|
Equities
|
|
|
1.9
|
%
|
|
Cash
|
|
|
3.6
|
%
|
|
|
|
|
|
|
|
Total
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
ASSET ALLOCATION
3
|
|
|
|
|
|
Residential Mortgage Related Holdings
|
|
|
53
|
%
|
|
Commercial Mortgage Related Holdings
|
|
|
33
|
%
|
|
Corporate Bonds
|
|
|
12
|
%
|
|
Common Stocks
|
|
|
2
|
%
|
|
Short-Term Investments
|
|
|
0
|
%
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
|
|
|
|
|
1
|
Dividends may include net investment income, capital gains and/or return of capital. The dividend yield referenced above is calculated as the annualized
amount of the most recent monthly dividend declared divided by December 31, 2013 stock price.
|
|
2
|
Coupon types are expressed as a percentage of total investments (by market value) and will vary over time.
|
|
3
|
Percentages are based on total investments.
|
6
Brookfield
Investment
Management Inc.
The following notes should be read in conjunction with the accompanying Schedule of Investments.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Statement of Assets and Liabilities (Unaudited)
December 31, 2013
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
Investments in securities, at value (Note 2)
|
|
$
|
447,478,887
|
|
|
Investments in short-term securities, at value
|
|
|
999,871
|
|
|
|
|
|
|
|
|
Total investments, at value
|
|
|
448,478,758
|
|
|
Cash
|
|
|
15,747,127
|
|
|
Interest and dividend receivable
|
|
|
2,128,484
|
|
|
Variation margin receivable
|
|
|
76,047
|
|
|
Prepaid expenses
|
|
|
45,857
|
|
|
|
|
|
|
|
|
Total assets
|
|
|
466,476,273
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
Reverse repurchase agreements (Note 6)
|
|
|
47,115,890
|
|
|
Interest payable for reverse repurchase agreements (Note 6)
|
|
|
111,974
|
|
|
Investment advisory fee payable (Note 4)
|
|
|
395,913
|
|
|
Administration fee payable (Note 4)
|
|
|
59,387
|
|
|
Directors’ fee payable
|
|
|
11,150
|
|
|
Accrued expenses
|
|
|
127,619
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
47,821,933
|
|
|
|
|
|
|
|
|
Net Assets
|
|
$
|
418,654,340
|
|
|
|
|
|
|
|
|
Composition of Net Assets:
|
|
|
|
|
|
Capital stock, at par value ($0.001 par value, 1,000,000,000 shares authorized) (Note 7)
|
|
$
|
22,714
|
|
|
Additional paid-in capital (Note 7)
|
|
|
431,440,937
|
|
|
Distributions in excess of net investment income
|
|
|
(3,330,671
|
)
|
|
Accumulated net realized loss on investment and futures transactions
|
|
|
(2,561,337
|
)
|
|
Net unrealized depreciation on investments and futures
|
|
|
(6,917,303
|
)
|
|
|
|
|
|
|
|
Net assets applicable to capital stock outstanding
|
|
$
|
418,654,340
|
|
|
|
|
|
|
|
|
Total investments, at cost
|
|
$
|
456,689,044
|
|
|
|
|
|
|
|
|
Shares Outstanding and Net Asset Value Per Share:
|
|
|
|
|
|
Common shares outstanding
|
|
|
22,713,931
|
|
|
Net asset value per share
|
|
$
|
18.43
|
|
|
|
|
|
|
|
See Notes to Financial
Statements.
2013 Semi-Annual
Report
13
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Statement of Operations (Unaudited)
For the Six
Months Ended December 31, 2013
|
|
|
|
|
|
|
Investment Income (Note 2)
|
|
|
|
|
|
Interest
|
|
$
|
17,049,088
|
|
|
Dividends
|
|
|
206,285
|
|
|
|
|
|
|
|
|
Total income
|
|
|
17,255,373
|
|
|
|
|
|
|
|
|
Expenses:
|
|
|
|
|
|
Investment advisory fees (Note 4)
|
|
|
2,232,284
|
|
|
Administration fees (Note 4)
|
|
|
334,843
|
|
|
Legal fees
|
|
|
65,376
|
|
|
Directors’ fees
|
|
|
64,275
|
|
|
Fund accounting servicing fees
|
|
|
51,709
|
|
|
Audit and tax services
|
|
|
32,859
|
|
|
Reports to stockholders
|
|
|
21,715
|
|
|
Registration fees
|
|
|
17,287
|
|
|
Insurance
|
|
|
16,234
|
|
|
Custodian fees
|
|
|
14,600
|
|
|
Miscellaneous
|
|
|
12,136
|
|
|
Transfer agent fees
|
|
|
7,884
|
|
|
|
|
|
|
|
|
Total expenses excluding interest expense
|
|
|
2,871,202
|
|
|
Interest expense on reverse repurchase agreements (Note 6)
|
|
|
154,546
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
3,025,748
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
14,229,625
|
|
|
|
|
|
|
|
|
Realized and Unrealized Gain (Loss) on Investments:
|
|
|
|
|
|
Net realized loss on:
|
|
|
|
|
|
Investment transactions
|
|
|
(1,700,198
|
)
|
|
Futures transactions
|
|
|
(572,097
|
)
|
|
|
|
|
|
|
|
Net realized loss on investment and futures transactions
|
|
|
(2,272,295
|
)
|
|
|
|
|
|
|
|
Net change in unrealized appreciation on:
|
|
|
|
|
|
Investments
|
|
|
6,714,633
|
|
|
Futures
|
|
|
1,015,163
|
|
|
|
|
|
|
|
|
Net change in unrealized appreciation on investments and futures
|
|
|
7,729,796
|
|
|
|
|
|
|
|
|
Net realized and unrealized gain on investment and futures transactions
|
|
|
5,457,501
|
|
|
|
|
|
|
|
|
Net increase in net assets resulting from operations
|
|
$
|
19,687,126
|
|
|
|
|
|
|
|
See Notes to Financial
Statements.
