TWO HARBORS INVESTMENT CORP. The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 . -------------------------------------------------------------------------------- Table of C ontents General We are aMaryland corporation focused on investing in and managing Agency residential mortgage-backed securities, or Agency RMBS, mortgage servicing rights, or MSR, and other financial assets, which we collectively refer to as our target assets. We operate as a real estate investment trust, or REIT, as defined under the Internal Revenue Code of 1986, as amended, or the Code. Our objective is to provide attractive risk-adjusted total return to our stockholders over the long term, primarily through dividends and secondarily through capital appreciation. We acquire and manage an investment portfolio of our target assets, which include the following: •Agency RMBS (which includes inverse interest-only Agency securities classified as "Agency Derivatives" for purposes ofU.S. generally accepted accounting principles, orU.S. GAAP), meaning RMBS whose principal and interest payments are guaranteed by theGovernment National Mortgage Association (orGinnie Mae ), the Federal National Mortgage Association (or Fannie Mae), or the Federal Home Loan Mortgage Corporation (or Freddie Mac), or collectively, the government sponsored entities, or GSEs; •MSR; and •Other financial assets comprising approximately 5% to 10% of the portfolio (includes certain non-hedging transactions that may produce non-qualifying income for purposes of the REIT gross income tests). Historically, we viewed our target assets in two strategies that were based on our core competencies of understanding and managing prepayment and credit risk. Our rates strategy included assets that were primarily sensitive to changes in interest rates and prepayment speeds, specifically Agency RMBS and MSR. Our credit strategy included assets that were primarily sensitive to changes in inherent credit risk, including non-Agency securities, meaning securities that are not issued or guaranteed byGinnie Mae , Fannie Mae or Freddie Mac. In the first quarter of 2020, we experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, we focused our efforts on raising excess liquidity and de-risking our portfolio. OnMarch 25, 2020 , we sold substantially all of our non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. We also sold approximately one-third of our Agency RMBS during the first quarter in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. Throughout the remainder of 2020, we focused on the composition of our Agency RMBS and MSR portfolio, deploying risk as the market entered a period of stabilization and asset price recovery. Going forward, management expects our capital to be fully allocated to our strategy of pairing Agency RMBS and MSR. Our Agency RMBS portfolio is comprised of adjustable rate and fixed rate mortgage-backed securities backed by single-family and multi-family mortgage loans. All of our principal and interest Agency RMBS are Fannie Mae or Freddie Mac mortgage pass-through certificates or collateralized mortgage obligations that carry an implied rating of "AAA ," orGinnie Mae mortgage pass-through certificates, which are backed by the guarantee of theU.S. government. The majority of these securities consist of whole pools in which we own all of the investment interests in the securities. Within our MSR business, we acquire MSR assets, which represent the right to control the servicing of residential mortgage loans and the obligation to service the loans in accordance with relevant standards, from high-quality originators. We do not directly service the mortgage loans underlying the MSR we acquire; rather, we contract with appropriately licensed third-party subservicers to handle substantially all servicing functions in the name of the subservicer. As the servicer of record, however, we remain accountable to the GSEs for all servicing matters and, accordingly, provide substantial oversight of each of our subservicers. We believe MSR are a natural fit for our portfolio over the long term. Our MSR business leverages our core competencies in prepayment and credit risk analytics and the MSR assets provide offsetting risks to our Agency RMBS, hedging both interest rate and mortgage spread risk. One of our goals is to create long-lasting relationships with high quality originators in order to facilitate our acquisition of MSR through both flow and bulk transactions. In making our capital allocation decisions, we take into consideration a number of factors, including the opportunities available in the marketplace, the cost and availability of financing, and the cost of hedging interest rate, prepayment, credit and other portfolio risks. We have expertise in mortgage credit and may choose to invest again in those assets should the opportunity arise. 31 -------------------------------------------------------------------------------- Table of C ontents For the three months endedDecember 31, 2020 , our net spread realized on the portfolio was slightly lower than the prior quarter, but higher than recent periods. Our average annualized portfolio yield was lower primarily due to higher amortization recognized on Agency RMBS due to prepayments, offset by lower servicing expenses on MSR. Cost of financing was lower as a result of the lower interest rate environment. The following table provides the average annualized yield on our assets, including Agency RMBS, non-Agency securities and MSR for the three months endedDecember 31, 2020 , and the four immediately preceding quarters: Three Months Ended December 31, September 30, June 30, March 31, December 31, 2020 2020 2020 2020 2019 Average annualized portfolio yield (1) 2.26% 2.42% 2.84% 3.52% 3.54% Cost of financing (2) 0.50% 0.64% 2.61% 2.39% 2.35% Net spread 1.76% 1.78% 0.23% 1.13% 1.19% ____________________ (1)Average annualized yield includes interest income on Agency RMBS and non-Agency securities and MSR servicing income, net of estimated amortization, and servicing expenses. (2)Cost of financing includes swap and cap interest rate spread and amortization of upfront payments made or received upon entering. We seek to deploy moderate leverage as part of our investment strategy. We generally finance our Agency RMBS securities through short- and long-term borrowings structured as repurchase agreements. We also finance our MSR through revolving credit facilities, term notes payable and convertible senior notes. Our Agency RMBS, given their liquidity and high credit quality, are eligible for higher levels of leverage, while MSR, with less liquidity and/or more exposure to prepayment, utilize lower levels of leverage. As a result, our debt-to-equity ratio is determined by our portfolio mix as well as many additional factors, including the liquidity of our portfolio, the availability and price of our financing, the diversification of our counterparties and their available capacity to finance our assets, and anticipated regulatory developments. Over the past several quarters, we have generally maintained a debt-to-equity ratio range of 5.0 to 7.0 times to finance our securities portfolio and MSR, on a fully deployed capital basis. Our debt-to-equity ratio is directly correlated to the composition of our portfolio; specifically, the higher percentage of Agency RMBS we hold, the higher our debt-to-equity ratio is. Following the sale of substantially all of our non-Agency securities in the first quarter of 2020, debt-to-equity may increase over time. We may alter the percentage allocation of our portfolio among our target assets depending on the relative value of the assets that are available to purchase from time to time, including at times when we are deploying proceeds from offerings we conduct. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Repurchase Agreements" for further discussion. We recognize that investing in our target assets is competitive and we compete with other entities for attractive investment opportunities. We believe that our significant focus in the residential market, the extensive mortgage market expertise of our investment team, our strong analytics and our disciplined relative value investment approach give us a competitive advantage versus our peers. We have elected to be treated as a REIT forU.S. federal income tax purposes. To qualify as a REIT we are required to meet certain investment and operating tests and annual distribution requirements. We generally will not be subject toU.S. federal income taxes on our taxable income to the extent that we annually distribute all of our net taxable income to stockholders, do not participate in prohibited transactions and maintain our intended qualification as a REIT. However, certain activities that we may perform may cause us to earn income which will not be qualifying income for REIT purposes. We have designated certain of our subsidiaries as taxable REIT subsidiaries, or TRSs, as defined in the Code, to engage in such activities. We also operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940, as amended, or the 1940 Act. While we do not currently originate or service residential mortgage loans, certain of our subsidiaries have obtained the requisite licenses and approvals to own and manage MSR. ThroughAugust 14, 2020 , we were externally managed and advised byPRCM Advisers LLC , a subsidiary ofPine River Capital Management L.P. , under the terms of a Management Agreement between us and PRCM Advisers. We terminated the Management Agreement effectiveAugust 14, 2020 for "cause" in accordance with Section 15(a) thereof. OnAugust 15, 2020 , we completed our transition to self-management and directly hired the senior management team and other personnel who had historically provided services to us. 32 -------------------------------------------------------------------------------- Table of C ontents Factors Affecting our Operating Results Our net interest income includes income from our securities portfolio, including the amortization of purchase premiums and accretion of purchase discounts. Net interest income, as well as our servicing income, net of subservicing expenses, will fluctuate primarily as a result of changes in market interest rates, our financing costs and prepayment speeds on our assets. Interest rates, financing costs and prepayment rates vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty. OnJanuary 1, 2020 we adopted Accounting Standards Update (ASU) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changed the impairment model for most financial assets and certain other instruments. Valuation allowances for credit losses on available-for-sale, or AFS, debt securities are recognized, rather than direct reductions in the amortized cost of the investments, regardless of whether the impairment is considered to be other-than-temporary. We use a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities. The estimated allowance for credit losses is equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that was in effect upon adoption of the standard. The contractual cash flows and expected cash flows are based on management's best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses causes an increase in the AFS security amortized cost and recognizes an allowance for credit losses in the same amount. Fair Value Measurement A significant portion of our assets and liabilities are reported at fair value and, therefore, our consolidated balance sheets and statements of comprehensive (loss) income are significantly affected by fluctuations in market prices. AtDecember 31, 2020 , approximately 83.7% of our total assets, or$16.3 billion , consisted of financial instruments recorded at fair value. See Note 10 - Fair Value to the consolidated financial statements, included in this Annual Report on Form 10-K, for descriptions of valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models and significant assumptions utilized. Although we execute various hedging strategies to mitigate our exposure to changes in fair value, we cannot fully eliminate our exposure to volatility caused by fluctuations in market prices. Any temporary change in the fair value of our AFS securities, excluding certain Agency interest-only mortgage-backed securities, is recorded as a component of accumulated other comprehensive income and does not impact our reported income (loss) forU.S. GAAP purposes, or GAAP net income (loss). However, beginning onJanuary 1, 2020 (as discussed above), changes in the provision for credit losses on AFS securities are recognized immediately in GAAP net income (loss). Our GAAP net income (loss) is also affected by fluctuations in market prices on the remainder of our financial assets and liabilities recorded at fair value, including interest rate swap, cap and swaption agreements and certain other derivative instruments (i.e., TBAs, put and call options for TBAs,U.S. Treasury futures, Markit IOS total return swaps and inverse interest-only securities), which are accounted for as derivative trading instruments underU.S. GAAP, Agency interest-only mortgage-backed securities and MSR. We have numerous internal controls in place to help ensure the appropriateness of fair value measurements. Significant fair value measures are subject to detailed analytics and management review and approval. Our entire investment portfolio reported at fair value is priced by third-party brokers and/or by independent pricing vendors. We generally receive three or more broker and vendor quotes on pass-through principal and interest (P&I) Agency RMBS, and generally receive multiple broker or vendor quotes on all other securities, including interest-only Agency RMBS and inverse interest-only Agency RMBS. We also receive three vendor quotes for the MSR in our investment portfolio. For Agency RMBS, the third-party pricing vendors and brokers use pricing models that commonly incorporate such factors as coupons, primary and secondary mortgage rates, rate reset periods, issuer, prepayment speeds, credit enhancements and expected life of the security. For MSR, vendors use pricing models that generally incorporate observable inputs such as principal balance, note rate, geographical location, loan-to-value (LTV) ratios, FICO, appraised value and other loan characteristics, along with observed market yields and trading levels. Pricing vendors will customarily incorporate loan servicing cost, servicing fee, ancillary income, and earnings rate on escrow as observable inputs. Unobservable or model-driven inputs include forecast cumulative defaults, default curve, forecast loss severity and forecast voluntary prepayment. We evaluate the prices we receive from both third-party brokers and pricing vendors by comparing those prices to actual purchase and sale transactions, our internally modeled prices calculated based on market observable rates and credit spreads, and to each other both in current and prior periods. We review and may challenge valuations from third-party brokers and pricing vendors to ensure that such quotes and valuations are indicative of fair value as a result of this analysis. We then estimate the fair value of each security based upon the median of the final broker quotes received, and we estimate the fair value of MSR based upon the average of prices received from third-party vendors, subject to internally-established hierarchy and override procedures. 