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OFFON

INVESCO MORTGAGE CAPITAL INC.

(IVR)
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INVESCO MORTGAGE CAPITAL : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. (form 10-Q)

05/05/2021 | 04:45pm EDT
In this quarterly report on Form 10-Q, or this "Quarterly Report," we refer to
Invesco Mortgage Capital Inc. and its consolidated subsidiaries as "we," "us,"
"our Company," or "our," unless we specifically state otherwise or the context
indicates otherwise. We refer to our external manager, Invesco Advisers, Inc.,
as our "Manager," and we refer to the indirect parent company of our Manager,
Invesco Ltd. together with its consolidated subsidiaries (which does not include
us), as "Invesco."
The following discussion should be read in conjunction with our condensed
consolidated financial statements and the accompanying notes to our condensed
consolidated financial statements, which are included in Item 1 of this Report,
as well as the information contained in our most recent Form 10-K filed with the
Securities and Exchange Commission (the "SEC").

Forward-Looking Statements
We make forward-looking statements in this Report and other filings we make with
the SEC within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and such statements are intended to be covered by the safe
harbor provided by the same. Forward-looking statements are subject to
substantial risks and uncertainties, many of which are difficult to predict and
are generally beyond our control. These forward-looking statements include
information about possible or assumed future results of our business, investment
strategies, financial condition, liquidity, results of operations, plans and
objectives. When we use the words "believe," "expect," "anticipate," "estimate,"
"plan," "intend," "project," "forecast" or similar expressions and future or
conditional verbs such as "will," "may," "could," "should," and "would," and any
other statement that necessarily depends on future events, we intend to identify
forward-looking statements, although not all forward-looking statements may
contain such words. Factors that could cause actual results to differ from those
expressed in our forward-looking statements include, but are not limited to:
•ongoing spread and economic and operational impact of the COVID-19 pandemic,
including but not limited to, the impact on the value, volatility, availability,
financing and liquidity of mortgage assets;
•our business and investment strategy;
•our investment portfolio and expected investments;
•our projected operating results;
•general volatility of financial markets and effects of governmental responses,
including actions and initiatives of the U.S. governmental agencies and changes
to U.S. government policies in response to the COVID-19 pandemic, mortgage loan
forbearance and modification programs, actions and initiatives of foreign
governmental agencies and central banks, monetary policy actions of the Federal
Reserve, including actions relating to its agency mortgage-backed securities
portfolio and our ability to respond to and comply with such actions,
initiatives and changes;
•the availability of financing sources, including our ability to obtain
additional financing arrangements and the terms of such arrangements;
•financing and advance rates for our target assets;
•changes to our expected leverage;
•our expected book value per common share;
•our intention and ability to pay dividends;
•interest rate mismatches between our target assets and our borrowings used to
fund such investments;
•the adequacy of our cash flow from operations and borrowings to meet our
short-term liquidity needs;
•our ability to maintain sufficient liquidity to meet our short-term liquidity
needs;
•changes in the credit rating of the U.S. government;
•changes in interest rates and interest rate spreads and the market value of our
target assets;
•changes in prepayment rates on our target assets;
•the impact of any deficiencies in loss mitigation of third parties and related
uncertainty in the timing of collateral disposition;
•our reliance on third parties in connection with services related to our target
assets;
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•disruption of our information technology systems;
•the impact of potential data security breaches or other cyber-attacks or other
disruptions;
•effects of hedging instruments on our target assets;
•rates of default or decreased recovery rates on our target assets;
•modifications to whole loans or loans underlying securities;
•the degree to which our hedging strategies may or may not protect us from
interest rate and foreign currency exchange rate volatility;
•the degree to which derivative contracts expose us to contingent liabilities;
•counterparty defaults;
•compliance with financial covenants in our financing arrangements;
•changes in governmental regulations, zoning, insurance, eminent domain and tax
law and rates, and similar matters and our ability to respond to such changes;
•our ability to maintain our qualification as a real estate investment trust for
U.S. federal income tax purposes;
•our ability to maintain our exception from the definition of "investment
company" under the Investment Company Act of 1940, as amended (the "1940 Act");
•availability of investment opportunities in mortgage-related, real
estate-related and other securities;
•availability of U.S. Government Agency guarantees with regard to payments of
principal and interest on securities;
•the market price and trading volume of our capital stock;
•availability of qualified personnel from our Manager and our Manager's
continued ability to find and retain such personnel;
•the relationship with our Manager;
•estimates relating to taxable income and our ability to continue to make
distributions to our stockholders in the future;
•estimates relating to fair value of our target assets and loan loss reserves;
•our understanding of our competition;
•changes to generally accepted accounting principles in the United States of
America ("U.S. GAAP");
•the adequacy of our disclosure controls and procedures and internal controls
over financial reporting; and
•market trends in our industry, interest rates, real estate values, the debt
securities markets or the general economy.
The forward-looking statements are based on our beliefs, assumptions and
expectations of our future performance, taking into account all information
currently available to us. You should not place undue reliance on these
forward-looking statements. These beliefs, assumptions and expectations can
change as a result of many possible events or factors, not all of which are
known to us. Some of these factors are described under the headings "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business." If a change occurs, our business,
financial condition, liquidity and results of operations may vary materially
from those expressed in our forward-looking statements. Any forward-looking
statement speaks only as of the date on which it is made. New risks and
uncertainties arise over time, and it is not possible for us 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.
The following discussion should be read in conjunction with our condensed
consolidated financial statements and the accompanying notes to our condensed
consolidated financial statements, which are included in this Report.
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Executive Summary
We are a Maryland corporation primarily focused on investing in, financing and
managing mortgage-backed securities ("MBS") and other mortgage-related assets.
Our objective is to provide attractive risk-adjusted returns to our
stockholders, primarily through dividends and secondarily through capital
appreciation. To achieve this objective, we currently invest in the following:
•Residential mortgage-backed securities ("RMBS") that are guaranteed by a
U.S. government agency such as the Government National Mortgage Association
("Ginnie Mae") or a federally chartered corporation such as the Federal National
Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage
Corporation ("Freddie Mac") (collectively "Agency RMBS");
•Commercial mortgage-backed securities ("CMBS") that are not guaranteed by a
U.S. government agency or a federally chartered corporation ("non-Agency
CMBS");
•RMBS that are not guaranteed by a U.S. government agency or a federally
chartered corporation ("non-Agency RMBS");
•To-be-announced securities forward contracts ("TBAs") to purchase Agency RMBS;
•Commercial mortgage loans; and
•Other real estate-related financing arrangements.
We have also historically invested in:
•CMBS that are guaranteed by a U.S. government agency such as Ginnie Mae or a
federally chartered corporation such as Freddie Mac or Fannie Mae (collectively
"Agency CMBS");
•Credit risk transfer securities that are unsecured obligations issued by
government-sponsored enterprises ("GSE CRT"); and
•Residential mortgage loans.
We are externally managed and advised by Invesco Advisers, Inc. (our "Manager"),
an indirect wholly-owned subsidiary of Invesco Ltd. ("Invesco").
We have elected to be taxed as a real estate investment trust ("REIT") for
U.S. federal income tax purposes under the provisions of the Internal Revenue
Code of 1986. To maintain our REIT qualification, we are generally required to
distribute at least 90% of our REIT taxable income to our stockholders annually.
We operate our business in a manner that permits our exclusion from the
definition of "Investment Company" under the 1940 Act.
Market Conditions
Macroeconomic factors that affect our business include interest rate spread
premiums, governmental policy initiatives, monetary policy initiatives,
residential and commercial real estate prices, credit availability, consumer
personal income and spending, corporate earnings, employment conditions,
financial conditions and inflation.
Financial conditions eased during the first quarter, as equities and most credit
sectors continued to react favorably to an uptick in economic activity brought
on by the massive government stimulus in response to the COVID-19 pandemic as
well as the successful rollout of vaccines. Equities began the year in positive
territory, with the S&P 500 and the NASDAQ gaining 5.8% and 2.8%, respectively.
The employment picture continued to improve during the quarter, as gains in
nonfarm payrolls averaged 539,000 per month, and the unemployment rate fell to
6.0% from 6.7% at year-end. Consumer activity was mixed during the quarter, as
consumer confidence measures continued to rise but spending and retail sales
numbers were very volatile. With the rollout of vaccinations continuing, we
remain cautiously optimistic about near-term gains in economic activity,
particularly given the amount of anticipated government stimulus.
The yield curve steepened dramatically during the first quarter as inflation
fears drove interest rates at the long end of the curve higher. The yield on the
10 year Treasury bond rose 83 basis points to 1.74%, while the yield on the 2
year Treasury note rose only 4 basis points to 0.16%. The short end of the yield
curve remains pinned close to zero as the Federal Open Market Committee ("FOMC")
targets the lower bound, the futures market has begun to price in increases to
the Federal Funds rate beginning late next year. The consumer price index
("CPI") was 2.6% at quarter-end, up from 1.4% at year-end, while the CPI
excluding food and energy was flat for the quarter. Commodity prices rose
sharply during the quarter, with West Texas Intermediate ("WTI") crude recording
a 21.7% increase and the Commodity Research Bureau ("CRB") commodity index
gaining 10.2%. Breakeven rates on inflation-protected Treasuries continued to
increase as investors price in the potential impact of the recent stimulus
measures and positive growth expectations. The inflation rate implied by 2 year
U.S. Treasury inflation-protected securities ("TIPS") rose 65 basis points to
2.66%, while the 5 year breakeven rate rose 64 basis points to 2.60%.
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The COVID-19 pandemic has negatively impacted most commercial real estate
property types. The lodging and retail sectors have been the most impacted due
to travel restrictions and accelerated growth in e-commerce. In the retail
sector, many tenants are finding it difficult to meet rent obligations and, in
some instances, are foregoing payments or seeking forbearance relief. Real
estate loans have experienced growing delinquencies and are at greater risk of
default which could impact the fundamental performance of some of our
investments. Despite fundamental challenges, CMBS risk premiums contracted in
the first quarter due to a modest new issuance supply and continued investor
demand.
While residential real estate fundamentals deteriorated significantly at the
onset of the pandemic, low mortgage rates and tight housing supply have driven a
significant recovery. Demographic trends and changes in housing preferences
shaped by the COVID-19 pandemic have combined with improved affordability to
generate robust demand, especially for single family homes. This strength is
also reflected in home price appreciation, which has accelerated rapidly over
the past three quarters. Meanwhile, credit spreads on residential mortgage
backed securities have largely recovered the widening that occurred at the onset
of the pandemic.
Nevertheless, many individual homeowners have been adversely impacted by the
economic consequences of the COVID-19 pandemic. The U.S. government has
responded by passing a number of fiscal stimulus measures and relief programs
for households and businesses directly or indirectly impacted by the virus. We
believe that stimulus payments and the provision of borrower relief including
forbearance and loan modifications has and will continue to substantially reduce
borrower defaults and loan losses relative to levels that would have likely
occurred without these actions.
Lower coupon Agency mortgages underperformed during the quarter, as robust
issuance and higher interest rate volatility offset continued strong demand via
the Federal Reserve and commercial banks. Prepayment speeds remained elevated
during the quarter, reflecting the low mortgage rate environment that was
prevalent in the second half of 2020 and into 2021. Expectations for future
prepayment speeds have declined, reflecting higher mortgage rates at
quarter-end. These lowered speed expectations led to lower premiums on specified
pool Agency collateral, as investors are less willing to pay for protection
against higher speeds as mortgage rates rise. The dollar roll environment
remained favorable, despite weakening modestly over the quarter. Although
relatively tight valuations and increased volatility represent headwinds for
Agency RMBS, slowing prepayment speeds and continued demand from the Federal
Reserve support the sector.
As we move into the second quarter, investors are focused on the pace of the
recovery and the implementation of COVID-19 vaccines. Concerns around the
potential for inflationary pressures, brought on by the unprecedented stimulus
and anticipated sharp economic recovery also remain. Our expectation is that
growth in the U.S. will remain robust as the economy continues to reopen over
the course of the year, and that inflation will remain subdued in the near-term.
Proposed Changes to LIBOR
In 2017, the U.K. Financial Conduct Authority (the "FCA"), which regulates
LIBOR, announced that the FCA will no longer persuade or compel banks to submit
rates for the calculation of the LIBOR benchmark after 2021. This announcement
indicates that the continuation of LIBOR will not be guaranteed after 2021. The
Alternative Reference Rates Committee ("ARRC"), which was convened by the
Federal Reserve Board and the New York Fed to help ensure a successful
transition from LIBOR, has proposed that the Secured Overnight Financing Rate
("SOFR") is the rate that represents best practice as the alternative to LIBOR
for use in derivatives and other financial contracts that are currently indexed
to LIBOR. ARRC has proposed a paced market transition plan to SOFR from LIBOR,
and organizations are currently working on industry wide and company specific
transition plans as it relates to derivatives and cash markets exposed to LIBOR.
Further, on March 5, 2021, the FCA announced that December 31, 2021 will be the
cessation date for 1-week & 2-month tenors of USD-LIBOR. The FCA also set June
30, 2023 as the cessation date for the other five tenors (overnight, 1-month,
3-month, 6-month and 12-month) of USD-LIBOR. Additionally, this FCA announcement
constitutes an index cessation event under the International Swaps and
Derivatives Association Inc.'s ("ISDA") IBOR Fallbacks Supplement and the ISDA
2020 IBOR Fallbacks Protocol, as well as the ARRC's fallback language for
non-consumer cash products, giving the market clarity on the spread adjustments
to alternative reference rate based fallbacks for all EUR-, CHF-, GBP-, JPY- and
USD-LIBOR settings.
On April 6, 2021, New York State (NYS) put into law legislation to help address
challenges surrounding legacy LIBOR contracts that have no effective means to
transition away from LIBOR and to incentivize the selection of SOFR-based
fallback rates in other contracts. The law applies to existing USD-LIBOR
contracts governed by NYS law that use LIBOR as a benchmark and contain no
fallback provisions or contain fallback provisions that result in a benchmark
replacement that is based in any way on any LIBOR value. For these in scope
contracts, the NYS law provides that on and after "LIBOR Replacement Date" (the
date that USD LIBOR ceases to be published or to be representative), USD-LIBOR
is replaced by operation of law with the relevant SOFR-based rate plus the
spread adjustment recommended for that contract type by the US Federal Reserve
or the ARRC, and any LIBOR-based fallback provisions are permanently overridden.
Additionally, the law applies to existing USD LIBOR contracts governed by NYS
law that contain fallback provisions that permit or require a party to select a
benchmark replacement that is based in any way on any LIBOR value or otherwise
in its discretion. For such contracts, the law authorizes and safe harbors the
selection by such party of the relevant SOFR-based rate plus the spread
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adjustment recommended for that contract type by the Federal Reserve or the ARRC
to apply on and after the "LIBOR Replacement Date".
SOFR is an overnight rate unlike LIBOR which is a forward-looking term rate,
making SOFR an inexact replacement for LIBOR. There is currently no perfect way
to create robust, forward-looking, SOFR term rates. Note that the ARRC has
announced that they will not recommend a forward-looking SOFR term rate by
mid-2021, as previously announced, due to insufficient development of the SOFR
derivatives markets. Market participants are still considering how various types
of financial instruments and securitization vehicles should react to a
discontinuation of LIBOR. It is possible that not all of our assets and
liabilities will transition away from LIBOR at the same time or to the same
alternative reference rate, in each case increasing the difficulty of hedging.
Switching existing financial instruments and hedging transactions from LIBOR to
SOFR requires calculations of a spread and there is no assurance that the spread
adjustments will avoid negative financial impacts on our portfolio at the time
of transition.
We have material contracts that are indexed to LIBOR and are monitoring this
activity and evaluating the related risks. However, it is not possible to
predict the effect of any of these developments, and any future initiatives to
regulate, reform or change the manner of administration of LIBOR could result in
adverse consequences to the rate of interest payable and receivable on, market
value of and market liquidity for LIBOR-based financial instruments. We do not
currently intend to amend our 7.75% Fixed-to-Floating Series B Cumulative
Redeemable Preferred Stock or our 7.50% Fixed-to-Floating Series C Cumulative
Redeemable Preferred Stock to change the existing USD-LIBOR cessation fallback
language. Our Series B and Series C Preferred Stock each become callable at the
time the stock begins to pay a USD-LIBOR-based rate. Should we choose to call
the Series B or Series C Preferred Stock in order to avoid a dispute over the
results of the USD-LIBOR fallbacks for that class, we may be forced to raise
additional funds at an unfavorable time.
In October 2019, the IRS and Treasury proposed regulations that are expected to
provide taxpayers relief from adverse impacts resulting from the transition away
from LIBOR to an alternative reference rate. The proposed regulations make clear
that a change in the reference rate (and associated alterations to payment
terms) of a financial instrument is generally not considered a taxable event,
provided the fair value of the modified instrument is substantially equivalent
to the fair value of the unmodified instrument.
The Financial Accounting Standards Board has also issued accounting guidance
that provides optional expedients and exceptions to contracts, hedging
relationships and other transactions impacted by LIBOR transition if certain
criteria are met. The guidance can be applied as of January 1, 2020. We will
evaluate our contracts that are eligible for modification relief and may apply
the elections prospectively as needed. We are currently evaluating what impact
the guidance will have on our consolidated financial statements.
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Investment Activities The table below shows the composition of our investment portfolio as of March 31, 2021, December 31, 2020 and March 31, 2020:

