In this quarterly report on Form 10-Q, or this "Quarterly Report," we refer toInvesco Mortgage Capital Inc. and its consolidated subsidiaries as "we," "us," "our Company," or "our," unless we specifically state otherwise or the context indicates otherwise. We refer to our external manager,Invesco Advisers, Inc. , as our "Manager," and we refer to the indirect parent company of our Manager, Invesco Ltd. together with its consolidated subsidiaries (which does not include us), as "Invesco." The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in Item 1 of this Report, as well as the information contained in our most recent Form 10-K filed with theSecurities and Exchange Commission (the "SEC"). Forward-Looking Statements We make forward-looking statements in this Report and other filings we make with theSEC within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and such statements are intended to be covered by the safe harbor provided by the same. Forward-looking statements are subject to substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. These forward-looking statements include information about possible or assumed future results of our business, investment strategies, financial condition, liquidity, results of operations, plans and objectives. When we use the words "believe," "expect," "anticipate," "estimate," "plan," "intend," "project," "forecast" or similar expressions and future or conditional verbs such as "will," "may," "could," "should," and "would," and any other statement that necessarily depends on future events, we intend to identify forward-looking statements. Factors that could cause actual results to differ from those expressed in our forward-looking statements include, but are not limited to: •Ongoing spread and economic and operational impact of the COVID-19 pandemic;
•our business and investment strategy;
•our investment portfolio and expected investments; •our projected operating results; •general volatility of financial markets and effects of governmental responses, including actions and initiatives of theU.S. governmental agencies and changes toU.S. government policies in response to the COVID-19 pandemic, mortgage loan modification programs, actions and initiatives of foreign governmental agencies and central banks, monetary policy actions of theFederal Reserve , including actions relating to its agency mortgage-backed securities portfolio and the continuation of re-investment of principal payments, and our ability to respond to and comply with such actions, initiatives and changes; •the availability of financing sources, including our ability to obtain additional financing arrangements and the terms of such arrangements; •financing and advance rates for our target assets; •changes to our expected leverage; •our expected book value per common share; •interest rate mismatches between our target assets and our borrowings used to fund such investments; •the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs; •our ability to maintain sufficient liquidity to meet our short-term liquidity needs; •changes in the credit rating of theU.S. government; •changes in interest rates and interest rate spreads and the market value of our target assets; •changes in prepayment rates on our target assets; •the impact of any deficiencies in foreclosure practices of third parties and related uncertainty in the timing of collateral disposition; •our reliance on third parties in connection with services related to our target assets; 35
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•disruption of our information technology system; •effects of hedging instruments on our target assets; •rates of default or decreased recovery rates on our target assets; •modifications to whole loans or loans underlying securities; •the degree to which our hedging strategies may or may not protect us from interest rate volatility and foreign currency exchange rate; •the degree to which derivative contracts expose us to contingent liabilities; •counterparty defaults; •compliance with financial covenants in our financing arrangements; •changes in governmental regulations, zoning, insurance, eminent domain and tax law and rates, and similar matters and our ability to respond to such changes; •our ability to maintain our qualification as a real estate investment trust forU.S. federal income tax purposes; •our ability to maintain our exception from the definition of "investment company" under the Investment Company Act of 1940, as amended (the "1940 Act"); •availability of investment opportunities in mortgage-related, real estate-related and other securities; •availability ofU.S. Government Agency guarantees with regard to payments of principal and interest on securities; •the market price and trading volume of our capital stock; •availability of qualified personnel of our Manager; •the relationship with our Manager; •estimates relating to taxable income and our ability to continue to make distributions to our stockholders in the future; •estimates relating to fair value of our target assets and loan loss reserves; •our understanding of our competition; •changes to generally accepted accounting principles inthe United States of America ("U.S. GAAP"); •the adequacy of our disclosure controls and procedures and internal controls over financial reporting; and •market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy. The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. You should not place undue reliance on these forward-looking statements. These beliefs, assumptions and expectations can change as a result of many possible events or factors, not all of which are known to us. Some of these factors are described under the headings "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with our condensed consolidated financial statements and the accompanying notes to our condensed consolidated financial statements, which are included in this Report. Executive Summary We are aMaryland corporation primarily focused on investing in, financing and managing residential and commercial mortgage-backed securities ("MBS") and mortgage loans. Our objective is to provide attractive risk-adjusted returns to our investors, primarily through dividends and secondarily through capital appreciation. To achieve this objective, we have historically invested in the following: •Residential mortgage-backed securities ("RMBS") that are guaranteed by aU.S. government agency such as theGovernment National Mortgage Association ("Ginnie Mae") or a federally chartered corporation such as the Federal National Mortgage Association ("Fannie Mae") or the Federal Home Loan Mortgage Corporation ("Freddie Mac") (collectively "Agency RMBS"); 36
