The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes included elsewhere in this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the year endedDecember 31, 2020 .
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; and •MSR; and •Other financial assets comprising approximately 5% to 10% of the portfolio. 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 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 primarily of 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. 45
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For the three months endedJune 30, 2021 , our net spread realized on the portfolio was higher than the prior quarter due primarily to higher MSR servicing income, net of estimated amortization, and lower servicing expenses. Cost of financing was higher as a result of increased use of MSR financing, which carry higher rates relative to Agency RMBS financing, as well as the issuance of additional convertible notes in the first quarter of 2021, offset by lower interest rates on RMBS financing. The following table provides the average annualized yield on our assets for the three months endedJune 30, 2021 , and the four immediately preceding quarters: Three Months Ended June 30, March 31, December 31, September 30, June 30, 2021 2021 2020 2020 2020 Average annualized portfolio yield (1) 2.72% 2.25% 2.26% 2.42% 2.84% Cost of financing (2) 0.79% 0.60% 0.50% 0.64% 2.61% Net spread 1.93% 1.65% 1.76% 1.78% 0.23% ____________________ (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 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, repurchase agreements, 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. 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. 46
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Forward-Looking Statements This Quarterly Report on Form 10-Q contains, or incorporates by reference, not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, and that are subject to the safe harbors created by such sections. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as "anticipate," "estimate," "will," "should," "expect," "target," "believe," "intend," "seek," "plan," "goals," "future," "likely," "may" and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K for the year endedDecember 31, 2020 , under the caption "Risk Factors." Other risks, uncertainties and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with theSecurities and Exchange Commission , orSEC , including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Forward -looking statements speak only as of the date they are made, and we undertake no obligation to update or revise any such forward-looking statements, whether as a result of new information, future events, or otherwise. Important factors, among others, that may affect our actual results include: •changes in interest rates and the market value of our target assets; •changes in prepayment rates of mortgages underlying our target assets; •the state of the credit markets and other general economic conditions, particularly as they affect the price of earning assets, the credit status of borrowers and home prices; •the ongoing impact of the COVID-19 pandemic, and the actions taken by federal and state governmental authorities and GSEs in response, on theU.S. economy, financial markets and our target assets; •legislative and regulatory actions affecting our business; •the availability and cost of our target assets; •the availability and cost of financing for our target assets, including repurchase agreement financing, revolving credit facilities, term notes and convertible notes; •the impact of any increases in payment delinquencies and defaults on the mortgages comprising and underlying our target assets, including additional servicing costs and servicing advance obligations on the MSR assets we own; •changes in liquidity in the market for real estate securities, the re-pricing of credit risk in the capital markets, inaccurate ratings of securities by rating agencies, rating agency downgrades of securities, and increases in the supply of real estate securities available-for-sale; •changes in the values of securities we own and the impact of adjustments reflecting those changes on our condensed consolidated statements of comprehensive income (loss) and balance sheets, including our stockholders' equity; •our ability to generate cash flow from our target assets; •our ability to effectively execute and realize the benefits of strategic transactions and initiatives, including our transition to self-management, we have pursued or may in the future pursue; •our decision to terminate our Management Agreement with PRCM Advisers and the ongoing litigation with PRCM Advisers related to such termination; •changes in the competitive landscape within our industry, including changes that may affect our ability to attract and retain personnel; •our exposure to legal and regulatory claims, penalties or enforcement activities, including those related to the termination of our Management Agreement with PRCM Advisers and arising from our ownership and management of MSR and prior securitization transactions; •our exposure to counterparties involved in our MSR business and prior securitization transactions and our ability to enforce representations and warranties made by them; •our ability to acquire MSR and successfully operate our seller-servicer subsidiary and oversee the activities of our subservicers; •our ability to manage various operational and regulatory risks associated with our business; •interruptions in or impairments to our communications and information technology systems; •our ability to maintain appropriate internal controls over financial reporting; •our ability to establish, adjust and maintain appropriate hedges for the risks in our portfolio; •our ability to maintain our REIT qualification forU.S. federal income tax purposes; and 47