                                                                                        As of
$ in thousands                                       March 31, 2021               December 31, 2020               March 31, 2020
Agency RMBS:
30 year fixed-rate, at fair value                       8,997,918                     8,050,866                     1,421,162
15 year fixed-rate, at fair value                               -                             -                        71,166
Hybrid ARM, at fair value                                       -                             -                         2,672
Agency CMO, at fair value                                       -                             -                       300,535
Agency CMBS, at fair value                                      -                             -                     2,278,027
Non-Agency CMBS, at fair value                             91,250                       109,583                     2,869,051
Non-Agency RMBS, at fair value                             10,574                        11,733                       568,081
GSE CRT, at fair value                                          -                             -                       534,114
Loan participation interest, at fair value                      -                             -                        21,577
Commercial loan, at fair value                             20,000                        23,098                        22,577
Investments in unconsolidated ventures                     15,766                        16,408                        21,088
Subtotal                                                9,135,508                     8,211,688                     8,110,050
TBAs, at implied cost basis (1)                         1,548,066                     1,772,211                             -
Total investment portfolio, including TBAs             10,683,574                     9,983,899                     8,110,050


(1)TBAs that we do not intend to physically settle on the contractual settlement
date are accounted for as derivative financial instruments and recorded on our
consolidated balance sheets at net carrying value, which represents the
difference between the fair market value and the implied cost basis of the TBAs.
Refer to Note 8 "Derivatives and Hedging Activities" in Part I. Item 1 of this
report on Form 10-Q.
To capitalize on the sharp increase in interest rates and lower valuations on
investment opportunities during the three months ended March 31, 2021, we sold
$5.5 billion of lower yielding Agency RMBS and purchased $7.0 billion of higher
yielding Agency RMBS. Purchases were funded with proceeds from the sales,
paydowns of securities and by leveraging proceeds from the issuance of common
stock.
As of March 31, 2021, our holdings of 30 year fixed-rate Agency RMBS represented
approximately 84% of our total investment portfolio, including TBAs, versus 81%
as of December 31, 2020 and 18% as of March 31, 2020. We sold substantially all
of our Agency RMBS portfolio in the first half of 2020 to generate liquidity and
reduce leverage. We resumed investing in 30 year fixed-rate Agency RMBS in July
2020 and began investing in TBAs in the third quarter of 2020. Our Agency RMBS
holdings as of March 31, 2021 consisted primarily of specified pools with coupon
distributions as shown in the table below.
$ in thousands                     Fair Value        Percentage
2.0%                             4,135,167               46.0  %
2.5%                             4,255,013               47.2  %
3.0%                               607,738                6.8  %
Total Agency RMBS                8,997,918              100.0  %