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•Commercial mortgage-backed securities ("CMBS") that are guaranteed by aU.S. government agency such asGinnie Mae or a federally chartered corporation such as Freddie Mac or Fannie Mae (collectively "Agency CMBS"); •RMBS that are not guaranteed by aU.S. government agency or a federally chartered corporation ("non-Agency RMBS"); •CMBS that are not guaranteed by aU.S. government agency or a federally chartered corporation ("non-Agency CMBS"); •Credit risk transfer securities that are unsecured obligations issued by government-sponsored enterprises ("GSE CRT"); •Residential and commercial mortgage loans; and •Other real estate-related financing arrangements. We elected to be taxed as a real estate investment trust ("REIT") forU.S. federal income tax purposes under the provisions of the Internal Revenue Code of 1986. To maintain our REIT qualification, we are generally required to distribute at least 90% of our REIT taxable income to our stockholders annually. We operate our business in a manner that permits our exclusion from the definition of "Investment Company" under the 1940 Act. We are externally managed and advised byInvesco Advisers, Inc. , our Manager, which is an indirect, wholly-owned subsidiary of Invesco Ltd. During the quarter endedMarch 31, 2020 , we experienced unprecedented market conditions as a result of the global COVID-19 pandemic. Due to significant spread widening in both Agency and non-Agency securities, we received an unusually high number of margin calls from counterparties. OnMarch 23, 2020 , we notified our financing counterparties that we were not in a position to fund the margin calls we received onMarch 23, 2020 , and that we did not expect to be in a position to fund the anticipated volume of future margin calls under our financing arrangements in the near term as a result of market disruptions created by the COVID-19 pandemic. We engaged third party financial and legal advisors to assist us in restructuring our debt with our financing counterparties. To generate liquidity and reduce leverage,we sold MBS and GSE CRTs for cash proceeds of$16.2 billion and repaid$11.2 billion of our repurchase agreements during the quarter endedMarch 31, 2020 . We also terminated our entire interest rate swap portfolio as our exposure to interest rate risk decreased as we sold Agency assets. We have continued to focus on generating liquidity and reducing leverage in the second quarter of 2020. As ofMay 31, 2020 , we have a cash balance of$327.8 million , approximately$55.3 million of which is posted with FHLBI as collateral for our remaining secured loans. BetweenApril 1, 2020 andMay 31, 2020 , we sold additional MBS and GSE CRTs with a fair value of$6.2 billion atMarch 31, 2020 for cash proceeds of$5.9 billion and our loan participation interest for cash proceeds of$21.6 million . As ofMay 31, 2020 , we have a total investment portfolio, excluding cash and Agency CMBS purchase commitments, of approximately$1.6 billion consisting of 92% commercial credit investments, 7% residential credit investments, and 1% Agency mortgage-backed securities. Approximately$540 million of our investment portfolio is unencumbered. We have elected to hold our remaining non-Agency CMBS and GSE CRTs for a period of time given our view that these investments could benefit from actions taken by the federal government to stimulate the economy and the market for these securities. Our investment portfolio has not materially changed betweenMay 31, 2020 and the filing date of this Quarterly Report. In addition, we have not entered into any interest rate swap contracts during the second quarter as of the filing date of this Quarterly Report BetweenApril 1, 2020 andMay 31, 2020 , we repaid the outstanding balance of our repurchase agreements (approximately$6.3 billion as ofMarch 31, 2020 ). In addition, we repaid$512.5 million of our secured loans, reducing the outstanding balance of our secured loans to$837.5 million as of the filing date of this Quarterly Report. We also paid our dividends that were in arrears on our Series A Preferred, Series B Preferred, and Series C Preferred Stock onMay 22, 2020 . We will pay our first quarter 2020 common stock dividend of$0.50 per share onJune 30, 2020 in a combination of cash and common shares. In addition, onJune 17, 2020 , we declared a second quarter 2020 common stock cash dividend of$0.02 per common share that will be paid onJuly 28, 2020 . While theFederal Reserve (the "Fed") has taken a number of proactive measures to bolster liquidity in the second quarter of 2020, we expect market conditions for the mortgage REIT industry to continue to be challenging. We believe our current cash balances and cash flows from operations will meet our near-term liquidity requirements. Our secured loans are due byDecember 2020 , and we intend to repay our secured loans with proceeds from sales of non-Agency CMBS assets that are currently collateralizing these loans. 37