33 -------------------------------------------------------------------------------- Table of C ontents We utilize "bid side" pricing for our Agency RMBS and, as a result, certain assets, especially the most recent purchases, may realize a markdown due to the "bid-offer" spread. To the extent that this occurs, any economic effect of this would be reflected in accumulated other comprehensive income. Considerable judgment is used in forming conclusions and estimating inputs to our Level 3 fair value measurements. Level 3 inputs such as interest rate movements, prepayments speeds, credit losses and discount rates are inherently difficult to estimate. Changes to these inputs can have a significant effect on fair value measurements. Accordingly, there is no assurance that our estimates of fair value are indicative of the amounts that would be realized on the ultimate sale or exchange of these assets. The Company classified 8.2% of its total assets as Level 3 fair value assets atDecember 31, 2020 . Critical Accounting Estimates The preparation of financial statements in accordance withU.S. GAAP requires us to make certain judgments and assumptions, based on information available at the time of our preparation of the financial statements, in determining accounting estimates used in preparation of the statements. Our significant accounting policies are described in Note 2 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K. Accounting estimates are considered critical if the estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made and if different estimates reasonably could have been used in the reporting period or changes in the accounting estimate are reasonably likely to occur from period to period that would have a material impact on our financial condition, results of operations or cash flows. The methods used by us to estimate fair value for AFS securities and MSR may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we believe that our valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. We use inputs that are current as of the measurement date, which in periods of market dislocation, may have reduced transparency. Classification and Valuation ofAvailable-for-Sale Securities Our securities investments consist primarily of Agency RMBS and non-Agency securities that we classify as available-for-sale, or AFS. All assets classified as AFS, excluding certain Agency interest-only mortgage-backed securities, are reported at estimated fair value with changes in fair value included in accumulated other comprehensive income, a separate component of stockholders' equity, on an after-tax basis. OnJuly 1, 2015 , we elected the fair value option for Agency interest-only securities acquired on or after such date. All Agency interest-only securities acquired on or afterJuly 1, 2015 are carried at estimated fair value with changes in fair value recorded as a component of (loss) gain on investment securities in the consolidated statements of comprehensive (loss) income. In accordance with ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, we use a discounted cash flow method to estimate and recognize an allowance for credit losses on both Agency and non-Agency AFS securities that are not accounted for under the fair value option. The estimated allowance for credit losses is equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that was in effect upon adoption of the standard. The contractual cash flows and expected cash flows are based on management's best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses on Agency AFS securities relates to prepayment assumption changes on interest-only Agency RMBS. The allowance for credit losses causes an increase in the AFS security amortized cost and recognizes an allowance for credit losses in the same amount, with the provision for credit losses recognized in earnings (within (loss) gain on investment securities) and the balance of the unrealized loss recognized in either other comprehensive (loss) income, net of tax, or (loss) gain on investment securities, depending on the accounting treatment. Classification and Valuation of Mortgage Servicing Rights We account for our MSR at fair value, with changes in fair value recorded in GAAP net (loss) income, rather than at amortized cost. Fair value is generally determined based on prices obtained from third-party pricing vendors. Although MSR transactions are observable in the marketplace, the details of those transactions are not necessarily reflective of the value of our MSR portfolio. Third-party vendors use both observable market data and unobservable market data (including prepayment speeds, delinquency levels, discount rates and cost to service) as inputs into models, which help to inform their best estimates of fair value market price. 34 -------------------------------------------------------------------------------- Table of C ontents Interest Income Recognition Interest income on securities is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency RMBS and non-Agency securities rated AA and higher at the time of purchase, are amortized and accreted, respectively, as an adjustment to interest income over the life of such securities using the contractual method under ASC 310-20, Nonrefundable Fees and Other Costs, which is applied at the individual security level based upon each security's effective interest rate. Each security's effective interest rate is calculated at the time of purchase by solving for the discount rate that equates the present value of that security's remaining contractual cash flows, assuming no principal prepayments, to its purchase price. When applying the contractual effective interest method, as principal prepayments occur, an amount of the unamortized premium or discount is recognized in interest income such that the contractual effective interest rate on the remaining security balance is unaffected. Interest income on non-Agency securities that were purchased at a discount to par value and were rated below AA at the time of purchase and Agency and non-Agency interest-only securities that can be contractually prepaid or otherwise settled in such a way that we would not recover substantially all of our recorded investment is recognized based on the security's effective interest rate using the prospective method under ASC 325-40, Investments - Other: Beneficial Interests in Securitized Financial Assets. At the time of acquisition, the security's effective interest rate is calculated by solving for the single discount rate that equates the present value of our best estimate of the amount and timing of the cash flows expected to be collected from the security to its purchase price. On at least a quarterly basis, we review and, if appropriate, make adjustments to our cash flow projections based on input and analysis received from external sources, internal models, and management's judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the effective interest rate and interest income recognized on such securities. Derivative Financial Instruments and Hedging Activities We apply the provisions of ASC 815, which requires the recognition of all derivatives as either assets or liabilities on our consolidated balance sheets and to measure those instruments at fair value. The fair value adjustments of our current derivative instruments affect net income as the hedge for accounting purposes is being treated as an economic, or trading, hedge and not as a qualifying hedging instrument. Derivatives are primarily used for hedging purposes rather than speculation. We utilize third-party pricing vendors and broker quotes to value our financial derivative instruments. If our hedging activities do not achieve their desired results, our reported GAAP net (loss) income may be adversely affected. Income Taxes Our financial results are generally not expected to reflect provisions for current or deferred income taxes, except for those taxable benefits or provisions recognized by our TRSs. We estimate, based on existence of sufficient evidence, the ability to realize the remainder of any deferred tax asset our TRSs recognize. Any adjustments to such estimates will be made in the period such determination is made. We plan to operate in a manner that will allow us to qualify for taxation as a REIT. As a result of our expected REIT qualification, we do not generally expect to payU.S. federal corporate level taxes. However, many of the REIT requirements are highly technical and complex. If we were to fail to meet the REIT requirements, we would be subject toU.S. federal, state and local income taxes. The Tax Cuts and Jobs Act of 2017, or TCJA, significantly changed how theU.S. taxes corporations. The TCJA requires complex computations to be performed that were not previously required inU.S. tax law, significant judgments to be made in interpretation of the provisions of the TCJA and significant estimates in calculations, and the preparation and analysis of information not previously relevant or regularly produced. Technical corrections or other amendments of the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. While we do not anticipate a material effect on our operations, we continue to analyze and monitor the application of the TCJA to our business, our peers and the economic environment. Market Conditions and Outlook TheU.S. Federal Reserve , or the Fed, moved overnight interest rates to the zero bound in early 2020 and is expected to hold overnight interest rates near current levels for an extended period of time. During the fourth quarter, the overnight rate cleared at less than 10 basis points and term overnight indexed swap markets indicate expectations for continued low levels in the near term. In addition, the Fed remains committed to large scale asset purchases. After announcing QE4 in March, the Fed has purchased more than$1.25 trillion MBS and more than$2.0 trillion U.S. Treasuries, increasing its overall balance sheet to approximately$7 trillion . This overwhelming purchase activity resulted in significant mortgage spread tightening and price stability since its onset. Interest rates across the yield curve remain low. AllU.S. Treasuries yield less than 175 basis points, with all maturities through five years yielding less than 50 basis points. Realized and implied volatility levels continue to be subdued. Primary and secondary mortgage spreads remain wide, but decreased somewhat during the fourth quarter, and constant prepayment rates remain at elevated levels. 35 -------------------------------------------------------------------------------- Table of C ontents The economic outlook for 2021 is quite uncertain and much will depend on the course of the global pandemic and the successful distribution and efficacy of vaccines. The traditional macro influences of GDP growth, job growth and inflation may be secondary to the global economy's progression through the health crisis. Additional fiscal support from theU.S. government, or lack thereof, will also have a hand in shaping the upcoming year. The Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, was passed inMarch 2020 and extended inDecember 2020 to address the economic fallout of the COVID-19 pandemic. One provision of the Act provides up to 360 days of forbearance relief from mortgage loan payments for borrowers with federally backed (e.g. Fannie Mae or Freddie Mac) mortgages who experience financial hardship related to the pandemic. Subsequently, inFebruary 2021 , the FHFA announced extensions to the foreclosure moratorium and forbearance periods for borrowers with Fannie Mae- or Freddie Mac-backed mortgages, and the Biden administration announced similar foreclosure moratorium and forbearance extensions for borrowers withFederal Housing Administration ,U.S. Department of Agriculture orU.S. Department of Veterans Affairs mortgages. Much uncertainty has arisen around the ultimate effect on delinquencies, defaults, prepayment speeds, low interest rates and home price appreciation. These provisions of the CARES Act also impact MSR owners, like Two Harbors, that are required for certain of the MSR assets to advance principal, interest, taxes and insurance payments during the time when borrowers are in forbearance or while foreclosure moratorium is in effect. After increasing in the months following the passage of the Act, the number of loans in forbearance in our servicing portfolio has subsequently decreased. If the economy is further impacted by future surges in COVID-19 virus cases across the country, more borrowers could opt for forbearance relief from their mortgage loan payments. As a result, we could see the number of loans in forbearance in our servicing portfolio increase. We believe our current portfolio allocation and our investing expertise, as well as our operational capabilities to invest in MSR, will allow us to navigate the dynamic mortgage market while future regulatory and policy activities take shape. Our portfolio, consisting as it does of Agency RMBS and MSR, with offsetting risk characteristics, allows us to mitigate a variety of risks, including interest rate and RMBS spread volatility. The following table provides the carrying value of our investment portfolio by product type: December 31,
(dollars in thousands) 2020 2019
Agency
Fixed Rate $ 14,627,097 89.7 % $ 27,763,471 83.2 %
Hybrid ARM 10,794 - % 14,584 - %
Total Agency 14,637,891 89.7 % 27,778,055 83.2 %
Agency Derivatives 61,617 0.4 % 68,925 0.2 %
Non-Agency 13,031 0.1 % 3,628,273 10.9 %
Mortgage servicing rights 1,596,153 9.8 % 1,909,444 5.7 %
Total $ 16,308,692 $ 33,384,697
Prepayment speeds and volatility due to interest rates
Our portfolio is subject to market risks, primarily interest rate risk and
prepayment risk. We seek to offset a portion of our Agency pool market value
exposure through our MSR and interest-only Agency RMBS portfolios. Generally,
rising prepayment speeds will cause the market value of our RMBS trading at a
premium to par (including interest-only securities) and MSR to decrease, and our
RMBS trading at a discount to par to increase. The inverse relationship occurs
when prepayment speeds slow. During periods of decreasing interest rates, the
market value of our Agency pools generally increases and the market value of our
interest-only securities and MSR generally decreases. We believe the low
interest rate environment is expected to persist in the near term. Changes in
home price performance, key employment metrics and government programs, among
other macroeconomic factors, could cause prepayment speeds to increase on many
RMBS, which could lead to less attractive reinvestment opportunities.
Nonetheless, we believe our portfolio management approach, including our asset
selection process, positions us to respond to a variety of market scenarios,
including an overall faster prepayment environment.