Our purchases of Agency RMBS have been primarily focused on specified pools with
prepayment protection, as low mortgage rates and a robust housing market have
increased borrower incentives to prepay their mortgage loans. We seek to
mitigate the negative impact of prepayments on our investment portfolio by
purchasing specified pools with characteristics that diminish borrower incentive
to prepay, such as a lower loan balance, higher loan-to-value ("LTV") ratio,
lower FICO score, higher percentage of non-owner occupied loans (investment and
vacation properties) and newly originated loans. In addition, we focus a
significant amount of purchases in specified pools that have higher geographic
concentrations in states that exhibit slower prepayments such as New York,
Florida and Texas.
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We invest in TBAs as an alternative means of investing in and financing Agency
RMBS. As of March 31, 2021, the implied cost basis of TBAs represented
approximately 14% of our total investment portfolio versus 18% as of
December 31, 2020. Our investments consist of 30 year Agency RMBS TBAs with
coupons that range from 2.0% to 2.5% in conventional and Ginnie Mae collateral.
We maintain a meaningful allocation to TBAs given attractive implied financing
rates in the Agency RMBS TBA dollar roll market. Implied financing rates in the
dollar roll market were substantially below those available in the repurchase
market due to the magnitude and persistence of the Federal Reserve's MBS
purchase program, which began to increase holdings in March of 2020. We expect
the purchase program to continue in 2021, as the Federal Reserve views the
program as a key component of its stated objectives.
We sold all of our Agency CMBS holdings during the first half of 2020. Agency
CMBS represented approximately 28% of our investment portfolio as of March 31,
2020. We historically focused our Agency CMBS investments in securities issued
by Freddie Mac, Fannie Mae and Ginnie Mae that had characteristics that reduced
prepayment risk.
As of March 31, 2021 and December 31, 2020 our holdings of non-Agency CMBS
represented approximately 1% of our total investment portfolio, including TBAs,
versus 35% as of March 31, 2020. Our non-Agency CMBS portfolio is collateralized
by loans secured by various property types located across the United States
including office, retail, multifamily, industrial warehouses and hotels. The
largest property geographic locations are in Texas, California, New York,
Illinois and Florida. Most of our non-Agency CMBS portfolio is comprised of
fixed-rate securities that are rated investment grade by a nationally recognized
statistical rating organization. Approximately 68% of non-Agency CMBS are rated
single-A (or equivalent) or higher by a nationally recognized statistical rating
organization as of March 31, 2021. Further, approximately 49% of non-Agency CMBS
are rated double-A (or equivalent) or higher by a nationally recognized
statistical rating organization as of March 31, 2021.
As of March 31, 2021 and December 31, 2020, our holdings of non-Agency RMBS
represented less than 1% of our total investment portfolio, including TBAs,
versus 7% as of March 31, 2020. We historically held non-Agency RMBS securities
collateralized by prime and Alt-A loans and invested in re-securitizations of
real estate mortgage investment conduit ("Re-REMIC") RMBS and securitizations of
reperforming mortgage loans.
We did not hold any GSE CRTs as of March 31, 2021 or December 31, 2020. Our
holdings of GSE CRT represented approximately 7% as of March 31, 2020. GSE CRTs
are unsecured general obligations of the GSEs that are structured to provide
credit protection to the issuer with respect to defaults and other credit events
within pools of mortgage loans that collateralize MBS issued and guaranteed by
the GSEs.
As of March 31, 2021, we held an investment in one commercial real estate
mezzanine loan that is due in 2022 and has a loan-to-value ratio of
approximately 78.9%.
As of March 31, 2021, we held investments in two unconsolidated ventures that
are managed by an affiliate of our Manager. The unconsolidated ventures invest
in our target assets.
Financing and Other Liabilities
We have historically used repurchase agreements to finance the majority of our
target assets and expect to continue to use repurchase agreements to finance
Agency investments in the future. Repurchase agreements are generally settled on
a short-term basis, usually from one to six months, and bear interest at rates
that have historically moved in close relationship to LIBOR.
We also used secured loans from the FHLBI to finance a portion of our investment
portfolio. We repaid our secured loans during 2020 with proceeds from sales of
assets that collateralized the secured loans. We terminated our membership in
FHLBI in the third quarter of 2020.
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The following table presents the amount of collateralized borrowings outstanding
under repurchase agreements and secured loans as of the end of each quarter, the
average amount outstanding during the quarter and the maximum balance
outstanding during the quarter:
$ in thousands                                                         

Collateralized borrowings under repurchase agreements and secured loans

                                                                                             Average quarterly balance
Quarter Ended                                       Quarter-end balance                                 (1)                                  Maximum balance (2)
March 31, 2020                                            7,637,746                                     16,673,939                                 23,132,234
June 30, 2020                                               740,000                                        983,599                                  1,373,296
September 30, 2020                                        5,243,288                                      3,373,356                                  5,243,288
December 31, 2020                                         7,228,699                                      6,883,773                                  7,237,496
March 31, 2021                                            8,240,887                                      8,359,010                                  8,708,686

(1)Average quarterly balance for each period is based on month-end balances. (2)Amount represents the maximum borrowings at month-end during each of the respective periods.


We have committed to invest up to $125.4 million in unconsolidated ventures that
are sponsored by an affiliate of our Manager. As of March 31, 2021, $118.7
million of our commitment to these unconsolidated ventures has been called. We
are committed to fund $6.7 million in additional capital to fund future
investments and cover future expenses should they occur.
Hedging Instruments
We enter into interest rate swap agreements that are designed to mitigate the
effects of increases in interest rates for a portion of our borrowings. Under
these swap agreements, we pay fixed interest rates and receive floating interest
rates indexed off of one- or three-month LIBOR.
We actively manage our swap portfolio by terminating and entering into new swaps
as the size and composition of our investment portfolio changes. During the
three months ended March 31, 2021, we terminated existing swaps with a notional
amount of $500.0 million and entered into new swaps with a notional amount of
$500.0 million to hedge repurchase agreement debt associated with purchases of
Agency RMBS. Daily variation margin payment for interest rate swaps is
characterized as settlement of the derivative itself rather than collateral and
is recorded as a realized gain or loss in our condensed consolidated statement
of operations. We realized a net gain of $327.5 million on interest rate swaps
during the three months ended March 31, 2021 primarily due to rising interest
rates.
We enter into currency forward contracts to help mitigate the potential impact
of changes in foreign currency exchange rates on investments denominated in
foreign currencies. As of March 31, 2021, we had €13.9 million or $16.9 million
(December 31, 2020: €27.8 million or $33.1 million) of notional amount of
forward contracts denominated in Euro related to our investment in an
unconsolidated venture. During the three months ended March 31, 2021, we settled
currency forward contracts of €27.8 million or $33.1 million (March 31, 2020:
€20.8 million or $23.1 million) in notional amount and realized a net loss of
$539,000 (March 31, 2020: $484,000 net gain).
Capital Activities
On February 4, 2021, we completed a public offering of 27,600,000 shares of
common stock at the price of $3.75 per share. Total net proceeds were
approximately $103.1 million after deducting offering expenses.
As of March 31, 2021, we may sell up to 22,060,000 shares of our common stock
from time to time in at-the-market or privately negotiated transactions under an
equity distribution agreement with a placement agent. We sold 15,550,000 shares
of common stock for proceeds of $57.8 million, net of approximately $831,000 in
commissions and fees, under our equity distribution agreement during the three
months ended March 31, 2021. We did not sell any shares of common stock under
equity distribution agreements during the three months ended March 31, 2020.
For information on dividends declared during the three months ended March 31,
2021 and 2020, see Note 12 - "Stockholders' Equity" of our condensed
consolidated financial statements in Part I. Item 1 of this report on Form 10-Q.
During the three months ended March 31, 2021, we did not repurchase any shares
of our common stock.
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Book Value per Common Share
We calculate book value per common share as follows:
                                                                                      As of
$ in thousands except per share amounts                           March 31, 2021              December 31, 2020
Numerator (adjusted equity):
Total equity                                                        1,481,932                     1,367,158
Less: Liquidation preference of Series A Preferred Stock             (140,000)                     (140,000)
Less: Liquidation preference of Series B Preferred Stock             (155,000)                     (155,000)
Less: Liquidation preference of Series C Preferred Stock             (287,500)                     (287,500)
Total adjusted equity                                                 899,432                       784,658

Denominator (number of shares):
Common stock outstanding                                              246,398                       203,222

Book value per common share                                              3.65                          3.86


Our book value per common share decreased 5.4% as of March 31, 2021 compared to
December 31, 2020 as higher interest rates and an increase in volatility led to
wider interest rate spreads on our 30 year Agency RMBS holdings. In addition, a
sharp increase in mortgage rates and reduced investor demand for prepayment
protection resulted in lower valuation premiums on our Agency RMBS specified
pools. The benchmark U.S. treasury rate rose 83 basis points to 1.74% as of
March 31, 2021. Refer to Item 3. "Quantitative and Qualitative Disclosures About
Market Risk" for interest rate risk and its impact on fair value.
Critical Accounting Policies
There have been no significant changes to our critical accounting policies that
are disclosed in our most recent Form 10-K for the year ended December 31, 2020.
Recent Accounting Standards
See Part I, Item 1, Financial Statements Note 2 - "Accounting Pronouncements
Recently Issued".

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Results of Operations
The table below presents certain information from our condensed consolidated
statements of operations for the three months ended March 31, 2021 and 2020.
                                                                                Three Months Ended March 31,
$ in thousands, except share data                                                                          2021                       2020
Interest income
Mortgage-backed and credit risk transfer securities                                                            39,434                  185,536
Commercial and other loans                                                                                        576                    1,163
Total interest income                                                                                          40,010                  186,699
Interest expense
Repurchase agreements (1)                                                                                      (1,660)                  79,042
Secured loans                                                                                                       -                    6,646
Total interest expense                                                                                         (1,660)                  85,688
Net interest income                                                                                            41,670                  101,011
Other income (loss)
Gain (loss) on investments, net                                                                              (331,857)                (755,483)
(Increase) decrease in provision for credit losses                                                                938                        -
Equity in earnings (losses) of unconsolidated ventures                                                            (94)                     170
Gain (loss) on derivative instruments, net                                                                    286,961                 (910,779)
Realized and unrealized credit derivative income (loss), net                                                        -                  (33,052)
Net gain (loss) on extinguishment of debt                                                                           -                   (4,806)
Other investment income (loss), net                                                                               (16)                     803
Total other income (loss)                                                                                     (44,068)              (1,703,147)

Expenses

Management fee - related party                                                                                  4,884                   10,953
General and administrative                                                                                      1,993                    3,103
Total expenses                                                                                                  6,877                   14,056

Net income (loss) attributable to Invesco Mortgage Capital, Inc.

                                                                                                           (9,275)              (1,616,192)

Dividends to preferred stockholders                                                                            11,107                   11,107
Net income (loss) attributable to common stockholders                                                         (20,382)              (1,627,299)

Net income (loss) per share: Net income (loss) attributable to common stockholders Basic

                                                                                                           (0.09)                  (10.38)
Diluted                                                                                                         (0.09)                  (10.38)
Weighted average number of shares of common stock:
Basic                                                                                                     223,954,989              156,771,279
Diluted                                                                                                   223,954,989              156,771,279


(1)Negative interest expense on repurchase agreements for the three months ended
March 31, 2021 consists of $3.7 million of current period interest expense on
repurchase agreements and $5.4 million of amortization of net deferred gains on
de-designated interest rate swaps. For further information on amortization of
amounts classified in accumulated other comprehensive income before we
discontinued hedge accounting, see Note 8 - "Derivatives and Hedging Activities"
and Note 12 - "Stockholders' Equity" in Part I. Item 1. of this report on Form
10-Q.
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Interest Income and Average Earning Asset Yields
The table below presents information related to our average earning assets and
earning asset yields for the three months ended March 31, 2021 and 2020.
                                                                     Three Months Ended March 31,
$ in thousands                                                                           2021                       2020
Average earning assets (1)                                                               9,330,134                  17,837,749
Average earning asset yields (2)                                                              1.72  %                     4.19  %