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In the near-term, we intend to deploy capital into attractive opportunities in Agency securities and seek to finance these securities with prudent levels of debt. Further, we will evaluate potential credit investments that do not rely on short-term or mark-to-market financing. To further strengthen our balance sheet and position ourselves for future investment opportunities, we have explored and will continue to explore additional sources of financing including issuances of debt and equity securities and other forms of long-term financing arrangements. However, no assurance can be given that we will be able to access any additional sources of financing. Market Conditions Macroeconomic factors that affect our business include interest rate spread premiums, governmental policy initiatives, residential and commercial real estate prices, credit availability, consumer personal income and spending, corporate earnings, employment conditions, financial conditions and inflation. During the first quarter of 2020 and continuing into the second quarter, financial markets experienced significant volatility as a result of the COVID-19 pandemic. OnMarch 11, 2020 , theWorld Health Organization characterized COVID-19 as a pandemic, and onMarch 13, 2020 a national emergency inthe United States was declared. Economic activity has been severely impacted as the pandemic resulted in stay-at-home orders and widespread business shutdowns. The precipitous decline in business activity has substantially increased unemployment levels and driven a sharp contraction in GDP to levels not seen in decades. Reactions to the impacts of the pandemic led to swift and severe financial market dislocations during the first quarter. During the first quarter, the significant dislocation in the financial markets caused, among other things, credit spread widening, a marked decrease in interest rates and unprecedented illiquidity in Agency and non-Agency MBS trading and financing markets. We expect this volatility to persist in the near term due to the continued uncertainty around the COVID-19 pandemic duration and ultimate impact. Further, we expect the COVID-19 pandemic to negatively impact real estate markets. The lodging and retail property markets are likely to experience the greatest impact due to travel restrictions and a sharp slowdown in discretionary consumption. In the retail sector, despite long-term leases, tenants that are not open for business may find it difficult to meet rent obligations, and may forego payments or seek relief in the months ahead. Real estate loans are likely to experience increased delinquencies and defaults, which could impact the fundamental performance of our investments.The Fed responded to the COVID-19 pandemic with a series of measures aimed at returning stability to the financial markets and fostering economic recovery. These measures included cutting the federal funds target rate by 150 basis points to 0%-0.25% onMarch 15, 2020 and committing to purchases ofU.S. Treasuries and Agency MBS. These actions helped improveAgency RMBS and Agency CMBS liquidity and, eventually, market prices. Additionally, onMarch 23, 2020 , the Fed announced it would purchase debt issued byU.S. investment grade rated companies and established the Term Asset-Backed Securities Loan Facility ("TALF") to support the flow of credit to consumers and businesses. Initially, the TALF provided financing for asset-backed securities collateralized by student loans, auto loans, credit card loans and loans guaranteed by theSmall Business Administration . Subsequently, the Fed expanded the TALF to cover secondary market triple-A rated conduit non-Agency CMBS. Since their inclusion, triple-A rated non-Agency CMBS has recorded some recovery of the spread widening experienced in March. We expect this trend to continue as investors look to capitalize on favorable financing made available by the Fed. We also believe bonds rated below triple-A have the potential to benefit from increased investor demand as more senior bonds experience price appreciation. In addition to the Fed purchases and facilities mentioned above, the repurchase financing markets for high-quality assets such as Treasuries and Agency RMBS continued to be supported by substantial Fed action in the form of upsized open market operations, both in the overnight and term markets. These facilities were established in late 2019 and were significantly increased in the first quarter of 2020.The U.S. Congress has also responded to the COVID-19 pandemic by passing three rounds of fiscal stimulus measures, the most notable being the$2.2 trillion Coronavirus Aid, Relief, and Economic Security Act ("CARES Act"), which included relief measures for households and businesses directly or indirectly impacted by the virus. The CARES Act includes provisions for COVID-19 related temporary forbearance on federally backed mortgage loans, which allows borrowers of loans guaranteed by Fannie Mae, Freddie Mac andGinnie Mae to suspend making principal and interest payments for a period of up to 360 days if they are facing hardship. Following the temporary forbearance period, mortgage servicers have to provide several options to impacted borrowers, including a repayment schedule or loan modification, depending on the borrowers' circumstances. We believe the provision of forbearance and loan modifications will substantially reduce borrower defaults and loan losses relative to levels that would have likely occurred without these actions. Despite the unprecedented measures discussed above, market conditions continue to be challenging for asset classes that have not been directly targeted by government intervention. While the markets for Agency RMBS and Agency CMBS have largely recovered in response to large-scale purchases by the Fed, the markets for non-Agency CMBS, non-Agency RMBS and GSE CRTs have yet to fully recover as the ultimate impact of the COVID-19 pandemic on these credit assets remains unclear. 38