14
Brookfield
Investment
Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Statements of Changes in Net Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six
Months Ended
December 31, 2013
(Unaudited)
|
|
|
For the period
March 26, 2013
1
through
June 30, 2013
|
|
|
Increase (Decrease) in Net Assets Resulting from Operations:
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
14,229,625
|
|
|
$
|
3,675,525
|
|
|
Net realized gain (loss) on investment and futures transactions
|
|
|
(2,272,295
|
)
|
|
|
29,909
|
|
|
Net change in unrealized appreciation (depreciation) on investments and futures
|
|
|
7,729,796
|
|
|
|
(14,647,099
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net assets resulting from operations
|
|
|
19,687,126
|
|
|
|
(10,941,665
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Distributions to Stockholders:
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
(17,321,644
|
)
|
|
|
(4,233,128
|
)
|
|
Return of capital
|
|
|
—
|
|
|
|
(1,540,340
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions paid
|
|
|
(17,321,644
|
)
|
|
|
(5,773,468
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Capital Stock Transactions:
|
|
|
|
|
|
|
|
|
|
Proceeds from shares sold
|
|
|
—
|
|
|
|
432,963,977
|
|
|
Reinvestment of dividends and distributions
|
|
|
—
|
|
|
|
40,014
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in net assets from capital stock transactions
|
|
|
—
|
|
|
|
433,003,991
|
|
|
|
|
|
|
|
|
|
|
|
|
Total increase in net assets
|
|
|
2,365,482
|
|
|
|
416,288,858
|
|
|
Net Assets:
|
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
416,288,858
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
End of period
|
|
$
|
418,654,340
|
|
|
$
|
416,288,858
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions in excess of net investment income
|
|
$
|
(3,330,671
|
)
|
|
$
|
(238,652
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Share Transactions:
|
|
|
|
|
|
|
|
|
|
Shares issued
|
|
|
—
|
|
|
|
22,711,790
|
|
|
Reinvested shares
|
|
|
—
|
|
|
|
2,141
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in shares outstanding
|
|
|
—
|
|
|
|
22,713,931
|
|
|
|
|
|
|
|
|
|
|
|
|
1
|
Commencement of operations.
|
See Notes to Financial Statements.
2013 Semi-Annual
Report
15
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Statement of Cash Flows (Unaudited)
For the Six
Months Ended December 31, 2013
|
|
|
|
|
|
|
Increase (Decrease) in Cash:
|
|
|
|
|
|
|
|
|
Cash flows provided by operating activities:
|
|
|
|
|
|
Net increase in net assets resulting from operations
|
|
$
|
19,687,126
|
|
|
Adjustments to reconcile net increase in net assets resulting from operations to net cash used for operating activities:
|
|
|
|
|
|
Purchases of long-term portfolio investments
|
|
|
(117,381,658
|
)
|
|
Proceeds from disposition of long-term portfolio investments and principal paydowns
|
|
|
82,841,296
|
|
|
Purchases of short-term portfolio investments, net
|
|
|
(999,675
|
)
|
|
Decrease in payable for investments purchased
|
|
|
(9,304,236
|
)
|
|
Decrease in interest and dividend receivable
|
|
|
92,326
|
|
|
Decrease in dividend reinvestment receivable
|
|
|
20,311
|
|
|
Decrease in cash collateral pledged for futures contracts
|
|
|
147,025
|
|
|
Increase in variation margin receivable
|
|
|
(70,735
|
)
|
|
Increase in prepaid expenses
|
|
|
(23,922
|
)
|
|
Decrease in payable for variation margin
|
|
|
(2,508
|
)
|
|
Increase in interest payable for reverse repurchase agreements
|
|
|
107,943
|
|
|
Increase in investment advisory fee payable
|
|
|
46,166
|
|
|
Increase in administration fee payable
|
|
|
6,925
|
|
|
Increase in directors’ fee payable
|
|
|
525
|
|
|
Decrease in accrued expenses
|
|
|
(6,981
|
)
|
|
Net amortization on investments and paydown gains on investments
|
|
|
(8,981,965
|
)
|
|
Unrealized appreciation on investments
|
|
|
(6,714,633
|
)
|
|
Net realized loss on investment transactions
|
|
|
1,700,198
|
|
|
|
|
|
|
|
|
Net cash used for operating activities
|
|
|
(38,836,472
|
)
|
|
|
|
|
|
|
|
Cash flows provided by financing activities:
|
|
|
|
|
|
Net cash provided by reverse repurchase agreements
|
|
|
42,677,890
|
|
|
Distributions paid to stockholders
|
|
|
(17,321,644
|
)
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
|
25,356,246
|
|
|
|
|
|
|
|
|
Net decrease in cash
|
|
|
(13,480,226
|
)
|
|
Cash at beginning of period
|
|
|
29,227,353
|
|
|
|
|
|
|
|
|
Cash at end of period
|
|
$
|
15,747,127
|
|
|
|
|
|
|
|
Supplemental Disclosure of Cash Flow Information:
Interest payments on the reverse repurchase agreements for the six months ended December 31, 2013, totaled $46,603.
See Notes to Financial Statements.
16
Brookfield
Investment
Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Financial Highlights
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Six
Months Ended
December 31, 2013
(Unaudited)
|
|
|
For the Period
March 26, 2013
1
through
June 30, 2013
|
|
|
Per Share Operating Performance:
|
|
|
|
|
|
|
|
|
|
Net asset value, beginning of period
|
|
$
|
18.33
|
|
|
$
|
19.10
|
2
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
0.61
|
|
|
|
0.17
|
|
|
Net realized and unrealized gain (loss) on investment transactions
|
|
|
0.25
|
|
|
|
(0.69
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in net asset value resulting from operations
|
|
|
0.86
|
|
|
|
(0.52
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Distributions from net investment income
|
|
|
(0.76
|
)
|
|
|
(0.18
|
)
|
|
Return of capital distributions
|
|
|
—
|
|
|
|
(0.07
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total distributions paid
|
|
|
(0.76
|
)
|
|
|
(0.25
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net asset value, end of period
|
|
$
|
18.43
|
|
|
$
|
18.33
|
|
|
|
|
|
|
|
|
|
|
|
|
Market price, end of period
|
|
$
|
16.57
|
|
|
$
|
18.46
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Investment Return
†
|
|
|
-6.04
|
%
3
|
|
|
-6.44
|
%
3
|
|
Ratios to Average Net Assets/Supplementary Data:
|
|
|
|
|
|
|
|
|
|
Net assets, end of period (000s)
|
|
$
|
418,654
|
|
|
$
|
416,289
|
|
|
Gross operating expenses
|
|
|
1.37
|
%
4
|
|
|
1.44
|
%
4
|
|
Interest expense
|
|
|
0.07
|
%
4
|
|
|
0.0
|
%
4,5
|
|
Total expenses
|
|
|
1.44
|
%
4
|
|
|
1.44
|
%
|
|
Net investment income
|
|
|
6.78
|
%
4
|
|
|
3.36
|
%
4
|
|
Portfolio turnover rate
|
|
|
20
|
%
3
|
|
|
2
|
%
3
|
|
Loans Outstanding, end of period (000s)
|
|
$
|
47,116
|
|
|
$
|
4,438
|
|
|
Asset Coverage per $1,000 unit of senior indebtedness
6
|
|
$
|
9,886
|
|
|
$
|
94,801
|
|
|
†
|
Total investment return is computed based upon the New York Stock Exchange market price of the Fund’s shares and excludes the effect of broker
commissions. Distributions are assumed to be reinvested at the prices obtained under the Fund’s dividend reinvestment plan.