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•limitations imposed on our business due to our REIT status and our status as exempt from registration under the 1940 Act. This Quarterly Report on Form 10-Q may contain statistics and other data that, in some cases, have been obtained or compiled from information made available by mortgage loan servicers and other third-party service providers. 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, as detailed in Note 2 to the condensed consolidated financial statements, included under Item 1 of this Quarterly Report on Form 10-Q.. Fair Value Measurement A significant portion of our assets and liabilities are reported at fair value and, therefore, our condensed consolidated balance sheets and statements of comprehensive (loss) income are significantly affected by fluctuations in market prices. AtJune 30, 2021 , approximately 79.4% of our total assets, or$9.9 billion , consisted of financial instruments recorded at fair value. See Note 10 - Fair Value to the condensed consolidated financial statements, included in this Quarterly Report on Form 10-Q, 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 and Eurodollar 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. 48
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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. AtJune 30, 2021 , 16.2% of our total assets were classified as Level 3 fair value assets. Market Conditions and Outlook During the second quarter of 2021, theU.S. Federal Reserve , or the Fed, moved its overnight reverse repurchase rate from 0 to 5 basis points and term overnight indexed swap markets indicate expectations for continued low levels in the near term. Longer dated rates declined over 40 basis points, retracing more than 50 percent of the first quarter increase, while shorter term rates were up slightly.The Fed has maintained its monthly pace of net purchasing$40 billion of MBS and$80 billion ofU.S. Treasuries but has started to discuss tapering these purchases as inflation has exceeded expectations and the labor market has continued to make progress towards the Fed's goals. The current pace of asset purchases has kept spreads on current coupon MBS near record tight levels. We expect the reduced pace of future purchases, which is likely to be announced later this year, to cause current coupon spreads to widen off their current tight levels. The spread between primary and secondary mortgage rates was largely unchanged in the second quarter despite significantly lower rates. Prepayment rates on MBS remain at elevated levels and are likely to increase as primary rates declined approximately 25 basis points throughout the second quarter. The economic outlook for the remainder of 2021 and beyond remains uncertain and will be heavily dependent on the path of inflation, fiscal policy and the Fed's ability to navigate the transition to a less accommodative policy stance. In the housing market, the past quarter has seen a number of policy and administrative changes in theFederal Housing Finance Agency , or the FHFA, and GSEs.Sandra Thompson was named the Acting Director of the FHFA, replacingMark Calabria . Programs announced in the quarter such as RefiNow and RefiPossible reduced the cost of refinancing for lower income borrowers, while the removal the Adverse MarketRefi Fee that will take effect in August, will reduce the cost of refinancing for all borrowers when it goes into effect. The new leadership is expected to exhibit a renewed focus on expanding opportunity for distressed or low-income borrowers and we expect the policy risk around prepayment speeds for mortgage investors to stay elevated in the near term. 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:June 30 ,
(dollars in thousands) 2021
2020
Agency RMBS$ 7,834,487 79.0 % $
14,637,891 89.7 %
Mortgage servicing rights 2,020,106 20.4 % 1,596,153 9.8 %
Agency Derivatives 50,463 0.5 % 61,617 0.4 % Non-Agency securities 5,559 0.1 % 13,031 0.1 % Total$ 9,910,615 $ 16,308,692 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. During periods of decreasing interest rates with rising prepayment speeds, the market value of our Agency pools generally increases and the market value of our interest-only securities and MSR generally decreases. The inverse relationship occurs when interest rates rise and prepayments fall. Although interest rates moved higher during the first quarter of 2021, they retraced lower in the second quarter of 2021 and 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 remain fast 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. 49
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The following table provides the three-month average constant prepayment rate, or CPR, experienced by Agency RMBS and MSR owned by us as ofJune 30, 2021 , and the four immediately preceding quarter-ends: June 30, March 31, December 31, September 30, June 30, 2021 2021 2020 2020 2020 Agency RMBS 32.3 % 30.8 % 27.0 % 23.1 % 19.9 % Mortgage servicing rights 29.0 % 37.7 % 41.2 % 41.5 % 35.6 % 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 primarily collateralized by pools of fixed-rate mortgage loans. 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: June 30, 2021 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% $ - $ - - % - % - % $ - $ - 0 3.0% 1,278,481 1,356,599 19.4 % 100.0 % 3.7 % 1,316,295 - 20 3.5% 1,206,002 1,295,416 31.8 % 100.0 % 4.3 % 1,261,045 - 24 4.0% 2,035,962 2,218,839 37.3 % 100.0 % 4.6 % 2,118,338 - 42 4.5% 1,792,623 1,977,125 36.7 % 100.0 % 5.0 % 1,889,286 - 42 ? 5.0% 409,699 459,873 38.7 % 98.2 % 5.9 % 433,991 - 74 6,722,767 7,307,852 33.1 % 99.9 % 4.6 % 7,018,955 - 37 Other P&I 89,536 101,379 33.4 % - % 6.6 % 99,144 - 232 Interest-only 4,274,783 425,256 17.5 % - % 3.6 % 419,475 (15,154) 38 Agency Derivatives 281,473 50,463 18.2 % - % 6.7 % 39,338 - 200 Total Agency RMBS$ 11,368,559 $ 7,884,950 92.6 %$ 7,576,912 $ (15,154) 50