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Proposed Changes to LIBOR In 2017, theU.K. Financial Conduct Authority (the "FCA"), which regulates LIBOR, announced that theFCA will no longer persuade or compel banks to submit rates for the calculation of the LIBOR benchmark after 2021. This announcement indicates that the continuation of LIBOR will not be guaranteed after 2021. The Alternative Reference Rates Committee ("ARRC"), which was convened by theFederal Reserve Board and theNew York Fed to help ensure a successful transition from LIBOR, has proposed that the Secured Overnight Financing Rate ("SOFR") is the rate that represents best practice as the alternative to LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR. ARRC has proposed a paced market transition plan to SOFR from LIBOR, and organizations are currently working on industry wide and company specific transition plans as it relates to derivatives and cash markets exposed to LIBOR. SOFR is an overnight rate unlike LIBOR which is a forward-looking term rate, making SOFR an inexact replacement for LIBOR. There is currently no perfect way to create robust, forward-looking, SOFR term rates. Market participants are still considering how various types of financial instruments and securitization vehicles should react to a discontinuation of LIBOR. It is possible that not all of our assets and liabilities will transition away from LIBOR at the same time, and it is possible that not all of our assets and liabilities will transition to the same alternative reference rate, in each case increasing the difficulty of hedging. Switching existing financial instruments and hedging transactions from LIBOR to SOFR requires calculations of a spread. Industry organizations are attempting to structure the spread calculation in an objective manner, but there is no assurance that all asset types or securitization vehicles will use the same spread. We and other market participants have less experience understanding and modeling SOFR-based assets and liabilities than LIBOR-based assets and liabilities, increasing the difficulty of investing, hedging, and risk management. We have material contracts that are indexed to LIBOR and are monitoring this activity and evaluating the related risks. However, it is not possible to predict the effect of any of these developments, and any future initiatives to regulate, reform or change the manner of administration of LIBOR could result in adverse consequences to the rate of interest payable and receivable on, market value of and market liquidity for LIBOR-based financial instruments. Our Manager is finalizing its global assessment of exposure in relation to our LIBOR-based instruments and benchmarks and is prioritizing the mitigation of risks associated with the forecasted changes to financial instruments and performance benchmarks referencing existing LIBOR rates. InOctober 2019 , theIRS andTreasury proposed regulations that are expected to provide taxpayers relief from adverse impacts resulting from the transition away from LIBOR to an alternative reference rate. The proposed regulations make clear that a change in the reference rate (and associated alterations to payment terms) of a financial instrument is generally not considered a taxable event, provided the fair value of the modified instrument is substantially equivalent to the fair value of the unmodified instrument.The Financial Accounting Standards Board has also issued accounting guidance that provides optional expedients and exceptions to contracts, hedging relationships and other transactions impacted by LIBOR transition if certain criteria are met. The guidance is effective for all entities as ofMarch 12, 2020 throughDecember 31, 2022 . 39
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Investment Activities As previously discussed, the COVID-19 pandemic caused unprecedented market disruption in the three months endedMarch 31, 2020 . To raise liquidity and reduce leverage, we sold MBS and GSE CRTs for cash proceeds of$16.2 billion . Our equity allocation and investment portfolio composition as ofMarch 31, 2020 were directly impacted by these sales as detailed in the tables below. The table below shows the allocation of our stockholders' equity as ofMarch 31, 2020 ,December 31, 2019 andMarch 31, 2019 : As of $ in thousands March 31, 2020 December 31, 2019 March 31, 2019 Agency RMBS 30 % 44 % 45 % Agency CMBS 20 % 16 % 5 % Commercial Credit (1) 38 % 28 % 32 % Residential Credit (2) 12 % 12 % 18 % Total 100 % 100 % 100 % (1)Commercial credit includes non-Agency CMBS, Multifamily GSE CRTs, commercial loans and investments in unconsolidated ventures. (2)Residential credit includes non-Agency RMBS, Single Family GSE CRTs and a loan participation interest. The table below shows the breakdown of our investment portfolio as ofMarch 31, 2020 ,December 31, 2019 andMarch 31, 2019 : As of $ in thousands March 31, 2020 December 31, 2019 March 31, 2019 Agency RMBS: 30 year fixed-rate, at fair value 1,421,162 10,524,220 12,716,636 15 year fixed-rate, at fair value 71,166 292,414 352,102 Hybrid ARM, at fair value 2,672 56,893 179,925 Agency CMO, at fair value 300,535 427,512 327,151 Agency CMBS, at fair value 2,278,027 4,767,930 2,001,553 Non-Agency CMBS, at fair value 2,869,051 3,823,474 3,455,806 Non-Agency RMBS, at fair value 568,081 955,671 1,186,896 GSE CRT, at fair value 534,114 923,672 907,529 Loan participation interest, at fair value 21,577 44,654 53,827 Commercial loan, at amortized cost 22,577 24,055 24,454 Investments in unconsolidated ventures 21,088 21,998 24,129 Total investment portfolio 8,110,050 21,862,493 21,230,008 40