|
|
1
|
Commencement of operations.
|
|
2
|
Net asset value, beginning of period, reflects a deduction of $0.90 per share sales charge from the initial public offering price of $20.00 per share.
|
|
5
|
Interest expense ratio was less than 0.01%.
|
|
6
|
Calculated by subtracting the Fund’s total liabilities (not including borrowings) from the Fund’s total assets and dividing by the total number of
senior indebtedness units, where one unit equals $1,000 of senior indebtedness.
|
See Notes to Financial Statements.
2013 Semi-Annual
Report
17
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited)
December 31, 2013
1. Organization
Brookfield
Mortgage Opportunity Income Fund Inc. (the “Fund”) was incorporated under the laws of the State of Maryland on November 26, 2012. The Fund is registered under the Investment Company Act of 1940, as amended (the “1940 Act”),
as a diversified, closed-end management investment company which invests primarily in mortgage-related securities. The Fund commenced operations on March 26, 2013.
Brookfield Investment Management Inc. (“BIM” or “Adviser”), a wholly-owned subsidiary of Brookfield Asset Management Inc., is
registered as an investment adviser under the Investment Advisers Act of 1940, as amended, and serves as investment adviser to the Fund.
The
investment objective of the Fund is to provide a high total investment return by providing a high level of current income and the potential for capital appreciation. The investment objective is not fundamental and may be changed by the Board of
Directors without stockholder approval, upon not less than 60 days prior notice to stockholders. No assurances can be given that the Fund’s investment objective will be achieved.
2. Significant Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”)
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of increases and
decreases in net assets from operations during the reporting period. Actual results could differ from those estimates.
Valuation of Investments:
Debt securities, including U.S. government securities, listed corporate bonds, other fixed income and asset-backed securities, and unlisted securities and private placement securities, are generally valued at the bid prices furnished by an
independent pricing service or, if not valued by an independent pricing service, using bid prices obtained from active and reliable market makers in any such security or a broker-dealer. The broker-dealers or pricing services use multiple valuation
techniques to determine fair value. In instances where sufficient market activity exists, the broker-dealers or pricing services may utilize a market-based approach through which quotes from market makers are used to determine fair value. In
instances where sufficient market activity may not exist or is limited, the broker-dealers or pricing services utilize proprietary valuation models which may consider market transactions in comparable securities and the various relationships between
securities in determining fair value and/or market characteristics such as benchmark yield curves, option-adjusted spreads, credit spreads, estimated default rates, coupon-rates, anticipated timing of principal repayments, underlying collateral, and
other unique security features in order to estimate the relevant cash flows, which are then discounted to calculate the fair values. Short-term debt securities with remaining maturities of sixty days or less are valued at amortized cost with
interest accrued or discount accreted to the date of maturity, unless such valuation, in the judgment of the Adviser’s Valuation Committee, does not represent market value.
Investments in equity securities listed or traded on any securities exchange or traded in the over-the-counter market are valued at the trade price as
of the close of business on the valuation date. Equity securities for which no sales were reported for that date are valued at “fair value” as determined in good faith by the Adviser’s Valuation Committee. Investments in open-end
registered investment companies, if any, are valued at the net asset value (“NAV”) as reported by those investment companies.
When price
quotations for certain securities are not readily available, or if the available quotations are not believed to be reflective of market value by the Adviser, those securities will be valued at “fair value” as determined in good faith by
the Adviser’s Valuation Committee using procedures adopted by and under the supervision of the Fund’s Board of Directors (the “Board”). There can be no assurance that the Fund could purchase or sell a portfolio security at the
price used to calculate the Fund’s NAV.
18
Brookfield
Investment
Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
Fair valuation procedures may be used to value a portion of the assets of the Fund. The Fund may use
the fair value of a security to calculate its NAV when, for example, (1) a portfolio security is not traded in a public market or the principal market in which the security trades is closed, (2) trading in a portfolio security is suspended
and not resumed prior to the normal market close, (3) a portfolio security is not traded in significant volume for a substantial period, or (4) the Adviser determines that the quotation or price for a portfolio security provided by a
broker-dealer or an independent pricing service is inaccurate.
The “fair value” of securities may be difficult to determine and thus
judgment plays a greater role in the valuation process. The fair valuation methodology may include or consider the following guidelines, as appropriate: (1) evaluation of all relevant factors, including but not limited to, pricing history,
current market level, supply and demand of the respective security; (2) comparison to the values and current pricing of securities that have comparable characteristics; (3) knowledge of historical market information with respect to the
security; (4) other factors relevant to the security which would include, but not be limited to, duration, yield, fundamental analytical data, the Treasury yield curve, and credit quality.
The values assigned to fair valued investments are based on available information and do not necessarily represent amounts that might ultimately be
realized, since such amounts depend on future developments inherent in long-term investments. Changes in the fair valuation of portfolio securities may be less frequent and of greater magnitude than changes in the price of portfolio securities
valued at their last sale price, by an independent pricing service, or based on market quotations. Imprecision in estimating fair value can also impact the amount of unrealized appreciation or depreciation recorded for a particular portfolio
security and differences in the assumptions used could result in a different determination of fair value, and those differences could be material.