The following table provides the three-month average constant prepayment rate,
or CPR, experienced by Agency RMBS and MSR owned by us as of December 31, 2020 ,
and the four immediately preceding quarter-ends:
December 31, September 30, June 30, March 31, December 31,
2020 2020 2020 2020 2019
Agency RMBS 27.0 % 23.1 % 19.9 % 12.3 % 14.3 %
Mortgage servicing rights 41.2 % 41.5 % 35.6 % 19.9 % 20.8 %
36-------------------------------------------------------------------------------- Table of C ontents Although we are unable to predict future interest rate movements, our strategy of pairing Agency RMBS with MSR, with a focus on managing various associated risks, including interest rate, prepayment, credit, mortgage spread and financing risk, is intended to generate attractive yields with a low level of sensitivity to changes in the yield curve, prepayments and interest rate cycles. Our Agency RMBS are collateralized by pools of fixed-rate mortgage loans and hybrid adjustable-rate mortgage loans, or hybrid ARMs, which are mortgage loans that have interest rates that are fixed for an initial period and adjustable thereafter. Our Agency portfolio also includes securities with implicit prepayment protection, including lower loan balances (securities collateralized by loans of less than$200,000 in initial principal balance), higher LTVs (securities collateralized by loans with LTVs greater than or equal to 80%), certain geographic concentrations and lower FICO scores. Our overall allocation of Agency RMBS and holdings of pools with specific characteristics are viewed in the context of our aggregate rates strategy, including MSR and related derivative hedging instruments. Additionally, the selection of securities with certain attributes is driven by the perceived relative value of the securities, which factors in the opportunities in the marketplace, the cost of financing and the cost of hedging interest rate, prepayment, credit and other portfolio risks. As a result, Agency RMBS capital allocation reflects management's flexible approach to investing in the marketplace. The following tables provide the carrying value of our Agency RMBS portfolio by underlying mortgage loan rate type: December 31, 2020 Gross Weighted Weighted Principal/ Weighted Average % Prepayment Average Coupon Allowance for Average Loan (dollars in thousands) Current Face Carrying Value CPR Protected Rate Amortized Cost Credit Losses Age (months) Agency RMBS AFS: 30-Year Fixed ? 2.5%$ 1,878,319 $ 2,005,269 7.7 % 100.0 % 3.4 %$ 1,977,388 $ - 7 3.0% 2,359,772 2,541,676 19.3 % 100.0 % 3.7 % 2,433,757 - 14 3.5% 3,327,048 3,636,988 28.5 % 100.0 % 4.2 % 3,485,035 - 17 4.0% 2,642,730 2,911,556 37.5 % 100.0 % 4.6 % 2,751,139 - 36 4.5% 2,276,487 2,538,418 34.3 % 100.0 % 5.0 % 2,400,043 - 35 ? 5.0% 519,976 590,044 33.6 % 98.4 % 5.8 % 551,230 - 65 13,004,332 14,223,951 27.4 % 99.9 % 4.3 % 13,598,592 - 24 Other P&I 99,023 113,302 9.6 % - % 6.6 % 110,002 - 226 Interest-only 3,649,556 300,638 14.0 % - % 3.5 % 315,876 (17,889) 48 Agency Derivatives 318,162 61,617 16.5 % - % 6.7 % 45,618 - 195 Total Agency RMBS$ 17,071,073 $ 14,699,508 96.7 %$ 14,070,088 $ (17,889) December 31, 2019 Gross Weighted Weighted Principal/ Weighted % Prepayment Average Coupon Average Loan (dollars in thousands) Current Face Carrying Value Average CPR Protected Rate Amortized Cost Age (months) Agency RMBS AFS: 30-Year Fixed ? 2.5% $ - $ - - % - % - % $ - - 3.0% 6,034,075 6,168,095 3.3 % 98.3 % 3.8 % 6,169,224 3 3.5% 6,174,872 6,451,660 7.0 % 100.0 % 4.3 % 6,386,051 7 4.0% 8,455,585 8,993,011 19.4 % 100.0 % 4.6 % 8,808,458 25 4.5% 4,714,844 5,082,166 25.2 % 100.0 % 5.0 % 4,942,234 20 ? 5.0% 741,000 813,503 23.5 % 100.0 % 5.8 % 786,727 48 26,120,376 27,508,435 14.4 % 99.6 % 4.5 % 27,092,694 16 Other P&I 119,168 133,436 7.3 % 0.3 % 6.7 % 133,174 210 Interest-only 2,601,693 136,184 10.9 % - % 4.4 % 169,811 104 Agency Derivatives 397,137 68,925 12.3 % - % 6.7 % 56,959 184 Total Agency RMBS$ 29,238,374 $ 27,846,980 98.4 %$ 27,452,638 37
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Table of C ontents
Counterparty exposure and leverage ratio We monitor counterparty exposure in our broker, banking and lending counterparties on a daily basis. We believe our broker and banking counterparties are well-capitalized organizations and we attempt to manage our cash balances across these organizations to reduce our exposure to any single counterparty. As ofDecember 31, 2020 , we had entered into repurchase agreements with 45 counterparties, 20 of which had outstanding balances atDecember 31, 2020 . In addition, we held short- and long-term borrowings under revolving credit facilities, long-term term notes payable and long-term unsecured convertible senior notes. As ofDecember 31, 2020 , the debt-to-equity ratio funding our AFS securities, MSR and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 5.2:1.0. As ofDecember 31, 2020 , we held$1.4 billion in cash and cash equivalents, approximately$7.4 million of unpledged Agency securities and derivatives and$10.4 million of unpledged non-Agency securities. As a result, we had an overall estimated unused borrowing capacity on our unpledged securities of approximately$13.1 million . As ofDecember 31, 2020 , we held approximately$449.4 million of unpledged MSR and$52.3 million of unpledged servicing advances. Overall, we had unused committed borrowing capacity on MSR asset and servicing advance financing facilities of$215.2 million and$191.0 million , respectively. Generally, unused borrowing capacity may be the result of our election not to utilize certain financing, as well as delays in the timing in which funding is provided, insufficient collateral or the inability to meet lenders' eligibility requirements for specific types of asset classes. We also monitor exposure to our MSR counterparties. We may be required to make representations and warranties to investors in the loans underlying the MSR we own; however, some of our MSR were purchased on a bifurcated basis, meaning the representation and warranty obligations remain with the seller. If the representations and warranties we make prove to be inaccurate, we may be obligated to repurchase certain mortgage loans, which may impact the profitability of our portfolio. Although we obtain similar representations and warranties from the counterparty from which we acquired the relevant asset, if those representations and warranties do not directly mirror those we make to the investor, or if we are unable to enforce the representations and warranties against the counterparty for a variety of reasons, including the financial condition or insolvency of the counterparty, we may not be able to seek indemnification from our counterparties for any losses attributable to the breach. Proposed changes toLIBOR LIBOR is used extensively in theU.S. and globally as a "benchmark" or "reference rate" for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives. It had been expected that a number of private-sector banks currently reporting information used to set LIBOR would stop doing so after 2021 when their current reporting commitment ends, which would either cause LIBOR to stop publication immediately or cause LIBOR's regulator to determine that its quality has degraded to the degree that it is no longer representative of its underlying market. OnNovember 30, 2020 , Intercontinental Exchange Inc. announced thatICE Benchmark Administration Limited , the administrator of LIBOR, does not intend to stop publication of the majority of USD-LIBOR tenors untilJune 30, 2023 . In theU.S. , the Alternative Reference Rates Committee, or ARRC, has identified the Secured Overnight Financing Rate, or SOFR, as its preferred alternative rate forU.S. dollar-based LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized byU.S. Treasury securities, and is based on directly observableU.S. Treasury -backed repurchase transactions. Some market participants may continue to explore whether otherU.S. dollar-based reference rates would be more appropriate for certain types of instruments. The ARRC has proposed a paced market transition plan to SOFR, and various organizations are currently working on industry wide and company-specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. We have material contracts that are indexed to USD-LIBOR and are monitoring this activity, evaluating the related risks and our exposure, and adding alternative language to contracts, where necessary. Summary of Results of Operations and Financial Condition During the first quarter of 2020, we experienced unprecedented market conditions as a result of the global COVID-19 pandemic, including unusually significant spread widening in both Agency RMBS and non-Agency securities. In response, we focused our efforts on raising excess liquidity and de-risking our portfolio. OnMarch 25, 2020 , we sold substantially all of our non-Agency securities in order to eliminate the risks posed by continued margin calls and ongoing funding concerns associated with the significant spread widening on these assets. We also sold approximately one-third of our Agency RMBS portfolio in order to reduce risk and raise cash to establish a strong defensive liquidity position to weather potential ongoing economic and market instability. These actions, occurring at a time of wide spreads and low prices, resulted in large realized losses in the first quarter and a corresponding decline in book value. 38 -------------------------------------------------------------------------------- Table of C ontents The actions taken by the Fed to purchase Agency RMBS have been successful in stabilizing this market, as spreads and prices largely recovered on these assets in the second quarter. In addition, repurchase agreement financing markets for Agency RMBS continue to function well, term markets have re-developed, and we have experienced no issues in accessing this source of funding. Certain mortgage loan forbearance programs were announced in connection with the CARES Act. As the servicer of record for the MSR assets in our portfolio, we may be responsible for continuing to advance principal, interest, taxes and insurance on mortgage loans that are in forbearance, delinquency or default. AtDecember 31, 2020 , 27,088 loans, or 3.5% of our MSR portfolio by loan count, were in forbearance, of which 14.7% had made their December payment and were current as ofDecember 31, 2020 . Therefore, approximately 2.9% of our portfolio by loan count was in forbearance and not current as ofDecember 31, 2020 . We are confident in our ability to meet our servicing advance obligations and have entered into a revolving credit facility to finance these advances. Our GAAP net income attributable to common stockholders was$192.2 million ($0.68 per diluted weighted average share) for the three months endedDecember 31, 2020 and our GAAP net loss attributable to common stockholders was$1.7 billion ($(6.24) per diluted weighted average share) for the year endedDecember 31, 2020 , as compared to GAAP net income attributable to common stockholders of$115.8 million and$248.2 million ($0.41 and$0.93 per diluted weighted average share) for the three and twelve months endedDecember 31, 2019 . With our accounting treatment for AFS securities, unrealized fluctuations in the market values of AFS securities, excluding Agency interest-only securities and certain securities with an allowance for credit losses, do not impact our GAAP net (loss) income or taxable income but are recognized on our consolidated balance sheets as a change in stockholders' equity under "accumulated other comprehensive income." For the three and twelve months endedDecember 31, 2020 , net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were$78.7 million and$47.8 million , respectively. This, combined with GAAP net income attributable to common stockholders of$192.2 million and GAAP net loss attributable to common stockholders of$1.7 billion for the three and twelve months endedDecember 31, 2020 , respectively, resulted in comprehensive income attributable to common stockholders of$113.5 million and comprehensive loss attributable to common stockholders of$1.8 billion for the three and twelve months endedDecember 31, 2020 , respectively. For the three and twelve months endedDecember 31, 2019 , net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were$59.0 million and net unrealized gains on AFS securities recognized as other comprehensive income, net of tax, were$578.6 million , respectively. This, combined with GAAP net income attributable to common stockholders of$115.8 million and$248.2 million , resulted in comprehensive income attributable to common stockholders of$56.9 million and$826.7 million for the three and twelve months endedDecember 31, 2019 , respectively. Our book value per common share forU.S. GAAP purposes was$7.63 atDecember 31, 2020 , a decrease from$14.54 per common share atDecember 31, 2019 . For the year endedDecember 31, 2020 , we recognized comprehensive loss attributable to common stockholders of$1.8 billion , which drove the overall decrease in book value. Although some uncertainty remains regarding the future effects of the COVID-19 pandemic and the actions that may be taken by federal and state governmental authorities and GSEs in response, the Agency RMBS market has stabilized and there is more clarity regarding forbearance levels and deferral programs on Agency MSR. Our liquidity position is strong, with$1.4 billion in unrestricted cash as ofDecember 31, 2020 . Given our increased confidence, we expect to continue to deploy such capital to our target assets over time. 39 -------------------------------------------------------------------------------- Table of C ontents The following tables present the components of our comprehensive income (loss) for the three and twelve months endedDecember 31, 2020 and 2019: (in thousands, except share data) Three Months Ended Year Ended Income Statement Data: December 31, December 31, 2020 2019 2020 2019 (unaudited) Interest income: Available-for-sale securities$ 72,071 $ 230,567 $ 515,685 $ 962,283 Other 429 7,871 9,365 32,407 Total interest income 72,500 238,438 525,050 994,690 Interest expense: Repurchase agreements 11,001 152,919 233,069 654,280 Federal Home Loan Bank advances - 514 1,747 10,920 Revolving credit facilities 3,513 4,038 12,261 19,354 Term notes payable 3,296 5,002 14,974 10,708 Convertible senior notes 4,831 4,811 19,197 19,067 Total interest expense 22,641 167,284 281,248 714,329 Net interest income 49,859 71,154 243,802 280,361 Other-than-temporary impairment losses - (3,308) - (14,312) Other income (loss): Gain (loss) on investment securities 37,363 28,141 (999,859) 280,118 Servicing income 100,549 127,690 443,351 501,612 Gain (loss) on servicing asset 2,522 (21,739) (935,697) (697,659) Loss on interest rate swap, cap and swaption agreements (14,689) (6,875) (310,806) (108,289) Gain (loss) on other derivative instruments 81,289 (10,800) 90,023 259,998 Other income 474 60 1,422 337 Total other income (loss) 207,508 116,477 (1,711,566) 236,117 Expenses: Management fees - 17,546 31,738 60,102 Servicing expenses 24,217 20,253 94,266 74,607 Compensation and benefits 11,220 7,965 37,723 33,229 Other operating expenses 7,237 6,177 28,626 23,826 Restructuring charges (294) - 5,706 - Total expenses 42,380 51,941 198,059 191,764 Income (loss) before income taxes 214,987 132,382 (1,665,823) 310,402 Provision for (benefit from) income taxes 3,816 (2,372) (35,688) (13,560) Net income (loss) 211,171 134,754 (1,630,135) 323,962 Dividends on preferred stock 18,951 18,950 75,802 75,801 Net income (loss) attributable to common stockholders$ 192,220