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Prior to disruption in the financial markets caused by the COVID-19 pandemic, we purchased$4.3 billion of fixed rate Agency RMBS,$435.5 million of Agency CMBS,$56.6 million of non-Agency CMBS and$99.0 million of GSE CRTs during the three months endedMarch 31, 2020 . We funded these purchases by leveraging the proceeds of ourFebruary 2020 common stock issuance and with cash proceeds from paydowns and sales of securities. As ofMarch 31, 2020 , our holdings of 30 year fixed-rate Agency RMBS represented approximately 18% of our total investment portfolio versus 48% as ofDecember 31, 2019 and 60% as ofMarch 31, 2019 . We have historically focused our purchases of 30 year fixed-rate Agency RMBS on specified pools priced at modest pay-ups to generic Agency RMBS because those securities have characteristics that reduce prepayment risk. We hold approximately$10.1 million of Agency RMBS as ofMay 31, 2020 . As ofMarch 31, 2020 , our holdings of Agency CMBS represented approximately 28% of our total investment portfolio versus 22% as ofDecember 31, 2019 and 9% as ofMarch 31, 2019 . Our Agency CMBS holdings as ofMarch 31, 2020 include approximately$507.2 million (December 31, 2019 :$96.2 million ;March 31, 2019 :$221.9 million ) of Agency CMBS purchase commitments. We have historically focused our investments in Agency CMBS issued by Freddie Mac, Fannie Mae andGinnie Mae that have characteristics that reduce prepayment risk. Our hedging costs for Agency CMBS are relatively low because they are less sensitive to interest rate risk given limited extension beyond initial expected maturity dates and underlying loan prepayment protection. We hold approximately$192.4 million of Agency CMBS as ofMay 31, 2020 , including$191.6 million of Agency CMBS purchase commitments. We have sold our Agency CMBS holdings as of the filing date of this Quarterly Report. Our investments that have credit exposure include non-Agency CMBS, non-Agency RMBS, GSE CRTs, a commercial real estate loan, and a loan participation interest. Rather than relying on the rating agencies, we utilize proprietary models as well as third party applications to quantify and monitor the credit risk associated with these holdings. Our analysis generally begins at the underlying asset level, where we gather detailed information on loan, borrower, and property characteristics that inform our expectations for future performance. In addition to base case cash flow projections, we perform a range of scenario stresses to gauge the sensitivity of returns to potential deviations in underlying asset behavior. We perform this detailed credit analysis at the time of initial purchase and regularly throughout the holding period of each investment. As ofMarch 31, 2020 our holdings of non-Agency CMBS represented approximately 35% of our total investment portfolio versus 17% as ofDecember 31, 2019 and 16% as ofMarch 31, 2019 . Our non-Agency CMBS portfolio is collateralized by loans secured by various property types located acrossthe United States including office, retail, multifamily, industrial warehouses and hotels. The largest property geographic locations are inNew York ,California ,Texas ,Florida andIllinois as detailed in the tables below. The majority of our non-Agency CMBS portfolio is comprised of fixed rate credits that are rated investment grade by a nationally recognized statistical rating organization. The remainder of our assets were originated during and after 2017. We hold approximately$1.5 billion of non-Agency CMBS as ofMay 31, 2020 . Over 87% of non-Agency CMBS are rated single-A (or equivalent) or higher by a nationally recognized statistical rating organization as ofMay 31, 2020 . Further, over 75% of non-Agency CMBS are rated double-A (or equivalent) or higher by a nationally recognized statistical rating organization as ofMay 31, 2020 . As ofMarch 31, 2020 , our holdings of non-Agency RMBS represented approximately 7% of our total investment portfolio versus 4% as ofDecember 31, 2019 and 6% as ofMarch 31, 2019 . We primarily hold non-Agency RMBS securities collateralized by prime and Alt-A loans. In addition, we have invested in re-securitizations of real estate mortgage investment conduit ("Re-REMIC") RMBS and securitizations of reperforming mortgage loans that we expect to provide attractive risk adjusted returns. We hold approximately$13.2 million of non-Agency RMBS as ofMay 31, 2020 . As ofMarch 31, 2020 , our holdings of GSE CRTs represented approximately 7% of our total investment portfolio versus 4% as ofDecember 31, 2019 and 4% as ofMarch 31, 2019 . GSE CRTs are unsecured general obligations of the GSEs that are structured to provide credit protection to the issuer with respect to defaults and other credit events within pools of mortgage loans secured by single family properties that collateralize Agency RMBS issued and guaranteed by the GSEs ("Single Family GSE CRT") or within pools of mortgage loans secured by multifamily properties that collateralize Agency CMBS issued and guaranteed by the GSEs ("Multifamily GSE CRT"). The majority of our GSE CRT holdings are concentrated in 2013 and 2014 vintages, where reference loans have significant embedded home price appreciation. GSE CRTs have the added benefit of paying a floating rate coupon that reduces our need to hedge interest rate risk. We hold approximately$94.7 million of GSE CRTs as ofMay 31, 2020 . We had funded$25.4 million of a participation interest in a secured loan collateralized by mortgage servicing rights associated with Fannie Mae, Freddie Mac, andGinnie Mae loans as ofMarch 31, 2020 . We sold our loan participation interest onApril 1, 2020 . 41
