Except where the context suggests otherwise, references in this Quarterly Report on Form 10-Q to "EFC," "we," "us," and "our" refer to (i)Ellington Financial Inc. and its consolidated subsidiaries, includingEllington Financial Operating Partnership LLC , our operating partnership subsidiary, which we refer to as our "Operating Partnership," following our conversion to a corporation effectiveMarch 1, 2019 (our "corporate conversion"), and (ii)Ellington Financial LLC and its consolidated subsidiaries, including ourOperating Partnership , before our corporate conversion. References in this Quarterly Report on Form 10-Q to (1) "common shares" refer to (i) our common shares representing limited liability company interests, previously outstanding prior to our corporate conversion, and (ii) shares of our common stock outstanding after our corporate conversion and (2) "common shareholders" refer to (i) holders of our common shares representing limited liability company interests prior to our corporate conversion, and (ii) holders of shares of our common stock after our corporate conversion. We conduct all of our operations and business activities through ourOperating Partnership . Our "Manager" refers toEllington Financial Management LLC , our external manager, "Ellington" refers toEllington Management Group, L.L.C. and its affiliated investment advisory firms, including our Manager, and "Manager Group " refers collectively to officers and directors of EFC, and partners and affiliates of Ellington (including families and family trusts of the foregoing). In certain instances, references to our Manager and services to be provided to us by our Manager may also include services provided by Ellington and its other affiliates from time to time. Special Note Regarding Forward-Looking Statements When used in this Quarterly Report on Form 10-Q, in future filings with theSecurities and Exchange Commission , or the "SEC ," or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as "believe," "expect," "anticipate," "estimate," "project," "plan," "continue," "intend," "should," "would," "could," "goal," "objective," "will," "may," "seek," or similar expressions, are intended to identify "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, or the "Securities Act," and Section 21E of the Securities Exchange Act of 1934, as amended, or the "Exchange Act," and, as such, may involve known and unknown risks, uncertainties, and assumptions. Forward-looking statements are based on our beliefs, assumptions, and expectations of our future operations, business strategies, performance, financial condition, liquidity and prospects, taking into account information currently available to us. These beliefs, assumptions, and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity, results of operations and strategies may vary materially from those expressed or implied in our forward-looking statements. The following factors are examples of those that could cause actual results to vary from our forward-looking statements: changes in interest rates and the market value of our securities; market volatility; changes in the prepayment rates on the mortgage loans underlying the securities owned by us for which the principal and interest payments are guaranteed by aU.S. government agency or aU.S. government-sponsored entity; increased rates of default and/or decreased recovery rates on our assets; our ability to borrow to finance our assets; changes in government regulations affecting our business; our ability to maintain our exclusion from registration under the Investment Company Act of 1940, as amended, or the "Investment Company Act"; our ability to qualify and maintain our qualification as a real estate investment trust, or "REIT"; and risks associated with investing in real estate assets, including changes in business conditions and the general economy, such as those resulting from the economic effects related to the COVID-19 pandemic, and associated responses to the pandemic. These and other risks, uncertainties and factors, including the risk factors described under Item 1A of our Annual Report on Form 10-K and Part II. Item 1A. of our Quarterly Report on Form 10-Q, as amended, for the three-month period endedMarch 31, 2020 , could cause our actual results to differ materially from those projected or implied in any forward-looking statements we make. All forward-looking statements speak only as of the date on which they are made. New risks and uncertainties arise over time, and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Executive Summary We invest in a diverse array of real-estate-related and other financial assets, including residential and commercial mortgage loans, residential mortgage-backed securities, or "RMBS," commercial mortgage-backed securities, or "CMBS," consumer loans and asset-backed securities, or "ABS," including ABS backed by consumer loans, collateralized loan obligations, or "CLOs," non-mortgage- and mortgage-related derivatives, equity investments in loan origination companies, and other strategic investments. We are externally managed and advised by our Manager, an affiliate of Ellington. Ellington is a registered investment adviser with a 25-year history of investing in the Agency and credit markets. We conduct all of our operations and business activities through theOperating Partnership . As ofJune 30, 2020 , we have an ownership interest of approximately 98.8% in theOperating Partnership . The remaining ownership interest of approximately 1.2% in theOperating Partnership represents the interests in theOperating Partnership that are owned by an affiliate of our 76
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Manager, our directors, and certain current and former Ellington employees and their related parties, and is reflected in our financial statements as a non-controlling interest. Our primary objective is to generate attractive, risk-adjusted total returns for our stockholders. We seek to attain this objective by utilizing an opportunistic strategy to make investments, without restriction as to ratings, structure, or position in the capital structure, that we believe compensate us appropriately for the risks associated with them rather than targeting a specific yield. Our evaluation of the potential risk-adjusted return of any potential investment typically involves weighing the potential returns of such investment under a variety of economic scenarios against the perceived likelihood of the various scenarios. Potential investments subject to greater risk (such as those with lower credit ratings and/or those with a lower position in the capital structure) will generally require a higher potential return to be attractive in comparison to investment alternatives with lower potential return and a lower degree of risk. However, at any particular point in time, depending on how we perceive the market's pricing of risk both generally and across sectors, we may favor higher-risk assets or we may favor lower-risk assets, or a combination of the two, in the interests of portfolio diversification or other considerations. ThroughJune 30, 2020 , our credit portfolio, which includes all of our investments other than RMBS for which the principal and interest payments are guaranteed by aU.S. government agency or aU.S. government-sponsored entity, or "Agency RMBS," has been the primary driver of our risk and return, and we expect that this will continue in the near- to medium-term. For more information on our targeted assets, see "-Our Targeted Asset Classes" below. We believe that Ellington's capabilities allow our Manager to identify attractive assets in these classes, value these assets, monitor and forecast the performance of these assets, and opportunistically hedge our risk with respect to these assets. We continue to maintain a highly leveraged portfolio of Agency RMBS to take advantage of opportunities in that market sector, to help maintain our exclusion from registration as an investment company under the Investment Company Act, and to help qualify as well as maintain our qualification as a REIT. Unless we acquire very substantial amounts of whole mortgage loans or there are changes to the rules and regulations applicable to us under the Investment Company Act, we expect that we will always maintain some amount of Agency RMBS. The strategies that we employ are intended to capitalize on opportunities in the current market environment. Subject to qualifying and maintaining our qualification as a REIT, we intend to adjust our strategies to changing market conditions by shifting our asset allocations across various asset classes as credit and liquidity trends evolve over time. We believe that this flexibility, combined with Ellington's experience, will help us generate more consistent returns on our capital throughout changing market cycles. Subject to qualifying and maintaining our qualification as a REIT, we opportunistically hedge our credit risk, interest rate risk, and foreign currency risk; however, at any point in time we may choose not to hedge all or a portion of these risks, and we will generally not hedge those risks that we believe are appropriate for us to take at such time, or that we believe would be impractical or prohibitively expensive to hedge. We also use leverage in our credit strategy, albeit significantly less leverage than that used in our Agency RMBS strategy. ThroughJune 30, 2020 , we financed the vast majority of our Agency RMBS assets, and a portion of our credit assets, through repurchase agreements, which we sometimes refer to as "repos," which we account for as collateralized borrowings. We expect to continue to finance the vast majority of our Agency RMBS through the use of repos. In addition to financing assets through repos, we also enter into other secured borrowing transactions, which are accounted for as collateralized borrowings, to finance certain of our loan assets. We have also obtained, through the securitization markets, term financing for certain of our non-qualified mortgage, or "non-QM," loans, certain of our consumer loans, and certain of our leveraged corporate loans. Additionally, we have issued unsecured long-term debt. As ofJune 30, 2020 , outstanding borrowings under repos and Total other secured borrowings (which include Other secured borrowings and Other secured borrowings, at fair value, as presented on our Condensed Consolidated Balance Sheet) were$2.2 billion , of which approximately 39%, or$851.6 million , relates to our Agency RMBS holdings. The remaining outstanding borrowings relate to our credit portfolio. As ofJune 30, 2020 , we also had$86.0 million outstanding of unsecured long-term debt, maturing in September of 2022, or the "Senior Notes." The Senior Notes bear interest at a rate of 5.50%, subject to adjustment based on changes, if any, in the ratings of the Senior Notes. The indenture governing the Senior Notes contains a number of covenants, including several financial covenants. The Senior Notes were issued in connection with an exchange of our previously issued unsecured long-term debt (the "Old Senior Notes") onFebruary 13, 2019 (the "Note Exchange"), in connection with our intended election to be taxed as a REIT. At the time of the Note Exchange, the Senior Notes were rated A by Egan-Jones Rating Company1. See Note 11 of the notes to our condensed consolidated financial statements for further detail on the Senior Notes and the Note Exchange. 77
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As ofJune 30, 2020 , our book value per share of common stock, calculated using Total Stockholders' Equity less the aggregate liquidation preference of outstanding preferred stock, was$15.67 . Our debt-to-equity ratio was 2.7:1 as ofJune 30, 2020 . Our debt-to-equity ratio does not account for liabilities other than debt financings and does not include debt associated with securitization transactions accounted for as sales. Excluding repos onU.S. Treasury securities, our recourse debt-to-equity ratio was 1.5:1 as ofJune 30, 2020 . Adjusted for unsettled purchases and sales, these ratios were not materially different as ofJune 30, 2020 . OnJanuary 24, 2020 , we completed a follow-on offering of 5,290,000 shares of our common stock, of which 690,000 shares were issued pursuant to the exercise of the underwriters' option. The issuance and sale of such common shares generated net proceeds, after underwriters' discount and offering costs, of$95.3 million . During the six-month period endedJune 30, 2020 we repurchased 288,172 shares of our common stock at an average price per share of$10.53 and a total cost of$3.0 million . In addition to making discretionary repurchases, we from time to time use 10b5-1 plans to increase the number of trading days available to implement these repurchases. We will elect to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, or "the Code," upon the filing of our tax return for the taxable year endedDecember 31, 2019 . Provided that we maintain our qualification as a REIT, we generally will not be subject toU.S. federal, state, and local income tax on our REIT taxable income that is currently distributed to our stockholders. Any taxes paid by a domestic taxable REIT subsidiary, or "TRS," will reduce the cash available for distribution to our stockholders. REITs are subject to a number of organizational and operational requirements, including a requirement that they currently distribute at least 90% of their annual REIT taxable income excluding net capital gains. OnFebruary 28, 2019 , we filed a certificate of conversion with the Secretary of State of theState of Delaware (the "Secretary of State") to convert from aDelaware limited liability company to aDelaware corporation (the "Conversion") and change our name toEllington Financial Inc. (the "Corporation"). The Conversion became effective onMarch 1, 2019 , and upon effectiveness, each of our existing common shares representing limited liability company interests, no par value, converted into one issued and outstanding, fully paid and nonassessable share of common stock,$0.001 par value per share, of the Corporation. 1A rating is not a recommendation to buy, sell or hold securities. Ratings may be subject to revision or withdrawal at any time by the assigning rating organization. Each rating should be evaluated independently of any other rating. Our Targeted Asset Classes Our targeted asset classes currently include investments in theU.S. andEurope (as applicable) in the categories listed below. Subject to qualifying and maintaining our qualification as a REIT, we expect to continue to invest in these targeted asset classes. Also, we expect to continue to hold certain of our targeted assets through one or more TRSs. As a result, a portion of the income from such assets will be subject toU.S. federal corporate income tax. 78
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Table of Contents Asset Class Principal Assets Agency RMBS . Whole pool pass-through certificates; . Partial pool pass-through certificates; . Agency collateralized mortgage obligations, or "CMOs," including interest only securities, or "IOs," principal only securities, or "POs," inverse interest only securities, or "IIOs"; and CLOs . Retained tranches from CLO securitizations, including participating in the accumulation of the underlying assets for such securitization by providing capital to the vehicle accumulating assets; and . Other CLO debt and equity tranches. CMBS and Commercial . CMBS; and Mortgage Loans . Commercial mortgage loans and other commercial real estate debt. Consumer Loans and ABS . Consumer loans; . ABS, including ABS backed by consumer loans; and . Retained tranches from securitizations to which we have contributed assets. Mortgage-Related . To-Be-Announced mortgage pass-through certificates, or Derivatives "TBAs"; . Credit default swaps, or "CDS," on individual RMBS, on the ABX, CMBX and PrimeX indices and on other mortgage-related indices; and . Other mortgage-related derivatives. Non-Agency RMBS . RMBS backed by prime jumbo, Alt-A, manufactured housing, and subprime mortgages; . RMBS backed by fixed rate mortgages, Adjustable rate mortgages, or "ARMs," Option-ARMs, and Hybrid ARMs; . RMBS backed by first lien and second lien mortgages; . Investment grade and non-investment grade securities; . Senior and subordinated securities; . IOs, POs, IIOs, and inverse floaters; . Collateralized debt obligations, or "CDOs"; . RMBS backed by European residential mortgages, or "European RMBS"; and . Retained tranches from securitizations in which we have participated. Residential Mortgage . Residential non-performing mortgage loans, or "NPLs"; Loans . Re-performing loans, or "RPLs," which generally are loans that were modified and/or formerly NPLs where the borrower has resumed making payments in some form or amount; . Residential "transition loans," such as residential bridge loans and residential "fix-and-flip" loans; . Non-QM loans; and . Retained tranches from securitizations to which we have contributed assets. Other . Real estate, including commercial and residential real property; . Strategic debt and/or equity investments in loan originators and mortgage-related entities; . Corporate debt and equity securities and corporate loans; . Mortgage servicing rights, or "MSRs"; . Credit risk transfer securities, or "CRTs"; and . Other non-mortgage-related derivatives. 79