(1)Average balances for each period are based on weighted month-end balances.
(2)Average earning asset yields for the period were calculated by dividing
interest income, including amortization of premiums and discounts, by average
earning assets based on the amortized cost of the investments. All yields are
annualized.
Our primary source of income is interest earned on our investment portfolio. We
had average earning assets of approximately $9.3 billion for the three months
ended March 31, 2021 (March 31, 2020: $17.8 billion). Average earning assets
decreased for the three months ended March 31, 2021 compared to 2020 as we sold
a substantial portion of our MBS and GSE CRT portfolio in the first half of 2020
to generate liquidity and reduce leverage due to the financial market disruption
caused by the COVID-19 pandemic.
We earned total interest income of $40.0 million for the three months ended
March 31, 2021 (March 31, 2020: $186.7 million). Our interest income includes
coupon interest and net premium amortization on MBS and GSE CRTs as well as
interest income on commercial and other loans as shown in the table below.
                                                                                 Three Months Ended March 31,
$ in thousands                                                                                              2021                   2020
Interest Income
MBS and GSE CRT - coupon interest                                                                             51,490              202,109
MBS and GSE CRT - net premium amortization                                                                   (12,056)             (16,573)
MBS and GSE CRT - interest income                                                                             39,434              185,536
Commercial and other loans                                                                                       576                1,163
Total interest income                                                                                         40,010              186,699


MBS and GSE CRT interest income decreased $146.1 million for the three months
ended March 31, 2021 compared to 2020 primarily due to a $150.6 million decrease
in coupon interest reflecting lower average earnings assets and a 247 basis
point decrease in average earning asset yields. Average earnings asset yields
decreased due to a change in portfolio composition. Almost all of our investment
portfolio (excluding TBAs) was invested in Agency RMBS as of March 31, 2021. For
further details on the composition of our investment portfolio as of March 31,
2021 and 2020, see the discussion under Investment Activities above in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
Interest income on our commercial and other loans decreased $587,000 during the
three months ended March 31, 2021 compared to 2020 primarily due to the sale of
our loan participation interest in April 2020.
Prepayment Speeds
Our RMBS portfolio (and previously our GSE CRT portfolio) is subject to inherent
prepayment risk primarily driven by changes in interest rates, which impacts the
amount of premium and discount on the purchase of these securities that is
recognized into interest income. Expected future prepayment speeds are estimated
on a quarterly basis. Generally, in an environment of falling interest rates,
prepayment speeds will increase as homeowners are more likely to prepay their
existing mortgage and refinance into a lower borrowing rate. If the actual
prepayment speed during the period is faster than estimated, the amortization on
securities purchased at a premium to par value will be accelerated, resulting in
lower interest income recognized. Conversely, for securities purchased at a
discount to par value, interest income will be reduced in periods where
prepayment speeds were slower than expected.
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The following table presents net premium amortization recognized on our MBS and GSE CRT portfolio for the three months ended March 31, 2021 and 2020.

                                                                             Three Months Ended March 31,
$ in thousands                                                                                          2021                   2020
Agency RMBS                                                                                              (12,484)             (20,913)
Agency CMBS                                                                                                    -               (1,666)
Non-Agency CMBS                                                                                              878                5,058
Non-Agency RMBS                                                                                             (450)               2,698
GSE CRT                                                                                                        -               (1,750)
Net (premium amortization) discount accretion                                                            (12,056)             (16,573)


Net premium amortization decreased $4.5 million for the three months ended
March 31, 2021 compared to the same period in 2020 primarily due to sales of
assets purchased at premiums and slower prepayment speeds on Agency RMBS
purchased during 2020 and 2021.
Our interest income is subject to interest rate risk. Refer to Item 3.
"Quantitative and Qualitative Disclosures about Market Risk" for more
information relating to interest rate risk and its impact on our operating
results.
Interest Expense and Cost of Funds
The table below presents the components of interest expense for the three months
ended March 31, 2021 and 2020:
                                                                            Three Months Ended March 31,
$ in thousands                                                                                         2021                   2020
Interest Expense
Interest expense on repurchase agreement borrowings                                                       3,708               89,109

Amortization of net deferred (gain) loss on de-designated interest rate swaps

                                                                                      (5,368)             (10,067)
Repurchase agreements interest expense                                                                   (1,660)              79,042
Secured loans                                                                                                 -                6,646

Total interest expense                                                                                   (1,660)              85,688


Our interest expense on repurchase agreement borrowings decreased $85.4 million
for the three months ended March 31, 2021 compared to 2020 due to lower average
borrowings and a lower average cost of funds reflecting decreases in the Federal
Funds interest rate.
Our repurchase agreement interest expense as reported in our condensed
consolidated statement of operations includes amortization of net deferred gains
and losses on de-designated interest rate swaps as summarized in the table
above. Amortization of net deferred gains on de-designated interest rate swaps
decreased our total interest expense by $5.4 million during the three months
ended March 31, 2021 and $10.1 million during the three months ended March 31,
2020. Amounts recorded in AOCI before we discontinued cash flow hedge accounting
for our interest rate swaps are reclassified to interest expense on repurchase
agreements on the condensed consolidated statements of operations as interest is
accrued and paid on the related repurchase agreements over the remaining life of
the interest rate swap agreements. We increased the amount of gains and losses
reclassified as a decrease to interest expense during the three months ended
March 31, 2020 by $4.2 million because it was probable that the original
forecasted repurchase agreement transactions would not occur by the end of the
originally specified time period. During the next twelve months, we estimate
that $21.8 million of net deferred gains on de-designated interest rate swaps
will be reclassified from other comprehensive income and recorded as a decrease
to interest expense.
We repaid our secured loans in the third quarter of 2020 and did not incur
interest expense for secured loans during the three months ended March 31, 2021.
For the three months ended March 31, 2020, the weighted average borrowing rate
on our secured loans was 1.83%.
Our total interest expense during the three months ended March 31, 2021
decreased $87.3 million from the same period in 2020 primarily due to the $92.0
million decrease in interest expense on repurchase agreements borrowings and
secured loans in the 2021 period as discussed above.
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The table below presents information related to our borrowings and cost of funds for the three months ended March 31, 2021 and 2020:

                                                                      Three Months Ended March 31,
$ in thousands                                                                            2021                       2020
Total average borrowings (1)                                                              8,347,354                  16,531,997
Maximum borrowings during the period (2)                                                  8,708,686                  23,132,234
Cost of funds (3)                                                                             (0.08) %                     2.07  %


(1)Average borrowings for each period are based on weighted month-end balances.
(2)Amount represents the maximum borrowings at month-end during each of the
respective periods.
(3)Average cost of funds is calculated by dividing annualized interest expense
including amortization of net deferred gain (loss) on de-designated interest
rate swaps by our average borrowings.
Total average borrowings decreased $8.2 billion in the three months ended March
31, 2021 compared to 2020 primarily because we repaid repurchase agreements in
the first half of 2020 with proceeds from asset sales due to the financial
market disruption caused by the COVID-19 pandemic. Average borrowings also
decreased because we repaid $1.65 billion of secured loans during 2020. Our
average cost of funds decreased 215 basis points for three months ended March
31, 2021 versus 2020 primarily due to decreases in the Federal Funds rate since
the beginning of 2020.
Net Interest Income
The table below presents the components of net interest income for the three
months ended March 31, 2021 and 2020:
                                                                        Three Months Ended March 31,
$ in thousands                                                                              2021                     2020
Interest Income
Mortgage-backed and credit risk transfer securities                                           39,434                  185,536
Commercial and other loans                                                                       576                    1,163
Total interest income                                                                         40,010                  186,699
Interest Expense
Interest expense on repurchase agreement borrowings                                            3,708                   89,109

Amortization of net deferred (gain) loss on de-designated interest rate swaps

                                                                           (5,368)                 (10,067)
Repurchase agreements interest expense                                                        (1,660)                  79,042
Secured loans                                                                                      -                    6,646

Total interest expense                                                                        (1,660)                  85,688
Net interest income                                                                           41,670                  101,011
Net interest rate margin                                                                        1.80  %                  2.12  %


Our net interest income, which equals interest income less interest expense,
totaled $41.7 million for the three months ended March 31, 2021 (March 31, 2020:
$101.0 million). The decrease in net interest income for the three months ended
March 31, 2021 was primarily due to the sale of MBS and GSE CRTs in the first
half of 2020 as previously discussed.
Our net interest rate margin, which equals the yield on our average assets for
the period less the average cost of funds for the period, was 1.80% for the
three months ended March 31, 2021 (March 31, 2020: 2.12%). The decrease in net
interest rate margin for the three months ended March 31, 2021 compared to the
same period in 2020 was primarily due to the change in our portfolio
composition, including related repurchase agreements borrowings, and decreases
in the Federal Funds rate that had a greater impact on our average cost of funds
than on our average asset yields. Our cost of funds on all of our borrowings is
influenced by changes in short term interest rates, whereas substantially all of
the Company's investments were fixed-rate assets as of March 31, 2021.
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Gain (Loss) on Investments, net
The table below summarizes the components of gain (loss) on investments, net for
the three months ended March 31, 2021 and 2020:
                                                                            Three Months Ended March 31,
$ in thousands                                                                                         2021                    2020
Net realized gains (losses) on sale of investments                                                      (116,847)               (4,285)

Impairment of investments the Company intends to sell or more likely than not will be required to sell before recovery of amortized cost basis and other impairments

                                                         -               (78,834)

Net unrealized gains (losses) on MBS and GSE CRT accounted for under the fair value option

                                                                         (211,912)             (666,872)

Net unrealized gains (losses) on commercial loan and loan participation interest

                                                                                    (3,098)               (5,492)
Total gain (loss) on investments, net                                                                   (331,857)             (755,483)