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As ofMarch 31, 2020 , we held an investment in one commercial real estate mezzanine loan that matures in 2021 and has a loan-to-value ratio of approximately 68.3%. We continue to hold this investment as of the filing date of this Quarterly Report. As ofMarch 31, 2020 , we held investments in two unconsolidated ventures that are managed by an affiliate of our Manager. The unconsolidated ventures invest in our target assets. We continue to hold these investments as of the filing date of this Quarterly Report. Portfolio Characteristics The table below illustrates the vintage distribution of our non-Agency RMBS, GSE CRT and non-Agency CMBS portfolio as ofMarch 31, 2020 as a percentage of the fair value: 2003-2007 2008-2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Total Prime 13.3 % 0.1 % - % - % 17.6 % 6.8 % - % 0.5 % - % 23.3 % 11.0 % - % 72.6 % Alt-A 15.4 % - % - % - % - % - % - % - % - % - % - % - % 15.4 % Re-REMIC (1) 0.9 % 5.9 % 2.5 % 1.8 % 0.8 % - % - % - % - % - % - % - % 11.9 % Subprime/RPL 0.1 % - % - % - % - % - % - % - % - % - % - % - % 0.1 % Total Non-Agency RMBS 29.7 % 6.0 % 2.5 % 1.8 % 18.4 % 6.8 % - % 0.5 % - % 23.3 % 11.0 % - % 100.0 % GSE CRT - % - % - % - % 15.2 % 24.7 % 4.8 % 21.9 % 3.1 % 4.5 % 14.9 % 10.9 % 100.0 % Non-Agency CMBS - % 2.0 % 14.1 % 11.9 % 10.7 % 32.0 % 7.1 % 5.3 % 7.5 % 5.1 % 3.6 % 0.7 % 100.0 % (1)Reflects the year in which the re-securitizations were issued. The vintage distribution of the securities that collateralize our Re-REMIC investments is 0.4% for 2006, and 99.6% for 2007. The tables below represent the geographic concentration of the underlying collateral for our non-Agency RMBS, GSE CRT and non-Agency CMBS portfolio as ofMarch 31, 2020 . The geographic markets that we invest in have been and continue to be severely impacted by the ongoing COVID-19 pandemic. Non-Agency RMBS GSE CRT Non-Agency CMBS State Percentage State Percentage State Percentage California 44.2 % California 16.5 % New York 15.3 % New York 8.7 % Texas 7.0 % California 14.5 % Florida 6.5 % Florida 5.5 % Texas 8.7 % New Jersey 3.3 % New York 4.5 % Florida 6.1 % Colorado 3.1 % Illinois 3.8 % Illinois 4.8 % Washington 3.1 % Virginia 3.7 % New Jersey 3.9 % Virgina 3.0 % Washington 3.5 % Pennsylvania 3.4 % Massachusetts 2.7 % New Jersey 3.2 % Virginia 3.2 % Texas 2.7 % Colorado 3.2 % Michigan 3.1 % Maryland 2.5 % Pennsylvania 3.1 % Ohio 3.1 % Other 20.2 % Other 46.0 % Other 33.9 % Total 100.0 % Total 100.0 % Total 100.0 % Financing and Other Liabilities We have historically used repurchase agreements to finance the majority of our target assets and expect to use repurchase agreements to finance Agency investments in the future. Repurchase agreements are generally settled on a short-term basis, usually from one to six months, and bear interest at rates that have historically moved in close relationship to LIBOR. As ofMarch 31, 2020 , we had entered into repurchase agreements totaling$6.3 billion (December 31, 2019 :$17.5 billion ) that were secured by our mortgage-backed and credit risk transfer securities and an investment in a loan participation interest. We repaid all of our repurchase agreements as ofMay 7, 2020 with proceeds from asset sales and the return of cash margin previously pledged on our repurchase agreements. Our wholly-owned subsidiary,IAS Services LLC , is a member of theFederal Home Loan Bank of Indianapolis ("FHLBI") and has borrowed funds from the FHLBI in the form of secured loans. As ofMarch 31, 2020 ,IAS Services LLC had$1.35 billion in outstanding secured loans that are due byDecember 2020 . As ofMay 31, 2020 , we reduced the balance of 42
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our secured loans to$837.5 million . We intend to repay the remaining balance of our secured loans with proceeds from sales of assets collateralizing the secured loans. As discussed in Note 5 - "Other Assets,"IAS Services LLC is required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured loans from the FHLBI. FHLBI redeemed a portion of our stock in connection with the repayment of our secured loans discussed above. The balance of our FHLBI stock is$37.7 million as of the filing date of this Quarterly Report. The following table presents the amount of collateralized borrowings outstanding under repurchase agreements and secured loans as of the end of each quarter, the average amount outstanding during the quarter and the maximum balance outstanding during the quarter: $ in thousands Collateralized
borrowings under repurchase agreements and secured loans
Average quarterly Quarter Ended Quarter-end balance balance Maximum balance March 31, 2019 18,474,387 17,229,809 18,474,387 June 30, 2019 18,725,065 19,019,503 19,365,413 September 30, 2019 19,722,032 19,535,263 19,898,863 December 31, 2019 19,182,303 19,842,868 20,377,801 March 31, 2020 7,637,746 16,673,939 23,132,234 We have committed to invest up to$125.1 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As ofMarch 31, 2020 ,$118.7 million of our commitment to these unconsolidated ventures has been called. We are committed to fund$6.4 million in additional capital to fund future investments and cover future expenses should they occur. Hedging Instruments We enter into interest rate swap agreements that are designed to mitigate the effects of increases in interest rates for a portion of our borrowings. Under these swap agreements, we pay fixed interest rates and receive floating interest rates indexed off of one- or three-month LIBOR. We actively manage our swap portfolio by terminating and entering into new swaps as the size and composition of our investment portfolio changes. During the three months endedMarch 31, 2020 , we terminated existing swaps with a notional amount of$107.7 billion and entered into new swaps with a notional amount of$93.7 billion to hedge repurchase agreement debt associated with purchases of Agency RMBS and Agency CMBS securities. We terminated all of our remaining interest rate swaps inMarch 2020 as we positioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pandemic. Our exposure to interest rate risk decreased as we sold Agency assets and repaid borrowings. We realized a net loss of$904.7 million on interest rate swaps during the three months endedMarch 31, 2020 primarily due to falling interest rates in 2020. We enter into currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on investments denominated in foreign currencies. As ofMarch 31, 2020 , we had €20.8 million or$22.7 million (December 31, 2019 : €20.8 million or$23.1 million ) of notional amount of forward contracts denominated in Euro related to our investment in an unconsolidated