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Agency RMBS Our Agency RMBS assets consist primarily of whole pool (and to a lesser extent, partial pool) pass-through certificates, the principal and interest of which are guaranteed by a federally chartered corporation, such as the Federal National Mortgage Association, or "Fannie Mae," the Federal Home Loan Mortgage Corporation, or "Freddie Mac," or theGovernment National Mortgage Association , within theU.S. Department of Housing and Urban Development , or "Ginnie Mae ," and which are backed by ARMs, Hybrid ARMs, or fixed-rate mortgages. In addition to investing in pass-through certificates which are backed by traditional mortgages, we have also invested in Agency RMBS backed by reverse mortgages. Reverse mortgages are mortgage loans for which neither principal nor interest is due until the borrower dies, the home is sold, or other trigger events occur. Mortgage pass-through certificates are securities representing undivided interests in pools of mortgage loans secured by real property where payments of both interest and principal, plus prepaid principal, on the securities are made monthly to holders of the security, in effect "passing through" monthly payments made by the individual borrowers on the mortgage loans that underlie the securities, net of fees paid to the issuer/guarantor and servicers of the securities. Whole pool pass-through certificates are mortgage pass-through certificates that represent the entire ownership of (as opposed to merely a partial undivided interest in) a pool of mortgage loans. Our Agency RMBS assets are typically concentrated in specified pools. Specified pools are fixed-rate Agency pools consisting of mortgages with special characteristics, such as mortgages with low loan balances, mortgages backed by investor properties, mortgages originated through the government-sponsored "Making Homes Affordable" refinancing programs, and mortgages with various other characteristics. Our Agency strategy also includes RMBS that are backed by ARMs or Hybrid ARMs and reverse mortgages, and CMOs, including IOs, POs, and IIOs. CLOs CLOs are a form of asset-backed security collateralized by syndicated corporate loans. We have retained, and may retain in the future, tranches from CLO securitizations for which we have participated in the accumulation of the underlying assets, typically by providing capital to a vehicle accumulating assets for such CLO securitization. Such vehicles may enter into warehouse financing facilities in order to facilitate such accumulation. Securitizations can effectively provide us with long-term, locked-in financing on the related collateral pool, with an effective cost of funds well below the expected yield on the collateral pool. Our CLO holdings may include both debt and equity interests. CMBS We acquire CMBS, which are securities collateralized by mortgage loans on commercial properties. The majority of CMBS issued are fixed rate securities backed by fixed rate loans made to multiple borrowers on a variety of property types, though single-borrower CMBS and floating rate CMBS have also been issued. The majority of CMBS utilize senior/subordinate structures, similar to those found in non-Agency RMBS. Subordination levels vary so as to provide for one or moreAAA credit ratings on the most senior classes, with less senior securities rated investment grade and non-investment grade, including a first loss component which is typically unrated. This first loss component is commonly referred to as the "B-piece," which is the most subordinated (and therefore highest yielding and riskiest) tranche of a CMBS securitization. Much of our focus within the CMBS sector has been on B-pieces, but we also acquire other CMBS with more senior credit priority. Commercial Mortgage Loans and Other Commercial Real Estate Debt We acquire commercial mortgage loans, which are loans secured by liens on commercial properties, including hotel, industrial, multi-family, office and retail properties. Loans may be fixed or floating rate and will generally range from two to ten years. We typically acquire first lien loans but may also acquire subordinated loans. As ofJune 30, 2020 , all of our commercial mortgage loans were first lien loans. Commercial real estate debt typically limits the borrower's right to freely prepay for a period of time through provisions such as prepayment fees, lockout, yield maintenance, or defeasance provisions. Some of the commercial mortgage loans that we acquire may be non-performing, underperforming, or otherwise distressed; these loans are typically acquired at a discount both to their unpaid principal balances and to the value of the underlying real estate. We also participate in the origination of "bridge" loans, which have shorter terms and higher interest rates than more traditional commercial mortgage loans. Bridge loans are typically secured by properties in transition, where the borrower is in the process of either re-developing or stabilizing operations at the property. Properties securing these loans may include multi-family, retail, office, industrial, and other commercial property types. Within both our loan acquisition and loan origination strategies, we generally focus on smaller balance loans and/or loan packages that are less-competitively-bid. These loans typically have balances that are less than$20 million , and are secured by 80
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real estate and, in some cases, a personal guarantee from the borrower. Consumer Loans and ABS We acquireU.S. consumer whole loans and ABS, including ABS backed byU.S. consumer loans. OurU.S. consumer loan portfolio primarily consists of unsecured loans, but also includes secured auto loans. We are currently purchasing newly originated consumer loans under flow agreements with originators, and we continue to evaluate new opportunities. We seek to purchase newly originated consumer loans from originators that have demonstrated disciplined underwriting with a significant focus on regulatory compliance and sound lending practices. TBAs and Other Mortgage-Related Derivatives In addition to investing in specified pools of Agency RMBS, subject to our satisfying the requirements for qualification as a REIT, we utilize TBA transactions, whereby we agree to purchase or sell, for future delivery, Agency RMBS with certain principal and interest terms and certain types of underlying collateral, but the particular Agency RMBS to be delivered is not identified until shortly before the TBA settlement date. TBAs are liquid and have quoted market prices and represent the most actively traded class of mortgage-backed securities, or "MBS." TBA trading is based on the assumption that mortgage pools that are eligible to be delivered at TBA settlement are fungible and thus the specific mortgage pools to be delivered do not need to be explicitly identified at the time a trade is initiated. We generally engage in TBA transactions for purposes of managing certain risks associated with our investment strategies. Other than with respect to TBA transactions entered into by our TRSs, most of our TBA transactions are treated for tax purposes as hedging transactions used to hedge indebtedness incurred to acquire or carry real estate assets, or "qualifying liability hedges." The principal risks that we use TBAs to mitigate are interest rate and yield spread risks. For example, we may hedge the interest rate and/or yield spread risk inherent in our long Agency RMBS by taking short positions in TBAs that are similar in character. Alternatively, we may opportunistically engage in TBA transactions because we find them attractive in their own right, from a relative value perspective or otherwise. For accounting purposes, in accordance with generally accepted accounting principles inthe United States of America , or "U.S. GAAP," we classify TBA transactions as derivatives. We also take long and short positions in various other mortgage-related derivative instruments, including mortgage-related credit default swaps. A credit default swap is a credit derivative contract in which one party (the protection buyer) pays an ongoing periodic premium (and often an upfront payment as well) to another party (the protection seller) in return for compensation for default (or similar credit event) by a reference entity. In this case, the reference entity can be an individual MBS or an index of several MBS, such as an ABX, PrimeX, or CMBX index. Payments from the protection seller to the protection buyer typically occur if a credit event takes place. A credit event can be triggered by, among other things, the reference entity's failure to pay its principal obligations or a severe ratings downgrade of the reference entity. Non-Agency RMBS We acquire non-Agency RMBS backed by prime jumbo, Alt-A, manufactured housing, and subprime residential mortgage loans. Our non-Agency RMBS holdings can include investment-grade and non-investment grade classes, including non-rated classes. Non-Agency RMBS are generally debt obligations issued by private originators of, or investors in, residential mortgage loans. Non-Agency RMBS generally are issued as CMOs and are backed by pools of whole mortgage loans or by mortgage pass-through certificates. Non-Agency RMBS generally are securitized in senior/subordinated structures, or in excess spread/over-collateralization structures. In senior/subordinated structures, the subordinated tranches generally absorb all losses on the underlying mortgage loans before any losses are borne by the senior tranches. In excess spread/over-collateralization structures, losses are first absorbed by any existing over-collateralization, then borne by subordinated tranches and excess spread, which represents the difference between the interest payments received on the mortgage loans backing the RMBS and the interest due on the RMBS debt tranches, and finally by senior tranches and any remaining excess spread. We also have acquired, and may acquire in the future, European RMBS, including retained tranches from European RMBS securitizations in which we have participated. Residential Mortgage Loans Our residential mortgage loans include newly originated non-QM loans, residential transition loans, as well as legacy residential NPLs and RPLs. A non-QM loan is not necessarily high-risk, or subprime, but is instead a loan that does not conform to the complex Qualified Mortgage, or "QM," rules of theConsumer Financial Protection Bureau . For example, many non-QM loans are made to creditworthy borrowers who cannot provide traditional documentation for income, such as borrowers who are self-employed. There is also demand from certain creditworthy borrowers for loans above the QM 43% 81
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debt-to-income ratio limit that still meet all ability-to-repay standards. We hold an equity investment in a non-QM originator, and to date we have purchased the vast majority of our non-QM loans from this originator, although we could potentially purchase a greater share of non-QM loans from other sources in the future. The residential transition loans that we originate or purchase include: (i) "fix and flip" loans, which are made to real estate investors for the purpose of acquiring residential homes, making value-add improvements to such homes, and reselling the newly rehabilitated homes for a potential profit, and (ii) loans made to real estate investors for a "business purpose," such as purchasing a rental investment property, financing or refinancing a fully rehabilitated home awaiting sale, or securing short-term financing pending qualification for longer-term lower-rate financing. Our residential transition loans are secured by non-owner occupied properties, and are typically structured as fixed-rate, interest-only loans with terms to maturity between 6 and 24 months. Our underwriting guidelines focus on both the "as is" and "as repaired" property values, borrower experience as a real estate investor, and asset verification. We remain active in the market for residential NPLs and RPLs. The market for large residential NPL and RPL pools has remained highly concentrated, with the great majority having traded to only a handful of large players who typically securitize the residential NPLs and RPLs that they purchase. As a result, we have continued to focus our acquisitions on less-competitively-bid, and more attractively-priced mixed legacy pools sourced from motivated sellers. Other Investment Assets Our other investment assets include real estate, including residential and commercial real property, strategic debt and/or equity investments in loan originators, corporate debt and equity securities, corporate loans, which can include litigation finance loans, CRTs, and other non-mortgage-related derivatives. We do not typically purchase real property directly; rather, our real estate ownership usually results from foreclosure activity with respect to our acquired residential and commercial loans. We have made investments in loan originators and other related entities in the form of debt and/or equity and, to date, our investments have represented non-controlling interests. We have also entered into flow agreements with certain of the loan originators in which we have invested. We have not yet acquired mortgage servicing rights directly, but we may do so in the future. Hedging Instruments Interest Rate Hedging We opportunistically hedge our interest rate risk by using various hedging strategies, subject to qualifying and maintaining our qualification as a REIT. The interest rate hedging instruments that we use and may use in the future include, without limitation: • TBAs;
• interest rate swaps (including floating-to-fixed, fixed-to-floating,
floating-to-floating, or more complex swaps such as floating-to-inverse
floating, callable or non-callable);
• CMOs; •U.S. Treasury securities;
• swaptions, caps, floors, and other derivatives on interest rates;
• futures and forward contracts; and
• options on any of the foregoing.
Because fluctuations in short-term interest rates may expose us to fluctuations in the spread between the interest we earn on our investments and the interest we pay on our borrowings, we may seek to manage such exposure by entering into short positions in interest rate swaps. An interest rate swap is an agreement to exchange interest rate cash flows, calculated on a notional principal amount, at specified payment dates during the life of the agreement. Typically, one party pays a fixed interest rate and receives a floating interest rate and the other party pays a floating interest rate and receives a fixed interest rate. Each party's payment obligation is computed using a different interest rate. In an interest rate swap, the notional principal is generally not exchanged. Credit Risk Hedging We enter into credit-hedging positions in order to protect against adverse credit events with respect to our credit investments, subject to qualifying and maintaining our qualification as a REIT. Our credit hedging portfolio can vary significantly from period to period, and can encompass a wide variety of financial instruments, including corporate debt or equity-related instruments, RMBS- or CMBS-related instruments, or instruments involving other markets. Our hedging 82
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instruments can include both "single-name" instruments (i.e., instruments referencing one underlying entity or security) and hedging instruments referencing indices. Currently, our credit hedges consist primarily of financial instruments tied to corporate credit, such as CDS on corporate bond indices, short positions in and CDS on corporate bonds; and positions involving exchange traded funds, or "ETFs," of corporate bonds. Our credit hedges also currently include CDS tied to individual MBS or an index of several MBS, such as CDS on CMBS indices, or "CMBX." Foreign Currency Hedging To the extent that we hold instruments denominated in currencies other thanU.S. dollars, we may enter into transactions to offset the potential adverse effects of changes in currency exchange rates, subject to qualifying and maintaining our qualification as a REIT. In particular, we may use currency forward contracts and other currency-related derivatives to mitigate this risk. Trends and Recent Market Developments Market Overview • TheU.S. Federal Reserve , or the "Federal Reserve ," continued its
accommodative monetary policy in the second quarter. At its April and June
meetings, the
for the federal funds rate, noting that "the coronavirus outbreak is
causing tremendous human and economic hardship across
and around the world" including "sharp declines in economic activity and a
surge in job losses." It further noted that "the
committed to using its full range of tools to support the
this challenging time." After the June meeting, the chairman of the
rates. We're not even thinking about thinking about raising rates." During
the quarter, the
of
pursuant to the asset purchase programs it outlined in March.
• After implementing several stimulus programs to counteract the economic
impact and negative risk sentiment associated with the spread of the novel
coronavirus disease ("COVID-19") in the first quarter, the
announced on
additional loans through the expansion of several programs implemented
during the previous quarter, including the Paycheck Protection Program,
the Main Street Lending Program, the Primary and Secondary Market Corporate Credit Facilities, and the Term Asset-Backed Securities Loan Facility, as well as through new facilities, including the Municipal Liquidity Facility. Similarly, central banks and governments around the
globe continued to implement quantitative easing programs and stimulus
packages during the second quarter. • In May,Jerome Powell stated that "additional policy measures" may be necessary, noting that "the path ahead is both highly uncertain and subject to significant downside risks." OnMay 15th , theU.S. House of
Representatives passed the HEROES Act, which would provide for
of additional stimulus, but as of
theSenate . Regardless, as the second quarter concluded, many market participants were anticipating additional stimulus measures to be implemented during the second half of 2020.
• After dropping dramatically during the first quarter of 2020 as the spread
of COVID-19 prompted a flight to safety, interest rates hovered near
all-time lows during the second quarter.
slightly quarter over quarter, with the 10-yearU.S. Treasury yield finishing the second quarter at 0.66%, virtually unchanged from the start of the quarter and only 12 basis points above the record low reached in
March. After a volatile first quarter, interest-rate volatility subsided
considerably in the second quarter. After reaching its highest point since
the 2008-2009 financial crisis in March, the MOVE index, which measures
interest-rate volatility, had reverted to pre-COVID-19 levels by mid-April
and remained low through quarter-end. The 10-yearU.S. Treasury yield traded in a 33-basis-point range in the second quarter, compared to a 134-basis-point range in the first quarter.
• Mortgage rates continued to decline during the second quarter, with the
close the quarter at 3.13%, and setting a new all-time low of 3.07% on
applications remained elevated with the declining mortgage rates. As of
30% quarter over quarter, but was still up 74% year over year. Overall
Fannie Mae 30-year MBS prepayments increased from a CPR of 23.6 in March to 29.8 in April, before declining slightly to 29.3 in May, and then reaching a more than 7-year high of 33.0 in June. • LIBOR rates, which drive many of our financing costs, declined dramatically in the second quarter. One-month LIBOR decreased 83 basis points to end the quarter at 0.16%, and three-month LIBOR fell 115 basis points to 0.30%. 83
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• After declining at an annualized rate of 5.0% in the first quarter,
real GDP shrank at an estimated annualized rate of 32.9% in the second
quarter, further reflecting the negative impact of the COVID-19 pandemic
and associated measures to contain it.U.S. retail sales declined by a record rate in April, before rebounding by a record rate in May and increasing again in June, although a surge in COVID-19 cases in June muddled the picture going forward. Elsewhere, theEurozone's GDP contracted by 3.8% in the first quarter, the fastest rate of decline on record, whileChina's GDP shrank by 6.8% in the first quarter, the first decline recorded since data collection began in 1992. For the second quarter, Chinese GDP growth was again positive at 3.2%.