$ 0.70
$ 0.68
$ 0.17 $ 0.40 $ 0.50 $ 1.67 Weighted average number of shares of common stock: Basic 273,699,079 272,906,815 273,600,947 267,826,739 Diluted 291,870,229 291,070,864 273,600,947 267,826,739 40
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Table of C ontents
(in thousands) Three Months Ended Year Ended
Income Statement Data: December 31, December 31,
2020 2019 2020 2019
(unaudited)
Comprehensive income (loss):
Net income (loss) $ 211,171 $ 134,754 $ (1,630,135) $ 323,962
Other comprehensive (loss) income, net of tax:
Unrealized (loss) gain on available-for-sale
securities (78,739) (58,954) (47,799) 578,583
Other comprehensive (loss) income (78,739) (58,954) (47,799) 578,583
Comprehensive income (loss) 132,432 75,800 (1,677,934) 902,545
Dividends on preferred stock 18,951 18,950 75,802 75,801
Comprehensive income (loss) attributable to
common stockholders $ 113,481
(in thousands) December 31 ,
Balance Sheet Data: 2020 2019
(unaudited)
Available-for-sale securities $ 14,650,922 $31,406,328
Mortgage servicing rights $ 1,596,153 $ 1,909,444
Total assets $ 19,515,921 $35,921,622
Repurchase agreements $ 15,143,898 $29,147,463
Federal Home Loan Bank advances $ - $ 210,000
Revolving credit facilities $ 283,830 $ 300,000
Term notes payable $ 395,609 $ 394,502
Convertible senior notes $ 286,183 $ 284,954
Total stockholders' equity $ 3,088,926 $ 4,970,466 Results of Operations The following analysis focuses on financial results during the three and twelve months endedDecember 31, 2020 and 2019. The analysis of our financial results during the three and twelve months endedDecember 31, 2019 and 2018 is omitted from this Form 10-K and included in Part II Item 7 of our Annual Report on Form 10-K for the year endedDecember 31, 2019 , which analysis is incorporated by reference. Interest Income Interest income decreased from$238.4 million and$994.7 million for the three and twelve months endedDecember 31, 2019 to$72.5 million and$525.1 million for the same periods in 2020 due to the sale of both Agency RMBS and non-Agency securities that occurred during the first quarter of 2020, further sales of some higher coupon Agency RMBS and higher amortization recognized on Agency RMBS due to prepayments. Interest Expense Interest expense decreased from$167.3 million and$714.3 million for the three and twelve months endedDecember 31, 2019 , respectively, to$22.6 million and$281.2 million for the same periods in 2020 due to lower borrowing balances related to the sale of both Agency RMBS and non-Agency securities that occurred during the first quarter of 2020 and a lower interest rate environment. 41 -------------------------------------------------------------------------------- Table of C ontents Net Interest Income The following tables present the components of interest income and average annualized net asset yield earned by asset type, the components of interest expense and average annualized cost of funds on borrowings incurred by liability and/or collateral type, and net interest income and average annualized net interest rate spread for the three and twelve months endedDecember 31, 2020 and 2019: Three Months Ended December 31, 2020 Year Ended December 31, 2020 Average Balance Interest Net Yield/Cost of Interest Net Yield/Cost of (dollars in thousands) (1) Income/Expense Funds (2) Average Balance (1) Income/Expense Funds (2)
Interest-earning assets
Agency available-for-sale securities
2.0 % $ 18,626,188 $ 461,951 2.5 %
Non-Agency available-for-sale
securities 22,449 61 1.1 % 806,274 53,734 6.7 %
Other - 429 - % 2,059 9,365 3.8 %
Total interest income/net asset yield
2.0 % $ 19,434,521 $ 525,050 2.7 %
Interest-bearing liabilities
Borrowings collateralized by:
Agency available-for-sale securities $ 15,413,060 $ 11,079 0.3 % $ 19,096,633 $ 218,562 1.1 %
Non-Agency available-for-sale
securities 2,048 12 2.3 % 434,244 12,929 3.0 %
Agency derivatives (3) 52,244 123 0.9 % 51,740 850 1.6 %
Mortgage servicing rights (4) 678,094 6,596 3.9 % 729,172 29,710 4.1 %
Unsecured borrowings:
Convertible senior notes 286,070 4,831 6.8 % 285,592 19,197 6.7 %
Total interest expense/cost of funds $ 16,431,516 22,641 0.6 % $ 20,597,381 281,248 1.4 %
Net interest income/spread (5) $ 49,859 1.4 % $ 243,802 1.3 %
42--------------------------------------------------------------------------------
Table of C ontents
Three Months Ended December 31, 2019 Year Ended December 31, 2019
Average Balance Interest Net Yield/Cost of Interest Net Yield/Cost of
(dollars in thousands) (1) Income/Expense Funds (2) Average Balance (1) Income/Expense Funds (2)
Interest-earning assets
Agency available-for-sale securities
2.9 % $ 23,593,771 $ 763,601 3.2 %
Non-Agency available-for-sale
securities 3,300,836 51,946 6.3 % 3,278,228 198,682 6.1 %
Other 9,308 7,871 4.2 % 15,530 32,407 4.6 %
Total interest income/net asset yield
3.4 % $ 26,887,529 $ 994,690 3.7 %
Interest-bearing liabilities
Borrowings collateralized by:
Agency available-for-sale securities $ 24,728,724 $ 137,919 2.2 % $ 23,018,643 $ 583,646 2.5 %
Non-Agency available-for-sale
securities 1,598,573 12,179 3.0 % 1,909,564 67,442 3.5 %
Agency derivatives (3) 50,263 359 2.9 % 47,824 1,556 3.3 %
Mortgage servicing rights (4) 956,985 12,016 5.0 % 807,486 42,618 5.3 %
Unsecured borrowings:
Convertible senior notes 284,848 4,811 6.8 % 284,413 19,067 6.7 %
Total interest expense/cost of funds $ 27,619,393 167,284 2.4 % $ 26,067,930 714,329 2.7 %
Net interest income/spread (5) $ 71,154 1.0 % $ 280,361 1.0 %
____________________
(1)Average asset balance represents average amortized cost on AFS securities.
(2)Cost of funds does not include the accrual and settlement of interest
associated with interest rate swaps and caps. In accordance with U.S. GAAP,
those costs are included in (loss) gain on interest rate swap, cap and swaption
agreements in the consolidated statements of comprehensive (loss) income. For
the three and twelve months ended December 31, 2020 , our total average cost of
funds on the assets assigned as collateral for borrowings shown in the table
above, including interest spread expense associated with interest rate swaps and
caps, was 0.5% and 1.7%, respectively, compared to 2.4% and 2.5% for the same
periods in 2019.
(3)Yields on Agency Derivatives not shown as interest income is included in gain
(loss) on other derivative instruments in the consolidated statements of
comprehensive (loss) income.
(4)Includes financing for both MSR assets and related servicing advance
obligations. Yields on mortgage servicing rights and advances not shown as these
assets do not earn interest.
(5)Net interest spread does not include the accrual and settlement of interest
associated with interest rate swaps and caps. In accordance with U.S. GAAP,
those costs are included in gain (loss) on interest rate swap, cap and swaption
agreements in the consolidated statements of comprehensive (loss) income. For
the three and twelve months ended December 31, 2020 , our total average net
interest rate spread on the assets and liabilities shown in the table above,
including interest spread expense associated with interest rate swaps and caps,
was 1.5% and 1.0%, respectively, compared to 0.9% and 1.1% for the same periods
in 2019.
The decrease in yields on Agency AFS securities for the three and twelve months
ended December 31, 2020 , as compared to the same period in 2019, was
predominantly driven by sales of pools with higher yields. The decrease in cost
of funds associated with the financing of Agency AFS securities for the three
and twelve months ended December 31, 2020 , as compared to the same period
in 2019, was the result of decreases in the borrowing rates offered by financing
counterparties.
The decrease in yields on non-Agency securities for the three and twelve months
ended December 31, 2020 , as compared to the same periods in 2019, was due to the
sale of substantially all legacy non-Agencies during the first quarter of 2020.
The decrease in cost of funds associated with the financing of non-Agency AFS
securities for the three and twelve months ended December 31, 2020 , as compared
to the same period in 2019, was also a result of the sale.
The decrease in cost of funds associated with the financing of Agency
Derivatives for the three and twelve months ended December 31, 2020 , as compared
to the same period in 2019, was the result of decreases in the borrowing rates
offered by counterparties.
The decrease in cost of funds associated with the financing of MSR assets and
related servicing advance obligations for the three and twelve months ended
December 31, 2020 , as compared to the same period in 2019, was the result of
better financing terms offered by counterparties. During the year ended December
31, 2020 , we entered into a new revolving credit facility to finance our
servicing advance obligations, which are included in other assets on our
consolidated balance sheets.
Our convertible senior notes due 2022 were issued in January 2017 , are unsecured
and pay interest semiannually at a rate of 6.25% per annum. The cost of funds
associated with our convertible senior notes due 2022 for the three and twelve
months ended December 31, 2020 , as compared to the same period in 2019, was
consistent.
43
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Table of C ontents
The following tables present the components of the yield earned on our AFS
securities portfolio as a percentage of our average amortized cost of securities
for the three and twelve months ended December 31, 2020 and 2019:
Three Months Ended Year Ended
December 31, December 31,
(in thousands) 2020 2019 2020 2019
Gross yield/stated coupon 3.9 % 4.0 % 3.9 % 4.2 %
Net (premium amortization) discount accretion (1.9) % (0.7) % (1.2) % (0.6) %
Net yield (1) 2.0 % 3.3 % 2.7 % 3.6 %
____________________
(1)Excludes Agency Derivatives. For the three and twelve months ended
December 31, 2020 , the average annualized net yield on total RMBS, including
Agency Derivatives, was 2.0% and 2.7%, respectively, compared to 3.3% and 3.6%
for the same periods in 2019. Yields have not been adjusted for cost of delay
and cost to carry purchase premiums.
Other-Than-Temporary Impairments
Prior to the adoption of Topic 326 on January 1, 2020 , we reviewed each of our
securities on a quarterly basis to determine if an OTTI charge was necessary.
During the three and twelve months ended December 31, 2019 , we recorded $3.3
million and $14.3 million in other-than-temporary credit impairments on six and
eighteen non-Agency securities, respectively, where the future expected cash
flows for each security were less than its amortized cost. For further
information about evaluating AFS securities for OTTI prior to January 1, 2020 ,
refer to Note 4 - Available-for-Sale Securities , at Fair Value of the notes to
the consolidated financial statements.
Gain (Loss) On Investment Securities
The following tables present the components of (loss) gain on investment
securities for the three and twelve months ended December 31, 2020 and 2019:
Three Months Ended December 31, 2020 Year Ended December 31, 2020
Available-For-Sale Available-For-Sale Trading
(in thousands) Securities Trading Securities Total Securities Securities Total
Proceeds from sales $ 1,379,468 $
-
(1,325,981) - (1,325,981) (19,273,667) (1,052,500) (20,326,167)
Total realized gains (losses) on
sales 53,487 - 53,487 (924,329) 977 (923,352)
Provision for credit losses (4,509) - (4,509) (58,440) - (58,440)
Other (11,615) - (11,615) (18,067) - (18,067)
Gain (loss) on investment securities $ 37,363 $ - $ 37,363 $ (1,000,836) $ 977 $ (999,859)
Three Months Ended December 31, 2019 Year Ended December 31, 2019
Available-For-Sale Available-For-Sale
(in thousands) Securities Trading Securities Total Securities Trading Securities Total
Proceeds from sales $ 1,814,250 $ - $ 1,814,250 15,879,823 $ - $ 15,879,823
Amortized cost of securities sold (1,786,635) - (1,786,635) (15,595,809) - (15,595,809)
Total realized gains on sales 27,615 - 27,615 284,014 - 284,014
Provision for credit losses - - - - - -
Other 526 - 526 (3,896) - (3,896)
Gain on investment securities $ 28,141 $ - $ 28,141 $ 280,118 $ - $ 280,118
44-------------------------------------------------------------------------------- Table of C ontents Due to the unprecedented market conditions experienced as a result of the global COVID-19 pandemic, we sold substantially all of our portfolio of non-Agency securities and approximately one-third of our Agency RMBS during the first quarter of 2020. We do not expect to sell assets on a frequent basis, but may sell assets to reallocate capital into new assets that we believe have higher risk-adjusted returns. Subsequent to the adoption of Topic 326 onJanuary 1, 2020 , the Company uses a discounted cash flow method to estimate and recognize an allowance for credit losses on AFS securities. The estimated allowance for credit losses is equal to the difference between the prepayment adjusted contractual cash flows with no credit losses and the prepayment adjusted expected cash flows with credit losses, discounted at the effective interest rate on the AFS security that was in effect upon adoption of the standard. The contractual cash flows and expected cash flows are based on management's best estimate and take into consideration current prepayment assumptions, lifetime expected losses based on past loss experience, current market conditions, and reasonable and supportable forecasts of future conditions. The allowance for credit losses causes an increase in the AFS security amortized cost and recognizes an allowance for credit losses in the same amount, with the provision for credit losses recognized in earnings (within (loss) gain on investment securities) and the balance of the unrealized loss recognized in either other comprehensive (loss) income, net of tax, or (loss) gain on investment securities, depending on the accounting treatment. Servicing Income The following table presents the components of servicing income for the three and twelve months endedDecember 31, 2020 and 2019: Three Months Ended Year Ended December 31, December 31, (in thousands) 2020 2019 2020 2019 Servicing fee income$ 98,250 $ 109,403 $ 416,936 $ 436,587
Ancillary and other fee income 557 499
1,945 1,801
Float income 1,742 17,788 24,470 63,224
Total $ 100,549 $ 127,690 $ 443,351 $ 501,612
The decrease in servicing income for the three and twelve months ended
December 31, 2020 , as compared to the same periods in 2019, was the result of
lower servicing fee income as a result of a lower portfolio balance due to
prepayments and deferred servicing fee income for loans in forbearance as a
result of COVID-19. Additionally, the decrease in float income was the result of
decreased float earning rates.