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Table of Contents 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) 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 ofJune 30, 2021 , we had entered into repurchase agreements with 45 counterparties, 16 of which had outstanding balances atJune 30, 2021 . In addition, we held short- and long-term borrowings under revolving credit facilities, long-term term notes payable and short- and long-term unsecured convertible senior notes. As ofJune 30, 2021 , the debt-to-equity ratio funding our AFS securities, MSR and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 3.9:1.0. As ofJune 30, 2021 , we held$1.3 billion in cash and cash equivalents, approximately$5.3 million of unpledged Agency securities and derivatives and$4.7 million of unpledged non-Agency securities. As a result, we had an overall estimated unused borrowing capacity on our unpledged securities of approximately$7.7 million . As ofJune 30, 2021 , we held approximately$216.9 million of unpledged MSR and$70.3 million of unpledged servicing advances. Overall, we had unused committed borrowing capacity on MSR asset and servicing advance financing facilities of$304.0 million and$177.5 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. 51
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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. OnMarch 5, 2021 , Intercontinental Exchange Inc. announced thatICE Benchmark Administration Limited , the administrator of LIBOR, intends to stop publication of the majority of USD-LIBOR tenors onJune 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. 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 of 2020. 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 Coronavirus Aid, Relief, and Economic Security Act, or 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. AtJune 30, 2021 , 17,579 loans, or 2.2% of our MSR portfolio by loan count, were in forbearance, of which 12.8% had made theirJune 2021 payment and were current as ofJune 30, 2021 . Therefore, approximately 2.0% of our portfolio by loan count was in forbearance and not current as ofJune 30, 2021 . 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 loss attributable to common stockholders was$131.7 million ($(0.48) per diluted weighted average share) for the three months endedJune 30, 2021 and our GAAP net income attributable to common stockholders was$91.2 million ($0.32 per diluted weighted average share) for the six months endedJune 30, 2021 , as compared to GAAP net loss attributable to common stockholders of$192.5 million and$2.1 billion ($(0.70) and$(7.61) per diluted weighted average share) for the three and six months endedJune 30, 2020 . 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 condensed consolidated balance sheets as a change in stockholders' equity under "accumulated other comprehensive income." For the three and six months endedJune 30, 2021 , net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were$62.9 million and$334.4 million , respectively. This, combined with GAAP net loss attributable to common stockholders of$131.7 million and GAAP net income attributable to common stockholders of$91.2 million for the three and six months endedJune 30, 2021 , respectively, resulted in comprehensive loss attributable to common stockholders of$194.6 million and$243.1 million for the three and six months endedJune 30, 2021 , respectively. For the three and six months endedJune 30, 2020 , net unrealized gains on AFS securities recognized as other comprehensive income, net of tax, were$192.8 million and net unrealized losses on AFS securities recognized as other comprehensive loss, net of tax, were$5.3 million , respectively. This, combined with GAAP net loss attributable to common stockholders of$192.5 million and$2.1 billion , resulted in comprehensive income attributable to common stockholders of$0.3 million and comprehensive loss attributable to common stockholders of$2.1 billion for the three and six months endedJune 30, 2020 , respectively. 52
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Our book value per common share forU.S. GAAP purposes was$6.42 atJune 30, 2021 , a decrease from$7.63 per common share atDecember 31, 2020 . For the six months endedJune 30, 2021 , we recognized comprehensive loss attributable to common stockholders of$243.1 million and declared common dividends of$46.8 million , 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$1.3 billion in unrestricted cash as ofJune 30, 2021 . Given our increased confidence, we expect to continue to deploy such capital to our target assets over time. 53
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The following tables present the components of our comprehensive (loss) income
for the three and six months ended
Three Months Ended Six Months Ended Income Statement Data: June 30, June 30, 2021 2020 2021 2020 (unaudited) (unaudited) Interest income: Available-for-sale securities$ 43,092 $ 105,730 $ 98,744 $ 354,414 Other 351 1,597 808 8,420 Total interest income 43,443 107,327 99,552 362,834 Interest expense: Repurchase agreements 6,981 50,811 15,451 203,416 Revolving credit facilities 7,075 2,826 11,770 6,357 Term notes payable 3,225 3,553 6,436 8,357 Convertible senior notes 7,126 4,769 13,476 9,545 Federal Home Loan Bank advances - 155 - 1,747 Total interest expense 24,407 62,114 47,133 229,422 Net interest income 19,036 45,213 52,419 133,412 Other (loss) income: (Loss) gain on investment securities (41,519) 53,492 91,349 (1,028,115) Servicing income 112,816 112,891 219,935 243,688 (Loss) gain on servicing asset (268,051) (238,791) 59,387 (825,456) Gain (loss) on interest rate swap and swaption agreements 24,648 (46,922) 9,049 (297,518) Gain (loss) on other derivative instruments 51,312 76,606 (224,699) (56,862) Other income (loss) 41 66 (5,701) 864 Total other (loss) income (120,753) (42,658) 149,320 (1,963,399) Expenses: Management fees - 11,429 - 25,979 Servicing expenses 18,680 23,947 43,627 43,852 Compensation and benefits 11,259 8,127 19,447 16,404 Other operating expenses 7,218 5,711 14,705 12,512 Restructuring charges - 145,069 - 145,788 Total expenses 37,157 194,283 77,779 244,535 (Loss) income before income taxes (138,874) (191,728) 123,960 (2,074,522) (Benefit from) provision for income taxes (20,914) (18,164) 1,763 (31,302) Net (loss) income (117,960) (173,564) 122,197 (2,043,220) Dividends on preferred stock 13,747 18,951 30,963 37,901 Net (loss) income attributable to common stockholders$ (131,707)