During the three months ended March 31, 2021, we sold MBS and GSE CRTs for cash
proceeds of $5.5 billion (March 31, 2020: $16.2 billion) and realized net losses
of $116.8 million (March 31, 2020: net losses of $4.3 million). We sold lower
yielding Agency RMBS during the three months ended March 31, 2021 and purchased
higher yielding Agency RMBS to capitalize on the sharp increase in interest
rates and lower valuations on investment opportunities during the quarter. We
sold securities during the three months ended March 31, 2020 to generate
liquidity and reduce leverage in response to the financial market disruption
caused by the COVID-19 pandemic. A portion of these sales were involuntary
liquidations at significantly distressed market prices as certain of our
repurchase agreement counterparties seized and sold our securities when we were
unable to meet margin calls in March 2020.
We did not record any impairment during the three months ended March 31, 2021
because we intended to sell or more likely than not would be required to sell
the securities before recovery of amortized cost basis. We recorded $78.8
million of impairment on non-Agency RMBS and CMBS securities during the three
months ended March 31, 2020 because we intended to sell or more likely than not
would be required to sell the securities before recovery of amortized cost
basis.
We have elected the fair value option for all of our MBS purchased on or after
September 1, 2016 and our GSE CRTs purchased on or after August 24, 2015. Before
September 1, 2016, we had also elected the fair value option for our non-Agency
RMBS interest-only securities. Under the fair value option, changes in fair
value are recognized in income in the condensed consolidated statements of
operations and are reported as a component of gain (loss) on investments, net.
As of March 31, 2021, $9.0 billion (December 31, 2020: $8.1 billion) or 99%
(December 31, 2020: 99%) of our MBS and GSE CRT are accounted for under the fair
value option.
We recorded net unrealized losses on our MBS and GSE CRT portfolio accounted for
under the fair value option of $211.9 million in the three months ended March
31, 2021 compared to net unrealized losses of $666.9 million in the three months
ended March 31, 2020. Net unrealized losses in three months ended March 31, 2021
reflect wider interest rate spreads on our Agency assets as a sharp increase in
mortgage rates and reduced investor demand for prepayment protection resulted in
lower valuation premiums on our Agency RMBS specified pools. Net unrealized
losses in the three months ended March 31, 2020 reflect lower interest rates and
wider interest rate spreads on our Agency and non-Agency assets.
We recorded unrealized losses of $3.1 million and $1.7 million on our commercial
loan in the three months ended March 31, 2021 and 2020, respectively. We value
our commercial loan based upon a valuation from an independent pricing service.
We recorded an unrealized loss of $3.8 million on our loan participation
interest in the three months ended March 31, 2020. We sold our loan
participation interest on April 1, 2020.
(Increase) Decrease in Provision for Credit Losses
As of March 31, 2021, $98.2 million of our MBS are classified as
available-for-sale and subject to evaluation for credit losses (December 31,
2020: $116.9 million). As of December 31, 2020, we had established a $1.8
million allowance for credit losses on a single non-Agency CMBS based on a
comparison of the security's amortized cost basis to discounted expected cash
flows. We recorded a $938,000 decrease in the provision for credit losses for
this security during the three months ended March 31, 2021 because the valuation
for the security improved. We did not record any provisions for credit losses
the during three months ended March 31, 2020. Refer to Note 4 - "Mortgage-Backed
Securities and Credit Risk Transfer Securities" of our condensed consolidated
financial statements included in Part I. Item 1 of this Report for additional
information on our allowance for credit losses.
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Equity in Earnings (Losses) of Unconsolidated Ventures
For the three months ended March 31, 2021, we recorded equity in losses of
unconsolidated ventures of $94,000 (March 31, 2020: equity in earnings of
$170,000). We recorded equity in losses for the three months ended March 31,
2021 primarily due to realized and unrealized losses on the underlying portfolio
investments. We recorded equity in earnings for the three months ended March 31,
2020 primarily due to realized and unrealized gains on the underlying portfolio
investments.
Gain (Loss) on Derivative Instruments, net
We record all derivatives on our condensed consolidated balance sheets at fair
value. Changes in the fair value of our derivatives are recorded in gain (loss)
on derivative instruments, net in our condensed consolidated statements of
operations. Net interest paid or received under our interest rate swaps is also
recognized in gain (loss) on derivative instruments, net in our condensed
consolidated statements of operations.
The tables below summarize our realized and unrealized gain (loss) on derivative
instruments, net for the following periods:






$ in thousands                                                             

Three Months Ended March 31, 2021

                                           Realized gain
              Derivative                     (loss) on                    Contractual net                                                         Gain (loss) on
           not designated as                derivative                   interest income                                                     derivative instruments,
          hedging instrument             instruments, net                   (expense)                   Unrealized gain (loss), net                    net
Interest Rate Swaps                           327,527                            (4,549)                           21,081                               344,059
Interest Rate Swaptions                          (553)                                -                                 -                                  (553)
Currency Forward Contracts                       (539)                                -                             1,255                                   716
TBAs                                          (44,185)                                -                           (13,076)                              (57,261)
Total                                         282,250                            (4,549)                            9,260                               286,961



$ in thousands                                                             

Three Months Ended March 31, 2020

             Derivative              Realized gain (loss)               Contractual net
         not designated as              on derivative                  interest income                                                     Gain (loss) on derivative
         hedging instrument            instruments, net                  
(expense)                   Unrealized gain (loss), net              instruments, net
Interest Rate Swaps                        (904,704)                           11,924                           (18,532)                              (911,312)

Currency Forward Contracts                      484                                 -                                49                                    533

Total                                      (904,220)                           11,924                           (18,483)                              (910,779)



During the three months ended March 31, 2021, we terminated existing swaps with
a notional amount of $500.0 million and entered into new swaps with a notional
amount of $500.0 million to hedge repurchase agreement debt associated with
purchases of Agency RMBS. We realized a net gain of $327.5 million for the three
months ended March 31, 2021 on interest rate swaps primarily due to rising
interest rates. During the three months ended March 31, 2020, we terminated all
of our outstanding interest rate swaps as we repositioned our portfolio in
response to unprecedented market conditions associated with the COVID-19
pandemic. Our exposure to interest rate risk decreased as we sold Agency assets
and repaid borrowings. We realized a net loss of $904.7 million for the three
months ended March 31, 2020 on interest rate swaps primarily due to falling
interest rates.
We resumed entering into interest rate swaps in July 2020 as we resumed
investing in Agency RMBS and financing our investments with repurchase
agreements. As of March 31, 2021, we had $8.2 billion of repurchase agreement
borrowings with a weighted average remaining maturity of 18 days. We typically
refinance each repurchase agreement at market interest rates upon maturity. We
use interest rate swaps to manage our exposure to changing interest rates and
add stability to interest rate expense.
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As of March 31, 2021 and December 31, 2020, we held the following interest rate swaps whereby we receive interest at a one-month LIBOR rate: $ in thousands

                                                   As of March 31, 2021                                                                               As of December 31, 2020
                                                      Average Fixed           Average                                                                     Average Fixed           Average
   Derivative instrument      Notional Amounts           Pay Rate          

Receive Rate Average Maturity (Years) Notional Amounts

      Pay Rate           Receive Rate         Average Maturity (Years)
Interest Rate Swaps (1)            6,300,000                 0.41  %              0.11  %                              6.5             6,300,000                 0.41  %              0.15  %                              6.7


(1)Notional amount as of March 31, 2021 excludes $1.3 billion of interest rate
swaps with forward start dates.
We use currency forward contracts to help mitigate the potential impact of
changes in foreign currency exchange rates. As of March 31, 2021, we had $16.9
million (December 31, 2020: $33.1 million) of notional amount of currency
forward contracts related to an investment in an unconsolidated venture
denominated in euro.
We primarily use TBAs that we do not intend to physically settle on the
contractual settlement date as an alternative means of investing in and
financing Agency RMBS. As of March 31, 2021, we had $1.5 billion notional amount
of TBAs (December 31, 2020: $1.7 billion). We recorded $57.3 million of realized
and unrealized losses, net on TBAs during the three months ended March 31, 2021
primarily due to a sharp increase in mortgage rates. We did not invest in TBAs
during the three months ended March 31, 2020.
Realized and Unrealized Credit Derivative Income (Loss), net
The table below summarizes the components of realized and unrealized credit
derivative income (loss), net for the three months ended March 31, 2020.
                                                                             Three Months Ended March 31,
$ in thousands                                                                                                              2020
GSE CRT embedded derivative coupon interest                                                                                      4,718
Gain (loss) on settlement of GSE CRT embedded derivatives                                                                        2,283
Change in fair value of GSE CRT embedded derivatives                                                                           (40,053)

Total realized and unrealized credit derivative income (loss), net

                                                                                                                            (33,052)


Realized and unrealized credit derivative loss in the three months ended
March 31, 2020 was driven by a decline in the fair value of our GSE CRT embedded
derivatives as asset prices dropped due to spread widening. We did not hold any
GSE CRTs during the three months ended March 31, 2021.
Net Gain (Loss) on Extinguishment of Debt
As discussed in Note 6 - "Borrowings" of our condensed consolidated financial
statements include in Part I. Item 1. of this report on Form 10-Q, certain of
our counterparties seized and sold securities that we had posted as collateral
for our repurchase agreements during the three months ended March 31, 2020. We
recorded early termination and legal fees paid to our counterparties that were
associated with the termination of these repurchase agreements as a loss on
extinguishment of debt in our condensed consolidated statement of operations.
Other Investment Income (Loss), net
Our other investment income (loss), net during the three months ended March 31,
2020 primarily consisted of quarterly dividends from FHLBI stock. The amount of
our dividend income varied based upon the number of shares that we were required
to own and the dividend declared per share. FHLBI redeemed our stock at cost
during 2020. We terminated our FHLBI membership in the third quarter of 2020.
Expenses