The Board has adopted procedures for the valuation of the Fund’s securities and has delegated the day to day responsibilities for valuation
determinations under these procedures to the Adviser. The Board has reviewed and approved the valuation procedures utilized by the Adviser and regularly reviews the application of the procedures to the securities in the Fund’s portfolio.
Securities are valued using unadjusted quoted market prices, when available, as supplied primarily by third party pricing services or dealers. If a market value or price cannot be determined for a security or a significant event has occurred that
would materially affect the value of the security, the security is fair valued by the Adviser’s Valuation Committee. The Adviser’s Valuation Committee is comprised of senior members of the Adviser’s management team. As of
December 31, 2013, there were no securities that were fair valued by the Adviser’s Valuation Committee.
The Fund has established methods
of fair value measurements in accordance with GAAP. Fair value denotes the price that the Fund would receive upon selling an investment in a timely transaction to an independent buyer in the principal or most advantageous market of the investment. A
three-tier hierarchy has been established to maximize the use of observable market data and minimize the use of unobservable inputs and to establish classification of fair value measurements for disclosure purposes. Inputs refer broadly to the
assumptions that market participants would use in pricing the asset or liability, including assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value including such a pricing model and/or
the risk inherent in the inputs to the valuation technique. Inputs may be observable or unobservable. Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market
data obtained from sources independent of the reporting entity. Unobservable inputs are inputs that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed
based on the best information available in the circumstances. The three-tier hierarchy of inputs is summarized in the three broad levels listed below.
|
|
|
|
|
|
|
|
|
|
|
•
|
|
Level 1 -
|
|
quoted prices in active markets for identical assets or liabilities
|
|
|
|
|
|
|
|
|
•
|
|
Level 2 -
|
|
quoted prices in markets that are not active or other significant observable inputs (including, but not limited to: quoted prices for similar assets or liabilities,
quoted prices based on recently executed transactions, interest rates, credit risk, etc.)
|
2013 Semi-Annual
Report
19
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
•
|
|
Level 3 -
|
|
significant unobservable inputs (including the Fund’s own assumptions in determining the fair value of assets or liabilities)
|
The Adviser’s valuation policy, as previously stated, establishes parameters for the sources and types of valuation
analysis, as well as, the methodologies and inputs the Adviser uses in determining fair value, including the use of the Adviser’s Valuation Committee. If the Adviser’s Valuation Committee determines that additional techniques, sources or
inputs are appropriate or necessary in a given situation, such additional work will be undertaken.
Significant increases or decreases in any of the
unobservable inputs in isolation may result in a lower or higher fair value measurement.
To assess the continuing appropriateness of security
valuations, the Adviser (or its third party service provider, who is subject to oversight by the Adviser), regularly compares one of its prior day prices, prices on comparable securities and sale prices to the current day prices and challenges those
prices that exceed certain tolerance levels with the third party pricing service or broker source. For those securities valued by fair valuations, the Adviser’s Valuation Committee reviews and affirms the reasonableness of the valuations based
on such methodologies and fair valuation determinations on a regular basis after considering all relevant information that is reasonably available.
The inputs or methodology used for valuing investments are not necessarily an indication of the risk associated with investing in those securities.
The following table summarizes the Fund’s investments categorized in the disclosure hierarchy as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Valuation Inputs
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
|
Residential Mortgage Related Holdings
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
235,766,279
|
|
|
$
|
235,766,279
|
|
|
Commercial Mortgage Related Holdings
|
|
|
—
|
|
|
|
—
|
|
|
|
146,735,679
|
|
|
|
146,735,679
|
|
|
Corporate Bonds
|
|
|
—
|
|
|
|
55,926,169
|
|
|
|
—
|
|
|
|
55,926,169
|
|
|
Common Stocks
|
|
|
9,050,760
|
|
|
|
—
|
|
|
|
—
|
|
|
|
9,050,760
|
|
|
Short-Term Investments
|
|
|
—
|
|
|
|
999,871
|
|
|
|
—
|
|
|
|
999,871
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
9,050,760
|
|
|
$
|
56,926,040
|
|
|
$
|
382,501,958
|
(1)
|
|
$
|
448,478,758
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Valuation Inputs
|
|
Other Financial
Instruments
(2)
|
|
|
Level 1 — Quoted Prices
|
|
$
|
1,292,983
|
|
|
Level 2 — Quoted Prices in Inactive Markets or Other Significant Observable Inputs
|
|
|
—
|
|
|
Level 3 — Significant Unobservable Inputs
|
|
|
—
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,292,983
|
|
|
|
|
|
|
|
|
(1)
|
The Fund generally uses evaluated bid prices provided by an independent pricing service on the valuation
date as the primary basis for the fair value determinations. These evaluated bid prices are based on unobservable inputs. A significant change in third party information inputs could result in a significantly lower or higher value of such Level 3
investments.
|
|
(2)
|
Other financial instruments include futures contracts.
|
20
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
The following is a reconciliation of assets in which significant unobservable inputs (Level 3) were
used in determining fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investments in Securities
|
|
Residential
Mortgage
Related
Holdings
|
|
|
Commercial
Mortgage
Related
Holdings
|
|
|
Total
|
|
|
Balance as of June 30, 2013
|
|
$
|
177,335,807
|
|
|
$
|
150,261,162
|
|
|
$
|
327,596,969
|
|
|
Accrued Discounts
|
|
|
4,970,270
|
|
|
|
141,305
|
|
|
|
5,111,575
|
|
|
Realized Gain (Loss)
|
|
|
2,612,577
|
|
|
|
(245,560
|
)
|
|
|
2,367,017
|
|
|
Change in Unrealized Appreciation (Depreciation)
|
|
|
(839,581
|
)
|
|
|
4,872,451
|
|
|
|
4,032,870
|
|
|
Purchases at cost
|
|
|
91,172,354
|
|
|
|
21,124,020
|
|
|
|
112,296,374
|
|
|
Sales
|
|
|
(39,485,148
|
)
|
|
|
(29,417,699
|
)
|
|
|
(68,902,847
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of December 31, 2013
|
|
$
|
235,766,279
|
|
|
$
|
146,735,679
|
|
|
$
|
382,501,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized gains or losses relating to assets still held at the reporting date
|
|
$
|
(1,375,576
|
)
|
|
$
|
3,805,627
|
|
|
$
|
2,430,051
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of the Fund’s reverse repurchase agreements, which qualify as financial instruments under FASB
Accounting Standards Codification (“ASC”) 820 “Disclosures about Fair Values of Financial Instruments”, approximates the carrying amounts presented in the Statement of Assets and Liabilities. As of December 31, 2013, this
financial instrument is categorized as a Level 2 within the disclosure hierarchy.