Gain (Loss) on Servicing Asset
The following table presents the components of loss on servicing asset for the
three and twelve months ended December 31, 2020 and 2019:
Three Months Ended Year Ended
December 31, December 31,
(in thousands) 2020 2019 2020 2019
Changes in fair value due to changes in
valuation inputs or assumptions used in the
valuation model $ 173,447 $ 87,561 $ (396,900) $ (390,149)
Changes in fair value due to realization of
cash flows (runoff) (170,897) (109,333) (538,761) (307,918)
(Losses) gains on sales (28) 33 (36) 408
Gain (loss) on servicing asset $ 2,522 $ (21,739) The increase in gain on servicing asset (decrease in loss on servicing asset) for the three months endedDecember 31, 2020 , as compared to the same period in 2019, was driven by favorable change in valuation assumptions used in the fair market valuation of MSR, including the impact of acquiring MSR at a cost below fair value, offset by increased portfolio runoff during the three months endedDecember 31, 2020 . The increase in loss on servicing asset for the year endedDecember 31, 2020 , as compared to the same period in 2019, was driven by an increase in prepayment speed assumptions used in the fair valuation of MSR, higher expected cost-to-service due to COVID-19 related forbearances and higher portfolio runoff on a larger average MSR portfolio balance throughout the year endedDecember 31, 2020 . 45 -------------------------------------------------------------------------------- Table of C ontents Loss on Interest Rate Swap, Cap and Swaption Agreements The following table summarizes the net interest spread and gains and losses associated with our interest rate swap, cap and swaption positions recognized during the three and twelve months endedDecember 31, 2020 and 2019: Three Months Ended Year Ended December 31, December 31, (in thousands) 2020 2019 2020 2019 Net interest spread$ 1,953 $ 4,768 $ (66,175) $ 70,514 Early termination, agreement maturation and option expiration (losses) gains (2,546) (1,495) (387,748) 94,929 Change in unrealized (loss) gain on interest rate swap, cap and swaption agreements, at fair value (14,096) (10,148) 143,117 (273,732) Loss on interest rate swap, cap and swaption agreements$ (14,689) $ (6,875) $ (310,806) $ (108,289) Net interest spread recognized for the accrual and/or settlement of the net interest expense associated with our interest rate swaps and caps results from receiving either a floating interest rate (LIBOR or the OIS rate) or a fixed interest rate and paying either a fixed interest rate or a floating interest rate (LIBOR or the OIS rate) on positions held to economically hedge/mitigate portfolio interest rate exposure (or duration) risk. We may elect to terminate certain swaps, caps and swaptions to align with our investment portfolio, agreements may mature or options may expire resulting in full settlement of our net interest spread asset/liability and the recognition of realized gains and losses, including early termination penalties. During the second quarter of 2020, we elected to terminate certain swaps and swaptions in order to adjust the total notional and fixed interest rates on these instruments, as a result of adjustments made to our investment portfolio and changes in interest rates. The change in fair value of interest rate swaps, caps and swaptions during the three and twelve months endedDecember 31, 2020 and 2019 was a result of changes to floating interest rates (LIBOR or the OIS rate), the swap curve and corresponding counterparty borrowing rates. Since swaps, caps and swaptions are used for purposes of hedging our interest rate exposure, their unrealized valuation gains and losses (excluding the reversal of unrealized gains and losses to realized gains and losses upon termination, maturation or option expiration) are generally offset by unrealized losses and gains in our Agency RMBS AFS portfolio, which are recorded either directly to stockholders' equity through other comprehensive (loss) income, net of tax, or to (loss) gain on investment securities, in the case of Agency interest-only mortgage-backed securities. Gain (Loss) on Other Derivative Instruments The following table provides a summary of the total net gains (losses) recognized on other derivative instruments we hold for purposes of both hedging and non-hedging activities, principally TBAs, put and call options for TBAs, Markit IOS total return swaps, shortU.S. Treasuries,U.S. Treasury futures and inverse interest-only securities during the three and twelve months endedDecember 31, 2020 and 2019: Three Months Ended Year Ended December 31, December 31, (in thousands) 2020 2019 2020 2019 Interest income, net of accretion, on inverse interest-only securities$ 2,232 $ 1,702 $ 9,479 $ 5,586 Interest expense on short U.S. treasuries - - - (1,315) Realized and unrealized net gains (losses) on other derivative instruments (1) 79,057 (12,502) 80,544 255,727 Gain (loss) on other derivative instruments$ 81,289 $ (10,800) $ 90,023 $ 259,998 ____________________
(1)As these derivative instruments are considered trading instruments, our financial results include both realized and unrealized gains (losses) associated with these instruments.
For further details regarding our use of derivative instruments and related activity, refer to Note 7 - Derivative Instruments and Hedging Activities to the consolidated financial statements, included in this Annual Report on Form 10-K.
46
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Table of C ontents
Expenses
The following table presents the components of expenses, other than
restructuring charges, for the three and twelve months ended December 31, 2020
and 2019:
Three Months Ended Year Ended
December 31, December 31,
(in thousands, except share data) 2020 2019 2020 2019
Management fees $ - $ 17,546 $ 31,738 $ 60,102
Servicing expenses $ 24,217 $ 20,253 $ 94,266 $ 74,607
Operating expenses:
Compensation and benefits:
Non-cash equity compensation expenses $ 2,243 $ 2,423 $ 9,730 $ 8,660
All other compensation and benefits 8,977 5,542 27,993 24,569
Total compensation and benefits $ 11,220 $ 7,965 $ 37,723 $ 33,229
Other operating expenses:
Nonrecurring expenses $ 1,541 $ - $ 5,205 $ -
All other operating expenses 5,696 6,177 23,421 23,826
Total other operating expenses $ 7,237 $ 6,177 $ 28,626 $ 23,826
Annualized operating expense ratio 2.4 % 1.1 % 2.0 % 1.2 %
Annualized operating expense ratio, excluding
non-cash equity compensation and other
nonrecurring expenses 1.9 % 0.9 % 1.5 % 1.0 %
Prior to the termination of the Management Agreement on August 14, 2020 ,
management fees were payable to PRCM Advisers under the agreement. The
management fee was calculated based on our stockholders' equity with certain
adjustments outlined in the management agreement. In connection with the
acquisition of CYS effective July 31, 2018 , the Management Agreement was amended
to reduce PRCM Advisers' base management fee with respect to the additional
equity under management resulting from the merger to 0.75% from the effective
time through the first anniversary of the effective time. Effective July 31,
2019 , the management fee reduction on the equity acquired in the CYS transaction
expired.
We also incur servicing expenses generally related to the subservicing of MSR.
The increase in servicing expenses during the three and twelve months ended
December 31, 2020 , as compared to the same periods in 2019, was a result of a
higher cost to service loans in forbearance.
Prior to the termination of the Management Agreement, included in compensation
and benefits and other operating expenses were direct and allocated costs
incurred by PRCM Advisers on our behalf and reimbursed by us. For the year ended
December 31, 2020 , these direct and allocated costs totaled approximately $19.3
million , compared to $4.6 million and $27.6 million for the three and twelve
months ended December 31, 2019 . Included in these reimbursed costs was
compensation paid to employees of an affiliate of PRCM Advisers serving as our
principal financial officer and general counsel of $1.4 million for the year
ended December 31, 2020 and $0.1 million and $3.1 million for the three and
twelve months ended December 31, 2019 , respectively. We did not reimburse PRCM
Advisers for compensation paid to our principal financial officer and general
counsel for the three months ended December 31, 2020 . Prior to termination of
the Management Agreement, the allocation of compensation paid to employees of an
affiliate of PRCM Advisers serving as our principal financial officer and
general counsel was based on time spent overseeing our activities in accordance
with the Management Agreement; we did not reimburse PRCM Advisers for any
expenses related to the compensation of our chief executive officer or chief
investment officer. Additionally, included in compensation and benefits is
non-cash equity compensation expense, which represents amortization of the
restricted stock awarded to our independent directors, executive officers and
other eligible individuals. Included in non-cash equity compensation expense for
the three and twelve months ended December 31, 2020 was amortization of
restricted stock awarded to our executive officers, including our chief
executive officer, chief investment officer, principal financial officer and
general counsel of $0.9 million and $3.9 million , compared to $1.2 million and
$3.4 million for the three and twelve months ended December 31, 2019 ,
respectively.
Following the termination of the Management Agreement, we no longer pay a
management fee to, or reimburse the expenses of, PRCM Advisers. Expenses for
which we previously reimbursed PRCM Advisers are now paid directly by us. We are
also now responsible for the cash compensation and employee benefits of our
chief executive officer, chief investment officer and investment professionals,
which were previously the responsibility of PRCM Advisers. Prior to the
termination of the Management Agreement, we were only responsible for the equity
compensation paid to such individuals.
47
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Table of C ontents
Restructuring Charges
On April 13, 2020 , we announced that we had elected to not renew the Management
Agreement with PRCM Advisers on the basis of unfair compensation payable to the
manager pursuant to Section 13(a)(ii) of the Management Agreement. As a result,
we had expected the Management Agreement to terminate on September 19, 2020 , at
which time we would have been required to pay a termination fee equal to three
times the sum of the average annual base management fee earned by PRCM Advisers
during the 24-month period immediately preceding the date of termination,
calculated as of the end of the most recently completed fiscal quarter prior to
the date of termination, pursuant to the terms of the Management Agreement. The
termination fee was calculated to be $139.8 million based on results as of June
30, 2020 .
On July 15, 2020 , we provided PRCM Advisers with a notice of termination of the
Management Agreement for "cause" on the basis of certain material breaches of
the Management Agreement by PRCM Advisers, its agents and/or its assignees that
are incapable of being cured within the time period set forth therein and
certain events of gross negligence on the part of PRCM Advisers in the
performance of its duties under the Management Agreement. The Management
Agreement subsequently terminated on August 14, 2020 . No termination fee was
payable to PRCM Advisers in connection with such termination, pursuant to
Section 15(a) of the Management Agreement.
In connection with the termination of the Management Agreement, we reversed the
$139.8 million accrued termination fee during the three months ended September
30, 2020 . For the year ended December 31, 2020 , we incurred a total of $5.7
million in contract termination costs, which includes all estimated costs
incurred for legal and advisory services provided to facilitate the termination
of the Management Agreement. In accordance with Accounting Standards
Codification (ASC) 420, Exit or Disposal Cost Obligations, all contract
termination costs are included within restructuring charges on our consolidated
statements of comprehensive (loss) income for the year ended December 31, 2020 .
Income Taxes
During the three and twelve months ended December 31, 2020 , our TRSs recognized
a provision for income taxes of $3.8 million and a benefit from income taxes of
$35.7 million , respectively. The provision recognized for the three months ended
December 31, 2020 was primarily due to gains recognized on MSR, offset by net
losses recognized on derivative instruments held in the our TRSs. The benefit
recognized for the year ended December 31, 2020 was primarily due to losses
recognized on MSR, offset by net gains recognized on derivative instruments held
in our TRSs. During the three and twelve months ended December 31, 2019 , our
TRSs recognized a benefit from income taxes of $2.4 million and $13.6 million ,
respectively, which was primarily due to losses recognized on MSR, offset by net
gains recognized on derivative instruments held in our TRSs.