We incurred management fees of $4.9 million for the three months ended March 31,
2021 (March 31, 2020: $11.0 million). Management fees decreased for the three
months ended March 31, 2021 compared to the same period in 2020 due to a lower
management fee base. Refer to Note 11 - "Related Party Transactions" of our
condensed consolidated financial statements for a discussion of our relationship
with our Manager and a description of how our fees are calculated.
Our general and administrative expenses not covered under our management
agreement amounted to $2.0 million for the three months ended March 31, 2021
(March 31, 2020: $3.1 million). General and administrative expenses primarily
consist of
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directors and officers insurance, legal costs, accounting, auditing and tax
services, filing fees, and miscellaneous general and administrative costs.
General and administrative costs were lower for the three months ended March 31,
2021 compared to the same period in 2020 primarily due to fees paid for
third-party legal and advisory services in connection with navigating market
disruption associated with the COVID-19 pandemic during the three months ended
March 31, 2020 totaling $1.1 million.
Net Income (Loss) attributable to Common Stockholders
For the three months ended March 31, 2021, our net loss attributable to common
stockholders was $20.4 million (March 31, 2020: $1.6 billion net loss
attributable to common stockholders) or $0.09 basic and diluted net loss per
average share available to common stockholders (March 31, 2020: $10.38 basic and
diluted net loss per average share available to common stockholders). The change
in net loss attributable to common stockholders was primarily due to (i) net
gains on derivative instruments of $287.0 million in the 2021 period compared to
net losses on derivative instruments of $910.8 million in the 2020 period; (ii)
net losses on investments of $331.9 million in the 2021 period compared to a net
losses on investments of $755.5 million in the 2020 period; (iii) credit
derivative net losses of $33.1 million in the 2020 period; and (iv) a $59.3
million decrease in net interest income.
For further information on the changes in net gains (loss) on derivative
instruments, net gain (loss) on investments, realized and unrealized credit
derivative income (loss), net and net interest income, see preceding discussion
under "Gain (Loss) on Derivative Instruments, net," "Gain (Loss) on Investments,
net," "Realized and Unrealized Credit Derivative Income (Loss), net," and "Net
Interest Income."
Non-GAAP Financial Measures
We use the following non-GAAP financial measures to analyze the Company's
operating results and believe these financial measures are useful to investors
in assessing our performance as further discussed below:
•core earnings (and by calculation, core earnings per common share),
•effective interest income (and by calculation, effective yield),
•effective interest expense (and by calculation, effective cost of funds),
•effective net interest income (and by calculation, effective interest rate
margin), and
•economic debt-to-equity ratio.
The most directly comparable U.S. GAAP measures are:
•net income (loss) attributable to common stockholders (and by calculation,
basic earnings (loss) per common share),
•total interest income (and by calculation, earning asset yields),
•total interest expense (and by calculation, cost of funds),
•net interest income (and by calculation, net interest rate margin), and
•debt-to-equity ratio.
We adjust our calculations of non-GAAP financial measures for changes in the
composition of our investment portfolio where appropriate. We have historically
adjusted core earnings to exclude the impact of realized and unrealized gains
and losses on GSE CRT embedded derivatives. Beginning in 2021, realized and
unrealized gains and losses on GSE CRT embedded derivatives no longer impacted
the reconciliation of U.S. GAAP net income (loss) attributable to common
stockholders to core earnings because we sold all of our GSE CRTs that were
accounted for as hybrid financial instruments during 2020. Additionally, we have
historically calculated effective interest income (and by calculation, effective
yield) as U.S. GAAP total interest income adjusted for GSE CRT embedded
derivative coupon interest that was recorded as realized and unrealized credit
derivative income (loss), net. As we no longer earn embedded derivative coupon
interest due to the sale of our GSE CRTs during 2020, effective interest income
will be equal to U.S. GAAP total interest income beginning in 2021.
We did not present core earnings for the first half of 2020 or for the year
ended December 31, 2020 because core earnings excluded the material adverse
impact of the market disruption caused by the COVID-19 pandemic on our financial
condition. In addition, core earnings for the first half of 2020 and the year
ended December 31, 2020 was not indicative of the reduced earnings potential of
our current investment portfolio.
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The non-GAAP financial measures used by management should be analyzed in
conjunction with U.S. GAAP financial measures and should not be considered
substitutes for U.S. GAAP financial measures. In addition, the non-GAAP
financial measures may not be comparable to similarly titled non-GAAP financial
measures of our peer companies.
Core Earnings
We calculate core earnings as U.S. GAAP net income (loss) attributable to common
stockholders adjusted for (gain) loss on investments, net; realized (gain) loss
on derivative instruments, net; unrealized (gain) loss on derivative
instruments, net; TBA dollar roll income; (gain) loss on foreign currency
transactions, net; amortization of net deferred (gain) loss on de-designated
interest rate swaps; and net (gain) loss on extinguishment of debt. We may add
and have added additional reconciling items to our core earnings calculation as
appropriate.
We believe the presentation of core earnings provides a consistent measure of
operating performance by excluding the impact of gains and losses described
above from operating results. We exclude the impact of gains and losses because
gains and losses are not accounted for consistently under U.S. GAAP. Under U.S.
GAAP, certain gains and losses are reflected in net income whereas other gains
and losses are reflected in other comprehensive income. For example, a portion
of our mortgage-backed securities are classified as available-for-sale
securities, and we record changes in the valuation of these securities in other
comprehensive income on our condensed consolidated balance sheets. We elected
the fair value option for our mortgage-backed securities purchased on or after
September 1, 2016, and changes in the valuation of these securities are recorded
in other income (loss) in our condensed consolidated statements of operations.
In addition, certain gains and losses represent one-time events.
We believe that providing transparency into core earnings enables our investors
to consistently measure, evaluate and compare our operating performance to that
of our peers over multiple reporting periods. However, we caution that core
earnings should not be considered as an alternative to net income (determined in
accordance with U.S. GAAP), or as an indication of our cash flow from operating
activities (determined in accordance with U.S. GAAP), a measure of our
liquidity, or as an indication of amounts available to fund our cash needs,
including our ability to make cash distributions.
The table below provides a reconciliation of U.S. GAAP net income (loss)
attributable to common stockholders to core earnings for the following periods:
                                                                               Three Months
                                                                               Ended March
                                                                                   31,
$ in thousands, except per share data                                                                  2021
Net income (loss) attributable to common stockholders                                                    (20,382)

Adjustments:

(Gain) loss on investments, net                                                                          331,857
Realized (gain) loss on derivative instruments, net (1)                                                 (282,250)
Unrealized (gain) loss on derivative instruments, net (1)                                                 (9,260)
TBA dollar roll income (2)                                                                                10,545

(Gain) loss on foreign currency transactions, net (3)                                                         16
Amortization of net deferred (gain) loss on de-designated interest rate
swaps(4)                                                                                                  (5,368)

Subtotal                                                                                                  45,540

Core earnings attributable to common stockholders                                                         25,158
Basic income (loss) per common share                                                                       (0.09)
Core earnings per share attributable to common stockholders (5)                                             0.11


(1)U.S. GAAP gain (loss) on derivative instruments, net on the condensed consolidated statements of operations includes the following components:

                                                                         Three Months
                                                                         Ended March
                                                                             31,
$ in thousands                                                                                   2021
Realized gain (loss) on derivative instruments, net                                               282,250
Unrealized gain (loss) on derivative instruments, net                                               9,260
Contractual net interest income (expense) on interest rate swaps                                   (4,549)
Gain (loss) on derivative instruments, net                                                        286,961



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(2)A TBA dollar roll is a series of derivative transactions where TBAs with the
same specified issuer, term and coupon but different settlement dates are
simultaneously bought and sold. The TBA settling in the later month typically
prices at a discount to the TBA settling in the earlier month. TBA dollar roll
income represents the price differential between the TBA price for current month
settlement versus the TBA price for forward month settlement. We include TBA
dollar roll income in core earnings because it is the economic equivalent of
interest income on the underlying Agency securities, less an implied financing
cost, over the forward settlement period. TBA dollar roll income is a component
of gain (loss) on derivative instruments, net on our condensed consolidated
statements of operations.
(3)Gain (loss) on foreign currency transactions, net is included in other
investment income (loss) net on the condensed consolidated statements of
operations.
(4)U.S. GAAP repurchase agreements interest expense on the condensed
consolidated statements of operations includes the following components:
                                                                          Three Months
                                                                          Ended March
                                                                              31,
$ in thousands                                                                                    2021
Interest expense on repurchase agreement borrowings                                                  3,708

Amortization of net deferred (gain) loss on de-designated interest rate swaps

                                                                                          (5,368)
Repurchase agreements interest expense                                                              (1,660)


(5)Core earnings per share attributable to common stockholders is equal to core
earnings divided by the basic weighted average number of common shares
outstanding.
The components of core earnings for the three months ended March 31, 2021 are:
                                                                           Three Months
                                                                           Ended March
                                                                               31,
$ in thousands                                                                                     2021
Effective net interest income(1)                                                                     31,753
TBA dollar roll income                                                                               10,545

Equity in earnings (losses) of unconsolidated ventures                                                  (94)
(Increase) decrease in provision for credit losses                                                      938
Total expenses                                                                                       (6,877)
Total core earnings                                                                                  36,265
Dividends to preferred stockholders                                                                 (11,107)

Core earnings attributable to common stockholders                                                    25,158


(1)See below for a reconciliation of net interest income to effective net interest income, a non-GAAP measure.

Core earnings during the three months ended March 31, 2021 was driven by effective net interest income and TBA dollar roll income. As discussed above, we did not report core earnings for the three months ended March 31, 2020.

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Effective Interest Income / Effective Yield / Effective Interest Expense /
Effective Cost of Funds / Effective Net Interest Income / Effective Interest
Rate Margin
Prior to 2021, we calculated effective interest income (and by calculation,
effective yield) as U.S. GAAP total interest income adjusted for GSE CRT
embedded derivative coupon interest that was recorded as realized and unrealized
credit derivative income (loss), net. We included our GSE CRT embedded
derivative coupon interest in effective interest income because GSE CRT coupon
interest was not accounted for consistently under U.S. GAAP. We accounted for
GSE CRTs purchased prior to August 24, 2015 as hybrid financial instruments, but
elected the fair value option for GSE CRTs purchased on or after August 24,
2015. Under U.S. GAAP, coupon interest on GSE CRTs accounted for using the fair
value option is recorded as interest income, whereas coupon interest on GSE CRTs
accounted for as hybrid financial instruments was recorded as realized and
unrealized credit derivative income (loss). We added back GSE CRT embedded
derivative coupon interest to our total interest income because we considered
GSE CRT embedded derivative coupon interest a current component of our total
interest income irrespective of whether we elected the fair value option for the
GSE CRT or accounted for the GSE CRT as a hybrid financial instrument.
We calculate effective interest expense (and by calculation, effective cost of
funds) as U.S. GAAP total interest expense adjusted for contractual net interest
income (expense) on our interest rate swaps that is recorded as gain (loss) on
derivative instruments, net and the amortization of net deferred gains (losses)
on de-designated interest rate swaps that is recorded as repurchase agreements
interest expense. We view our interest rate swaps as an economic hedge against
increases in future market interest rates on our floating rate borrowings. We
add back the net payments we make on our interest rate swap agreements to our
total U.S. GAAP interest expense because we use interest rate swaps to add
stability to interest expense. We exclude the amortization of net deferred gains
(losses) on de-designated interest rate swaps from our calculation of effective
interest expense because we do not consider the amortization a current component
of our borrowing costs.
We calculate effective net interest income (and by calculation, effective
interest rate margin) as U.S. GAAP net interest income adjusted for contractual
net interest income (expense) on our interest rate swaps that is recorded as
gain (loss) on derivative instruments, net; amortization of net deferred gains
(losses) on de-designated interest rate swaps that is recorded as repurchase
agreements interest expense and GSE CRT embedded derivative coupon interest that
was recorded as realized and unrealized credit derivative income (loss), net.
We believe the presentation of effective interest income, effective yield,
effective interest expense, effective cost of funds, effective net interest
income and effective interest rate margin measures, when considered together
with U.S. GAAP financial measures, provides information that is useful to
investors in understanding our borrowing costs and operating performance.
The following tables reconcile total interest income to effective interest
income and yield to effective yield for the following periods:
                                                                                             Three Months Ended March 31,
                                                                          2021                                                          2020
$ in thousands                                        Reconciliation             Yield/Effective Yield              Reconciliation             Yield/Effective Yield
Total interest income                                           40,010                           1.72  %                     186,699                           4.19  %
Add: GSE CRT embedded derivative coupon interest
recorded as realized and unrealized credit
derivative income (loss), net                                        -                              -  %                       4,718                           0.10  %
Effective interest income                                       40,010                           1.72  %                     191,417                           4.29  %