For the six months ended December 31, 2013, there was no
security transfer activity between Level 1 and Level 2. The basis for recognizing and valuing transfers is as of the end of the period in which the transfers occur.
Investment Transactions and Investment Income:
Securities transactions are recorded on the trade date. Realized gains and losses from securities
transactions are calculated on the identified cost basis. Interest income is recorded on the accrual basis. Discounts and premiums on securities are accreted and amortized, respectively, on a daily basis, using the effective yield method. Dividend
income is recorded on the ex-dividend date.
Taxes:
The Fund intends to continue to meet the requirements of the Internal Revenue Code of
1986, as amended, applicable to regulated investment companies and to distribute substantially all of its taxable income to its stockholders. Therefore, no federal income or excise tax provision is required. The Fund may incur an excise tax to the
extent it has not distributed all of its taxable income on a calendar year basis.
GAAP provides guidance for how uncertain tax positions should be
recognized, measured, presented and disclosed in the financial statements. An evaluation of tax positions taken in the course of preparing the Fund’s tax returns to determine whether the tax positions are “more-likely-than-not” of
being sustained by the taxing authority is required. Tax benefits of positions not deemed to meet the more-likely-than-not threshold would be booked as a tax expense in the current year and recognized as: a liability for unrecognized tax benefits; a
reduction of an income tax refund receivable; a reduction of a deferred tax asset; an increase in a deferred tax liability; or a combination thereof. As of December 31, 2013, the Fund has determined that there are no uncertain tax positions or
tax liabilities required to be accrued.
The Fund has reviewed all taxable years that are open for examination (
i.e.,
not barred by the
applicable statute of limitations) by taxing authorities of all major jurisdictions, including the Internal Revenue Service. As of December 31, 2013, open taxable years consisted of the taxable period ended June 30, 2013. No examination of
the Fund’s tax returns is currently in progress.
Expenses:
Expenses directly attributable to the Fund are charged directly to the Fund,
while expenses which are attributable to the Fund and other investment companies advised by the Adviser are allocated among the respective investment companies, including the Fund, based upon relative net assets.
Dividends and Distributions:
The Fund declares and pays dividends monthly from net investment income. To the extent these distributions exceed
net investment income, they may be classified as return of capital. The Fund also pays distributions at least annually from its net realized capital gains, if any. Dividends and distributions are recorded on the ex-dividend date. All common shares
have equal dividend and other distribution rights. A notice
2013 Semi-Annual
Report
21
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
disclosing the source(s) of a distribution will be provided if payment is made from any source other than net investment income. Any such notice would be provided only for informational purposes
in order to comply with the requirements of Section 19(a) of the 1940 Act and not for tax reporting purposes. The tax composition of the Fund’s distributions for each calendar year is reported on IRS Form 1099-DIV.
Dividends from net investment income and distributions from realized gains from investment transactions have been determined in accordance with Federal
income tax regulations and may differ from net investment income and realized gains recorded by the Fund for financial reporting purposes. These differences, which could be temporary or permanent in nature, may result in reclassification of
distributions; however, net investment income, net realized gains and losses and net assets are not affected.
When-Issued Purchases and Forward
Commitments:
The Fund may purchase securities on a “when-issued” basis and may purchase or sell securities on a “forward commitment” basis in order to hedge against anticipated changes in interest rates and prices and secure
a favorable rate of return. When such transactions are negotiated, the price, which is generally expressed in yield terms, is fixed at the time the commitment is made, but delivery and payment for the securities takes place at a later date, which
can be a month or more after the date of the transaction. At the time the Fund makes the commitment to purchase securities on a when-issued or forward commitment basis, the Fund will record the transactions and thereafter reflect the values of such
securities in determining its net asset value. At the time the Fund enters into a transaction on a when-issued or forward commitment basis, the Adviser will identify collateral consisting of cash or liquid securities equal to the value of the
when-issued or forward commitment securities and will monitor the adequacy of such collateral on a daily basis. On the delivery date, the Fund will meet its obligations from securities that are then maturing or sales of the securities identified as
collateral by the Adviser and/or from then available cash flow. When-issued securities and forward commitments may be sold prior to the settlement date. If the Fund disposes of the right to acquire a when-issued security prior to its acquisition or
disposes of the right to deliver or receive against a forward commitment, it can incur a gain or loss due to market fluctuation. There is always a risk that the securities may not be delivered and that the Fund may incur a loss. Settlements in the
ordinary course are not treated by the Fund as when-issued or forward commitment transactions and, accordingly, are not subject to the foregoing limitations even though some of the risks described above may be present in such transactions.
TBA Transactions:
The Fund may enter into to-be-announced (“TBA”) transactions to hedge its portfolio positions or to sell
mortgage-backed securities it owns under delayed delivery arrangements. A TBA transaction is a purchase or sale of a U.S. government agency mortgage pass-through security for future settlement at an agreed upon date. The term “U.S. government
agency mortgage pass-through security” refers to a category of pass-through securities backed by pools of mortgages and issued by one of several U.S. government-sponsored enterprises: the Government National Mortgage Association (Ginnie Mae),
Federal National Mortgage Association (Fannie Mae), or Federal Home Loan Mortgage Corporation (Freddie Mac). In the basic pass-through structure, mortgages with similar issuer, term and coupon characteristics are collected and aggregated into a
pool. The pool is assigned a CUSIP number and undivided interests in the pool are traded and sold as pass-through securities. The holder of the security is entitled to a pro rata share of principal and interest payments (including unscheduled
prepayments) from the pool of mortgage loans. TBA transactions increase the liquidity and pricing efficiency of transactions in such mortgage-backed securities since they permit similar mortgage-backed securities to be traded interchangeably
pursuant to commonly observed settlement and delivery requirements. Proceeds of TBA transactions are not received until the contractual settlement date. The Fund may use TBA transactions to acquire and maintain exposure to mortgage-backed securities
in either of two ways. Typically, the Fund will enter into TBA agreements and “roll over” such agreements prior to the settlement date stipulated in such agreements. This type of TBA transaction is commonly known as a “TBA roll.”