Financial Condition
Available-for-Sale Securities , at Fair Value
The majority of our AFS investment securities portfolio is comprised of
adjustable rate and fixed rate Agency mortgage-backed securities backed by
single-family and multi-family mortgage loans. We also hold $13.0 million in
tranches of mortgage-backed and asset-backed P&I and interest-only non-Agency
securities. All of our P&I Agency RMBS AFS are Fannie Mae or Freddie Mac
mortgage pass-through certificates or collateralized mortgage obligations that
carry an implied rating of "AAA ," or Ginnie Mae mortgage pass-through
certificates, which are backed by the guarantee of the U.S. government. The
majority of these securities consist of whole pools in which we own all of the
investment interests in the securities.
48
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Table of C ontents
The tables below summarizes certain characteristics of our Agency RMBS AFS at
December 31, 2020 and December 31, 2019 :
December 31, 2020
Weighted Weighted
(dollars in thousands, Principal/ Net (Discount) Allowance for Unrealized Unrealized Average Coupon Average
except purchase price) Current Face Premium Amortized Cost Credit Losses Gain Loss Carrying Value Rate Purchase Price
P&I securities:
Fixed $ 13,093,273 $ 604,790 $ 13,698,063 $ - $ 628,716 $ (320) $ 14,326,459 3.64 % $ 104.95
Hybrid ARM 10,082 449 10,531 - 363 (100) 10,794 5.19 % $ 107.87
Total P&I securities 13,103,355 605,239 13,708,594 - 629,079 (420) 14,337,253 3.64 % $ 104.95
Interest-only securities:
Fixed 2,021,657 233,866 233,866 (786) 7,747 (5,540) 235,287 2.96 % $ 16.04
Fixed Other (1) 1,627,899 82,010 82,010 (17,103) 7,933 (7,489) 65,351 1.85 % $ 8.57
Total $ 16,752,911 $ 921,115 $ 14,024,470 $ (17,889) $ 644,759 $ (13,449) $ 14,637,891
December 31, 2019
Weighted Weighted
(dollars in thousands, except Principal/ Net (Discount) Unrealized Unrealized Average Coupon Average
purchase price) Current Face Premium Amortized Cost Gain Loss Carrying Value Rate Purchase Price
P&I securities:
Fixed $ 26,225,918 $ 985,699 $ 27,211,617 $ 424,428 $ (8,758) $ 27,627,287 3.80 % $ 103.96
Hybrid ARM 13,626 625 14,251 390 (57) 14,584 5.81 % $ 107.58
Total P&I Securities 26,239,544 986,324 27,225,868 424,818 (8,815) 27,641,871 3.80 % $ 103.96
Interest-only securities:
Fixed 609,012 44,970 44,970 3,482 (676) 47,776 3.13 % $ 34.16
Fixed Other (1) 1,992,681 124,841 124,841 10,242 (46,675) 88,408 1.68 % $ 8.72
Total $ 28,841,237 $ 1,156,135 $ 27,395,679 $ 438,542 $ (56,166) $ 27,778,055
____________________
(1)Fixed Other represents weighted-average coupon interest-only securities that
are not generally used for our interest-rate risk management purposes. These
securities pay variable coupon interest based on the weighted average of the
fixed rates of the underlying loans of the security, less the weighted average
rates of the applicable issued P&I securities.
Our three-month average constant prepayment rate, or CPR, experienced by Agency
RMBS AFS owned by us as of December 31, 2020 and 2019 on an annualized basis,
was 27.0% and 14.3%, respectively.
Mortgage Servicing Rights, at Fair Value
One of our wholly owned subsidiaries has approvals from Fannie Mae and Freddie
Mac to own and manage MSR, which represent the right to control the servicing of
mortgage loans. We do not directly service mortgage loans, and instead contract
with appropriately licensed subservicers to handle substantially all servicing
functions in the name of the subservicer for the loans underlying our MSR. As of
December 31, 2020 and December 31, 2019 , our MSR had a fair market value of $1.6
billion and $1.9 billion , respectively.
49
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Table of C ontents
As of December 31, 2020 and December 31, 2019 , our MSR portfolio included MSR on
781,905 and 793,470 loans with an unpaid principal balance of approximately
$177.9 billion and $175.9 billion , respectively. The following tables summarize
certain characteristics of the loans underlying our MSR by gross weighted
average coupon rate types and ranges at December 31, 2020 and December 31, 2019 :
December 31, 2020
Gross Weighted Weighted Weighted
Unpaid Principal Average Coupon Average Loan Weighted Average Average
(dollars in thousands) Number of Loans Balance % Fannie Mae Rate Age (months) Original FICO Original LTV 60+ Day Delinquencies 3-Month CPR Net Servicing Fee (bps)
30-Year Fixed:
? 3.25% 87,561 $ 29,304,400 50.3 % 2.9 % 4 769 71.8 % 0.1 % 9.0 % 25.5
> 3.25 - 3.75% 148,065 39,634,267 67.5 % 3.5 % 30 764 73.1 % 1.6 % 38.2 % 26.3
> 3.75 - 4.25% 188,805 43,124,073 63.9 % 3.9 % 44 757 76.3 % 3.8 % 49.1 % 27.5
> 4.25 - 4.75% 130,598 26,096,168 65.7 % 4.4 % 45 741 78.3 % 6.2 % 49.2 % 26.6
> 4.75 - 5.25% 64,424 11,727,196 67.1 % 4.9 % 39 727 79.6 % 8.5 % 46.5 % 27.8
> 5.25% 25,637 3,958,181 70.4 % 5.5 % 36 707 79.7 % 10.8 % 41.2 % 30.8
645,090 153,844,285 62.9 % 3.8 % 32 755 75.3 % 3.5 % 42.7 % 26.8
15-Year Fixed:
? 2.25% 1,996 665,514 87.6 % 2.0 % 2 780 59.6 % - % 7.8 % 25.0
> 2.25 - 2.75% 19,260 5,256,640 70.6 % 2.5 % 7 778 59.5 % 0.1 % 12.4 % 25.8
> 2.75 - 3.25% 47,710 8,571,486 71.5 % 2.9 % 37 771 61.9 % 1.1 % 27.6 % 26.1
> 3.25 - 3.75% 36,327 5,223,663 71.6 % 3.4 % 45 759 64.9 % 2.2 % 33.7 % 27.6
> 3.75 - 4.25% 17,611 2,148,413 64.1 % 3.9 % 43 745 65.6 % 3.4 % 35.1 % 29.2
> 4.25% 9,149 958,531 62.8 % 4.5 % 34 731 66.3 % 3.6 % 37.0 % 31.2
132,053 22,824,247 70.7 % 3.1 % 32 766 62.5 % 1.4 % 28.8 % 26.8
Total ARMs 4,762 1,192,951 61.5 % 3.3 % 47 762 67.2 % 4.3 % 45.4 % 25.2
Total 781,905 $ 177,861,483 63.9 % 3.7 % 32 756 73.6 % 3.2 % 41.2 % 26.8
December 31, 2019
Gross Weighted Weighted Weighted
Unpaid Principal Average Coupon Average Loan Weighted Average Average
(dollars in thousands) Number of Loans Balance % Fannie Mae Rate Age (months) Original FICO Original LTV 60+ Day Delinquencies 3-Month CPR Net Servicing Fee (bps)
30-Year Fixed:
? 3.75% 106,097 $ 27,627,966 71.3 % 3.5 % 47 771 70.5 % 0.1 % 10.5 % 26.4
> 3.75 - 4.25% 241,274 59,172,782 64.5 % 3.9 % 39 761 76.3 % 0.2 % 16.1 % 26.9
> 4.25 - 4.75% 194,543 43,611,524 65.2 % 4.4 % 33 745 78.9 % 0.4 % 26.4 % 26.3
> 4.75 - 5.25% 95,468 19,780,323 65.9 % 4.9 % 26 732 80.4 % 0.5 % 32.9 % 28.0
> 5.25% 34,524 5,987,442 70.5 % 5.5 % 24 709 80.2 % 1.0 % 30.8 % 30.8
671,906 156,180,037 66.3 % 4.2 % 37 753 76.7 % 0.3 % 21.4 % 26.9
15-Year Fixed:
? 2.75% 2,325 464,650 80.8 % 2.6 % 46 778 59.7 % - % 8.6 % 26.1
> 2.75 - 3.25% 39,977 6,893,458 79.9 % 2.9 % 48 772 62.2 % 0.1 % 11.2 % 25.8
> 3.25 - 3.75% 40,052 6,311,291 74.0 % 3.4 % 40 760 65.0 % 0.1 % 15.0 % 27.6
> 3.75 - 4.25% 21,243 2,990,294 64.2 % 3.9 % 32 747 66.0 % 0.2 % 19.2 % 29.4
> 4.25% 11,644 1,423,018 61.9 % 4.5 % 23 734 66.6 % 0.2 % 24.8 % 31.4
115,241 18,082,711 73.9 % 3.4 % 40 761 64.0 % 0.1 % 15.0 % 27.5
Total ARMs 6,323 1,619,394 69.9 % 3.6 % 44 762 65.8 % 0.3 % 27.3 % 25.2
Total 793,470 $ 175,882,142 67.1 % 4.1 % 37 754 75.3 % 0.3 % 20.8 % 27.0
50-------------------------------------------------------------------------------- Table of C ontents Financing Our borrowings consist primarily of repurchase agreements, revolving credit facilities and term notes payable. These borrowings are collateralized by our pledge of AFS securities, derivative instruments, MSR, servicing advances and certain cash balances. Substantially all of our Agency RMBS are currently pledged as collateral, and a portion of our non-Agency securities have been pledged as collateral for repurchase agreements. During the year endedDecember 31, 2019 , we formed a trust entity, or theMSR Issuer Trust , for the purpose of financing MSR through securitization. OnJune 27, 2019 , we, through theMSR Issuer Trust , completed an MSR securitization transaction pursuant to which, through two of our wholly owned subsidiaries, MSR is pledged to theMSR Issuer Trust and in return, theMSR Issuer Trust issued (a) an aggregate principal amount of$400.0 million in term notes to qualified institutional buyers and (b) a variable funding note, or VFN, with a maximum principal balance of$1.0 billion to one of the subsidiaries, in each case secured on a pari passu basis. The term notes bear interest at a rate equal to one-month LIBOR plus 2.80% per annum. The term notes will mature onJune 25, 2024 or, if extended pursuant to the terms of the related indenture supplement,June 25, 2026 (unless earlier redeemed in accordance with their terms). Additionally, our convertible senior notes due 2022 were issued inJanuary 2017 , are unsecured and pay interest semiannually at a rate of 6.25% per annum. AtDecember 31, 2020 andDecember 31, 2019 , borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes had the following characteristics: (dollars in thousands) December 31, 2020 December 31, 2019 Weighted Weighted Weighted Average Average Years Weighted
Average Average Years
Borrowing Type Amount Outstanding Borrowing Rate to Maturity Amount Outstanding Borrowing Rate to Maturity
Repurchase agreements $ 15,143,898 0.28 % 0.2 $ 29,147,463 2.14 % 0.2
Federal Home Loan Bank
advances - - % - 210,000 2.00 % 3.5
Revolving credit
facilities 283,830 2.95 % 1.1 300,000 4.26 % 1.2
Term notes payable 395,609 2.95 % 3.5 394,502 4.59 % 4.5
Convertible senior notes
(1) 286,183 6.25 % 1.0 284,954 6.25 % 2.0
Total $ 16,109,520 0.50 % 0.3 $ 30,336,919 2.23 % 0.3
(dollars in thousands) December 31, 2020 December 31, 2019
Weighted Average Weighted Average
Weighted Average Haircut on Weighted Average Haircut on
Collateral Type Amount Outstanding Borrowing Rate Collateral Value Amount Outstanding Borrowing Rate Collateral Value
Agency RMBS $ 15,089,726 0.28 % 4.4 % $ 27,512,526 2.08 % 4.1 %
Non-Agency securities 1,899 2.33 % 34.3 % 1,531,608 2.90 % 24.9 %
Agency Derivatives 52,273 0.89 % 21.6 % 50,714 2.70 % 26.4 %
Mortgage servicing rights 670,439 2.95 % 24.6 % 957,117 4.19 % 31.7 %
Mortgage servicing advances 9,000 3.26 % 12.0 % - - % - %
Other (1) 286,183 6.25 % NA 284,954 6.25 % NA
Total $ 16,109,520 0.50 % 5.2 % $ 30,336,919 2.23 % 6.0 %
____________________
(1)Includes unsecured convertible senior notes paying interest semiannually at a
rate of 6.25% per annum on the aggregate principal amount of
As ofDecember 31, 2020 , the debt-to-equity ratio funding our AFS securities, MSR, servicing advances and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 5.2:1.0. We believe the current degree of leverage within our portfolio helps ensure that we have access to unused borrowing capacity, thus supporting our liquidity and the strength of our balance sheet. 51 -------------------------------------------------------------------------------- Table of C ontents The following table provides a summary of our borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes, our net TBA notional amounts and our debt-to-equity ratios for the three months endedDecember 31, 2020 , and the four immediately preceding quarters: (dollars in thousands) End of Period End of Period End of Period Net Economic End
of Period Maximum Balance Total Borrowings Long (Short) TBA Debt-to-Equity For the Three Months Ended
Quarterly Average Balance of Any Month-End to Equity Ratio Notional Ratio (1)
December 31, 2020 $ 16,431,516 $ 16,109,520 $ 16,842,273 5.2:1.0 $ 5,197,000 6.8:1.0
September 30, 2020 $ 17,702,696 $ 17,332,697 $ 17,896,976 5.7:1.0 $ 6,236,000 7.7:1.0
June 30, 2020 $ 18,121,689 $ 17,938,992 $ 18,062,737 6.3:1.0 $ 3,236,000 7.4:1.0
March 31, 2020 $ 30,142,279 $ 18,777,669 $ 33,225,403 6.5:1.0 $ 1,761,000 7.0:1.0
December 31, 2019 $ 27,619,393 $ 30,336,919 $ 30,336,919 6.1:1.0 $ 7,427,000 7.5:1.0
____________________(1)Defined as total borrowings under repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and convertible senior notes, plus implied debt on net TBA notional, divided by total equity.