Our effective interest income decreased in the three months ended March 31, 2021
versus the same period in 2020 due to lower average earning assets and changes
in portfolio composition. Our average earning assets decreased to $9.3 billion
for the three months ended March 31, 2021 from $17.8 billion for the same period
in 2020 primarily because we sold MBS and GSE CRTs due to disruption in the
financial markets caused by the COVID-19 pandemic as previously discussed. Our
effective yield decreased in the three months ended March 31, 2021 versus the
same period in 2020 due to changes in portfolio composition. Almost all of our
investment portfolio (excluding TBAs) was invested in Agency RMBS as of
March 31, 2021 compared to 18% as of March 31, 2020.
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The following tables reconcile total interest expense to effective interest
expense and cost of funds to effective cost of funds for the following periods.
                                                                                          Three Months Ended March 31,
                                                                          2021                                                    2020
                                                                                    Cost of Funds /                                         Cost of Funds /
                                                                                   Effective Cost of                                       Effective Cost of
$ in thousands                                           Reconciliation                  Funds                   Reconciliation                  Funds
Total interest expense                                             (1,660)                   (0.08) %                      85,688                     2.07  %
Add: Amortization of net deferred gain (loss) on
de-designated interest rate swaps                                   5,368                     0.26  %                      10,067                     0.24  %
Add (Less): Contractual net interest expense
(income) on interest rate swaps recorded as gain
(loss) on derivative instruments, net                               4,549                     0.22  %                     (11,924)                   (0.29) %
Effective interest expense                                          8,257                     0.40  %                      83,831                     2.02  %





Our effective interest expense and effective cost of funds decreased during the
three months ended March 31, 2021 compared to the same period in 2020 primarily
due to lower interest expense paid on our repurchase agreements due to lower
average borrowings and a lower Federal Funds target interest rate. Lower
interest expense on repurchase agreements was partially offset by contractual
net interest expense on interest rate swaps of $4.5 million during the three
months ended March 31, 2021 compared to $11.9 million of contractual net
interest income for the same period in 2020.
The following tables reconcile net interest income to effective net interest
income and net interest rate margin to effective interest rate margin for the
following periods.
                                                                                          Three Months Ended March 31,
                                                                          2021                                                    2020
                                                                                   Net Interest Rate                                       Net Interest Rate
                                                                                   Margin / Effective                                      Margin / Effective
                                                                                     Interest Rate                                           Interest Rate
$ in thousands                                           Reconciliation                  Margin                  Reconciliation                  Margin
Net interest income                                                41,670                     1.80  %                     101,011                     2.12  %
Less: Amortization of net deferred (gain) loss on
de-designated interest rate swaps                                  (5,368)                   (0.26) %                     (10,067)                   (0.24) %
Add: GSE CRT embedded derivative coupon interest
recorded as realized and unrealized credit
derivative income (loss), net                                           -                        -  %                       4,718                     0.10  %
Add (Less): Contractual net interest income
(expense) on interest rate swaps recorded as gain
(loss) on derivative instruments, net                              (4,549)                   (0.22) %                      11,924                     0.29  %
Effective net interest income                                      31,753                     1.32  %                     107,586                     2.27  %





Effective net interest income and effective interest rate margin for the three
months ended March 31, 2021 decreased from the same period in 2020 primarily due
to lower average earning assets and lower effective yields that were partially
offset by lower average borrowings and a lower effective cost of funds driven by
cuts in the Federal Funds rate.
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Economic Debt-to-Equity Ratio
The tables below show the allocation of our stockholders' equity to our target
assets, our debt-to-equity ratio, and our economic debt-to-equity ratio as of
March 31, 2021 and December 31, 2020. Our debt-to-equity ratio is calculated in
accordance with U.S. GAAP and is the ratio of total debt to total stockholders'
equity. As of March 31, 2021, approximately 91% of our equity is allocated to
Agency RMBS.

We present an economic debt-to-equity ratio, a non-GAAP financial measure of
leverage that considers the impact of the off-balance sheet financing of our
investments in TBAs that are accounted for as derivative instruments under U.S.
GAAP. We include our TBAs at implied cost basis in our measure of leverage
because a forward contract to acquire Agency RMBS in the TBA market carries
similar risks to Agency RMBS purchased in the cash market and funded with
on-balance sheet liabilities. Similarly, a contract for the forward sale of
Agency RMBS has substantially the same effect as selling the underlying Agency
RMBS and reducing our on-balance sheet funding commitments. We believe that
presenting our economic debt-to-equity ratio, when considered together with our
U.S. GAAP financial measure of debt-to-equity ratio, provides information that
is useful to investors in understanding how management evaluates our at-risk
leverage and gives investors a comparable statistic to those other mortgage
REITs who also invest in TBAs and present a similar non-GAAP measure of
leverage.

March 31, 2021
$ in thousands                                                     Agency RMBS       Credit Portfolio (1)         Total
Mortgage-backed securities                                         8,997,918               101,824              9,099,742
Cash and cash equivalents (2)                                        198,357                     -                198,357
Restricted cash (3)                                                  380,678                     -                380,678
Derivative assets, at fair value (3)                                  16,634                   559                 17,193
Other assets                                                          30,340                36,526                 66,866
Total assets                                                       9,623,927               138,909              9,762,836

Repurchase agreements                                              8,240,887                     -              8,240,887

Derivative liabilities, at fair value (3)                              4,273                     -                  4,273
Other liabilities                                                     31,155                 4,589                 35,744
Total liabilities                                                  8,276,315                 4,589              8,280,904

Total stockholders' equity (allocated)                             1,347,612               134,320              1,481,932
Debt-to-equity ratio (4)                                                 6.1                     -                    5.6
Economic debt-to-equity ratio (5)                                        7.3                     -                    6.6


(1)Investments in non-Agency CMBS, non-Agency RMBS, a commercial loan and
unconsolidated joint ventures are included in credit portfolio.
(2)Cash and cash equivalents is allocated based on our financing strategy for
each asset class.
(3)Restricted cash and derivative assets and liabilities are allocated based on
the hedging strategy for each asset class.
(4)Debt-to-equity ratio is calculated as the ratio of total repurchase
agreements to total stockholders' equity.
(5)Economic debt-to-equity ratio is calculated as the ratio of total repurchase
agreements and TBAs at implied cost basis ($1.5 billion as of March 31, 2021) to
total stockholders' equity.

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December 31, 2020
$ in thousands                                                     Agency RMBS       Credit Portfolio (1)         Total
Mortgage-backed securities                                         8,050,865               121,317              8,172,182
Cash and cash equivalents (2)                                        148,011                     -                148,011
Restricted cash                                                      243,963                   610                244,573
Derivative assets, at fair value (3)                                   9,893                   111                 10,004
Other assets                                                          17,606                40,475                 58,081
Total assets                                                       8,470,338               162,513              8,632,851

Repurchase agreements                                              7,228,699                     -              7,228,699

Derivative liabilities, at fair value (3)                              5,537                   807                  6,344
Other liabilities                                                     27,114                 3,536                 30,650
Total liabilities                                                  7,261,350                 4,343              7,265,693

Total stockholders' equity (allocated)                             1,208,988               158,170              1,367,158
Debt-to-equity ratio (4)                                                 6.0                     -                    5.3
Economic debt-to-equity ratio (5)                                        7.4                     -                    6.6


(1)Investments in non-Agency CMBS, non-Agency RMBS, a commercial loan and
unconsolidated joint ventures are included in credit portfolio.
(2)Cash and cash equivalents is allocated based on our financing strategy for
each asset class.
(3)Restricted cash and derivative assets and liabilities are allocated based on
the hedging strategy for each asset class.
(4)Debt-to-equity ratio is calculated as the ratio of total repurchase
agreements to total stockholders' equity.
(5)Economic debt-to-equity ratio is calculated as the ratio of total repurchase
agreements and TBAs at implied cost basis ($1.8 billion as of December 31, 2020)
to total stockholders' equity.