In a “TBA roll,” the Fund generally will sell the obligation to purchase the pools stipulated in the TBA agreement prior to the stipulated settlement date and will enter into a new TBA agreement for future delivery of pools of mortgage
pass-through securities. Alternatively, the Fund will enter into TBA agreements and settle such transactions on the stipulated settlement date by actual receipt or delivery of the pools of mortgage pass-through securities stipulated in the TBA
agreement. Unsettled TBA agreements are valued at the current market value of the underlying securities, according to the procedures described above under “Valuation of Investments.” Each TBA position is marked-to-market daily and the
change in market value is recorded by the Fund as an unrealized gain or loss.
22
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
Cash Flow Information:
The Fund invests in securities and distributes dividends and
distributions which are paid in cash or are reinvested at the discretion of stockholders. These activities are reported in the Statements of Changes in Net Assets Additional information on cash receipts and cash payments is presented in the
Statements of Cash Flows.
Financial Futures Contracts:
A futures contract is an agreement between two parties to buy and sell a financial
instrument for a set price on a future date. Initial margin deposits are made upon entering into futures contracts and can be either cash or securities. During the period the futures contract is open, changes in the value of the contract are
recognized as unrealized gains or losses by “marking-to-market” on a daily basis to reflect the market value of the contract at the end of each day’s trading. Variation margin payments are made or received, depending upon whether
unrealized gains or losses are incurred. When the contract is closed, the Fund records a realized gain or loss equal to the difference between the proceeds from (or cost of) the closing transaction and the Fund’s basis in the contract.
The Fund invests in financial futures contracts to hedge against fluctuations in the value of portfolio securities caused by changes in prevailing
market interest rates. Should interest rates move unexpectedly, a Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in
movements in the price of futures contracts, interest rates and the underlying hedged assets. The Fund is at risk that it may not be able to close out a transaction because of an illiquid market.
The following table sets forth the effect of derivative instruments on the Statement of Assets and Liabilities as of December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
Derivatives Not Accounted for
as Hedging Instruments
|
|
Statement of Assets and Liabilities
|
|
Fair Value as of
December 31, 2013
|
|
|
Futures contracts
|
|
Variation margin receivable (asset)
|
|
$
|
76,047
|
|
|
|
|
|
|
|
|
|
|
|
The average notional value of futures contracts outstanding during the six months ended December 31, 2013 was
$14,431,098, which represents the volume activity during the period.
The following table sets forth the effect of derivative instruments on the
Statement of Operations for the six months ended December 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives Not Accounted for
as Hedging Instruments
|
|
Location of Gains (Losses) on
Derivatives Recognized in Income
|
|
Net Realized Loss on
Futures Transactions
|
|
|
Net Change in
Unrealized Appreciation
on Futures
|
|
|
Futures contracts
|
|
Futures transactions
|
|
$
|
(572,097
|
)
|
|
$
|
1,015,163
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3. Risks of Investing in Asset-Backed Securities and Below-Investment Grade Securities
The value of asset-backed securities may be affected by, among other factors, changes in: interest rates, the market’s assessment of the quality of
the underlying assets, the creditworthiness of the servicer for the underlying assets, information concerning the originator of the underlying assets, or the creditworthiness or rating of the entities that provide any supporting letters of credit,
surety bonds, derivative instruments or other credit enhancement.
The value of asset-backed securities also will be affected by the exhaustion,
termination or expiration of any credit enhancement. The Fund has investments in below-investment grade debt securities, including mortgage-backed and asset-backed securities. Below-investment grade securities involve a higher degree of credit risk
than
2013 Semi-Annual
Report
23
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
investment grade debt securities. In the event of an unanticipated default, the Fund would experience a reduction in its income, a decline in the market value of the securities so affected and a
decline in the NAV of its shares. During an economic downturn or period of rising interest rates, highly leveraged and other below-investment grade issuers frequently experience financial stress that could adversely affect its ability to service
principal and interest payment obligations, to meet projected business goals and to obtain additional financing.
The market prices of
below-investment grade debt securities are generally less sensitive to interest rate changes than higher-rated investments but are more sensitive to adverse economic or political changes or individual developments specific to the issuer than
higher-rated investments. Periods of economic or political uncertainty and change can be expected to result in significant volatility of prices for these securities. Rating services consider these securities to be speculative in nature.
Below-investment grade securities may be subject to market conditions, events of default or other circumstances which cause them to be considered
“distressed securities.” Distressed securities frequently do not produce income while they are outstanding. The Fund may be required to bear certain extraordinary expenses in order to protect and recover its investments in certain
distressed securities. Therefore, to the extent the Fund seeks capital growth through investment in such securities, the Fund’s ability to achieve current income for its stockholders may be diminished. The Fund is also subject to significant
uncertainty as to when and in what manner and for what value the obligations evidenced by distressed securities will eventually be satisfied (
e.g.
, through a liquidation of the obligor’s assets, an exchange offer or plan of
reorganization involving the securities or a payment of some amount in satisfaction of the obligation). In addition, even if an exchange offer is made or a plan of reorganization is adopted with respect to distressed securities held by the Fund,
there can be no assurance that the securities or other assets received by the Fund in connection with such exchange offer or plan of reorganization will not have a lower value or income potential than may have been anticipated when the investment
was made. Moreover, any securities received by the Fund upon completion of an exchange offer or plan of reorganization may be restricted as to resale. As a result of the Fund’s participation in negotiations with respect to any exchange offer or
plan of reorganization with respect to an issuer of such securities, the Fund may be restricted from disposing of distressed securities.
4. Investment Advisory Agreement and Related Party Transactions
The Fund has entered into an
Investment Advisory Agreement (the “Advisory Agreement”) with the Adviser under which the Adviser is responsible for the management of the Fund’s portfolio and provides the necessary personnel, facilities, equipment and certain other
services necessary to the operations of the Fund. The Advisory Agreement provides, among other things, that the Adviser will bear all expenses of its employees and overhead incurred in connection with the performance of its duties under the Advisory
Agreement, and will pay all salaries of the Fund’s directors and officers who are affiliated persons (as such term is defined in the 1940 Act) of the Adviser. The Advisory Agreement provides that the Fund shall pay the Adviser a monthly fee for
its services at an annual rate of 1.00% of the Fund’s average daily net assets (plus the amount of borrowing for investment purposes) (“Managed Assets“).