• Unemployment claims totaled 38.5 million in the second quarter, and the
unemployment rate surged to 11.1% at
total of 48.6 million new unemployment claims were filed between March
15th and
million per week in April, to 1.5 million per week in June.
• Forbearance rates on residential mortgages rose sharply during the second
quarter, with the economic slowdown and spike in unemployment. According
to the
most significantly during the month of April, from 2.7% as ofMarch 29th to 7.5% as ofApril 26th , before rising further to 8.5% as ofMay 31st , and then plateauing during June and finishing the quarter at 8.4%.
Notably, many forbearance plans expired on
lockdown protocols in place, forbearance rates could increase again.
• For the second quarter, the Bloomberg Barclays
return of 0.68%, and an excess return (on a duration-adjusted basis) of 0.39% relative to the Bloomberg BarclaysU.S. Treasury Index. After underperforming in the first quarter, pay-ups on Agency specified pools performed exceptionally well during the second quarter.
• The Bloomberg Barclays
and an excess return of 8.10%, while the Bloomberg Barclays
High Yield Bond Index generated a gain of 8.89% and an excess return of 8.35%.
• Despite the negative economic impact of COVID-19,
dramatically in the second quarter, with the Dow Jones Industrial Average
("DJIA") and S&P 500 indexes posting their biggest quarterly gains since
1998 and offsetting most of the losses suffered in March, amidst optimism
over the reopening of the economy, possible additional stimulus measures,
and advances on COVID-19 treatments and a possible vaccine. The DJIA rose
17.8% and the S&P 500 rose 20.0% quarter over quarter; year-to-date
through
Meanwhile, the tech-heavy NASDAQ composite index rose 30.6% quarter over
quarter and was up 12.1% on the year. Equity volatility declined during
the quarter, but remained higher than pre-COVID-19 levels. The CBOE
Volatility Index, which measures expected moves in the S&P 500 index,
registered an all-time high of 82.69 on
declined for most of the second quarter, finishing at 30.43 at
Meanwhile,
while theMSCI World global equity index rebounded by 18.8% over the same period. Portfolio Overview and Outlook InMarch 2020 , in response to the market volatility associated with the outbreak of the COVID-19 pandemic, we had strategically reduced the size of our Agency portfolio in order to lower our leverage and enhance our liquidity position. We had also substantially suspended new investments in our credit strategies. High levels of market distress continued into April, and during that month, we further reduced the size of our Agency portfolio, and only resumed very limited purchase and sale activity in our credit portfolio. In May and June, with the markets stabilized, we fully resumed our investment activity in our credit and Agency portfolios. In total, our total long Agency RMBS portfolio decreased by 10% to$913.2 million as ofJune 30, 2020 , from$1.016 billion as ofMarch 31, 2020 , as additional sales in April and principal repayments during the quarter exceeded new purchases in May and June. Our total long credit portfolio, including REO but excluding hedges and other derivative positions, was essentially unchanged at$1.996 billion as ofJune 30, 2020 , as compared to$1.998 billion as ofMarch 31, 2020 . Excluding non-retained tranches of our consolidated non-QM securitization trusts, our total long credit portfolio decreased approximately 14% to$1.257 billion as ofJune 30, 2020 , as compared to$1.457 billion as ofMarch 31, 2020 . The quarter-over-quarter decline in the total credit portfolio, excluding non-retained tranches of our consolidated non-QM securitization trusts, was mainly due to the completion of our non-QM securitization in June; otherwise, sales and principal repayments roughly offset purchases and net realized and unrealized gains. 84
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Table of Contents Credit Summary (1) June 30, 2020 March 31, 2020 % of Total Long % of Total Long ($ in thousands) Fair Value Credit Portfolio Fair Value Credit Portfolio Dollar Denominated: CLOs(2)$ 156,158 7.8 %$ 170,905 8.6 % CMBS 77,815 3.9 % 75,815 3.8 % Commercial Mortgage Loans and REO(3)(4) 337,265 16.9 % 343,111 17.2 % Consumer Loans and ABS Backed by Consumer Loans(2) 216,289 10.8 % 252,385 12.6 % Corporate Debt and Equity and Corporate Loans 9,237 0.5 % 7,407 0.4 % Debt and Equity Investments in Loan Origination Entities 44,277 2.2 % 39,436 2.0 % Non-Agency RMBS 154,928 7.8 % 118,793 5.9 % Residential Mortgage Loans and REO(3) 950,565 47.6 % 942,202 47.2 % Non-Dollar Denominated: CLOs(2) 2,583 0.1 % 2,310 0.1 % Consumer Loans and ABS Backed by Consumer Loans 395 - % 459 - % Corporate Debt and Equity 25 - % 29 - % RMBS(5) 46,722 2.4 % 44,928 2.2 % Total Long Credit$ 1,996,259 100.0 %$ 1,997,780 100.0 %
(1) This information does not include
swaps, TBA positions, or other hedge positions.
(2) Includes equity investments in securitization-related vehicles.
(3) As discussed in Note 2 of the notes to condensed consolidated financial
statements, REO is not considered a financial instrument and as a result is
included at the lower of cost or fair value.
(4) Includes investments in unconsolidated entities holding small balance
commercial mortgage loans and REO.
(5) Includes an investment in an unconsolidated entity holding European RMBS.
In March, the market turmoil associated with the COVID-19 pandemic caused significant volatility, price declines and yield spread widening across virtually all credit assets, and as result, we incurred considerable mark-to-market losses in the first quarter. Consequently, we also received margin calls under our financing arrangements and under our derivative contracts that were higher than typical historical levels. In contrast, prices in many credit-sensitive fixed income sectors rebounded in the second quarter, generating significant net realized and unrealized gains on our credit assets, which reversed a portion of our losses from the first quarter. Accordingly, our margin calls reverted to more typical levels in the second quarter. We satisfied all margin calls during both periods. As ofJune 30, 2020 , we had cash and cash equivalents of$146.5 million , along with unencumbered assets of approximately$311.8 million . During March and early April, while we were able to roll our repos in an orderly manner, haircuts and borrowing rates were generally higher, and maturities generally shorter. During the remainder of the second quarter, however, we made substantial progress extending and improving our sources of financing and leverage. In addition to completing our non-QM securitization, we also obtained term financing for numerous loan assets that we had previously held unfinanced, and we extended the terms of several of our credit facilities. By the end of the quarter, the market for standard repo financing of securities had largely returned to pre-March levels. Most of our credit strategies performed well during the second quarter. We had large gains on our non-QM loans, non-Agency RMBS, and CMBS, all markets where there was substantial distressed selling during the first quarter, followed by a sharp rebound in prices and liquidity in the second quarter. Our loan strategies also performed well, led by excellent performance in our consumer loan and residential transition loan portfolios. Our investments in loan originators had strong performance during the quarter, driven by an excellent quarter from the reverse mortgage originator in which we hold a minority stake. Our CLO strategy and Euro-denominated RMBS portfolio generated net losses for the quarter. The market recovery also resulted in a loss on our credit hedges. Finally, the net interest income on our credit portfolio decreased sequentially from the prior quarter as a result of lower average holdings. 85
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Economic Impacts of COVID-19 Despite the partial market recovery in the second quarter, we are still anticipating eventual principal losses on many of our credit investments as a result of the economic impacts of COVID-19. As has been widely reported, there has been a significant nationwide increase in loan delinquencies, forbearances, deferments, and modifications, and we are seeing the effects of this on our own portfolios, as detailed below. We have also reduced the volume of new investment activity in each of these portfolios as a result of the COVID-19 pandemic. Non-QM Loan Portfolio-Since the onset of the COVID-19 pandemic, we have worked with the servicer of our non-QM loans to develop a process to document and verify hardship due to the COVID-19 pandemic. We use this information to determine the suitability for a borrower to be granted forbearance, typically for a term lasting three months. We have also worked with the servicer to develop a process to evaluate the possible loss mitigation options in the event that a borrower, at the end of the forbearance period, cannot fully repay the forborne payments. Such options may include various repayment plans, deferment plans, rate and/or term modifications, short sales, and principal reduction modifications. As ofJune 30, 2020 , non-QM loans with a unpaid principal balance of$73.8 million , or 8.8% of our non-QM loan portfolio, were in forbearance; 41.7% of these loans in forbearance continued to make their regular payments and were current under the terms of their notes despite being in forbearance plans as ofJune 30, 2020 . The vast majority of these forbearance plans expired inJuly 2020 . •Small Balance Commercial Mortgage Loan Portfolio-In our small balance commercial mortgage loan portfolio, we have granted short-term interest deferments to certain borrowers, with such deferred interest capitalized and added to the outstanding principal balance of the loan. In certain other cases, we have granted loan modifications to permit the use of cash reserves to pay interest due on the loan. As ofJune 30, 2020 , small balance commercial mortgage loans with a unpaid principal balance of$60.7 million , or 20.5%, of our small balance commercial mortgage loan portfolio that were current prior toMarch 2020 , have entered into a deferment or modification agreement. •Consumer Loan Portfolio-We have also seen an increase in loan deferments in our consumer loan portfolio as a result of the COVID-19 pandemic. As ofJune 30, 2020 , consumer loans with a unpaid principal balance of$25.1 million , or 15.4%, of our consumer loan portfolio had entered into a deferment plan at some point between March and June of 2020. Of these loans that had entered into a deferment plan, we had received payments on 65.5% of them, based on unpaid principal balance, as ofJune 30, 2020 . •Residential Transition Loan Portfolio-In our residential transition loan portfolio, we had no loans subject to forbearance, deferment, or modification plans as ofJune 30, 2020 . Supplemental Credit Portfolio Information The table below summarizes our interests in commercial mortgage loans by property type of the underlying real estate collateral as a percentage of total outstanding unpaid principal balance as ofJune 30, 2020 : Property TypeJune 30, 2020 Multifamily 29.2 % Mixed Use 15.0 % Retail 11.3 % Industrial(1) 14.3 % Hotel(1) 16.0 % Office 2.7 % Other(1) 11.5 % 100.0 %
(1) Includes our allocable portion of small-balance commercial loans, based on
our ownership percentage, held in variable interest entities. Our equity
investments in such variable interest entities are included in Investments in
unconsolidated entities, at fair value on the Condensed Consolidated Balance
Sheet. 86
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Table of Contents Agency RMBS Summary June 30, 2020 March 31, 2020 % of Long Agency % of Long Agency ($ in thousands) Fair Value Portfolio Fair Value Portfolio Long Agency RMBS: Fixed Rate$ 724,756 79.3 %$ 834,002 82.1 % Floating Rate 7,899 0.9 % 9,054 0.9 % Reverse Mortgages 131,535 14.4 % 130,601 12.8 % IOs 49,007 5.4 % 42,344 4.2 % Total Long Agency RMBS$ 913,197 100.0 %$ 1,016,001 100.0 % Our Agency strategy performed exceptionally well during the second quarter, driven by significantly higher pay-ups on our specified pools. Pay-ups are price premiums for specified pools relative to their TBA counterparts. During the first quarter of 2020, pay-ups had declined in the face of market-wide liquidity stresses, exacerbated by quarter-end balance sheet pressures, as well as the implementation of theFederal Reserve's amplified asset purchase program implemented in March, which was generally limited to TBAs and generic pools, as opposed to specified pools with pay-ups. During the quarter, asset purchases by theFederal Reserve continued to be significant, and the liquidity stresses of the previous quarter subsided. Pay-ups on specified pools expanded as investors sought prepayment protection amidst record-low mortgage rates and increasing actual and projected prepayment rates. Average pay-ups on our specified pools increased to 3.30% as ofJune 30, 2020 , as compared to 1.47% as ofMarch 31, 2020 , generating significant net realized and unrealized gains on our portfolio. Our Agency strategy also benefited from the appreciation of our reverse mortgage pools, driven by strong investor demand and a recovery in yield spreads after the distress in March. During the quarter, we continued to hedge interest rate risk in our Agency strategy, primarily through the use of interest rate swaps, short positions in TBAs,U.S. Treasury securities, and futures. We significantly reduced the size of our net short TBA position during the quarter, including an increase in the amount of long TBAs held for investment. As a result, the relative proportion, based on 10-year equivalents, of short positions in TBAs decreased period over period relative to other hedging instruments. Ten-year equivalents for a group of positions represent the amount of 10-yearU.S. Treasury securities that would be expected to experience a similar change in market value under a standard parallel move in interest rates. As ofJune 30, 2020 andMarch 31, 2020 , the weighted average net pass-through rate on our fixed-rate specified pools was 4.0% and 4.1%, respectively. Portfolio turnover for our Agency strategy, as measured by sales and excluding paydowns, was approximately 15% for the three-month period endedJune 30, 2020 . We expect to continue to target specified pools that, taking into account their particular composition and based on our prepayment projections, should: (1) generate attractive yields relative to other Agency RMBS andU.S. Treasury securities, (2) have less prepayment sensitivity to government policy shocks, and/or (3) create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months, when actual prepayment experience can be observed. We believe that our research team, proprietary prepayment models, and extensive databases remain essential tools in our implementation of this strategy. The following table summarizes the prepayment rates for our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) for the three-month periods endedJune 30, 2020 ,March 31, 2020 ,December 31, 2019 ,September 30, 2019 , andJune 30, 2019 . Three-Month Period Ended December September June 30, 2020 March 31, 2020 31, 2019 30, 2019 June 30, 2019 Three-Month Constant Prepayment Rates(1) 21.1% 20.1% 19.9% 15.7% 12.8%
(1)
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The following table provides details about the composition of our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) as ofJune 30, 2020 andMarch 31, 2020 : June 30, 2020 March 31, 2020 Weighted Weighted Current Average Loan Current Average Loan Coupon Principal Fair Value Age (Months) Principal Fair Value Age (Months) (In thousands) (In thousands) Fixed-rate Agency RMBS: 15-year fixed-rate mortgages: 2.50$ 8,300 $ 8,383 15$ 8,300 $ 8,774 12 3.00 6,243 6,572 34 6,358 6,663 31 3.50 23,753 25,236 59 49,408 52,408 47 4.00 8,590 9,191 46 5,088 5,417 62 4.50 5,127 5,398 118 5,637 5,928 116 Total 15-year fixed-rate mortgages 52,013 54,780 53 74,791 79,190 48 20-year fixed-rate mortgages: 4.50 740 813 79 752 828 76 Total 20-year fixed-rate mortgages 740 813 79 752 828 76 30-year fixed-rate mortgages: 3.00 54,287 58,155 15 38,692 40,953 17 3.28 104 114 96 105 111 93 3.50 141,558 153,591 42 184,122 196,731 34 3.75 1,843 1,965 37 2,181 2,321 34 4.00 202,138 219,702 42 258,997 279,449 42 4.50 130,536 143,461 40 110,008 119,611 43 5.00 75,597 84,034 42 96,914 104,969 36 5.50 5,409 6,103 57 6,290 6,973 49 6.00 1,786 2,038 70 2,598 2,866 51 Total 30-year fixed-rate mortgages 613,258 669,163 39 699,907 753,984 38 Total fixed-rate Agency RMBS$ 666,011 $ 724,756 41$ 775,450 $ 834,002 39 Our net Agency premium as a percentage of the fair value of our specified pool holdings is one metric that we use to measure the overall prepayment risk of our specified pool portfolio.Net Agency premium represents the total premium (excess of market value over outstanding principal balance) on our specified pool holdings less the total premium on related net short TBA positions. The lower our net Agency premium, the less we believe that our specified pool portfolio is exposed to market-wide increases in Agency RMBS prepayments. Our net Agency premium as a percentage of fair value of our specified pool holdings was approximately 5.5% and 3.9% as ofJune 30, 2020 andMarch 31, 2020 , respectively. These figures take into account the net short TBA positions that we use to hedge our specified pool holdings, which had a notional value of$330.1 million and a fair value of$354.2 million as ofJune 30, 2020 , as compared to a notional value of$468.5 million and a fair value of$498.2 million as ofMarch 31, 2020 . Excluding these TBA hedging positions, our Agency premium as a percentage of fair value was approximately 8.3% and 6.9% as ofJune 30, 2020 andMarch 31, 2020 , respectively. Our Agency premium percentage and net Agency premium percentage may fluctuate from period to period based on a variety of factors, including market factors such as interest rates and mortgage rates, and, in the case of our net Agency premium percentage, based on the degree to which we hedge prepayment risk with short TBA positions. We believe that our focus on purchasing pools with specific prepayment characteristics provides a measure of protection against prepayments. 88
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Financing
The following table details our borrowings outstanding and debt-to-equity ratios
as of
As of ($ in thousands) June 30, 2020 March 31, 2020 Recourse(1) Borrowings: Repurchase Agreements$ 1,147,725 $ 1,846,719 Other Secured Borrowings 46,289 55,045 Senior Notes, at par 86,000 86,000 Total Recourse Borrowings$ 1,280,014 $ 1,987,764 Debt-to-Equity Ratio Based on Total Recourse Borrowings(1) 1.5:1
2.5:1
Debt-to-Equity Ratio Based onTotal Recourse Borrowings Excluding U.S. Treasury Securities 1.5:1 2.5:1 Non-Recourse(2) Borrowings: Repurchase Agreements$ 146,824 $ 187,506 Other Secured Borrowings 109,800 122,810 Other Secured Borrowings, at fair value(3) 742,688
549,668
Total Recourse and Non-Recourse Borrowings
2,847,748
Debt-to-Equity Ratio Based on Total Recourse and Non-Recourse Borrowings 2.7:1
3.5:1
Debt-to-Equity Ratio Based on Total Recourse and Non-Recourse Borrowings ExcludingU.S. Treasury Securities 2.7:1
3.5:1
(1) As of
unconsolidated entities that are recourse to us. Including such borrowings,
our debt-to-equity ratio based on total recourse borrowings is 1.6:1 and
2.5:1 as of
(2) All of our non-recourse borrowings are secured by collateral. In the event of
default under a non-recourse borrowing, the lender has a claim against the
collateral but not any of the
event of default under a recourse borrowing, the lender's claim is not
limited to the collateral (if any).