Liquidity and Capital Resources
Liquidity is a measurement of our ability to meet potential cash requirements,
including ongoing commitments to pay dividends, fund investments, repay
borrowings and fund other general business needs. Our primary sources of funds
for liquidity consist of the net proceeds from our common and preferred equity
offerings, net cash provided by operating activities, proceeds from repurchase
agreements and other financing arrangements and future issuances of equity
and/or debt securities.
We currently believe that we have sufficient liquidity and capital resources
available for the acquisition of additional investments, repayments on
borrowings, margin requirements and the payment of cash dividends as required
for continued qualification as a REIT. We generally maintain liquidity to pay
down borrowings under repurchase arrangements to reduce borrowing costs and
otherwise efficiently manage our long-term investment capital. Because the level
of these borrowings can be adjusted on a daily basis, the level of cash and cash
equivalents carried on our consolidated balance sheets is significantly less
important than our potential liquidity available under borrowing arrangements or
through the sale of liquid investments. However, there can be no assurance that
we will maintain sufficient levels of liquidity to meet any margin calls.
The COVID-19 pandemic-driven disruptions in the real estate, mortgage and
financial markets negatively affected our liquidity during the year ended
December 31, 2020. Under the terms of our repurchase agreements, our lenders
have the contractual right to mark the underlying securities that we post as
collateral to fair value as determined in their sole discretion. In addition,
our lenders have the contractual right to increase the "haircut", or percentage
amount by which collateral value must exceed the amount of borrowings, as market
conditions become more volatile. As a result of significant spread widening in
both Agency and non-Agency securities in the latter part of the first quarter of
2020, valuations of our portfolio assets declined sharply in a short period of
time, leading to an exceptional increase in the frequency and magnitude of
margin calls. We sold portfolio assets to generate liquidity, in many cases at
significantly distressed market prices. Additionally, our lenders raised
required haircuts on our collateral for new repurchase agreements, driving
further liquidity needs. These events have led us to seek to avoid financing
less liquid assets, such as non-Agency securities, with repurchase agreements.
We held cash, cash equivalents and restricted cash of $579.0 million at
March 31, 2021 (March 31, 2020: $365.0 million). Our cash, cash equivalents and
restricted cash increased due to normal fluctuations in cash balances related to
the
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timing of principal and interest payments, repayments of debt, and asset
purchases and sales. Our operating activities provided net cash of $34.5 million
for the three months ended March 31, 2021 (March 31, 2020: $110.0 million).
Our investing activities used net cash of $986.3 million in the three months
ended March 31, 2021 compared to net cash provided by investing activities of
$11.6 billion in the three months ended March 31, 2020. Our primary source of
cash from investing activities for the three months ended March 31, 2021 was
proceeds from sales of MBS and GSE CRTs of $5.5 billion (March 31, 2020: $16.2
billion). We also generated $200.6 million from principal payments of MBS and
GSE CRTs during the three months ended March 31, 2021 (March 31, 2020: $636.5
million). We invested $7.0 billion in MBS and GSE CRTs during the three months
ended March 31, 2021 (March 31, 2020: $4.4 billion). We received cash of $282.3
million to settle derivative contracts in the three months ended March 31, 2021
(March 31, 2020: net cash used of $904.2 million).
Our financing activities provided net cash of $1.1 billion for the three months
ended March 31, 2021 (March 31, 2020: net cash used by financing activities of
$11.6 billion). We received net cash from repurchase agreement borrowing of $1.0
billion (March 31, 2020: net repayments of $11.2 billion). In addition, we
repaid $300.0 million of secured loans from the FHLBI upon their maturity during
the three months ended March 31, 2020. We also used cash of $27.4 million for
the three months ended March 31, 2021 to pay dividends (March 31, 2020: $74.8
million). Proceeds from issuance of common stock provided $161.4 million for the
three months ended March 31, 2021 (March 31, 2020: $347.3 million).
As of March 31, 2021, the average margin requirement (weighted by borrowing
amount), or the haircut, under our repurchase agreements was 4.9% for Agency
RMBS. The haircuts ranged from a low of 4% to a high of 5%. Declines in the
value of our securities portfolio can trigger margin calls by our lenders under
our repurchase agreements. An event of default or termination event may give our
counterparties the option to terminate all repurchase transactions outstanding
with us and require any amount due from us to the counterparties to be payable
immediately.
Effects of Margin Requirements, Leverage and Credit Spreads
Our securities have values that fluctuate according to market conditions and the
market value of our securities will decrease as prevailing interest rates or
credit spreads increase. When the value of the securities pledged to secure a
repurchase loan decreases to the point where the positive difference between the
collateral value and the loan amount is less than the haircut, our lenders may
issue a "margin call," which means that the lender will require us to pay cash
or pledge additional collateral. Under our repurchase facilities, our lenders
have full discretion to determine the value of the securities we pledge to them.
Most of our lenders will value securities based on recent trades in the market.
Lenders also issue margin calls as the published current principal balance
factors change on the pool of mortgages underlying the securities pledged as
collateral when scheduled and unscheduled paydowns are announced monthly.
We experience margin calls and increased collateral requirements in the ordinary
course of our business. In seeking to effectively manage the margin requirements
established by our lenders, we maintain a position of cash and unpledged
securities. We refer to this position as our liquidity. The level of liquidity
we have available to meet margin calls is directly affected by our leverage
levels, our haircuts and the price changes on our securities. If interest rates
increase as a result of a yield curve shift or for another reason or if credit
spreads widen, then the prices of our collateral (and our unpledged assets that
constitute our liquidity) will decline, we will experience margin calls, and we
will seek to use our liquidity to meet the margin calls. There can be no
assurance that we will maintain sufficient levels of liquidity to meet any
margin calls or increased collateral requirements. If our haircuts increase, our
liquidity will proportionately decrease. In addition, if we increase our
borrowings, our liquidity will decrease by the amount of additional haircut on
the increased level of indebtedness.
We intend to maintain a level of liquidity in relation to our assets that
enables us to meet reasonably anticipated margin calls and increased collateral
requirements but that also allows us to be substantially invested in securities.
We may misjudge the appropriate amount of our liquidity by maintaining excessive
liquidity, which would lower our investment returns, or by maintaining
insufficient liquidity, which would force us to liquidate assets into
unfavorable market conditions and harm our results of operations and financial
condition.
We are subject to financial covenants in connection with our lending,
derivatives and other agreements we enter into in the normal course of our
business. We intend to operate in a manner which complies with all of our
financial covenants. Our lending and derivative agreements provide that we may
be declared in default of our obligations if our leverage ratio exceeds certain
thresholds and we fail to maintain stockholders' equity or market value above
certain thresholds over specified time periods.
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Forward-Looking Statements Regarding Liquidity
As of March 31, 2021, we held $8.6 billion of Agency securities that are
financed by repurchase agreements. We also had approximately $494.5 million of
unencumbered investments and unrestricted cash of $198.4 million as of March 31,
2021.
Based upon our current portfolio and existing borrowing arrangements, we believe
that cash flow from operations, and available borrowing capacity will be
sufficient to enable us to meet anticipated short-term (one year or less)
liquidity requirements to fund our investment activities, pay fees under our
management agreement, fund our required distributions to stockholders and fund
other general corporate expenses.
Our ability to meet our long-term (greater than one year) liquidity and capital
resource requirements will be subject to obtaining additional debt financing. We
may increase our capital resources by obtaining long-term credit facilities or
through public or private offerings of equity or debt securities, possibly
including classes of preferred stock, common stock, senior or subordinated notes
and convertible notes. Such financing will depend on market conditions for
capital raises and our ability to invest such offering proceeds. If we are
unable to renew, replace or expand our sources of financing on substantially
similar terms, it may have an adverse effect on our business and results of
operations.
Contractual Obligations
We have entered into an agreement with our Manager under which our Manager is
entitled to receive a management fee and the reimbursement of certain operating
expenses incurred on our behalf. The management fee is calculated and payable
quarterly in arrears in an amount equal to 1.50% of our stockholders' equity,
per annum. Refer to Note 11 - "Related Party Transactions" of our condensed
consolidated financial statements for additional information on how our
management fee is calculated. Our Manager uses the proceeds from its management
fee in part to pay compensation to its officers and personnel who,
notwithstanding that certain of those individuals are also our officers, receive
no cash compensation directly from us. We are required to reimburse our Manager
for operating expenses related to us incurred by our Manager, including certain
salary expenses and other expenses relating to legal, accounting, due diligence
and other services. Our reimbursement obligation is not subject to any dollar
limitation. Refer to Note 11 - "Related Party Transactions" of our condensed
consolidated financial statements for details of our reimbursements to our
Manager.
As of March 31, 2021, we had the following contractual obligations:
                                                                            

Payments Due by Period

                                                                   Less than 1                                                       After 5
$ in thousands                                 Total                  year                1-3 years            3-5 years              years

Repurchase agreements                        8,240,887            8,240,887                     -                    -                    -
Interest expense on repurchase agreements        1,153                1,153                     -                    -                    -
Total (1)                                    8,242,040            8,242,040                     -                    -                    -



(1)Excluded from total contractual obligations are the amounts due to our
Manager under the management agreement, as those obligations do not have fixed
and determinable payments.
Off-Balance Sheet Arrangements
We have committed to invest up to $125.4 million in unconsolidated ventures that
are sponsored by an affiliate of our Manager. As of March 31, 2021, $118.7
million of our commitment to these unconsolidated ventures had been called. We
are committed to fund $6.7 million in additional capital to fund future
investments and cover future expenses should they occur.
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Dividends

To maintain our qualification as a REIT, U.S. federal income tax law generally
requires that we distribute at least 90% of our REIT taxable income annually,
determined without regard to the deduction for dividends paid and excluding net
capital gains. We must pay tax at regular corporate rates to the extent that we
annually distribute less than 100% of our taxable income. Before we pay any
dividend, whether for U.S. federal income tax purposes or otherwise, we must
first meet both our operating requirements and debt service on our repurchase
agreements and other debt payable. If our cash available for distribution is
less than our REIT taxable income, we could be required to sell assets or borrow
funds to make cash distributions, or we may make a portion of the required
distribution in the form of a taxable stock distribution or distribution of debt
securities.
As discussed above, our distribution requirements are based on REIT taxable
income rather than U.S. GAAP net income. The primary differences between our
REIT taxable income and U.S. GAAP net income are: (i) unrealized gains and
losses on investments that we have elected the fair value option for that are
included in current U.S. GAAP income but are excluded from REIT taxable income
until realized or settled; (ii) gains and losses on derivative instruments that
are included in current U.S. GAAP net income but are excluded from REIT taxable
income until realized; and (iii) temporary differences related to amortization
of premiums and discounts on investments. For additional information regarding
the characteristics of our dividends, refer to Note 12 - "Stockholders' Equity"
of our annual report on Form 10-K for the year ended December 31, 2020.
Unrelated Business Taxable Income
We have not engaged in transactions that would result in a portion of our income
being treated as unrelated business taxable income.
Exposure to Financial Counterparties
We finance a substantial portion of our investment portfolio through repurchase
agreements. Under these agreements, we pledge assets from our investment
portfolio as collateral. Additionally, certain counterparties may require us to
provide cash collateral in the event the market value of the assets declines to
maintain a contractual repurchase agreement collateral ratio. If a counterparty
were to default on its obligations, we would be exposed to potential losses to
the extent the fair value of collateral pledged by us to the counterparty
including any accrued interest receivable on such collateral exceeded the amount
loaned to us by the counterparty plus interest due to the counterparty.
As of March 31, 2021, no counterparties held collateral that exceeded the
amounts borrowed under the related repurchase agreements by more than $74.1
million, or 5% of our stockholders' equity. The following table summarizes our
exposure to counterparties by geographic concentration as of March 31, 2021. The
information is based on the geographic headquarters of the counterparty or
counterparty's parent company. However, our repurchase agreements are generally
denominated in U.S. dollars.
                                                                                                   Repurchase Agreement
$ in thousands                                     Number of Counterparties                             Financing                                 Exposure
North America                                                    11                                        5,182,059                               270,933
Europe (excluding United Kingdom)                                 2                                          884,295                                42,148
Asia                                                              4                                        2,174,533                               109,449

Total                                                            17                                        8,240,887                               422,530



Other Matters
We believe that we satisfied each of the asset tests in Section 856(c)(4) of the
Internal Revenue Code of 1986, as amended (the "Code") for the period ended
March 31, 2021, and that our proposed method of operation will permit us to
satisfy the asset tests, gross income tests, and distribution and stock
ownership requirements for our taxable year that will end on December 31, 2021.
At all times, we intend to conduct our business so that neither we nor our
Operating Partnership nor the subsidiaries of our Operating Partnership are
required to register as an investment company under the 1940 Act. If we were
required to register as an investment company, then our use of leverage would be
substantially reduced. Because we are a holding company that conducts our
business through our Operating Partnership and the Operating Partnership's
wholly-owned or majority-owned subsidiaries, the securities issued by these
subsidiaries that are excepted from the definition of "investment company" under
Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other
investment securities the Operating Partnership may own, may not have a combined
value in excess of 40% of the value of the Operating Partnership's total assets
(exclusive of
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U.S. government securities and cash items) on an unconsolidated basis, which we
refer to as the 40% test. This requirement limits the types of businesses in
which we are permitted to engage in through our subsidiaries. In addition, we
believe neither we nor the Operating Partnership are considered an investment
company under Section 3(a)(1)(A) of the 1940 Act because they do not engage
primarily or hold themselves out as being engaged primarily in the business of
investing, reinvesting or trading in securities. Rather, through the Operating
Partnership's wholly-owned or majority-owned subsidiaries, we and the Operating
Partnership are primarily engaged in the non-investment company businesses of
these subsidiaries. IAS Asset I LLC and certain of the Operating Partnership's
other subsidiaries that we may form in the future rely upon the exclusion from
the definition of "investment company" under the 1940 Act provided by
Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily
engaged in the business of purchasing or otherwise acquiring mortgages and other
liens on and interests in real estate." This exclusion generally requires that
at least 55% of each subsidiary's portfolio be comprised of qualifying assets
and at least 80% be comprised of qualifying assets and real estate-related
assets (and no more than 20% comprised of miscellaneous assets). We calculate
that as of March 31, 2021, we conducted our business so as not to be regulated
as an investment company under the 1940 Act.

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