$ (0.48)
$ (0.48)
$ 0.17 $ 0.19 $ 0.34 $ 0.19 Weighted average number of shares of common stock: Basic 273,718,561 273,604,079 273,714,684 273,498,347 Diluted 273,718,561 273,604,079 305,999,203 273,498,347 54
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Table of Contents (in thousands) Three Months Ended Six Months Ended Income Statement Data: June 30, June 30, 2021 2020 2021 2020 (unaudited) (unaudited) Comprehensive (loss) income: Net (loss) income$ (117,960) $ (173,564) $ 122,197 $ (2,043,220) Other comprehensive (loss) income, net of tax: Unrealized (loss) gain on available-for-sale securities (62,899) 192,794 (334,352) (5,276) Other comprehensive (loss) income (62,899) 192,794 (334,352) (5,276) Comprehensive (loss) income (180,859) 19,230 (212,155) (2,048,496) Dividends on preferred stock 13,747 18,951 30,963 37,901 Comprehensive (loss) income attributable to common stockholders$ (194,606)
(in thousands)June 30 ,
Balance Sheet Data: 2021
2020
(unaudited) Available-for-sale securities$ 7,840,046 $
14,650,922
Mortgage servicing rights$ 2,020,106 $
1,596,153
Total assets$ 12,502,112 $
19,515,921
Repurchase agreements$ 8,350,622 $
15,143,898
Revolving credit facilities$ 533,519 $ 283,830 Term notes payable$ 396,183 $ 395,609 Convertible senior notes$ 423,742 $ 286,183 Total stockholders' equity$ 2,484,055 $
3,088,926 Results of Operations The following analysis focuses on financial results during the three and six months endedJune 30, 2021 and 2020. Interest Income Interest income decreased from$107.3 million and$362.8 million for the three and six months endedJune 30, 2020 to$43.4 million and$99.6 million for the same periods in 2021 due to sales 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$62.1 million and$229.4 million for the three and six months endedJune 30, 2020 , respectively, to$24.4 million and$47.1 million for the same periods in 2021 due to lower borrowing balances related to the sale of both Agency RMBS and non-Agency securities that occurred during the first quarter of 2020 and a lower interest rate environment. 55
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Net Interest Income The following tables present the components of interest income and average annualized net asset yield earned by asset type, the components of interest expense and average annualized cost of funds on borrowings incurred by liability and/or collateral type, and net interest income and average annualized net interest rate spread for the three and six months endedJune 30, 2021 and 2020: Three Months Ended June 30, 2021 Six Months Ended June 30, 2021 Average Balance Interest Net Yield/Cost of Interest Net Yield/Cost of (dollars in thousands) (1) Income/Expense Funds (2) Average Balance (1) Income/Expense Funds (2) Interest-earning assets: Available-for-sale securities$ 9,073,951 $ 43,092 1.9 %$ 10,512,788 $ 98,744 1.9 % Other - 351 - % - 808 - %
Total interest income/net asset yield
1.9 %$ 10,512,788 $ 99,552 1.9 % Interest-bearing liabilities: Borrowings collateralized by: Available-for-sale securities$ 9,649,189 $
5,687 0.2 %$ 11,217,274 $ 14,051 0.3 % Agency derivatives (3) 44,067 89 0.8 % 46,645 195 0.8 % Mortgage servicing rights and advances (4) 1,012,706 11,505 4.5 % 909,365 19,411 4.3 % Unsecured borrowings: Convertible senior notes 423,613 7,126 6.7 % 399,852 13,476 6.7 %
Total interest expense/cost of funds
0.9 %$ 12,573,136 47,133 0.7 % Net interest income/spread (5) $ 19,036 1.0 % $ 52,419 1.2 % Three Months Ended June 30, 2020
Six Months Ended
Interest Net Yield/Cost of Interest Net Yield/Cost of (dollars in thousands) Average Balance (1) Income/Expense Funds (2) Average Balance (1) Income/Expense Funds (2) Interest-earning assets Available-for-sale securities$ 16,861,604 $ 105,730 2.5 %$ 23,538,072 $ 354,414 3.0 % Other - 1,597 - % 4,152 8,420 3.8 %
Total interest income/net asset yield
107,327 2.5 %$ 23,542,224 23542224$ 362,834 3.1 % Interest-bearing liabilities Borrowings collateralized by: Available-for-sale securities$ 17,099,037 $ 50,518 1.2 %$ 23,000,387 $ 202,116 1.8 % Agency derivatives (3) 51,967 236 1.8 % 51,057 572 2.2 % Mortgage servicing rights (4) 685,263 6,591 3.8 % 795,257 17,189 4.3 % Unsecured borrowings: Convertible senior notes 285,422 4,769 6.7 % 285,284 9,545 6.7 %
Total interest expense/cost of funds
62,114 1.4 %$ 24,131,985 $ 229,422 1.9 % Net interest income/spread (5) $ 45,213 1.1 %$ 133,412 1.2 % ____________________ (1)Average asset balance represents average amortized cost on AFS securities and average unpaid principal balance, adjusted for purchase price changes, on other assets. (2)Cost of funds does not include the accrual and settlement of interest associated with interest rate swaps. In accordance withU.S. GAAP, those costs are included in gain (loss) on interest rate swap and swaption agreements in the condensed consolidated statements of comprehensive (loss) income. For the three and six months endedJune 30, 2021 , 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, was 0.8% and 0.7%, respectively, compared to 0.1% and 1.6% for the same periods in 2020. (3)Yields on Agency Derivatives not shown as interest income is included in gain (loss) on other derivative instruments in the condensed consolidated statements of comprehensive (loss) income. (4)Yields on mortgage servicing rights 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. In accordance withU.S. GAAP, those costs are included in gain (loss) on interest rate swap and swaption agreements in the condensed consolidated statements of comprehensive (loss) income. For the three and six months endedJune 30, 2021 , our total average net interest rate spread on the assets 56
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and liabilities shown in the table above, including interest spread expense associated with interest rate swaps, was 1.1% and 1.2%, respectively, compared to 2.5% and 1.4% for the same periods in 2020.