(3) Relates to our non-QM loan securitizations, where we have elected the fair
value option on the related debt.
Primarily as a result of Agency RMBS sales, our debt-to-equity ratio including repos, Total other secured borrowings, and our Senior Notes, but excluding repos onU.S. Treasury securities, declined to 2.7:1 as ofJune 30, 2020 , from 3.5:1 as ofMarch 31, 2020 . Excluding repos onU.S. Treasury securities, our recourse debt-to-equity ratio decreased to 1.5:1 as ofJune 30, 2020 , from 2.5:1 as ofMarch 31, 2020 . Adjusted for unsettled purchases and sales, our debt-to-equity ratio decreased to 2.7:1 as ofJune 30, 2020 , as compared to 3.1:1 as ofMarch 31, 2020 . Similarly, our recourse debt-to-equity ratio, also adjusted for unsettled purchases and sales, decreased to 1.5:1 as ofJune 30, 2020 , from 2.1:1 as ofMarch 31, 2020 , driven also by our non-QM securitization, which reduced the amount of recourse borrowings in our credit portfolio. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, capital markets activities, and the timing of security purchase and sale transactions. Our financing costs include interest expense related to our repo borrowings, Total other secured borrowings, and Senior Notes. The interest rates on our repo borrowings and Other secured borrowings are generally based on, or correlated with, LIBOR. For the three-month period endedJune 30, 2020 , our average cost of funds decreased to 2.35%, compared to 2.58% for the three-month period endedMarch 31, 2020 , driven by lower short-term interest rates. 89
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Critical Accounting Policies We adopted ASC 946 upon commencement of operations inAugust 2007 , and appliedU.S. GAAP for investment companies. In connection with our internal restructuring and our intention to qualify as a REIT for the year endedDecember 31, 2019 , we have determined that, effectiveJanuary 1, 2019 , we no longer qualified for investment company accounting in accordance with ASC 946-10-25, and prospectively discontinued its use. We elected the fair value option for, and therefore we will continue to measure at fair value, those of our assets and liabilities for which such election is permitted, as provided for under ASC 825, Financial Instruments ("ASC 825"). Our condensed consolidated financial statements include the accounts ofEllington Financial Inc. , itsOperating Partnership , its subsidiaries, and variable interest entities, or "VIEs," for which the Company is deemed to be the primary beneficiary. All intercompany balances and transactions have been eliminated. Certain of our critical accounting policies require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that all of the decisions and assessments upon which our condensed consolidated financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on the experience of our Manager and Ellington and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 of the notes to our condensed consolidated financial statements for a complete discussion of our significant accounting policies. We have identified our most critical accounting policies to be the following: Valuation: For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of our financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. Summary descriptions, for various categories of financial instruments, of the valuation methodologies management uses in determining fair value of our financial instruments are detailed in Note 2 of the notes to our condensed consolidated financial statements. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument. See the notes to our condensed consolidated financial statements for more information on valuation techniques used by management in the valuation of our assets and liabilities. Purchases and Sales of Investments and Investment Income: Purchase and sales transactions are generally recorded on trade date. Realized and unrealized gains and losses are calculated based on identified cost. We generally amortize premiums and accrete discounts on our fixed-income investments using the effective interest method. See the notes to our condensed consolidated financial statements for more information on the assumptions and methods that we use to amortize purchase premiums and accrete purchase discounts. Recent Accounting Pronouncements Refer to the notes to our condensed consolidated financial statements for a description of relevant recent accounting pronouncements. 90
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Financial Condition The following table summarizes the fair value our investment portfolio(1) as ofJune 30, 2020 andDecember 31, 2019 . (In thousands) June 30, 2020 December 31, 2019 Long: Credit: Dollar Denominated: CLO(2)$ 156,158 $ 172,802 CMBS 77,815 124,693 Commercial Mortgage Loans and REO(3)(4) 337,265
320,926
Consumer Loans and ABS backed by Consumer Loans(2) 216,289
238,193
Corporate Debt and Equity and Corporate Loans 9,237
20,987
Equity Investments in Loan Origination Entities 44,277
41,393
Non-Agency RMBS 154,928
113,342
Residential Mortgage Loans and REO(3) 950,565 933,870 Non-Dollar Denominated: CLO(2) 2,583 5,722 CMBS - 175 Consumer Loans and ABS backed by Consumer Loans 395 549 Corporate Debt and Equity 25 30 RMBS(5) 46,722 55,156 Agency: Fixed-Rate Specified Pools 724,756 1,758,882 Floating-Rate Specified Pools 7,899 10,002 IOs 49,007 35,279 Reverse Mortgage Pools 131,535 132,800 Total Long$ 2,909,456 $ 3,964,801 Short: Credit: Dollar Denominated: Corporate Debt and Equity $ (459 ) $ (471 ) Government Debt: Dollar Denominated (4,324 ) (62,994 ) Non-Dollar Denominated (26,688 ) (9,944 ) Total Short$ (31,471 ) $ (73,409 )
(1) For more detailed information about the investments in our portfolio, please
see the notes to condensed consolidated financial statements.
(2) Includes equity investments in securitization-related vehicles.
(3) REO is not eligible to elect the fair value option as described in Note 2 of
the notes to condensed consolidated financial statements and, as a result, is
included at the lower of cost or fair value.
(4) Includes investments in unconsolidated entities holding small balance
commercial mortgage loans and REO.
(5) Includes an investment in an unconsolidated entity holding European RMBS.
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The following table summarizes our financial derivatives portfolio(1)(2) as ofJune 30, 2020 . Notional Net (In thousands) Long Short Net Fair Value Mortgage-Related Derivatives: CDS on MBS and MBS Indices$ 969 $ (27,859 ) $ (26,890 ) $ 7,991 Total Net Mortgage-Related Derivatives 7,991 Corporate-Related Derivatives: CDS on Corporate Bonds and Corporate Bond Indices 68,760 (160,123 ) (91,363 ) 133 Total Return Swaps on Corporate Bond Indices and Corporate Debt(3) 4,726 - 4,726 365 Warrants(4) 1,546 - 1,546 31 Total Net Corporate-Related Derivatives 529 Interest Rate-Related Derivatives: TBAs 132,000 (428,592 ) (296,592 ) 1,608 Interest Rate Swaps 422,425 (537,459 ) (115,034 ) (17,605 ) U.S. Treasury Futures(5) 1,900 (167,100 ) (165,200 ) (382 ) Total Interest Rate-Related Derivatives (16,379 ) Other Derivatives: Foreign Currency Forwards(6) - (22,710 ) (22,710 ) 182 Total Net Other Derivatives 182 Net Total$ (7,677 )
(1) For more detailed information about the financial derivatives in our
portfolio, please refer to Note 8 of the notes to condensed consolidated
financial statements.
(2) In the table above, fair value of certain derivative transactions are shown
on a net basis. The accompanying financial statements separate derivative
transactions as either assets or liabilities. As of
assets and derivative liabilities were
respectively, for a net fair value of
Total" above.
(3) Notional value represents the face amount of the underlying asset.
(4) Notional represents the maximum number of shares available to be purchased
upon exercise.
(5) Notional value represents the total face amount of
underlying all contracts held. As of
1,444 short
(6) Short notional value represents
maturity of the forward contract. 92
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The following table summarizes our financial derivatives portfolio(1)(2) as ofDecember 31, 2019 . Notional Net (In thousands) Long Short Net Fair Value Mortgage-Related Derivatives: CDS on MBS and MBS Indices$ 1,039 $ (70,656 ) $ (69,617 ) $ 4,062 Total Net Mortgage-Related Derivatives 4,062 Corporate-Related Derivatives: CDS on Corporate Bonds and Corporate Bond Indices 131,137 (262,885 ) (131,748 ) (10,616 ) Total Return Swaps on Corporate Bond Indices and Corporate Debt(3) 7,359 (17,560 ) (10,201 ) (589 ) Total Net Corporate-Related Derivatives (11,205 ) Interest Rate-Related Derivatives: TBAs 40,100 (1,093,730 ) (1,053,630 ) (416 ) Interest Rate Swaps 305,723 (732,961 ) (427,238 ) (3,251 ) U.S. Treasury Futures(4) - (16,000 ) (16,000 ) 148 Eurodollar Futures(5) - (14,000 ) (14,000 ) (45 ) Total Interest Rate-Related Derivatives (3,564 ) Other Derivatives: Foreign Currency Forwards(6) - (26,211 ) (26,211 ) (126 ) Total Net Other Derivatives (126 ) Net Total$ (10,833 )
(1) For more detailed information about the financial derivatives in our
portfolio, please refer to Note 8 of the notes to condensed consolidated
financial statements for the year ended
(2) In the table above, fair value of certain derivative transactions are shown
on a net basis. The accompanying financial statements separate derivative
transactions as either assets or liabilities. As of
derivative assets and derivative liabilities were
million, respectively, for a net fair value of
in "Net Total" above.
(3) Notional value represents the face amount of the underlying asset.