venture. During the three months endedMarch 31, 2020 , we settled currency forward contracts of €20.8 million or$23.1 million (March 31, 2019 : €20.3 million or$23.1 million ) in notional amount and realized a net gain of$484,000 (March 31, 2019 :$185,000 net gain). Capital Activities OnFebruary 6, 2020 , we completed a public offering of 20,700,000 shares of common stock at the price of$16.78 per share. Total net proceeds were approximately$347.0 million after deducting estimated offering costs. We may sell up to 17,000,000 shares of our common stock and 7,000,000 shares of our preferred stock from time to time in at-the-market or privately negotiated transactions under our equity distribution agreements. We did not sell any shares under these agreements during the quarter endedMarch 31, 2020 . OnFebruary 18, 2020 , we declared the following dividends: •a dividend of$0.4844 per share of Series B Preferred Stock. OnMarch 24, 2020 we announced that we would delay the payment of this dividend to preserve liquidity. OnMay 9, 2020 we announced that we would pay this dividend onMay 22, 2020 to stockholders of record as of the close of business onMarch 5, 2020 ; and 43
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•a dividend of$0.46875 per share of Series C Preferred Stock. OnMarch 24, 2020 we announced that we would delay the payment of this dividend to preserve liquidity. OnMay 9, 2020 we announced that we would pay this dividend onMay 22, 2020 to stockholders of record as of the close of business onMarch 5, 2020 . OnMarch 17, 2020 , we declared the following dividends: •a dividend of$0.50 per share of common stock. OnMarch 24, 2020 we announced that we would delay the payment of this dividend to preserve liquidity. OnMay 9, 2020 we announced that we would pay this dividend onJune 30, 2020 in a combination of cash and common shares to stockholders of record as of the close of business onMay 21, 2020 ; and •a dividend of$0.4844 per share of Series A Preferred Stock paid. OnMarch 24, 2020 we announced that we would delay the payment of this dividend to preserve liquidity. OnMay 9, 2020 , we announced that we would pay this dividend onMay 22, 2020 to stockholders of record as of the close of business onApril 1, 2020 . OnMay 9, 2020 , we declared the following dividends: •a dividend of$0.4844 per share of Series B Preferred Stock to be paid onJune 29, 2020 to stockholders of record as of the close of business onJune 5, 2020 ; and •a dividend of$0.46875 per share of Series C Preferred Stock to be paid onJune 29, 2020 to stockholders of record as of the close of business onJune 5, 2020 . OnJune 17, 2020 , we declared the following dividends: •a dividend of$0.02 per share of common stock to be paid onJuly 28, 2020 to stockholders of record as of the close of business onJuly 6, 2020 ; and •a dividend of$0.4844 per share of Series A Preferred Stock to be paid onJuly 27, 2020 to stockholders of record as of the close of business onJuly 1, 2020 . During the three months endedMarch 31, 2020 , we did not repurchase any shares of our common stock. Book Value per Common Share We calculate book value per common share as follows: As of $ in thousands except per share amounts March 31, 2020 December 31, 2019 Numerator (adjusted equity): Total equity 1,410,381 2,931,899 Less: Liquidation preference of Series A Preferred Stock (140,000) (140,000) Less: Liquidation preference of Series B Preferred Stock (155,000) (155,000) Less: Liquidation preference of Series C Preferred Stock (287,500) (287,500) Total adjusted equity 827,881 2,349,399 Denominator (number of shares): Common stock outstanding 164,966 144,256 Book value per common share 5.02 16.29 Our book value per common share decreased 69.2% as ofMarch 31, 2020 compared toDecember 31, 2019 primarily due to significant interest rate spread widening in both Agency and non-Agency assets. In particular, premiums over generic collateral on our Agency MBS specified pools decreased 2 to 4 points, as rapid deleveraging in the sector, given its relative liquidity, impacted valuations. In addition, prices of our credit holdings were severely impacted by the lack of liquidity and uncertainty surrounding the economic impact of the COVID-19 pandemic. Lastly, forced selling in order to fund margin calls was a significant detriment to book value as sales were executed at distressed levels. "Refer to Item 3. "Quantitative and Qualitative Disclosures About Market Risk" for interest rate risk and its impact on fair value. 44
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Critical Accounting Policies There have been no significant changes to our critical accounting policies that are disclosed in our most recent Form 10-K for the year endedDecember 31, 2019 except as discussed in Note 2 - "Summary of Significant Accounting Polices" to our condensed consolidated financial statements included in Part I, Item 1 of this report on Form 10-Q. Recent Accounting Standards See Part I, Item 1, Financial Statements Note 2 - "Accounting Pronouncements Recently Adopted". 45
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Results of Operations The table below presents certain information from our condensed consolidated statements of operations for the three months endedMarch 31, 2020 and 2019. Three Months Ended March 31, $ in thousands, except share data 2020 2019 Interest Income Mortgage-backed and credit risk transfer securities 185,536 185,492 Commercial and other loans 1,163 1,582 Total interest income 186,699 187,074 Interest Expense Repurchase agreements 79,042 101,875 Secured loans 6,646 11,144 Total interest expense 85,688 113,019 Net interest income 101,011 74,055 Other Income (loss) Gain (loss) on investments, net (755,483) 268,382 Equity in earnings (losses) of unconsolidated ventures 170 692 Gain (loss) on derivative instruments, net (910,779) (201,460) Realized and unrealized credit derivative income (loss), net (33,052) 7,884 Net loss on extinguishment of debt (4,806) - Other investment income (loss), net 803 1,029 Total other income (loss) (1,703,147) 76,527