The decrease in yields on AFS securities for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, was predominantly driven by the sale of substantially all legacy non-Agencies during the first quarter of 2020 as well as sales of Agency pools with higher yields. The decrease in cost of funds associated with the financing of AFS securities for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, was also a result of the sale of non-Agencies as well as decreases in the borrowing rates offered by financing counterparties. The decrease in cost of funds associated with the financing of Agency Derivatives for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, was the result of decreases in the borrowing rates offered by counterparties. The increase in cost of funds associated with the financing of MSR assets and related servicing advance obligations for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, was due to an increase in the use of revolving credit facility and repurchase agreement financing versus term notes financing, which carry lower rates, as well as an increase in amortization of deferred debt issuance costs on this financing. During the year endedDecember 31, 2020 , we entered into a new revolving credit facility to finance our servicing advance obligations, which are included in other assets on our condensed consolidated balance sheets. Our convertible senior notes due 2022 were issued inJanuary 2017 . Our convertible senior notes due 2026 were issued inFebruary 2021 , and a portion of the proceeds from the offering were used to partially repurchase our senior notes due 2022. Both convertible senior notes due 2022 and 2026 are unsecured and pay interest semiannually at a rate of 6.25% per annum. The cost of funds associated with our convertible senior notes for the three and six months endedJune 30, 2021 , as compared to the same periods in 2020, was consistent. 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 six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands) 2021 2020 2021 2020 Gross yield/stated coupon 4.7 % 4.0 % 4.4 % 3.9 % Net (premium amortization) discount accretion (2.8) % (1.5) % (2.5) % (0.9) % Net yield (1) 1.9 % 2.5 % 1.9 % 3.0 % ____________________
(1)Excludes Agency Derivatives. For the three and six months ended
(Loss) Gain On Investment Securities
The following tables present the components of (loss) gain on investment
securities for the three and six months ended
Three Months Ended June 30, 2021 Six Months Ended June 30, 2021 Available-For-Sale Available-For-Sale (in thousands) Securities Trading Securities Total Securities Trading Securities Total Proceeds from sales $ 2,549,602 $ -$ 2,549,602 $ 4,600,545 $ -$ 4,600,545 Amortized cost of securities sold (2,532,087) - (2,532,087) (4,516,832) - (4,516,832) Total realized gains on sales 17,515 - 17,515 83,713 - 83,713 Provision for credit losses (7,392) - (7,392) (6,257) - (6,257) Other (51,642) - (51,642) 13,893 - 13,893 (Loss) gain on investment securities $ (41,519) $ -$ (41,519) $ 91,349 $ -$ 91,349 57
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Table of Contents Three Months Ended June 30, 2020 Six Months Ended June 30, 2020 Available-For-Sale Available-For-Sale Trading (in thousands) Securities Trading Securities Total Securities Securities Total Proceeds from sales $ 1,383,118 $ -$ 1,383,118 16,969,870$ 1,053,477 $ 18,023,347 Amortized cost of securities sold (1,326,218) - (1,326,218) (17,947,686) (1,052,500) (19,000,186) Total realized gains (losses) on sales 56,900 - 56,900 (977,816) 977 (976,839) Provision for credit losses (1,193) - (1,193) (46,831) - (46,831) Other (2,215) - (2,215) (4,445) - (4,445) Gain (loss) on investment securities $ 53,492 $ -$ 53,492 $ (1,029,092)$ 977 $ (1,028,115) 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, as detailed in Note 2 to the condensed consolidated financial statements, included under Item 1 of this Quarterly Report on Form 10-Q. Subsequent adverse or favorable changes in expected cash flows are recognized immediately in earnings as a provision for or reversal of provision for credit losses (within (loss) gain on investment securities). The majority of the "other" component of (loss) gain on investment securities is related to changes in unrealized gains (losses) on Agency interest-only mortgage-backed securities. For the three months endedJune 30, 2021 , the unrealized losses recognized were primarily due to faster prepayment assumption. For the six months endedJune 30, 2021 , the unrealized gains recognized were primarily due to slower prepayment assumption. Servicing Income The following table presents the components of servicing income for the three and six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands) 2021 2020 2021 2020 Servicing fee income$ 111,083 $ 104,463 $ 216,248 $ 222,354