(4) Notional value represents the total face amount of
underlying all contracts held. As of
(5) Every
Short notional value representsU.S. Dollars to be received by us at the maturity of the forward contract As ofJune 30, 2020 , our Condensed Consolidated Balance Sheet reflected total assets of$3.2 billion and total liabilities of$2.4 billion . As ofDecember 31, 2019 , our Condensed Consolidated Balance Sheet reflected total assets of$4.3 billion and total liabilities of$3.5 billion . Our investments in securities, loans, and unconsolidated entities, financial derivatives, and real estate owned included in total assets were$2.9 billion and$4.0 billion as ofJune 30, 2020 andDecember 31, 2019 , respectively. Our investments in securities sold short and financial derivatives included in total liabilities were$66.3 million and$101.0 million as ofJune 30, 2020 andDecember 31, 2019 , respectively. As ofJune 30, 2020 andDecember 31, 2019 , investments in securities sold short consisted principally of short positions in sovereign bonds andU.S. Treasury securities, which we primarily use to hedge the risk of rising interest rates and foreign currency risk. Typically, we hold a net short position in TBAs. The amounts of net short TBAs, as well as of other hedging instruments, may fluctuate according to the size of our investment portfolio as well as according to how we view market dynamics as favoring the use of one hedging instrument or another. As ofJune 30, 2020 andDecember 31, 2019 , we had a net short notional TBA position of$0.3 billion and$1.1 billion , respectively. The size of the net short notional TBA position declined primarily because we covered TBA short positions in connection with sales of Agency RMBS, and because we increased the amount of long TBAs held for investment. For a more detailed discussion of our investment portfolio, see "-Trends and Recent Market Developments-Portfolio Overview and Outlook" above. We use mortgage-related credit derivatives primarily to hedge credit risk in certain credit strategies, although we also take net long positions in certain CDS on RMBS and CMBS indices. Our CDS on individual RMBS represent "single-name" positions whereby we have synthetically purchased credit protection on specific non-Agency RMBS bonds. As there is no longer an active market for CDS on individual RMBS, our portfolio in this sector continues to run off. We also use CDS on corporate bond indices, options thereon, and various other instruments as a means to hedge credit risk. As market conditions 93
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change, especially as the pricing of various credit hedging instruments changes in relation to our outlook on future credit performance, we continuously re-evaluate both the extent to which we hedge credit risk and the particular mix of instruments that we use to hedge credit risk. We may hold long and/or short positions in corporate bonds or equities. Our long and short positions in corporate bonds or equities may serve as outright investments or portfolio hedges. We use a variety of instruments to hedge interest rate risk in our portfolio, including non-derivative instruments such asU.S. Treasury securities and sovereign debt instruments, and derivative instruments such as interest rate swaps, TBAs, Eurodollar andU.S. Treasury futures, and options on the foregoing. The mix of instruments that we use to hedge interest rate risk may change materially from one period to the next. We have also entered into foreign currency forward and futures contracts in order to hedge risks associated with foreign currency fluctuations. We have entered into repos to finance many of our assets. We account for our repos as collateralized borrowings. As ofJune 30, 2020 indebtedness outstanding on our repos was approximately$1.3 billion . As ofJune 30, 2020 , our assets financed with repos consisted of Agency RMBS of$896.3 million and credit assets of$721.2 million . As ofJune 30, 2020 , outstanding indebtedness under repos was$851.6 million for Agency RMBS and$442.9 million for credit assets. As ofDecember 31, 2019 indebtedness outstanding on our repos was approximately$2.4 billion . As ofDecember 31, 2019 , our assets financed with repos consisted of Agency RMBS of$1.9 billion and credit assets of$830.3 million . As ofDecember 31, 2019 , outstanding indebtedness under repos was$1.9 billion for Agency RMBS and$580.8 million for credit assets. Our repos bear interest at rates that have historically moved in close relationship to LIBOR. In addition to our repos, as ofJune 30, 2020 we had Total other secured borrowings of$898.8 million , used to finance$1.016 billion of non-QM loans and REO, consumer loans and ABS backed by consumer loans, and small balance commercial loans. This compares to Total other secured borrowings of$744.7 million as ofDecember 31, 2019 , used to finance$843.4 million of non-QM loans and REO, and consumer loans and ABS backed by consumer loans. In addition to our secured borrowings, we had$86.0 million of Senior Notes outstanding as of bothJune 30, 2020 andDecember 31, 2019 . As ofJune 30, 2020 andDecember 31, 2019 our debt-to-equity ratio was 2.7:1 and 3.8:1, respectively. Excluding repos onU.S. Treasury securities, our recourse debt-to-equity ratio was 1.5:1 as ofJune 30, 2020 as compared to 2.6:1 as ofDecember 31, 2019 . See the discussion in "-Liquidity and Capital Resources" below for further information on our borrowings. Equity As ofJune 30, 2020 , our equity decreased by approximately$31.0 million to$837.7 million from$868.7 million as ofDecember 31, 2019 . The decrease principally consisted of a net loss of$87.9 million , dividends of$35.0 million , distributions to non-controlling interests of approximately$7.1 million , and payments to repurchase shares of common stock of$3.0 million . These decreases were partially offset by net proceeds from the issuance of common stock of$95.3 million and contributions from our non-controlling interests of approximately$6.4 million . Stockholders' equity, which excludes the non-controlling interests related to the minority interest in theOperating Partnership as well as the minority interests of our joint venture partners, was$800.9 million as ofJune 30, 2020 . 94
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Results of Operations for the Three- and Six-Month Periods EndedJune 30, 2020 and 2019 The following table summarizes our results of operations for the three- and six-month periods endedJune 30, 2020 and 2019: Three-Month Six-Month Period Ended Period Ended (In thousands except per share amounts) June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019 Interest Income (Expense) Interest income$ 39,281 $ 38,547 $ 91,389 $ 74,563 Interest expense (14,686 ) (19,702 ) (36,776 ) (37,320 ) Net interest income 24,595 18,845 54,613 37,243 Other Income (Loss) Realized and unrealized gains (losses) on securities and loans, net 28,072 16,982 (93,406 ) 38,048 Realized and unrealized gains (losses) on financial derivatives, net (3,503 ) (15,841 ) (25,893 ) (33,100 ) Realized and unrealized gains (losses) on real estate owned, net (439 ) (168 ) (445 ) (473 ) Other, net (435 ) 1,808 1,243 3,810 Total other income (loss) 23,695 2,781 (118,501 ) 8,285 Expenses Base management fee to affiliate (Net of fee rebates of$145 ,$508 ,$652 , and$447 , respectively) 2,906 1,661 5,349 3,383 Incentive fee to affiliate - - - - Other investment related expenses 5,275 5,153 9,229 8,629 Other operating expenses 3,771 3,134 7,588 7,147 Total expenses 11,952 9,948 22,166 19,159 Net Income (Loss) before Income Tax Expense (Benefit) and Earnings (Losses) from Investments in Unconsolidated Entities 36,338 11,678 (86,054 ) 26,369 Income tax expense (benefit) 1,542 376 995 376 Earnings (losses) from investments in unconsolidated entities 5,643 2,354 (854 ) 4,151 Net Income (Loss) 40,439 13,656 (87,903 ) 30,144 Net income (loss) attributable to non-controlling interests 1,220 1,012 335 2,092 Dividends on preferred stock 1,941 - 3,882 - Net Income (Loss) Attributable to Common Stockholders$ 37,278 $ 12,644
Core Earnings We calculate Core Earnings asU.S. GAAP net income (loss) as adjusted for: (i) realized and unrealized gain (loss) on securities and loans, REO, financial derivatives (excluding periodic settlements on interest rate swaps), other secured borrowings, at fair value, and foreign currency transactions; (ii) incentive fee to affiliate; (iii) Catch-up Premium Amortization Adjustment (as defined below); (iv) non-cash equity compensation expense; (v) provision for income taxes; and (vi) certain other income or loss items that are of a non-recurring nature. For certain investments in unconsolidated entities, we include the relevant components of net operating income in Core Earnings. The Catch-up Premium Amortization Adjustment is a quarterly adjustment to premium amortization triggered by changes in actual and projected prepayments on our Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). The adjustment is calculated as of the beginning of each quarter based on our then-current assumptions about cashflows and prepayments, and can vary significantly from quarter to quarter. Core Earnings is a supplemental non-GAAP financial measure. We believe that the presentation of Core Earnings provides a consistent measure of operating performance by excluding the impact of gains and losses and other adjustments 95
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listed above from operating results. We believe that Core Earnings provides information useful to investors because it is a metric that we use to assess our performance and to evaluate the effective net yield provided by our portfolio. In addition, we believe that presenting Core Earnings enables our investors to measure, evaluate, and compare our operating performance to that of our peers. However, because Core Earnings is an incomplete measure of our financial results and differs from net income (loss) computed in accordance withU.S. GAAP, it should be considered as supplementary to, and not as a substitute for, net income (loss) computed in accordance withU.S. GAAP. The following table reconciles, for the three- and six-month periods endedJune 30, 2020 and 2019, Core Earnings to the line on the our Condensed Consolidated Statement of Operations entitled Net Income (Loss), which we believe is the most directly comparableU.S. GAAP measure. Three-Month Six-Month Period Ended Period Ended (In thousands, except per share amounts) June 30, 2020 June 30, 2019(1) June 30, 2020 June 30, 2019(1) Net income (loss)$ 40,439 $ 13,656 $ (87,903 ) $ 30,144 Income tax expense (benefit) 1,542 376 995 376 Net income (loss) before income tax expense (benefit) 41,981 14,032 (86,908 ) 30,520
Adjustments:
Realized (gains) losses on securities and loans, net 16,040 1,505 3,780 6,827 Realized (gains) losses on financial derivatives, net 11,676 10,920 24,082 22,490 Realized (gains) losses on real estate owned, net 211 (98 ) (139 ) 40 Unrealized (gains) losses on securities and loans, net (44,112 ) (18,487 ) 89,626 (44,875 ) Unrealized (gains) losses on financial derivatives, net (8,173 ) 4,921 1,811 10,610 Unrealized (gains) losses on real estate owned, net 228 266 584 513 Other realized and unrealized (gains) losses, net(2) 1,302 (55 ) 1,632 (441 ) Net realized gains (losses) on periodic settlements of interest rate swaps (892 ) 52 (750 ) 770 Net unrealized gains (losses) on accrued periodic settlements of interest rate swaps 136 45 25 (231 ) Incentive fee to affiliate - - - - Non-cash equity compensation expense 182 114 346 230 Negative (positive) component of interest income represented by Catch-up Premium Amortization Adjustment 3,648 896 4,759 1,403 Debt issuance costs related to Other secured borrowings, at fair value 2,075 1,671 2,075 1,671 Non-recurring expenses(3) - 241 - 1,317 (Earnings) losses from investments in unconsolidated entities(4) (4,227 ) (1,304 ) 2,408 (1,667 ) Total Core Earnings 20,075 14,719 43,331 29,097 Dividends on preferred stock 1,941 - 3,882 - Core Earnings attributable to non-controlling interests 1,012 1,099 2,534 2,128 Core Earnings Attributable to Common Stockholders$ 17,122 $ 13,620 $ 36,915 $ 26,969 Core Earnings Attributable to Common Stockholders, per share$ 0.39 $ 0.46
$ 0.85 $ 0.91
(1) Conformed to current period presentation.
(2) Includes realized and unrealized gains (losses) on foreign currency and
unrealized gain (loss) on other secured borrowings, at fair value, included
in Other, net, on the Condensed Consolidated Statement of Operations. (3) Non-recurring expenses consist mostly of professional fees related to the REIT Conversion.
(4) Adjustment represents, for certain investments in unconsolidated entities,
the net realized and unrealized gains and losses of the underlying investments of such entities. 96
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Results of Operations for the Three-Month Periods EndedJune 30, 2020 and 2019 Net Income (Loss) Attributable to Common Stockholders For the three-month period endedJune 30, 2020 we had net income (loss) attributable to common stockholders of$37.3 million compared to$12.6 million for the three-month period endedJune 30, 2019 . The period-over-period increase in our results of operations was primarily due to an increase in other income (loss) and net interest income partially offset by an increase in expenses. Interest Income Interest income was$39.3 million for the three-month period endedJune 30, 2020 , as compared to$38.5 million for the three-month period endedJune 30, 2019 . Interest income for both periods included coupon payments received and accrued on our holdings, the net accretion and amortization of purchase discounts and premiums on those holdings, and interest on our cash balances, including those balances held by our counterparties as collateral. For the three-month period endedJune 30, 2020 , interest income from our credit portfolio was$35.9 million , as compared to$28.6 million for the three-month period endedJune 30, 2019 . This period-over-period increase was primarily due to the larger size of the credit portfolio for the three-month period endedJune 30, 2020 , partially offset by lower average asset yields on this portfolio. For the three-month period endedJune 30, 2020 , interest income from our Agency RMBS was$3.4 million , as compared to$9.5 million for the three-month period endedJune 30, 2019 . This period-over-period decrease was primarily due to the smaller size of the Agency portfolio and lower average asset yields for the three-month period endedJune 30, 2020 . The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the three-month periods endedJune 30, 2020 and 2019: Credit(1) Agency(1) Total(1) Interest Average Interest Average Interest Average (In thousands) Income Holdings Yield Income Holdings Yield Income Holdings Yield Three-month period ended June 30, 2020$ 35,878 $ 1,995,595 7.19 %$ 3,385 $ 922,957 1.47 %$ 39,263 $ 2,918,552 5.38 % Three-month period ended June 30, 2019$ 28,554 $ 1,372,590 8.32 %$ 9,501 $ 1,269,508 2.99 %$ 38,055 $ 2,642,098 5.76 %
(1) Amounts exclude interest income on cash and cash equivalents (including when
posted as margin) and long positions in
excludes long holdings of corporate securities that represent components of
certain relative value trading strategies.
Some of the variability in our interest income and portfolio yields is due to the Catch-up Premium Amortization Adjustment. For the three-month periods endedJune 30, 2020 and 2019, we had a negative Catch-up Premium Amortization Adjustment of approximately$(3.6) million and$(0.9) million , respectively, which decreased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 3.05% and 5.88%, respectively, for the three-month period endedJune 30, 2020 . Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 3.28% and 5.90%, respectively, for the three-month period endedJune 30, 2019 . Interest Expense Interest expense primarily includes interest on funds borrowed under repos and Total other secured borrowings, interest on our Senior Notes, coupon interest on securities sold short, the related net accretion and amortization of purchase discounts and premiums on those short holdings, and interest on our counterparties' cash collateral held by us. Our total interest expense decreased to$14.7 million for the three-month period endedJune 30, 2020 , as compared to$19.7 million for the three-month period endedJune 30, 2019 . The period-over-period decrease was primarily due to a decrease in borrowing rates on both our Agency and credit assets. 97
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The table below summarizes the components of interest expense for the
three-month periods ended
Three-Month Period
Ended
(In thousands) June 30, 2020 June 30, 2019 Repos and Total other secured borrowings$ 13,365 18,358 Senior Notes (1) 1,249 1,249 Securities sold short (2) 15 91 Other (3) 57 4 Total$ 14,686 19,702
(1) Amount includes the related amortization of debt issuance costs. Includes
interest expense on the Senior Notes.
(2) Amount includes the related net accretion and amortization of purchase
discounts and premiums.
(3) Primarily includes interest expense on our counterparties' cash collateral
held by us.