Equity
The tables below provide details of our changes in stockholders' equity from
Common Book
Value Per
(dollars in millions, except per share amounts) Book Value Common Shares Outstanding Share
Common stockholders' equity at
272.9$ 14.54
Reconciliation of non-GAAP measures to GAAP net loss and
Comprehensive loss:
Core Earnings, net of tax expense of
(75.8)
Core Earnings attributable to common stockholders, net
of tax expense of
210.7
Realized and unrealized gains and losses, net of tax
benefit of
(1,916.6)
Other comprehensive loss, net of tax (47.8)
Dividend declarations (136.8)
Other 9.7 0.8
Repurchase of common stock (1.1) (0.1)
Issuance of common stock, net of offering costs 0.4 0.1
Common stockholders' equity at
273.7$ 7.63 Total preferred stock liquidation preference 1,001.3
Total stockholders' equity at
52--------------------------------------------------------------------------------
Table of C ontents
Year Ended
December 31,
(in millions) 2020
Comprehensive loss attributable to common stockholders $ (1,753.7)
Adjustment for other comprehensive income attributable to common
stockholders:
Unrealized gains on available-for-sale securities 47.8
Net loss attributable to common stockholders (1,705.9)
Adjustments for non-Core Earnings:
Realized losses on investment securities 929.9 Unrealized loss on investment securities 11.5 Provision for credit losses on investment securities 58.5 Realized and unrealized losses on mortgage servicing rights 681.9
Realized loss on termination or expiration of interest rate swaps, caps and swaptions
387.7
Unrealized gain on interest rate swaps, caps and swaptions (143.1)
Loss on other derivative instruments 3.6
Other income (1.1)
Change in servicing reserves 2.8
Non-cash equity compensation expense 9.8
Other nonrecurring expenses 5.2
Restructuring charges 5.7
Net benefit from income taxes on non-Core Earnings (35.8)
Core Earnings attributable to common stockholders (1) $ 210.7
____________________
(1)Core Earnings is a non-U.S. GAAP measure that we define as comprehensive (loss) income attributable to common stockholders, excluding "realized and unrealized gains and losses" (impairment losses, provision for credit losses, realized and unrealized gains and losses on the aggregate portfolio, reserve expense for representation and warranty obligations on MSR, non-cash compensation expense related to restricted common stock, other nonrecurring expenses and restructuring charges). As defined, Core Earnings includes net interest income, accrual and settlement of interest on derivatives, dollar roll income on TBAs, servicing income, net of estimated amortization on MSR, management fees and recurring cash related operating expenses. Dollar roll income is the economic equivalent to holding and financing Agency RMBS using short-term repurchase agreements. Core Earnings provides supplemental information to assist investors in analyzing the Company's results of operations and helps facilitate comparisons to industry peers. 53 -------------------------------------------------------------------------------- Table of C ontentsU.S. GAAP to Estimated Taxable Income The following tables provide reconciliations of our GAAP net income (loss) to our estimated taxable income (loss) split between our REIT and TRSs for the years endedDecember 31, 2020 and 2019: Year Ended December 31, 2020 (dollars in millions) TRS REIT Eliminations Consolidated
GAAP net (loss) income, pre-tax
$ 18.8 $ (1,665.8) State taxes (1.2) (0.1) - (1.3) Adjusted GAAP net (loss) income , pre-tax (176.9) (1,509.0) 18.8 (1,667.1) Permanent differences Intercompany RMBS sales - - (18.8) (18.8) Other permanent differences 0.2 1.3 - 1.5 Temporary differences Net accretion of OID and market discount (48.7) (148.5) - (197.2) Net unrealized gains and losses on derivatives 237.7 38.9 - 276.6 Net realized gains and losses on sales of RMBS - (247.9) - (247.9) Credit loss impairment - 60.5 - 60.5 Other temporary differences 2.7 5.7 - 8.4 Capital loss carryforward deferral - 1,158.5 - 1,158.5 Estimated taxable income (loss) 15.0 (640.5) - (625.5) Dividend paid deduction - - - - Estimated taxable income (loss) post-dividend deduction$ 15.0 $ (640.5) $ -$ (625.5) Year Ended December 31, 2019 (dollars in millions) TRS REIT Eliminations Consolidated
GAAP net (loss) income, pre-tax
$ 38.4 $ 310.4 State taxes (2.1) (0.5) - (2.6) Adjusted GAAP (loss) net income, pre-tax (77.2) 346.6 38.4 307.8 Permanent differences Intercompany RMBS sales - - (38.4) (38.4) Dividends from TRSs - 50.1 - 50.1 Other permanent differences - (8.3) - (8.3) Temporary differences Net accretion of OID and market discount (39.3) 45.8 - 6.5 Net unrealized gains and losses on derivatives 231.0 557.9 - 788.9 Other temporary differences 4.8 20.9 - 25.7 Capital loss carryforward (utilized) deferral (0.1) (490.6) - (490.7) Net operating loss carryforward (utilized) deferral (77.9) (11.8) - (89.7) Estimated taxable income 41.3 510.6 - 551.9 Dividend paid deduction - (510.6) - (510.6) Estimated taxable income post-dividend deduction$ 41.3 $ - $ -$ 41.3 54
-------------------------------------------------------------------------------- Table of C ontents The permanent tax differences recorded in 2020 include a difference related to the intercompany sales of RMBS and a recurring difference in compensation expense related to restricted stock dividends and vesting. The permanent tax differences recorded in 2019 include dividends paid from the Company's TRSs to the REIT, a difference related to the intercompany sales of RMBS and a recurring difference in compensation expense related to restricted stock dividends and vesting. Temporary differences recorded in 2020 and 2019 are principally timing differences betweenU.S. GAAP and tax accounting related to unrealized gains and losses from derivative instruments, realized and unrealized gains and losses from MSR and accretion, amortization from Agency RMBS and non-Agency securities and changes in reserves related to servicing advances and allowance for credit losses on certain RMBS. Change in Accumulated Other Comprehensive Income With our accounting treatment for AFS securities, unrealized fluctuations in the market values of AFS securities, excluding Agency interest-only securities, do not impact our GAAP net (loss) income or taxable income but are recognized on our consolidated balance sheets as a change in stockholders' equity under "accumulated other comprehensive income." As a result of this fair value accounting through stockholders' equity, we expect our net income to have less significant fluctuations and result in lessU.S. GAAP to taxable income timing differences, than if the portfolio were accounted for as trading instruments. Dividends For the year endedDecember 31, 2020 , we declared cash dividends totaling$0.50 per share. As a REIT, we are required to distribute at least 90% of our taxable income to stockholders, subject to certain distribution requirements. For the year endedDecember 31, 2020 , our board of directors elected to make cash distributions even though the REIT incurred a taxable loss for the year. This loss may be utilized in future tax years to reduce taxable income after consideration for the dividends paid deduction. As such, temporary differences between GAAP net income (loss) and taxable income can generate deterioration in book value on a permanent and temporary basis as taxable income is distributed that has not been earned forU.S. GAAP purposes. Liquidity and Capital Resources Our liquidity and capital resources are managed and forecasted on a daily basis. We believe this ensures that we have sufficient liquidity to absorb market events that could negatively impact collateral valuations and result in margin calls. We also believe that it gives us the flexibility to manage our portfolio to take advantage of market opportunities. Our principal sources of cash consist of borrowings under repurchase agreements, revolving credit facilities, term notes payable, payments of principal and interest we receive on our target assets, cash generated from our operating results, and proceeds from capital market transactions. We typically use cash to repay principal and interest on our borrowings, to purchase our target assets, to make dividend payments on our capital stock, and to fund our operations. OnMarch 21, 2019 , we completed a public offering of 18,000,000 shares of our common stock at a price of$13.76 per share. OnMarch 22, 2019 , an additional 2,700,000 shares were sold to the underwriters of the offering pursuant to an overallotment option. The net proceeds were approximately$284.5 million , after deducting offering expenses of approximately$0.3 million . To the extent that we raise additional equity capital through capital market transactions, we anticipate using cash proceeds from such transactions to purchase our target assets and for other general corporate purposes. Such general corporate purposes may include the refinancing or repayment of debt, the repurchase or redemption of common and preferred equity securities, and other capital expenditures. As ofDecember 31, 2020 , we held$1.4 billion in cash and cash equivalents available to support our operations;$16.3 billion of AFS securities, MSR, and derivative assets held at fair value; and$16.1 billion of outstanding debt in the form of repurchase agreements, borrowings under revolving credit facilities, term notes payable and convertible senior notes. During the three months endedDecember 31, 2020 , the debt-to-equity ratio funding our AFS securities, MSR, servicing advances and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, decreased from 5.7:1.0 to 5.2:1.0. The decrease was driven by the repositioning of financing on Agency AFS securities to TBA positions and a higher equity balance driven by our financial results for the quarter. During the year endedDecember 31, 2020 , the debt-to-equity ratio funding our AFS securities, MSR, servicing advances and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, decreased from 6.1:1.0 to 5.2:1.0. The decrease was also driven by the repositioning of financing on Agency AFS securities to TBA positions. 55 -------------------------------------------------------------------------------- Table of C ontents As ofDecember 31, 2020 , we held approximately$7.4 million of unpledged Agency securities and derivatives and$10.4 million of unpledged non-Agency securities. As a result, we had an overall estimated unused borrowing capacity on unpledged securities of approximately$13.1 million . As ofDecember 31, 2020 , we held approximately$449.4 million of unpledged MSR and$52.3 million of unpledged servicing advances. Overall, we had unused committed borrowing capacity on MSR asset and servicing advance financing facilities of$215.2 million and$191.0 million , respectively. Generally, unused borrowing capacity may be the result of our election not to utilize certain financing, as well as delays in the timing in which funding is provided, insufficient collateral or the inability to meet lenders' eligibility requirements for specific types of asset classes. On a daily basis, we monitor and forecast our available, or excess, liquidity. Additionally, we frequently perform shock analyses against various market events to monitor the adequacy of our excess liquidity. If borrowing rates and/or collateral requirements change in the near term, we believe we are subject to less earnings volatility than a more leveraged organization. During the year endedDecember 31, 2020 , we did not experience any material issues accessing our funding sources, although the balance sheet capacity of some counterparties has tightened due to compliance with the Basel III regulatory capital reform rules as well as the management of perceived risk in the current market environment due to the COVID-19 pandemic. We expect ongoing sources of financing to be primarily repurchase agreements, revolving credit facilities, term notes payable, convertible notes and similar financing arrangements. We plan to finance our assets with a moderate amount of leverage, the level of which may vary based upon the particular characteristics of our portfolio and market conditions. As ofDecember 31, 2020 , we had master repurchase agreements in place with 45 counterparties (lenders), the majority of which areU.S. domiciled financial institutions, and we continue to evaluate additional counterparties to manage and optimize counterparty risk. Under our repurchase agreements, we are required to pledge additional assets as collateral to our lenders when the estimated fair value of the existing pledged collateral under such agreements declines and such lenders, through a margin call, demand additional collateral. Lenders generally make margin calls because of a perceived decline in the value of our assets collateralizing the repurchase agreements. This may occur following the monthly principal reduction of assets due to scheduled amortization and prepayments on the underlying mortgages, or may be caused by changes in market interest rates, a perceived decline in the market value of the investments and other market factors. To cover a margin call, we may pledge additional assets or cash. At maturity, any cash on deposit as collateral is generally applied against the repurchase agreement balance, thereby reducing the amount borrowed. Should the value of our assets suddenly decrease, significant margin calls on our repurchase agreements could result, causing an adverse change in our liquidity position. The following table summarizes our repurchase agreements and counterparty geographical concentration atDecember 31, 2020 andDecember 31, 2019 : December 31, 2020 December 31, 2019 Amount Net Counterparty Percent of Amount Net Counterparty Percent of (dollars in thousands) Outstanding Exposure(1) Funding Outstanding Exposure(1) Funding North America$ 9,653,053 $ 413,862 66.2 %$ 16,165,067 $ 1,026,474 57.6 % Europe (2) 3,413,584 117,463 18.8 % 7,519,258 521,804 29.3 % Asia (2) 2,077,261 93,865 15.0 % 5,463,138 234,180 13.1 % Total$ 15,143,898 $ 625,190 100.0 %$ 29,147,463 $ 1,782,458 100.0 % ____________________ (1)Represents the net carrying value of the assets sold under agreements to repurchase, including accrued interest plus any cash or assets on deposit to secure the repurchase obligation, less the amount of the repurchase liability, including accrued interest. (2)Exposure to European and Asian domiciled banks and theirU.S. subsidiaries. 