Ancillary and other fee income 622 476 1,238 997 Float income 1,111 7,952 2,449 20,337 Total$ 112,816 $ 112,891 $ 219,935 $ 243,688 For the three months endedJune 30, 2021 , as compared to the same period in 2020, servicing income was consistent. The decrease in servicing income for the six months endedJune 30, 2021 , as compared to the same period in 2020, 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. 58
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(Loss) Gain on Servicing Asset The following table presents the components of (loss) gain on servicing asset for the three and six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands) 2021 2020 2021 2020 Changes in fair value due to changes in valuation inputs or assumptions used in the valuation model$ (72,910) $ (111,013) $ 428,783 $ (611,776) Changes in fair value due to realization of cash flows (runoff) (195,141) (127,778) (369,396) (213,680) (Loss) gain on servicing asset$ (268,051) $ (238,791)
The increase in loss on servicing asset for the three months endedJune 30, 2021 , as compared to the same period in 2020, was driven by higher portfolio runoff, offset by a decrease in expected prepayment speed assumptions used in the fair valuation of MSR. The increase in gain (decrease in loss) on servicing asset for the six months endedJune 30, 2021 , as compared to the same period in 2020, 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 six months endedJune 30, 2021 . Gain (Loss) on Interest Rate Swap and Swaption Agreements The following table summarizes the net interest spread and gains and losses associated with our interest rate swap and swaption positions recognized during the three and six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands) 2021 2020 2021 2020 Net interest spread$ 2,399 $ (56,331) $ 4,049 $ (68,946) Early termination, agreement maturation and option expiration gains (losses) 8,642 (747,055) 2,292 (385,202) Change in unrealized gain on interest rate swap and swaption agreements, at fair value 13,607 756,464 2,708 156,630 Gain (loss) on interest rate swap and swaption agreements$ 24,648 $ (46,922) $ 9,049 $ (297,518) Net interest spread recognized for the accrual and/or settlement of the net interest expense associated with our interest rate swaps 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 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 and swaptions during the three and six months endedJune 30, 2021 and 2020 was a result of changes to floating interest rates (LIBOR or the OIS rate), the swap curve and corresponding counterparty borrowing rates. Since swaps 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. 59
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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,U.S. Treasury and Eurodollar futures and inverse interest-only securities during the three and six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands) 2021 2020 2021 2020 Interest income, net of accretion, on inverse interest-only securities$ 1,309 $ 2,659
Realized and unrealized net gains (losses) on other derivative instruments (1) 50,003 73,947 (227,883) (61,418) Gain (loss) on other derivative instruments$ 51,312 $ 76,606 $ (224,699) $ (56,862) ____________________
(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 condensed consolidated financial statements, included in this Quarterly Report on Form 10-Q.
Expenses
The following table presents the components of expenses, other than restructuring charges, for the three and six months endedJune 30, 2021 and 2020: Three Months Ended Six Months Ended June 30, June 30, (in thousands, except share data) 2021 2020 2021 2020 Management fees $ -$ 11,429 $ -$ 25,979 Servicing expenses$ 18,680 $ 23,947 $ 43,627 $ 43,852 Operating expenses: Compensation and benefits: Non-cash equity compensation expenses$ 4,611 $ 2,315 $ 6,401 $ 4,630 All other compensation and benefits 6,648 5,812 13,046 11,774 Total compensation and benefits$ 11,259 $ 8,127 $ 19,447 $ 16,404 Other operating expenses: Nonrecurring expenses$ 1,397 $ -$ 3,368 $ - All other operating expenses 5,821 5,711 11,337 12,512 Total other operating expenses$ 7,218 $ 5,711 $ 14,705 $ 12,512 Annualized operating expense ratio 2.8 % 1.9 % 2.4 % 1.6 % Annualized operating expense ratio, excluding non-cash equity compensation and other nonrecurring expenses 1.9 % 1.6 % 1.7 % 1.3 % Prior to the termination of the Management Agreement onAugust 14, 2020 , a management fee was 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. We incur servicing expenses generally related to the subservicing of MSR. The decrease in servicing expenses during the three months endedJune 30, 2021 , as compared to the same period in 2020, was a result of a decrease in loan forbearance and adjustments for preliquidation claims. For the six months endedJune 30, 2021 , as compared to the same period in 2020, servicing expenses were consistent. 60