The Fund has entered into an Administration Agreement with the Adviser. The Adviser has also entered into a sub-administration agreement with U.S.
Bancorp Fund Services, LLC (“Sub-Administrator”). The Adviser and Sub-Administrator perform administrative services necessary for the operation of the Fund, including maintaining certain books and records of the Fund and preparing reports
and other documents required by federal, state, and other applicable laws and regulations, and providing the Fund with administrative office facilities. For these services, the Fund pays to the Adviser a monthly fee at an annual rate of 0.15% of the
Fund’s average daily Managed Assets. The Adviser is responsible for any fees due to the Sub-Administrator.
24
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
5. Purchases and Sales of Investments
For the six months ended December 31, 2013, purchases and sales of investments, excluding short-term securities, reverse repurchase agreements, and
U.S. Government securities were $117,381,658 and $82,841,296, respectively.
6. Borrowings
The Fund may enter into reverse repurchase agreements. Under a reverse repurchase agreement, the Fund sells securities and agrees to repurchase them at a
mutually agreed upon date and price. Under the 1940 Act, reverse repurchase agreements will be regarded as a form of borrowing by the Fund unless, at the time it enters into a reverse repurchase agreement, it establishes and maintains a segregated
account with its custodian containing securities from its portfolios having a value not less than the repurchase price (including accrued interest). The Fund has established and maintained such accounts for its reverse repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the securities retained in lieu of sale by the Fund may decline below the price
of the securities the Fund has sold but is obligated to repurchase. In the event the buyer of securities under a reverse repurchase agreement files for bankruptcy or becomes insolvent, such buyer or its trustee or receiver may receive an extension
of time to determine whether to enforce the Fund’s obligation to repurchase the securities, and the Fund’s use of the proceeds of the reverse repurchase agreement may effectively be restricted pending such decision. Also, the Fund would
bear the risk of loss to the extent that the proceeds of the reverse repurchase agreement are less than the value of the securities subject to such agreements.
At December 31, 2013, the Fund had the following reverse repurchase agreements outstanding:
|
|
|
|
|
|
|
|
|
|
|
Face Value
|
|
|
Description
|
|
Maturity Amount
|
|
|
|
$41,962,990
|
|
|
RBC Capital Markets, 0.99%, dated 10/01/13, maturity date 04/01/14
|
|
$
|
42,171,451
|
|
|
|
666,920
|
|
|
RBC Capital Markets, 0.99%, dated 10/16/13, maturity date 04/01/14
|
|
|
669,988
|
|
|
|
263,980
|
|
|
RBC Capital Markets, 0.99%, dated 10/30/13, maturity date 04/01/14
|
|
|
265,092
|
|
|
|
4,222,000
|
|
|
RBC Capital Markets, 1.69%, dated 12/13/13, maturity date 06/11/14
|
|
|
4,257,756
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$47,115,890
|
|
|
Maturity Amount, Including Interest Payable
|
|
$
|
47,364,287
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Market Value of Assets Sold Under Agreements
|
|
$
|
59,418,879
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average Interest Rate
|
|
|
1.07
|
%
|
|
|
|
|
|
|
|
|
|
|
The average daily balance of reverse repurchase agreements outstanding for the Fund during the six months ended
December 31, 2013, was approximately $26,475,170 at a weighted average interest rate of 1.16%.
The maximum amount of reverse repurchase
agreements outstanding at any time during the six months was $50,628,740, which was 9.82% of total assets for the Fund.
2013 Semi-Annual
Report
25
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
Below is the gross and net information about instruments and transactions eligible for offset in the
Statement of Assets and Liabilities as well as instruments and transactions subject to an agreement similar to a master netting arrangement:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Amounts not offset in the
Statement of Assets and Liabilities
|
|
|
|
|
|
|
|
Gross
Amounts of
Recognized
Liabilities
|
|
Gross
Amounts
Offset in the
Statement of
Assets and
Liabilities
|
|
|
Net Amounts
Presented in
the Statement
of Assets and
Liabilities
|
|
Financial
Instruments
|
|
|
Collateral
Pledged
(Received)
|
|
|
Net Amount
|
|
|
Description
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reverse Repurchase Agreements
|
|
$47,115,890
|
|
$
|
—
|
|
|
$47,115,890
|
|
$
|
47,115,890
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Reverse repurchase transactions are entered into by the Fund under Master Repurchase Agreements (“MRA”) which
permit the Fund, under certain circumstances, including an event of default of the Fund (such as bankruptcy or insolvency), to offset payables under the MRA with collateral held with the counterparty and create one single net payment from the Fund.
Upon a bankruptcy or insolvency of the MRA counterparty, the Fund is considered an unsecured creditor with respect to excess collateral and, as such, the return of excess collateral may be delayed. In the event the buyer of securities (i.e. the MRA
counterparty) under a MRA files for bankruptcy or becomes insolvent, the Fund’s use of the proceeds of the agreement may be restricted while the other party, or its trustee or receiver, determines whether or not to enforce the Fund’s
obligation to repurchase the securities.
7. Capital Stock
The Fund has 1,000,000,000 shares of $0.001 par value common stock authorized. Of the 22,713,931 shares outstanding at December 31, 2013 for the
Fund, the Adviser owns 5,240 shares. The Fund’s Board of Directors is authorized to classify and reclassify any unissued shares of capital stock. The common shares have no preemptive, conversion, exchange or redemption rights. All common shares
have equal voting, dividend, distribution and liquidation rights. The common shares, when issued, will be fully paid and non-assessable. Common stockholders are entitled to one vote per share and all voting rights for the election of directors are
non-cumulative.
The Fund commenced operations on March 26, 2013, selling 21,000,000 shares and receiving $401,000,000. On January 30,
2013, the Fund had initially sold 5,240 shares to the Adviser, which represented the initial capital at $19.10 per share. On May 13, 2013, pursuant to the overallotment option, an additional 1,706,550 shares were issued for $32,595,105.