56 -------------------------------------------------------------------------------- Table of C ontents In addition to our master repurchase agreements to fund our Agency and non-Agency securities, we have one repurchase facility and two revolving credit facilities that provide short- and long-term financing for our MSR portfolio. We also have one revolving credit facility that provides long-term financing for our servicing advances. An overview of the facilities is presented in the table below: (dollars in thousands) December 31, 2020 Unused Unused Amount Committed Uncommitted Expiration Date (1) Outstanding Capacity (2) Capacity Total Capacity Eligible Collateral March 12, 2022$ 214,830 $ 135,170 $ 350,000 $ 700,000 Mortgage servicing rights July 16, 2021$ 60,000 $ 80,000 $ -$ 140,000 Mortgage servicing rights June 21, 2021 $ - $ -$ 200,000 $ 200,000 Mortgage servicing rights (3) September 28, 2022$ 9,000 $ 191,000 $ -$ 200,000 Mortgage servicing advances ____________________ (1)The facilities are set to mature on the stated expiration date, unless extended pursuant to their terms. (2)Represents unused capacity amounts to which commitment fees are charged. (3)This repurchase facility is secured by the VFN issued in connection with the MSR securitization transaction completed onJune 27, 2019 , which is collateralized by our MSR. ThroughFebruary 19, 2021 , our wholly owned subsidiary,TH Insurance , was a member of the FHLB. As a member of the FHLB,TH Insurance had access to a variety of products and services offered by the FHLB, including secured advances. However, we did not have any outstanding secured advances or credit capacity available as ofDecember 31, 2020 . The ability to borrow from the FHLB was subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with the FHLB. Each advance required approval by the FHLB and was secured by collateral in accordance with the FHLB's credit and collateral guidelines, as may be revised from time to time by the FHLB. Eligible collateral may include Agency RMBS and certain non-Agency securities with a rating of A and above. InJanuary 2016 , the FHFA released a final rule regarding membership in theFederal Home Loan Bank system. Among other effects, the final rule excludes captive insurers from membership eligibility, including our subsidiary member,TH Insurance . SinceTH Insurance was admitted as a member in 2013, it was eligible for a membership grace period that ran throughFebruary 19, 2021 , during which new advances or renewals that matured beyond the grace period were prohibited; however, any existing advances that matured beyond this grace period were permitted to remain in place subject to their terms insofar as we maintained good standing with the FHLB. Any new advances or renewals occurring during this time were limited to 40% ofTH Insurance's total assets.TH Insurance's FHLB membership expired onFebruary 19, 2021 . We are subject to a variety of financial covenants under our lending agreements. The following represent the most restrictive financial covenants across our lending agreements as ofDecember 31, 2020 : •Total indebtedness to tangible net worth must be less than 8.0:1.0. As ofDecember 31, 2020 , our total indebtedness to tangible net worth, as defined, was 5.3:1.0. •Cash liquidity must be greater than$200.0 million . As ofDecember 31, 2020 , our liquidity, as defined, was$1.4 billion . •Net worth must be greater than$1.5 billion or 50% of the highest net worth during the 24 calendar months prior, whichever is higher. As ofDecember 31, 2020 , 50% of the highest net worth during the 24 calendar months prior was$2.6 billion and our net worth, as defined, was$3.1 billion . We are also subject to additional financial covenants in connection with various other agreements we enter into in the normal course of our business. We intend to continue to operate in a manner which complies with all of our financial covenants. 57 -------------------------------------------------------------------------------- Table of C ontents The following table summarizes assets at carrying values that were pledged or restricted as collateral for the future payment obligations of repurchase agreements, FHLB advances, revolving credit facilities, term notes payable and derivative instruments atDecember 31, 2020 andDecember 31, 2019 : December 31,
(in thousands) 2020 2019
Available-for-sale securities, at fair value
Mortgage servicing rights, at fair value 1,146,710 1,554,825
Restricted cash 1,126,439 919,010
Due from counterparties 21,312 102,365
Derivative assets, at fair value 61,557
68,874
Other assets 28,540 -
Total $ 17,017,775 $ 32,447,530
Although we generally intend to hold our target assets as long-term investments,
we may sell certain of our assets in order to manage our interest rate risk and
liquidity needs, to meet other operating objectives and to adapt to market
conditions. Our Agency RMBS are generally actively traded and thus, in most
circumstances, readily liquid. However, certain of our assets, including MSR,
are subject to longer trade timelines, and, as a result, market conditions could
significantly and adversely affect the liquidity of our assets. Any illiquidity
of our assets may make it difficult for us to sell such assets if the need or
desire arises. Our ability to quickly sell certain assets, such as MSR may be
limited by delays encountered while obtaining certain regulatory approvals
required for such dispositions and may be further limited by delays due to the
time period needed for negotiating transaction documents, conducting diligence,
and complying with regulatory requirements regarding the transfer of such assets
before settlement may occur. Consequently, even if we identify a buyer for our
MSR, there is no assurance that we would be able to quickly sell such assets if
the need or desire arises.
In addition, if we are required to liquidate all or a portion of our portfolio
quickly, we may realize significantly less than the value at which we previously
recorded our assets. Assets that are illiquid are more difficult to finance, and
to the extent that we use leverage to finance assets that become illiquid, we
may lose that leverage or have it reduced. Assets tend to become less liquid
during times of financial stress, which is often the time that liquidity is most
needed. As a result, our ability to sell assets or vary our portfolio in
response to changes in economic and other conditions may be limited by liquidity
constraints, which could adversely affect our results of operations and
financial condition.
We cannot predict the timing and impact of future sales of our assets, if any.
Because many of our assets are financed with repurchase agreements, revolving
credit facilities and term notes payable, a significant portion of the proceeds
from sales of our assets (if any), prepayments and scheduled amortization are
used to repay balances under these financing sources.
The following table provides the maturities of our repurchase agreements, FHLB
advances, revolving credit facilities, term notes payable and convertible senior
notes as of December 31, 2020 and December 31, 2019 :
December 31, December 31,
(in thousands) 2020 2019
Within 30 days $ 5,370,506 $ 5,465,916
30 to 59 days 4,292,861 6,300,372
60 to 89 days 2,062,234 6,687,285
90 to 119 days 1,610,198 4,740,217
120 to 364 days 1,868,099 6,113,673
One to three years 510,013 584,954
Three to five years 395,609 394,502
Five to ten years - -
Ten years and over - 50,000
Total $ 16,109,520 $ 30,336,919
58-------------------------------------------------------------------------------- Table of C ontents For the year endedDecember 31, 2020 , our restricted and unrestricted cash balance increased approximately$1.0 billion to$2.6 billion atDecember 31, 2020 . The cash movements can be summarized by the following: •Cash flows from operating activities. For the year endedDecember 31, 2020 , operating activities increased our cash balances by approximately$0.6 billion , primarily driven by our financial results for the year. •Cash flows from investing activities. For the year endedDecember 31, 2020 , investing activities increased our cash balances by approximately$14.9 billion , primarily driven by proceeds from sales of and principal payments on AFS securities, offset by purchases of AFS securities and MSR. •Cash flows from financing activities. For the year endedDecember 31, 2020 , financing activities decreased our cash balance by approximately$14.5 billion , primarily driven by decreases in repurchase agreements as a result of sales of and principal payments on AFS securities. Off-Balance Sheet Arrangements We have not participated in transactions that create relationships with unconsolidated entities or financial partnerships which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities. Aggregate Contractual Obligations The following table summarizes the effect on our liquidity and cash flows from contractual obligations for repurchase agreements, revolving credit facilities, convertible senior notes, interest expense on borrowings and our non-cancelable office leases, net of contractual subleases: Due During the Year Ended December 31, (in thousands) 2021 2022 2023 2024 2025 Thereafter Total Repurchase agreements$ 15,143,898 $ - $ - $ - $ - $ -$ 15,143,898 Revolving credit facilities 60,000 223,830 - - - - 283,830 Convertible senior notes - 286,183 - - - - 286,183 Interest expense on borrowings(1) 31,789 2,055 - - - - 33,844 Long-term operating lease obligations 1,751 1,259 501 - - - 3,511 Total$ 15,237,438 $ 513,327 $ 501 $ - $ - $ -$ 15,751,266 ____________________
(1)Interest expense on borrowings calculated based on rates at
We are party to contracts that contain a variety of indemnification obligations, principally with brokers, underwriters, counterparties to lending agreements and investors in the RMBS we issued in connection with our previous residential mortgage loan securitization transactions, the term notes we issued in connection with our MSR securitization and the loans underlying our MSR. The maximum potential future payment amount we could be required to pay under these indemnification obligations may be unlimited. Recently Issued Accounting Standards Refer to Note 2 - Basis of Presentation and Significant Accounting Policies of the notes to the consolidated financial statements included in Item 8 of this Form 10-K.
Inflation
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors impact our performance far more than does inflation, although inflation rates can often have a meaningful influence over the direction of interest rates. Our financial statements are prepared in accordance withU.S. GAAP and dividends are based upon net ordinary income and capital gains as calculated for tax purposes; in each case, our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation. 59
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Table of C ontents
Other Matters We intend to conduct our business so as to maintain our exempt status under, and not to become regulated as, an investment company for purposes of the 1940 Act. If we failed to maintain our exempt status under the 1940 Act and became regulated as an investment company, our ability to, among other things, use leverage would be substantially reduced and, as a result, we would be unable to conduct our business as described in Item 1, "Business - Other Business - Regulation" of this Annual Report on Form 10-K. Accordingly, we monitor our compliance with both the 55% Test and the 80% Tests of the 1940 Act in order to maintain our exempt status. As ofDecember 31, 2020 , we determined that we maintained compliance with both the 55% Test and the 80% Test requirements. We calculate that at least 75% of our assets were qualified REIT assets, as defined in the Code for the year endedDecember 31, 2020 . We also calculate that our revenue qualified for the 75% source of income test and for the 95% source of income test rules for the year endedDecember 31, 2020 . Consequently, we met the REIT income and asset tests. We also met all REIT requirements regarding the ownership of our common stock and the distribution of our net income. Therefore, for the year endedDecember 31, 2020 , we believe that we qualified as a REIT under the Code.
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