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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 three and six months endedJune 30, 2020 these direct and allocated costs totaled approximately$4.3 million and$16.1 million , respectively. 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$0.2 million and$1.3 million respectively for the three and six months endedJune 30, 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 six months endedJune 30, 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$1.1 million and$2.1 million , 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. Restructuring Charges OnApril 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 onSeptember 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 ofJune 30, 2020 and recorded during the three months endedJune 30, 2020 . OnJuly 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 onAugust 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 endedSeptember 30, 2020 . For the year endedDecember 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 condensed consolidated statements of comprehensive (loss) income. During the three and six months endedJune 30, 2020 , we incurred$145.1 million and$145.8 million , respectively, of restructuring charges. We did not incur any restructuring charges during the three and six months endedJune 30, 2021 . Income Taxes During the three months endedJune 30, 2021 , our TRSs recognized a benefit from income taxes of$20.9 million , which was primarily due to losses recognized on MSR, offset by net gains recognized on derivative instruments held in the TRSs. During the six months endedJune 30, 2021 , our TRSs recognized a provision for income taxes of$1.8 million , which was primarily due to gains recognized on MSR, offset by net losses recognized on derivative instruments held in the TRSs. During the three and six months endedJune 30, 2020 , our TRSs recognized a benefit from income taxes of$18.2 million and$31.3 million respectively. The benefit recognized for the three months endedJune 30, 2020 was primarily due to losses recognized on MSR held in our TRSs. The benefit recognized for the six months endedJune 30, 2020 was primarily due to losses recognized on MSR, offset by net gains recognized on derivative instruments held in our TRSs. 61
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Financial ConditionAvailable-for-Sale Securities , at Fair Value The majority of our AFS investment securities portfolio is comprised of fixed rate Agency mortgage-backed securities backed by single-family and multi-family mortgage loans. We also hold$5.6 million in tranches of mortgage-backed and asset-backed P&I and interest-only non-Agency securities. All of ourP&I Agency RMBS AFS are Fannie Mae or Freddie Mac mortgage pass-through certificates or collateralized mortgage obligations that carry an implied rating of "AAA ," orGinnie Mae mortgage pass-through certificates, which are backed by the guarantee of theU.S. government. The majority of these securities consist of whole pools in which we own all of the investment interests in the securities. The table below summarizes certain characteristics of our Agency RMBS AFS atJune 30, 2021 : June 30, 2021 Weighted Weighted (dollars in thousands, Principal/ Net (Discount) Allowance for Unrealized Average Coupon Average except purchase price) Current Face Premium Amortized Cost Credit Losses Gain Unrealized Loss Carrying Value Rate Purchase Price P&I securities$ 6,812,303 $ 305,796 $ 7,118,099 $ -$ 291,473 $ (341)$ 7,409,231 3.97 %$ 105.03 Interest-only securities 4,274,783 419,475 419,475 (15,154) 30,561 (9,626) 425,256 2.86 %$ 14.03 Total$ 11,087,086 $ 725,271 $ 7,537,574 $ (15,154) $ 322,034 $ (9,967)$ 7,834,487 Our three-month average constant prepayment rate, or CPR, experienced by Agency RMBS AFS owned by us as ofJune 30, 2021 , on an annualized basis, was 32.3%. 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 ofJune 30, 2021 , our MSR had a fair market value of$2.0 billion . As ofJune 30, 2021 , our MSR portfolio included MSR on 784,334 loans with an unpaid principal balance of approximately$185.2 billion . The following tables summarize certain characteristics of the loans underlying our MSR by gross weighted average coupon rate types and ranges atJune 30, 2021 : June 30, 2021 Gross Weighted Weighted Weighted Unpaid Principal Average Coupon Average Loan Weighted Average Average (dollars in thousands) Number of Loans Balance % Fannie Mae Rate Age (months) Original FICO Original LTV 60+ Day Delinquencies 3-Month CPR Net Servicing Fee (bps) 30-Year Fixed: ? 3.25% 161,009$ 54,154,835 49.5 % 2.9 % 7 768 71.4 % 0.3 % 7.5 % 25.6 > 3.25 - 3.75% 154,486 40,599,280 62.5 % 3.4 % 28 759 73.9 % 1.2 % 27.7 % 26.3 > 3.75 - 4.25% 149,732 32,449,883 63.9 % 3.9 % 49 755 76.0 % 3.3 % 41.2 % 27.5 > 4.25 - 4.75% 100,082 18,906,967 65.9 % 4.4 % 51 739 77.9 % 5.7 % 45.8 % 26.5 > 4.75 - 5.25% 50,197 8,589,943 67.2 % 4.9 % 45 724 79.3 % 7.7 % 46.3 % 27.6 > 5.25% 20,400 2,958,553 70.2 % 5.5 % 44 706 79.4 % 10.4 % 44.3 % 30.6 635,906 157,659,461 59.1 % 3.6 % 29 756 74.3 % 2.4 % 30.0 % 26.5 15-Year Fixed: ? 