The following table summarizes our aggregate secured borrowings, which, other than Other secured borrowings, at fair value, carry interest rates that are based on, or correlated with, LIBOR, including repos and Total other secured borrowings, for the three-month periods endedJune 30, 2020 and 2019. Three-Month Period Ended June 30, 2020 June 30, 2019 Average Average Collateral for Secured Average Interest Cost of Average Interest Cost of Borrowing Borrowings Expense Funds Borrowings Expense Funds (In thousands) Credit(1)$ 1,377,059 $ 11,060 3.23 %$ 975,638 $ 10,474 4.31 % Agency RMBS 907,444 2,305 1.02 % 1,172,136 7,876 2.70 % Subtotal(1) 2,284,503 13,365 2.35 % 2,147,774 18,350 3.43 % U.S. Treasury Securities 37 - - % 1,252 8 2.49 % Total$ 2,284,540 $ 13,365 2.35 %$ 2,149,026 $ 18,358 3.43 % Average One-Month LIBOR 0.36 % 2.44 % Average Six-Month LIBOR 0.71 % 2.50 %
(1)
Among other instruments, we use interest rate swaps to hedge against the risk of rising interest rates. If we were to include as a component of our cost of funds the amortization of upfront payments and the actual and accrued periodic payments on our interest rate swaps used to hedge our assets, our total average cost of funds would increase to 2.49% for the three-month period endedJune 30, 2020 and decrease to 3.38% for the three-month period endedJune 30, 2019 . Excluding the Catch-up Premium Amortization Adjustment, our net interest margin, defined as the yield on our portfolio of yield-bearing targeted assets less our cost of funds (including amortization of upfront payments and actual and accrued periodic payments on interest rate swaps as described above), was 3.39% and 2.52% for the three-month periods endedJune 30, 2020 and 2019, respectively. These metrics do not include costs associated with other instruments that we use to hedge interest rate risk, such as TBAs and futures. Base Management Fees For the three-month period endedJune 30, 2020 , the gross base management fee, which is based on total equity at the end of each quarter, was$3.0 million , and our Manager credited us with rebates on our base management fee of$0.1 million , resulting in a net base management fee of$2.9 million . For the three-month period endedJune 30, 2019 , the gross base management fee was$2.2 million , and our Manager credited us with rebates on our base management fee of$0.5 million , resulting in a net base management fee of$1.7 million . For each period, the base management fee rebates related to those of our CLO investments for which Ellington or one of its affiliates earned CLO management fees. The period-over-period increase in the net base management fee was primarily due to our larger capital base atJune 30, 2020 , as well as a decrease in rebates on our base management fee. 98
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Incentive Fees In addition to the base management fee, our Manager is also entitled to a quarterly incentive fee if our performance (as measured by adjusted net income, as defined in the management agreement) over the relevant rolling four quarter calculation period exceeds a defined return hurdle for the period. No incentive fee was incurred for the three-month periods endedJune 30, 2020 or 2019, since on a rolling four quarter basis, our income did not exceed the prescribed hurdle amount. Because our operating results can vary materially from one period to another, incentive fee expense can be highly variable. Other Investment Related Expenses Other investment related expenses consist of servicing fees on our mortgage and consumer loans, as well as various other expenses and fees directly related to our financial assets and certain financial liabilities carried at fair value. For the three-month periods endedJune 30, 2020 and 2019 other investment related expenses were relatively unchanged at$5.3 million and$5.2 million , respectively. Other Operating Expenses Other operating expenses consist of professional fees, compensation expense related to our dedicated or partially dedicated personnel, and various other operating expenses necessary to run our business. Other operating expenses exclude management and incentive fees, interest expense, and other investment related expenses. Other operating expenses were$3.8 million for the three-month period endedJune 30, 2020 , as compared to$3.1 million for the three-month period endedJune 30, 2019 . The increase in other operating expenses for the three-month period endedJune 30, 2020 was primarily due to increases in professional fees and fund administration expense. Other Income (Loss) Other income (loss) consists of net realized and unrealized gains (losses) on securities and loans, financial derivatives, and real estate owned. Other, net, another component of Other income (loss), includes rental income and income related to loan origination, as well as realized gains (losses) on foreign currency transactions and unrealized gains (losses) on foreign currency remeasurement and Other Secured Borrowings, at fair value. For the three-month period endedJune 30, 2020 , other income (loss) was$23.7 million , consisting primarily of net realized and unrealized gains of$28.1 million on our securities and loans, partially offset by net realized and unrealized losses on our financial derivatives of$(3.5) million . Net realized and unrealized gains of$28.1 million on our securities and loans primarily resulted from net realized and unrealized gains on non-QM loans, Agency RMBS, non-Agency RMBS, and CMBS, partially offset by net realized and unrealized losses on CLOs. These gains were primarily due to a sharp rebound in credit prices and liquidity in the second quarter following substantial distressed selling in the first quarter, as well as a significant rally in pay-ups on specified pools. Net realized and unrealized losses of$(3.5) million on our financial derivatives was primarily related to net realized and unrealized losses on options, CDS on asset-backed indices, interest rate swaps, futures and warrants, partially offset by net realized and unrealized gains on TBAs and total return swaps. For the three-month period endedJune 30, 2019 , other income was$2.8 million , consisting primarily of net realized and unrealized gains of$17.0 million on our securities and loans and gains included in Other, net of$1.8 million , partially offset by net realized and unrealized losses of$(15.8) million on our financial derivatives. Net realized and unrealized gains of$17.0 million on our securities and loans primarily resulted from net realized and unrealized gains on Agency RMBS, non-Agency RMBS, CMBS, and residential mortgage loans, partially offset by net realized and unrealized losses on CLOs,U.S. Treasury securities, and consumer loans. Net realized and unrealized losses of$(15.8) million on our financial derivatives was primarily related to net realized and unrealized losses on interest rate swaps, TBAs, and futures. Results of Operations for the Six-Month Periods EndedJune 30, 2020 and 2019 Net Income (Loss) Attributable to Common Stockholders For the six-month period endedJune 30, 2020 we had net income (loss) attributable to common stockholders of$(92.1) million compared to$28.1 million for the three-month period endedJune 30, 2019 . The period-over-period reversal in our results of operations was primarily due to net realized and unrealized losses on securities and loans, partially offset by an increase in net interest income for the six-month period endedJune 30, 2020 . Interest Income Interest income was$91.4 million for the six-month period endedJune 30, 2020 , as compared to$74.6 million for the six-month period endedJune 30, 2019 . Interest income for both periods included coupon payments received and accrued on our holdings, the net accretion and amortization of purchase discounts and premiums on those holdings, and interest on our cash balances, including those balances held by our counterparties as collateral. 99
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For the six-month period endedJune 30, 2020 , interest income from our credit portfolio was$75.0 million , as compared to$56.4 million for the six-month period endedJune 30, 2019 . This period-over-period increase was primarily due to the larger size of the credit portfolio for the three-month period endedJune 30, 2020 , partially offset by lower average asset yields on this portfolio. For the six-month period endedJune 30, 2020 , interest income from our Agency RMBS was$15.5 million , as compared to$17.1 million for the six-month period endedJune 30, 2019 . This period-over-period decrease was primarily due to lower average asset yields for the six-month period endedJune 30, 2020 . The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the six-month periods endedJune 30, 2020 and 2019: Credit(1) Agency(1) Total(1) Interest Average Interest Average Interest Average (In thousands) Income Holdings Yield Income Holdings Yield Income Holdings Yield Six-month period ended June 30, 2020$ 75,023 $ 1,924,792 7.80 %$ 15,453 $ 1,377,148 2.24 %$ 90,476 $ 3,301,940 5.48 % Six-month period ended June 30, 2019$ 56,405 $ 1,356,350 8.32 %$ 17,063 $ 1,119,006 3.05 %$ 73,468 $ 2,475,356 5.94 %
(1) Amounts exclude interest income on cash and cash equivalents (including when
posted as margin) and long positions in
excludes long holdings of corporate securities that represent components of
certain relative value trading strategies.
Some of the variability in our interest income and portfolio yields is due to the Catch-up Premium Amortization Adjustment. For the six-month periods endedJune 30, 2020 and 2019, we had a negative Catch-up Premium Amortization Adjustment of approximately$(4.8) million and$(1.4) million , respectively, which decreased our interest income. Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 2.94% and 5.77%, respectively, for the six-month period endedJune 30, 2020 . Excluding the Catch-up Premium Amortization Adjustment, the weighted average yield of our Agency portfolio and our total portfolio was 3.30% and 6.05%, respectively for the six-month period endedJune 30, 2019 . Interest Expense Interest expense primarily includes interest on funds borrowed under repos and Total other secured borrowings, interest on our Senior Notes, coupon interest on securities sold short, the related net accretion and amortization of purchase discounts and premiums on those short holdings, and interest on our counterparties' cash collateral held by us. Our total interest expense decreased to$36.8 million for the six-month period endedJune 30, 2020 , as compared to$37.3 million for the six-month period endedJune 30, 2019 . Although average borrowings increased significantly period over period, interest expense declined as a result of a decrease in borrowing rates on our both our Agency and credit assets. The table below summarizes the components of interest expense for the six-month periods endedJune 30, 2020 and 2019. Six-Month Period Ended (In thousands) June 30, 2020 June 30, 2019 Repos and Total other secured borrowings$ 33,759 34,425 Senior Notes (1) 2,497 2,472 Securities sold short (2) 430 402 Other (3) 90 21 Total$ 36,776 37,320
(1) Amount includes the related amortization of debt issuance costs. For the
six-month period ended
Senior Notes. For the six-month period ended
interest expense on the Senior Notes and the Old Senior Notes.
(2) Amount includes the related net accretion and amortization of purchase
discounts and premiums.
(3) Primarily includes interest expense on our counterparties' cash collateral
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The following table summarizes our aggregate secured borrowings, which, other than Other secured borrowings, at fair value, carry interest rates that are based on, or correlated with, LIBOR, including repos and Total other secured borrowings, for the six-month periods endedJune 30, 2020 and 2019. Six-Month Period Ended June 30, 2020 June 30, 2019 Average Average Collateral for Secured Average Interest Cost of Average Interest Cost of Borrowing Borrowings Expense Funds Borrowings Expense Funds (In thousands) Credit(1)$ 1,403,418 $ 23,282 3.34 %$ 971,893 $ 20,501 4.25 % Agency RMBS 1,327,434 10,473 1.59 % 1,033,830 13,858 2.70 % Subtotal(1) 2,730,852 33,755 2.49 % 2,005,723 34,359 3.45 % U.S. Treasury Securities 759 4 0.98 % 5,519 66 2.41 % Total$ 2,731,611 $ 33,759 2.49 %$ 2,011,242 $ 34,425 3.45 % Average One-Month LIBOR 0.90 % 2.47 % Average Six-Month LIBOR 1.11 % 2.63 %
(1)
Among other instruments, we use interest rate swaps to hedge against the risk of rising interest rates. If we were to include as a component of our cost of funds the amortization of upfront payments and the actual and accrued periodic payments on our interest rate swaps used to hedge our assets, our total average cost of funds would increase to 2.53% for the six-month period endedJune 30, 2020 and decrease to 3.36% for the six-month period endedJune 30, 2019 . Excluding the Catch-up Premium Amortization Adjustment, our net interest margin, defined as the yield on our portfolio of yield-bearing targeted assets less our cost of funds (including amortization of upfront payments and actual and accrued periodic payments on interest rate swaps as described above), was 3.24% and 2.69% for the six-month periods endedJune 30, 2020 and 2019, respectively. These metrics do not include costs associated with other instruments that we use to hedge interest rate risk, such as TBAs and futures. Base Management Fees For the six-month period endedJune 30, 2020 , the gross base management fee, which is based on total equity at the end of each quarter, was$6.0 million , and our Manager credited us with rebates on our base management fee of$0.7 million , resulting in a net base management fee of$5.3 million . For the six-month period endedJune 30, 2019 , the gross base management fee was$4.4 million , and our Manager credited us with rebates on our base management fee of$1.0 million , resulting in a net base management fee of$3.4 million . For each period, the base management fee rebates related to those of our CLO investments for which Ellington or one of its affiliates earned CLO management fees. The period-over-period increase in the net base management fee was primarily due to our larger capital base atJune 30, 2020 . Incentive Fees In addition to the base management fee, our Manager is also entitled to a quarterly incentive fee if our performance (as measured by adjusted net income, as defined in the management agreement) over the relevant rolling four quarter calculation period exceeds a defined return hurdle for the period. No incentive fee was incurred for the six-month periods endedJune 30, 2020 or 2019, since on a rolling four quarter basis, our income did not exceed the prescribed hurdle amount. Because our operating results can vary materially from one period to another, incentive fee expense can be highly variable. Other Investment Related Expenses Other investment related expenses consist of servicing fees on our mortgage and consumer loans, as well as various other expenses and fees directly related to our financial assets and certain financial liabilities carried at fair value. For the six-month periods endedJune 30, 2020 and 2019 other investment related expenses were$9.2 million and$8.6 million , respectively. The increase in other investment related expenses was primarily due to period-over-period increases in debt issuance costs related to our non-QM loan securitizations and servicing expenses on our consumer loan portfolios, partially offset by a decrease in various other expenses related to our residential and commercial mortgage loan and REO portfolios. 101
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Other Operating Expenses Other operating expenses consist of professional fees, compensation expense related to our dedicated or partially dedicated personnel, and various other operating expenses necessary to run our business. Other operating expenses exclude management and incentive fees, interest expense, and other investment related expenses. Other operating expenses were$7.6 million for the six-month period endedJune 30, 2020 as compared to$7.1 million for the six-month period endedJune 30, 2019 . The increase in other operating expenses for the six-month period endedJune 30, 2020 was primarily due to an increase in fund administration expenses and the recognition ofDelaware corporate franchise tax, partially offset by decreases in professional fees and compensation expense. Other Income (Loss) Other income (loss) consists of net realized and unrealized gains (losses) on securities and loans, financial derivatives, and real estate owned. Other, net, another component of Other income (loss), includes rental income and income related to loan origination, as well as realized gains (losses) on foreign currency transactions and unrealized gains (losses) on foreign currency remeasurement and Other Secured Borrowings, at fair value. For the six-month period endedJune 30, 2020 , other income (loss) was$(118.5) million , consisting primarily of net realized and unrealized losses of$(93.4) million on our securities and loans and net realized and unrealized losses on our financial derivatives of$(25.9) million . Net realized and unrealized losses of$(93.4) million on our securities and loans primarily resulted from net unrealized losses on CLOs, non-Agency RMBS, CMBS, non-QM loans, and consumer loans and ABS backed by consumer loans, partially offset by net unrealized gains on Agency RMBS. These unrealized losses were primarily due to the market and economic disruptions caused by the COVID-19 pandemic. Net realized and unrealized losses of$(25.9) million on our financial derivatives was primarily related to net realized and unrealized losses on interest rate swaps, TBAs, futures, and total return swaps, partially offset by net realized and unrealized gains on CDS on asset-backed indices, CDS on corporate bond indices, and CDS on corporate bonds. For the six-month period endedJune 30, 2019 , other income was$8.3 million , consisting primarily of net realized and unrealized gains of$38.0 million on our securities and loans and gains included in Other, net of$3.8 million , partially offset by net realized and unrealized losses of$(33.1) million on our financial derivatives. Net realized and unrealized gains of$38.0 million on our securities and loans primarily resulted from net realized and unrealized gains on Agency RMBS, residential mortgage loans, and non-Agency RMBS and CMBS, partially offset by net realized and unrealized losses on consumer loans, small balance commercial loans, CLOs, andU.S. Treasury securities. Net realized and unrealized losses of$(33.1) million on our financial derivatives was primarily related to net realized and unrealized losses on interest rate swaps, TBAs, futures, CDS on corporate bond indices, and CDS on asset-backed indices partially offset by net realized and unrealized gains on forwards. Liquidity and Capital Resources Liquidity refers to our ability to meet our cash needs, including repaying our borrowings, funding and maintaining positions in our targeted assets, making distributions in the form of dividends, and other general business needs. Our short-term (one year or less) and long-term liquidity requirements include acquisition costs for assets we acquire, payment of our base management fee and incentive fee, compliance with margin requirements under our repos, reverse repos, and financial derivative contracts, repayment of repo borrowings and other secured borrowings to the extent we are unable or unwilling to extend such borrowings, payment of our general operating expenses, payment of interest payments on our Senior Notes, and payment of our dividends. Our capital resources primarily include cash on hand, cash flow from our investments (including principal and interest payments received on our investments and proceeds from the sale of investments), borrowings under repos and other secured borrowings, and proceeds from equity and debt offerings. We expect that these sources of funds will be sufficient to meet our short-term and long-term liquidity needs. 102