8. Financial Instruments
The
Fund regularly trades in financial instruments with off-balance sheet risk in the normal course of its investing activities to assist in managing exposure to various market risks. These financial instruments include futures contracts and may
involve, to a varying degree, elements of risk in excess of the amounts recognized for financial statement purposes. The notional or contractual amounts of these instruments represent the investment the Fund has in particular classes of financial
instruments and does not necessarily represent the amounts potentially subject to risk. The measurement of the risks associated with these instruments is meaningful only when all related and offsetting transactions are considered. During the six
months ended December 31, 2013, the Fund had segregated sufficient cash and/or securities to cover any commitments under these contracts.
As
of December 31, 2013, the following futures contracts were outstanding.
26
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short:
|
|
|
|
|
|
|
|
|
|
|
|
|
Contracts
|
|
Type
|
|
Expiration Date
|
|
|
Value at
December 31, 2013
|
|
|
Unrealized
Appreciation
|
|
|
450
|
|
5 Year U.S. Treasury Note
|
|
|
March 2014
|
|
|
$
|
53,690,625
|
|
|
$
|
775,120
|
|
|
197
|
|
10 Year U.S. Treasury Note
|
|
|
March 2014
|
|
|
|
24,240,234
|
|
|
|
517,863
|
|
9. Federal Income Tax Information
Income and capital gain distributions are determined in accordance with Federal income tax regulations, which may differ from GAAP.
The tax character of distributions for the six months ended December 31, 2013 is expected to be from ordinary income but will be determined at the
end of the Fund’s current fiscal year.
The tax character of distributions paid for the period ended June 30, 2013 was as follows:
|
|
|
|
|
|
|
Ordinary income (including short-term capital gains)
|
|
$
|
4,233,128
|
|
|
Return of capital
|
|
|
1,540,340
|
|
|
|
|
|
|
|
|
Total distributions
|
|
$
|
5,773,468
|
|
|
|
|
|
|
|
At June 30, 2013, the Fund’s most recently completed tax year-end, the components of net assets (excluding
paid-in capital) on a tax basis were as follows:
|
|
|
|
|
|
|
Other accumulated losses
|
|
$
|
(75,766
|
)
|
|
Capital loss carryforward
(1)
|
|
|
(11,222
|
)
|
|
|
|
|
|
|
|
Tax basis unrealized depreciation on investments
|
|
|
(15,087,805
|
)
|
|
Total tax basis net accumulated losses
|
|
$
|
(15,174,793
|
)
|
|
|
|
|
|
|
|
(1)
|
To the extent that future capital gains are offset by capital loss carryforwards, such gains will not be distributed.
|
As of June 30, 2013, the Fund’s capital loss carryforward was $11,222 which will not expire.
Federal Income Tax Basis:
The Federal income tax basis of the Fund’s investments at December 31, 2013 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of
Investments
|
|
|
Gross
Unrealized
Appreciation
|
|
|
Gross
Unrealized
Depreciation
|
|
|
Net
Unrealized
Appreciation
|
|
|
$
|
456,689,044
|
|
|
$
|
4,973,534
|
|
|
$
|
(13,183,820
|
)
|
|
$
|
(8,210,286
|
)
|
Capital Account Reclassifications:
Because Federal income tax regulations differ in certain respects from GAAP,
income and capital gain distributions, if any, determined in accordance with tax regulations may differ from net investment income and realized gains recognized for financial reporting purposes. These differences are primarily due to differing
treatments for gains/losses on principal payments of mortgage-backed and asset-backed securities, distribution reclassifications, and return of capital. Permanent book and tax differences, if any, relating to stockholder distributions will result in
reclassifications to paid-in-capital or to undistributed capital gains. These reclassifications have no effect on net assets or NAV per share. Any undistributed net income and realized gain remaining at fiscal year-end is distributed in the
following year.
10. Indemnification
Under the Fund’s organizational documents, its officers and directors are indemnified against certain liabilities arising out of the performance of
their duties to the Fund. In addition, in the normal course of business, the Fund enters into contracts with its vendors and others that provide for indemnification. The Fund’s maximum exposure
2013 Semi-Annual
Report
27
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.
Notes to Financial Statements (Unaudited) (continued)
December 31, 2013
under these arrangements is unknown, since this would involve the resolution of certain claims, as well
as future claims that may be made, against the Fund. Thus, an estimate of the financial impact, if any, of these arrangements cannot be made at this time. However, based on experience, the Fund expects the risk of loss due to these warranties and
indemnities to be unlikely.
11. New Accounting Pronouncements
In June 2013, FASB issued Accounting Standards Update 2013-08 Financial Services – Investment Companies (Topic 946) –Amendments to the Scope,
Measurement, and Disclosure Requirements (“ASU 2013-08”) which is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2013. ASU 2013-08 sets forth a methodology for determining whether an
entity should be characterized as an investment company and prescribes fair value accounting for an investment company’s non-controlling ownership interest in another investment company. FASB has determined that a fund registered under the
Investment Company Act of 1940 automatically meets ASU 2013-08’s criteria for an investment company. Although still evaluating the potential impacts of ASU 2013-08 to the fund, management expects that the impact of the fund’s adoption will
be limited to additional financial statement disclosures.
12. Subsequent Events
GAAP requires recognition in the financial statements of the effects of all subsequent events that provide additional evidence about conditions that
existed at the date of the Statement of Assets and Liabilities. For non-recognized subsequent events that must be disclosed to keep the financial statements from being misleading, the Fund is required to disclose the nature of the event as well as
an estimate of its financial effect, or a statement that such an estimate cannot be made.
Dividends:
The Fund’s Board of Directors
declared the following monthly dividends:
|
|
|
|
|
|
|
|
|
|
|
|
|
Dividend Per Share
|
|
|
Record Date
|
|
|
Payable Date
|
|
|
$
|
0.1271
|
|
|
|
January 16, 2014
|
|
|
|
January 30, 2014
|
|
|
$
|
0.1271
|
|
|
|
February 20, 2014
|
|
|
|
February 27, 2014
|
|
Management has evaluated subsequent events in the preparation of the Fund’s financial statements and has determined
that other than the items listed herein, there are no events that require recognition or disclosure in the financial statements.
28
Brookfield
Investment Management Inc.
BROOKFIELD MORTGAGE OPPORTUNITY INCOME FUND INC.