2.25% 10,336 3,543,357 91.0 % 2.0 % 4 778 58.9 % 0.1 % 4.9 % 25.0 > 2.25 - 2.75% 32,964 8,400,083 67.4 % 2.4 % 9 776 58.9 % 0.2 % 12.9 % 25.5 > 2.75 - 3.25% 47,013 8,037,948 70.3 % 2.9 % 38 769 61.8 % 0.7 % 25.5 % 26.1 > 3.25 - 3.75% 31,530 4,180,274 71.4 % 3.4 % 51 758 64.7 % 1.8 % 31.5 % 27.5 > 3.75 - 4.25% 15,066 1,697,354 64.5 % 3.9 % 49 744 65.3 % 2.7 % 31.9 % 29.0 > 4.25% 7,651 735,194 62.5 % 4.5 % 40 729 66.1 % 3.2 % 35.3 % 31.1 144,560 26,594,210 71.7 % 2.8 % 27 768 61.3 % 0.8 % 22.0 % 26.3 Total ARMs 3,868 956,067 63.2 % 3.1 % 49 762 68.1 % 3.6 % 41.4 % 25.2 Total 784,334$ 185,209,738 61.0 % 3.5 % 29 758 72.4 % 2.2 % 29.0 % 26.5 62
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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, pursuant to which, through two of our wholly owned subsidiaries, MSR is pledged to theMSR Issuer Trust and in return, theMSR Issuer Trust issues term notes to qualified institutional buyers and a variable funding note, or VFN, to one of the subsidiaries, in each case secured on a pari passu basis. In connection with the transaction, we also entered into a repurchase facility that is secured by the VFN issued in connection with the MSR securitization transaction, which is collateralized by our MSR. Additionally, our convertible senior notes due 2022 were issued inJanuary 2017 . Our convertible senior notes due 2026 were issued inFebruary 2021 , and a portion of the proceeds from the offering were used to partially repurchase our senior notes due 2022. Both convertible senior notes due 2022 and 2026 are unsecured and pay interest semiannually at a rate of 6.25% per annum. ThroughFebruary 19, 2021 , our wholly owned subsidiary,TH Insurance Holdings Company LLC , orTH Insurance , was a member of theFederal Home Loan Bank of Des Moines , or 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 .TH Insurance's FHLB membership expired onFebruary 19, 2021 . AtJune 30, 2021 , borrowings under repurchase agreements, revolving credit facilities, term notes payable and convertible senior notes had the following characteristics: (dollars in thousands) June 30, 2021 Weighted Average Weighted Average Borrowing Type Amount Outstanding Borrowing Rate Years to Maturity Repurchase agreements$ 8,350,622 0.28 % 0.2 Revolving credit facilities 533,519 3.68 % 1.2 Term notes payable 396,183 2.89 % 3.0 Convertible senior notes (1) 423,742 6.25 % 3.2 Total$ 9,704,066 0.84 % 0.5 (dollars in thousands)
June 30, 2021 Weighted Average Amount Weighted Average Haircut on Collateral Type Outstanding Borrowing Rate Collateral Value Agency RMBS$ 8,181,645 0.22 % 4.7 % Non-Agency securities 1,196 1.85 % 34.0 % Agency Derivatives 42,781 0.79 % 21.3 % Mortgage servicing rights 1,032,202 3.43 % 28.6 % Mortgage servicing advances 22,500 3.16 % 12.3 % Other (1) 423,742 6.25 % NA Total$ 9,704,066 0.84 % 7.2 % ____________________ (1)Includes unsecured convertible senior notes due 2022 and 2026 paying interest semiannually at a rate of 6.25% per annum on the aggregate principal amount of$431.3 million . As ofJune 30, 2021 , the debt-to-equity ratio funding our AFS securities, MSR, servicing advances and Agency Derivatives, which includes unsecured borrowings under convertible senior notes, was 3.9:1.0. We believe the current degree of leverage within our portfolio helps ensure that we have access to unused borrowing capacity, thus supporting our liquidity and the strength of our balance sheet. 63
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The following table provides a summary of our borrowings under repurchase agreements, revolving credit facilities, term notes payable, convertible senior notes and (previously held) FHLB advances, our net TBA notional amounts and our debt-to-equity ratios for the three months endedJune 30, 2021 , and the four immediately preceding quarters: (dollars in thousands) End of Period End of Period End of Period Net Economic End
of Period Maximum Balance Total Borrowings Long (Short) TBA Debt-to-Equity For the Three Months Ended
Quarterly Average Balance of Any Month-End to Equity Ratio Notional Ratio (1) June 30, 2021$ 11,129,575 $ 9,704,066 $ 12,837,520 3.9:1.0$ 6,854,000 6.5:1.0 March 31, 2021$ 14,016,694 $ 12,938,748 $ 14,525,894 4.8:1.0$ 4,800,000 6.4:1.0 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
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(1)Defined as total borrowings under repurchase agreements, revolving credit facilities, term notes payable, convertible senior notes and (previously held) FHLB advances, plus implied debt on net TBA notional, divided by total equity.
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