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The following summarizes our borrowings under repos by remaining maturity: (In thousands) June 30, 2020 December 31, 2019 Outstanding Outstanding Remaining Days to Maturity Borrowings % of Total Borrowings % of Total 30 Days or Less$ 241,355 18.7 %$ 528,545 21.6 % 31 - 60 Days 498,263 38.6 % 848,878 34.7 % 61 - 90 Days 262,078 20.2 % 733,575 30.0 % 91 - 120 Days 12,156 0.9 % 10,270 0.4 % 121 - 150 Days 2,708 0.2 % 7,460 0.3 % 151 - 180 Days 41,971 3.2 % 34,580 1.4 % 181 - 360 Days 194,315 15.0 % 186,661 7.7 % > 360 Days 41,703 3.2 % 95,331 3.9 %$ 1,294,549 100.0 %$ 2,445,300 100.0 % Repos involving underlying investments that were sold prior toJune 30, 2020 for settlement followingJune 30, 2020 , are shown using their original maturity dates even though such repos may be expected to be terminated early upon settlement of the sale of the underlying investment. The amounts borrowed under our repo agreements are generally subject to the application of "haircuts." A haircut is the percentage discount that a repo lender applies to the market value of an asset serving as collateral for a repo borrowing, for the purpose of determining whether such repo borrowing is adequately collateralized. As ofJune 30, 2020 , the weighted average contractual haircut applicable to the assets that serve as collateral for our outstanding repo borrowings (excluding repo borrowings related toU.S. Treasury securities) was 36.2% with respect to credit assets, 6.5% with respect to Agency RMBS assets, and 19.8% overall. As ofDecember 31, 2019 these respective weighted average contractual haircuts were 29.3%, 5.0%, and 12.3%. The increase in the weighted average contractual haircuts for both our credit assets and our Agency RMBS was primarily due to volatile market conditions and market-wide liquidity stresses resulting from the COVID-19 pandemic. Although this increase in financing haircuts has not yet been shown to be temporary, market haircut levels as of the end of the quarter were noticeably lower than those observed in earlyApril 2020 . Additionally, a significant portion of the increase in the weighted average contractual haircut on our overall portfolio is due to the lower share of our overall portfolio represented by Agency RMBS. We expect to continue to borrow funds in the form of repos as well as other similar types of financings. The terms of our repo borrowings are predominantly governed by master repurchase agreements, which generally conform to the terms in the standard master repurchase agreement as published by theSecurities Industry and Financial Markets Association as to repayment and margin requirements. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include the addition of or changes to provisions relating to margin calls, net asset value requirements, cross default provisions, certain key person events, changes in corporate structure, and requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction. These provisions may differ for each of our repo lenders. As ofJune 30, 2020 andDecember 31, 2019 , we had$1.3 billion and$2.4 billion , respectively, of borrowings outstanding under our repos. As ofJune 30, 2020 , the remaining terms on our repos ranged from 1 day to 700 days, with a weighted average remaining term of 110 days. Our repo borrowings were with a total of 25 counterparties as ofJune 30, 2020 . As ofJune 30, 2020 , our repos had a weighted average borrowing rate of 1.47%. As ofJune 30, 2020 , our repos had interest rates ranging from 0.27% to 7.95%. As ofDecember 31, 2019 , the remaining terms on our repos ranged from 2 days to 882 days, with a weighted average remaining term of 91 days. Our repo borrowings were with a total of 28 counterparties as ofDecember 31, 2019 . As ofDecember 31, 2019 , our repos had a weighted average borrowing rate of 2.37%. As ofDecember 31, 2019 , our repos had interest rates ranging from 0.15% to 5.20%. Investments transferred as collateral under repos had an aggregate fair value of$1.6 billion and$2.8 billion as ofJune 30, 2020 andDecember 31, 2019 , respectively. The interest rates of our repos have historically moved in close relationship to short-term LIBOR rates, and in some cases are explicitly indexed to short-term LIBOR rates and reset accordingly. It is expected that amounts due upon maturity of our repos will be funded primarily through the roll/re-initiation of repos and, if we are unable or unwilling to roll/re-initiate our repos, through free cash and proceeds from the sale of securities. During March and early April, while we were able to roll our repos in an orderly manner, haircuts and borrowing rates were generally higher, and maturities generally shorter. During the remainder of the second quarter, however, we made 103
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substantial progress extending and improving our sources of financing and leverage. In addition to completing our non-QM securitization, we also obtained term financing for numerous loan assets that we had previously held unfinanced, and we extended the terms of several of our credit facilities. By the end of the quarter, the market for standard repo financing of securities had largely returned to pre-March levels. The following table details total outstanding borrowings, average outstanding borrowings, and the maximum outstanding borrowings at any month end for each quarter under repos for the past twelve quarters: Borrowings Maximum Borrowings Outstanding at Average Outstanding at Any Quarter Ended Quarter End Borrowings Outstanding Month End (In thousands) June 30, 2020(1) $ 1,294,549 $ 1,520,985 $ 1,709,620 March 31, 2020(2) 2,034,225 2,440,982 2,485,496 December 31, 2019(3) 2,445,300 2,119,394 2,445,300 September 30, 2019 2,056,422 1,796,310 2,056,422 June 30, 2019 1,715,506 1,769,909 1,962,866 March 31, 2019 1,550,016 1,471,592 1,550,016 December 31, 2018 1,498,849 1,509,819 1,595,118 September 30, 2018 1,636,039 1,534,490 1,672,077 June 30, 2018 1,421,506 1,398,813 1,471,052 March 31, 2018 1,330,943 1,269,297 1,330,943 December 31, 2017(4) 1,209,315 1,050,018 1,209,315 September 30, 2017 1,029,810 1,078,165 1,133,586
(1) During this quarter, we continued to lower leverage and improve our liquidity
given the uncertainty as a result of the COVID-19 pandemic.
(2) In
the financial markets as a result of the spread of COVID-19, we significantly
reduced our outstanding borrowings to lower leverage and increase our
liquidity.
(3) At the end of 2019 we increased the size of both our
portfolios which we subsequently financed through repos.
(4) At the end of 2017 we increased the size of our Credit portfolio by
purchasing certain more liquid, lower-risk securities which we subsequently
financed through repos.
In addition to our borrowings under repos, we have entered into various other types of transactions to finance certain of our non-QM loans and REO, and consumer loans and ABS backed by consumer loans; these transactions are accounted for as collateralized borrowings. As ofJune 30, 2020 andDecember 31, 2019 , we had outstanding borrowings related to such transactions in the amount of$898.8 million and$744.7 million , respectively, which is reflected under the captions "Other secured borrowings" and "Other secured borrowings, at fair value" on the Condensed Consolidated Balance Sheet. As ofJune 30, 2020 andDecember 31, 2019 , the fair value of non-QM loans and REO, consumer loans and ABS backed by consumer loans, and small balance commercial mortgage loans collateralizing our Total other secured borrowings was$1.016 billion and$843.4 million , respectively. See Note 11 in the notes to our condensed consolidated financial statements for further information on our other secured borrowings. As of bothJune 30, 2020 andDecember 31, 2019 , we had$86.0 million outstanding of Senior Notes, maturing inSeptember 2022 and bearing interest at a rate of 5.50%, subject to adjustment based on changes, if any, in the ratings of the Senior Notes. These Senior Notes were issued onFebruary 13, 2019 in connection with the Note Exchange. See Note 11 in the notes to our condensed consolidated financial statements for further detail on the Senior Notes. As ofJune 30, 2020 , we had an aggregate amount at risk under our repos with 25 counterparties of approximately$333.9 million , and as ofDecember 31, 2019 , we had an aggregate amount at risk under our repos with 28 counterparties of approximately$348.4 million . Amounts at risk represent the excess, if any, for each counterparty of the fair value of collateral held by such counterparty over the amounts outstanding under repos. If the amounts outstanding under repos with a particular counterparty are greater than the collateral held by the counterparty, there is no amount at risk for the particular counterparty. Amount at risk as ofJune 30, 2020 andDecember 31, 2019 does not include approximately$4.8 million and$5.1 million , respectively, of net accrued interest receivable, which is defined as accrued interest on securities held as collateral less interest payable on cash borrowed. Our derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Act. We may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. Changes in the relative value of derivative transactions may require us or the counterparty to post or receive additional 104
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collateral. Entering into derivative contracts involves market risk in excess of amounts recorded on our balance sheet. In the case of cleared derivatives, the clearinghouse becomes our counterparty and the future commission merchant acts as an intermediary between us and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral. As ofJune 30, 2020 , we had an aggregate amount at risk under our derivative contracts, excluding TBAs, with ten counterparties of approximately$13.4 million . We also had$7.7 million of initial margin for cleared over-the-counter, or "OTC," derivatives posted to central clearinghouses as of that date. As ofDecember 31, 2019 , we had an aggregate amount at risk under our derivatives contracts, excluding TBAs, with ten counterparties of approximately$26.4 million . We also had$14.2 million of initial margin for cleared OTC derivatives posted to central clearinghouses as of that date. Amounts at risk under our derivatives contracts represent the excess, if any, for each counterparty of the fair value of our derivative contracts plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the financial derivatives plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty. We purchase and sellTBAs and Agency pass-through certificates on a when-issued or delayed delivery basis. The delayed delivery for these securities means that these transactions are more prone to market fluctuations between the trade date and the ultimate settlement date, and therefore are more vulnerable, especially in the absence of margining arrangements with respect to these transactions, to increasing amounts at risk with the applicable counterparties. As ofJune 30, 2020 , in connection with our forward settlingTBA and Agency pass-through certificates, we had an aggregate amount at risk with seven counterparties of approximately$6.3 million . As ofDecember 31, 2019 , in connection with our forward settlingTBA and Agency pass-through certificates, we had an aggregate amount at risk with nine counterparties of approximately$4.2 million . Amounts at risk in connection with our forward settlingTBA and Agency pass-through certificates represent the excess, if any, for each counterparty of the net fair value of the forward settling transactions plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the forward settling transactions plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty. We held cash and cash equivalents of approximately$146.5 million and$72.3 million as ofJune 30, 2020 andDecember 31, 2019 , respectively. OnJune 13, 2018 , our Board of Directors approved the adoption of a share repurchase program under which we are authorized to repurchase up to 1.55 million shares of common stock. The program, which is open-ended in duration, allows us to make repurchases from time to time on the open market or in negotiated transactions, including under 10b5-1 plans. Repurchases are at our discretion, subject to applicable law, share availability, price and our financial performance, among other considerations. In addition to making discretionary repurchases, we from time to time use 10b5-1 plans to increase the number of trading days available to implement these repurchases. During the six-month period endedJune 30, 2020 , we repurchased 288,172 shares at an average price per share of$10.53 and a total cost of$3.0 million . From inception of the current repurchase plan throughAugust 7, 2020 , we repurchased 701,965 shares at an average price per share of$13.36 and a total cost of$9.4 million , and have authorization to repurchase an additional 848,035 common shares. OnApril 3, 2019 , we commenced an "at-the-market" offering program, or "ATM program," by entering into equity distribution agreements with third party sales agents under which we are authorized to offer and sell shares of common stock from time to time with a maximum aggregate gross offering price of up to$150 million . ThroughJanuary 21, 2020 we did not issue any shares of common stock under the ATM program. EffectiveJanuary 21, 2020 , we terminated the ATM program. OnJanuary 24, 2020 , we completed a follow-on offering of 5,290,000 shares of our common stock, of which 690,000 shares were issued pursuant to the exercise of the underwriters' option. The issuance and sale of such common shares generated net proceeds, after underwriters' discount and offering costs, of$95.3 million . We may declare dividends based on, among other things, our earnings, our financial condition, the REIT qualification requirements of the Internal Revenue Code of 1986, as amended, our working capital needs and new opportunities. The declaration of dividends to our stockholders and the amount of such dividends are at the discretion of our Board of Directors. 105
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The following table sets forth the dividend distributions authorized by the Board of Directors payable to common shareholders and holders of Convertible Non-controlling Interest Units (as defined in Note 2 of the notes to condensed consolidated financial statements) for the periods indicated below: Six-Month Period EndedJune 30, 2020 Declaration Date Dividend Per Share Dividend Amount Record Date Payment Date (In thousands) January 8, 2020 $ 0.15 $ 6,699 January 31, 2020 February 25, 2020 February 7, 2020 0.15 6,699 February 28, 2020 March 25, 2020 March 6, 2020 0.15 6,658 March 31, 2020 April 27, 2020 April 7, 2020 0.08 3,551 April 30, 2020 May 26, 2020 May 7, 2020 0.08 3,551 May 29, 2020 June 25, 2020 June 5, 2020 0.09 3,995 June 30, 2020 July 27, 2020
Six-Month Period Ended
Declaration Date Dividend Per Share Dividend Amount Record Date Payment Date
(In thousands) February 14, 2019 $ 0.41 $ 12,496 March 1, 2019 March 15, 2019 March 11, 2019 0.14 4,267 March 29, 2019 April 25, 2019 April 5, 2019 0.14 4,267 April 30, 2019 May 28, 2019 May 7, 2019 0.14 4,267 May 31, 2109 June 25, 2019 June 7, 2019 0.14 4,267 June 28, 2019 July 25, 2019 OnJuly 8, 2020 , the Board of Directors approved a dividend in the amount of$0.09 per share of common stock payable onAugust 25, 2020 to stockholders of record as ofJuly 31, 2020 . OnAugust 7, 2020 , the Board of Directors approved a dividend in the amount of$0.09 per share of common stock payable onSeptember 25, 2020 to stockholders of record as ofAugust 31, 2020 . The following table sets forth the dividend distributions authorized by the Board of Directors payable to holders of our Series A Preferred Stock for the periods indicated below: Declaration Date Dividend Per Share Dividend Amount Record Date Payment Date (In thousands) April 7, 2020 $ 0.421875 $ 1,941 April 17, 2020 April 30, 2020 July 8, 2020 0.421875 1,941 July
20, 2020
For the six-month period endedJune 30, 2020 , our operating activities provided net cash in the amount of$66.5 million and our investing activities provided net cash in the amount of$848.2 million . Our repo activity used to finance many of our investments (including repayments of amounts borrowed under our repos) used net cash of$1.1 billion . We received$242.2 million in proceeds from the issuance of Total other secured borrowings and we used$37.4 million for principal payments on Other secured borrowings. Thus our operating and investing activities, when combined with our repo financings and Other secured borrowings (net of repayments), provided net cash of$16.0 million for the six-month period endedJune 30, 2020 . We received proceeds from the issuance of common stock, net of offering costs paid, of$95.3 million and contributions from non-controlling interests provided cash of$8.2 million . We used$36.7 million to pay dividends,$5.4 million for distributions to non-controlling interests (our joint venture partners), and$3.0 million to repurchase common stock. As a result there was an increase in our cash holdings of$74.2 million , from$72.5 million as ofDecember 31, 2019 to$146.7 million as ofJune 30, 2020 . For the six-month period endedJune 30, 2019 , our operating activities provided net cash in the amount of$43.3 million and our investing activities used net cash in the amount of$304.8 million . Our repo activity used to finance many of our investments (including repayments, in conjunction with the sales of investments, of amounts borrowed under our repos) provided net cash of$229.6 million . We received$91.4 million in proceeds from the issuance of Total other secured borrowings, we used$32.6 million for principal payments on Other secured borrowings, and we used$1.0 million for Debt issuance costs, which were related to Other secured borrowings, at fair value. Thus our operating and investing activities, when 106
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combined with our repo financings, Other secured borrowings (net of repayments), provided net cash of$25.9 million for the six-month period endedJune 30, 2019 . In addition, contributions from non-controlling interests provided cash of$7.4 million . We used$25.3 million to pay dividends,$9.5 million for distributions to non-controlling interests (our joint venture partners), and$0.8 million to repurchase common stock. As a result there was a decrease in our cash holdings of$2.2 million , from$45.1 million as ofDecember 31, 2018 to$42.8 million as ofJune 30, 2019 . Based on our current portfolio, amount of free cash on hand, debt-to-equity ratio, and current and anticipated availability of credit, we believe that our capital resources will be sufficient to enable us to meet anticipated short-term and long-term liquidity requirements. However, the unexpected inability to finance our Agency RMBS portfolio would create a serious short-term strain on our liquidity and would require us to liquidate much of that portfolio, which in turn would require us to restructure our portfolio to maintain our exclusion from registration as an investment company under the Investment Company Act and to qualify and maintain our qualification as a REIT. Steep declines in the values of our credit assets financed using repos, or in the values of our derivative contracts, would result in margin calls that would significantly reduce our free cash position. Furthermore, a substantial increase in prepayment rates on our assets financed by repos could cause a temporary liquidity shortfall, because we are generally required to post margin on such assets in proportion to the amount of the announced principal paydowns before the actual receipt of the cash from such principal paydowns. If our cash resources are at any time insufficient to satisfy our liquidity requirements, we may have to sell assets or issue additional debt or equity securities. InMarch 2020 , as a result of significant declines in asset prices and general price volatility, we received margin calls under our financing arrangements and under our derivative contracts that were higher than typical historical levels. During the second quarter, prices for most credit assets stabilized and market volatility subsided, and as a result, our margin calls reverted to more typical levels. We satisfied all margin calls during both periods. Although we may from time to time enter into financing arrangements that limit our leverage, our investment guidelines do not limit the amount of leverage that we may use, and we believe that the appropriate leverage for the particular assets we hold depends on the credit quality and risk of those assets, as well as the general availability and terms of stable and reliable financing for those assets. Contractual Obligations and Commitments We are a party to a management agreement with our Manager. Pursuant to that agreement, our Manager is entitled to receive a base management fee, an incentive fee, reimbursement of certain expenses and, in certain circumstances, a termination fee. Such fees and expenses do not have fixed and determinable payments. For a description of the management agreement provisions, see Note 13 of the notes to our condensed consolidated financial statements. We have numerous contractual obligations and commitments related to our outstanding borrowings (see Note 11 of the notes to our condensed consolidated financial statements) and related to our financial derivatives (see Note 8 of the notes to our condensed consolidated financial statements). See Note 21 of the notes to our condensed consolidated financial statements as ofJune 30, 2020 for further detail on our other contractual obligations and commitments. Off-Balance Sheet Arrangements As ofJune 30, 2020 , we did not have any material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment to provide funding to any such entities that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or resources that would be material to an investor in our securities. As such, we are not materially exposed to any market, credit, liquidity, or financing risk that could arise if we had engaged in such relationships. See Note 6 and Note 10 of the notes to our condensed consolidated financial statements for further detail about a multi-seller consumer loan securitization transaction we entered into inAugust 2016 . AtJune 30, 2020 we have not entered into any repurchase agreements for which delivery of the borrowed funds is not scheduled until after period end. Inflation Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation 107
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rates or changes in inflation rates. Our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation. Item 3. Quantitative and Qualitative Disclosures about Market Risk The primary components of our market risk atJune 30, 2020 are related to credit risk, prepayment risk, and interest rate risk. We seek to actively manage these and other risks and to acquire and hold assets that we believe justify bearing those risks, and to maintain capital levels consistent with those risks. Credit Risk We are subject to credit risk in connection with many of our assets, especially non-Agency RMBS, CMBS, residential and commercial mortgage loans, corporate debt investments including CLOs and investments in securitization warehouses, and consumer loans. Credit losses on real estate loans can occur for many reasons, including, but not limited to, poor origination practices, fraud, faulty appraisals, documentation errors, poor underwriting, legal errors, poor servicing practices, weak economic conditions, decline in the value of homes, businesses or commercial properties, special hazards, earthquakes and other natural events, such as the COVID-19 pandemic, or an outbreak of another highly infectious or contagious disease, over-leveraging of the borrower on a property, reduction in market rents and occupancies and poor property management services, changes in legal protections for lenders, reduction in personal income, job loss, and personal events such as divorce or health problems. Property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional, and local economic conditions (which may be adversely affected by industry slowdowns and other factors), local real estate conditions (such as an oversupply of housing), changes or continued weakness in specific industry segments, construction quality, age and design, demographic factors, and retroactive changes to building or similar codes. The ability of borrowers to repay consumer loans may be adversely affected by numerous borrower-specific factors, including unemployment, divorce, major medical expenses or personal bankruptcy. General factors, including an economic downturn, high energy costs or acts of God or terrorism, pandemics such as novel coronavirus (COVID-19) or another highly infectious or contagious disease, may also affect the financial stability of borrowers and impair their ability or willingness to repay their loans. Whenever any of our consumer loans defaults, we are at risk of loss to the extent of any deficiency between the liquidation value of the collateral, if any, securing the loan, and the principal and accrued interest of the loan. Many of our consumer loans are unsecured, or are secured by collateral (such as an automobile) that depreciates rapidly; as a result, these loans may be at greater risk of loss than residential real estate loans. Our corporate investments, especially our lower-rated or unrated CLO investments, corporate equity, and our investments in loan originators, have significant risk of loss, and our efforts to protect these investments may involve substantial costs and may not be successful. The risk of loss with respect to these investments has been, and will likely continue to be, exacerbated by the COVID-19 pandemic. We also will be subject to significant uncertainty as to when and in what manner and for what value the corporate debt in which we directly or indirectly invest will eventually be satisfied (e.g., through liquidation of the obligor's assets, an exchange offer or plan of reorganization involving the debt securities or a payment of some amount in satisfaction of the obligation). In addition, these investments could involve loans to companies that are more likely to experience bankruptcy or similar financial distress, such as companies that are thinly capitalized, employ a high degree of financial leverage, are in highly competitive or risky businesses, are in a start-up phase, or are experiencing losses. Similarly, we are exposed to the risk of potential credit losses on the other assets in our credit portfolio. For many of our investments, the two primary components of credit risk are default risk and severity risk. Default Risk Default risk is the risk that a borrower fails to make scheduled principal and interest payments on a mortgage loan or other debt obligation. We may attempt to mitigate our default risk by, among other things, opportunistically entering into credit default swaps and total return swaps. These instruments can reference various MBS indices, corporate bond indices, or corporate entities. We often rely on third-party servicers to mitigate our default risk, but such third-party servicers may have little or no economic incentive to mitigate loan default rates. Severity Risk Severity risk is the risk of loss upon a borrower default on a mortgage loan or other secured or unsecured debt obligation. Severity risk includes the risk of loss of value of the property or other asset, if any, securing the mortgage loan or debt obligation, as well as the risk of loss associated with taking over the property or other asset, if any, including foreclosure costs. We often rely on third-party servicers to mitigate our severity risk, but such third-party servicers may have little or no economic 108
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incentive to mitigate loan loss severities. In the case of mortgage loans, such mitigation efforts may include loan modification programs and prompt foreclosure and property liquidation following a default. Many of our consumer loans are unsecured, or are secured by collateral (such as an automobile) that depreciates rapidly; as a result, these loans may be at greater risk of loss than residential real estate loans. Pursuing any remaining deficiency following a default on a consumer loan is often difficult or impractical, especially when the borrower has a low credit score, making further substantial collection efforts unwarranted. In addition, repossessing personal property securing a consumer loan can present additional challenges, including locating and taking physical possession of the collateral. We rely on servicers who service these consumer loans, to, among other things, collect principal and interest payments on the loans and perform loss mitigation services, and these servicers may not perform in a manner that promotes our interests. In the case of corporate debt, if a company declares bankruptcy, the bankruptcy process has a number of significant inherent risks. Many events in a bankruptcy proceeding are the product of contested matters and adversarial proceedings and are beyond the control of the creditors. A bankruptcy filing by a company whose debt we have purchased may adversely and permanently affect such company. If the proceeding results in liquidation, the liquidation value of the company may have deteriorated significantly from what we believed to be the case at the time of our initial investment. The duration of a bankruptcy proceeding is also difficult to predict, and our return on investment can be adversely affected by delays until a plan of reorganization or liquidation ultimately becomes effective. A bankruptcy court may also re-characterize our debt investment as equity, and subordinate all or a portion of our claim to that of other creditors. This could occur even if our investment had initially been structured as senior debt. Prepayment Risk Prepayment risk is the risk of change, whether an increase or a decrease, in the rate at which principal is returned in respect of fixed-income assets in our portfolio, including both through voluntary prepayments and through liquidations due to defaults and foreclosures. Most significantly, our portfolio is exposed to the risk of changes in prepayment rates of mortgage loans, including the mortgage loans underlying our RMBS, and changes in prepayment rates of certain of our consumer loan holdings. This rate of prepayment is affected by a variety of factors, including the prevailing level of interest rates as well as economic, demographic, tax, social, legal, and other factors. Changes in prepayment rates will have varying effects on the different types of securities in our portfolio, and we attempt to take these effects into account in making asset management decisions. Additionally, increases in prepayment rates may cause us to experience losses on our interest only securities and inverse interest only securities, as those securities are extremely sensitive to prepayment rates. Prepayment rates, besides being subject to interest rates and borrower behavior, are also substantially affected by government policy and regulation. For example, the government sponsored HARP program, which was designed to encourage mortgage refinancings, was a steady contributor to Agency RMBS prepayment speeds from its inception in 2009 until its expiration at the end of 2018. Mortgage rates have declined significantly during 2020, and remain very low by historical standards. As a result, prepayments continue to represent a meaningful risk, especially with respect to our Agency RMBS. Interest Rate Risk Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. We are subject to interest rate risk in connection with most of our assets and liabilities. For some securities in our portfolio, the coupon interest rates on, and therefore also the values of, such securities are highly sensitive to interest rate movements, such as inverse floating rate RMBS, which benefit from falling interest rates. Our repurchase agreements generally carry interest rates that are determined by reference to LIBOR or similar short-term benchmark rates for those same periods. Whenever one of our fixed-rate repo borrowings matures, it will generally be replaced with a new fixed-rate repo borrowing based on market interest rates prevailing at such time. Subject to qualifying and maintaining our qualification as a REIT and our exclusion from registration under the Investment Company Act, we opportunistically hedge our interest rate risk by entering into interest rate swaps, TBAs,U.S. Treasury securities, Eurodollar futures,U.S. Treasury futures, and other instruments. In general, such hedging instruments are used to mitigate the interest rate risk arising from the mismatch between the duration of our financed assets and the duration of the liabilities used to finance such assets. The majority of this mismatch currently relates to our Agency RMBS. 109
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The following sensitivity analysis table shows the estimated impact on the value of our portfolio segregated by certain identified categories as ofJune 30, 2020 , assuming a static portfolio and immediate and parallel shifts in interest rates from current levels as indicated below. (In thousands) Estimated Change for a Decrease in Interest Rates by Estimated Change for an Increase in Interest Rates by 50 Basis Points 100 Basis Points 50 Basis Points 100 Basis Points Category of % of Total % of Total % of Total % of Total Instruments Market Value Equity Market Value Equity Market Value Equity Market Value Equity Agency RMBS$ 7,432 0.89 %$ 13,376 1.6 %$ (8,920 ) (1.06 )%$ (19,329 ) (2.31 )% Non-Agency RMBS, CMBS, ABS and Loans 5,617 0.67 % 11,957 1.43 % (4,893 ) (0.58 )% (9,062 ) (1.08 )% U.S. Treasury Securities, and Interest Rate Swaps, Options, and Futures (8,052 ) (0.96 )% (16,420 ) (1.96 )% 7,737 0.92 % 15,158 1.81 % Mortgage-Related Derivatives - - % - - % 1 - % 3 - %Corporate Securities and Derivatives on Corporate Securities (5 ) - % (9 ) - % 6 - % 14 - % Repurchase Agreements, Reverse Repurchase Agreements, and Senior Notes (1,085 ) (0.13 )% (967 ) (0.12 )% 2,012 0.24 % 4,702 0.56 % Total$ 3,907 0.47 %$ 7,937 0.95 %$ (4,057 ) (0.48 )%$ (8,514 ) (1.02 )% The preceding analysis does not show sensitivity to changes in interest rates for instruments for which we believe that the effect of a change in interest rates is not material to the value of the overall portfolio and/or cannot be accurately estimated. In particular, this analysis excludes certain of our holdings of corporate securities and derivatives on corporate securities, and reflects only sensitivity toU.S. interest rates. Our analysis of interest rate risk is derived from Ellington's proprietary models as well as third-party information and analytics. Many assumptions have been made in connection with the calculations set forth in the table above and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes. For example, for each hypothetical immediate shift in interest rates, assumptions have been made as to the response of mortgage prepayment rates, the shape of the yield curve, and market volatilities of interest rates; each of the foregoing factors can significantly and adversely affect the fair value of our interest rate-sensitive instruments. The above analysis utilizes assumptions and estimates based on management's judgment and experience, and relies on financial models, which are inherently imperfect; in fact, different models can produce different results for the same securities. While the table above reflects the estimated impacts of immediate parallel interest rate increases and decreases on specific categories of instruments in our portfolio, we actively trade many of the instruments in our portfolio, and therefore our current or future portfolios may have risks that differ significantly from those of ourJune 30, 2020 portfolio estimated above. Moreover, the impact of changing interest rates on fair value can change significantly when interest rates change by a greater amount than the hypothetical shifts assumed above. Furthermore, our portfolio is subject to many risks other than interest rate risks, and these additional risks may or may not be correlated with changes in interest rates. For all of the foregoing reasons and others, the table above is for illustrative purposes only and actual changes in interest rates would likely cause changes in the actual fair value of our portfolio that would differ from those presented above, and such differences might be significant and adverse. See "-Special Note Regarding Forward-Looking Statements." 110
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