Expenses
Management fee - related party 10,953 9,534 General and administrative 3,103 2,258 Total expenses 14,056 11,792 Net income (loss) (1,616,192) 138,790 Dividends to preferred stockholders 11,107 11,107 Net income (loss) attributable to common stockholders (1,627,299) 127,683
Earnings (loss) per share: Net income (loss) attributable to common stockholders Basic
(10.38) 1.05 Diluted (10.38) 1.05 Weighted average number of shares of common stock: Basic 156,771,279 121,097,686 Diluted 156,771,279 121,109,259 46
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Interest Income and Average Earning Asset Yields The table below presents information related to our average earning assets and earning asset yields for the three months endedMarch 31, 2020 and 2019. Three Months Ended March 31, $ in thousands 2020 2019 Average Earning Assets (1): Agency RMBS: 15 year fixed-rate, at amortized cost 232,551 371,228 30 year fixed-rate, at amortized cost 8,422,795 11,780,005 Hybrid ARM, at amortized cost 35,768 243,813 Agency - CMO, at amortized cost 365,936 291,914 Agency CMBS, at amortized cost 3,543,594 1,129,227 Non-Agency CMBS, at amortized cost 3,552,164 3,361,132 Non-Agency RMBS, at amortized cost 751,090 1,084,721 GSE CRT, at amortized cost 876,341 808,296 Loan participation interest 33,545 54,763 Commercial loans, at amortized cost 23,965 27,375 Average earning assets 17,837,749 19,152,474 Average Earning Asset Yields (2): Agency RMBS: 15 year fixed-rate 3.74 % 3.50 % 30 year fixed-rate 3.75 % 3.38 % Hybrid ARM 4.35 % 3.48 % Agency - CMO 3.74 % 3.56 % Agency CMBS 3.65 % 3.52 % Non-Agency CMBS 5.32 % 4.98 % Non-Agency RMBS 7.17 % 6.71 % GSE CRT (3) 3.11 % 3.67 % Loan participation interest 5.95 % 6.14 % Commercial loans 10.31 % 11.08 % Average earning asset yields 4.19 % 3.91 % (1)Average balances for each period are based on weighted month-end average earning assets. (2)Average earning asset yields for the period were calculated by dividing interest income, including amortization of premiums and discounts, by the average month-end earning assets based on the amortized cost of the investments. All yields are annualized. (3)GSE CRT average earning asset yields exclude coupon interest associated with embedded derivatives on securities not accounted for under the fair value option that is recorded as realized and unrealized credit derivative income (loss), net underU.S. GAAP. Our primary source of income is interest earned on our investment portfolio. We had average earning assets of approximately$17.8 billion for the three months endedMarch 31, 2020 (March 31, 2019 :$19.2 billion ). Average earning assets decreased for the three months endedMarch 31, 2020 primarily due to the sale of MBS and GSE CRTs for cash proceeds of$16.2 billion as previously discussed in the Executive Summary section of this Management's Discussion and Analysis of Financial Condition and Results of Operations. Our average earning assets for the three months endedMarch 31, 2020 are not indicative of our future ability to generate interest income because the sales referred to above primarily occurred during the latter part ofMarch 2020 , and we sold additional MBS and GSE CRTs with a fair value of$6.2 billion as ofMarch 31, 2020 for cash proceeds of$5.9 billion betweenApril 1, 2020 andMay 31, 2020 . 47
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We earned total interest income of
Three Months Ended March 31, $ in thousands 2020 2019 Interest Income MBS and GSE CRT - coupon interest 202,109 192,442 MBS and GSE CRT - net premium amortization (16,573) (6,950) MBS and GSE CRT - interest income 185,536 185,492 Commercial and other loans 1,163 1,582 Total interest income 186,699 187,074 MBS and GSE CRT interest income increased$44,000 for the three months endedMarch 31, 2020 compared to 2019 primarily due to a$9.7 million increase in coupon interest reflecting a 28 basis point increase in average earning asset yields. Average earnings asset yields rose due to purchases of 30 year fixed-rate Agency RMBS securities at higher yields. Higher coupon interest was offset by a$9.6 million increase in net premium amortization due to faster prepayment speeds driven by cuts in the federal funds interest rate over the past twelve months. Interest income on our commercial and other loans decreased$419,000 during the three months endedMarch 31, 2020 primarily due to principal payments on commercial loans totaling$7.1 million in 2019. Prepayment Speeds Our RMBS and GSE CRT portfolio is subject to inherent prepayment risk primarily driven by changes in interest rates, which impacts the amount of premium and discount on the purchase of these securities that is recognized into interest income. Expected future prepayment speeds on our RMBS and GSE CRT portfolio are estimated on a quarterly basis. Generally, in an environment of falling interest rates, prepayment speeds will increase as homeowners are more likely to prepay their existing mortgage and refinance into a lower borrowing rate. If the actual prepayment speed during the period is faster than estimated, the amortization on securities purchased at a premium to par value will be accelerated, resulting in lower interest income recognized. Conversely, for securities purchased at a discount to par value, interest income will be reduced in periods where prepayment speeds were slower than expected. The standard measure of prepayment speeds is the constant prepayment rate, also known as the conditional prepayment rate or "CPR". The table below provides the three month constant prepayment rate for our RMBS and GSE CRTs as ofMarch 31, 2020 ,December 31, 2019 , andMarch 31, 2019 . As of March 31, 2020 December 31, 2019 March 31, 2019 15 year fixed-rate Agency RMBS 16.0 12.5 7.1 30 year fixed-rate Agency RMBS 11.9 18.1 4.9 Hybrid ARM Agency RMBS 1.6 28.7 15.7 Non-Agency RMBS 18.4 17.2 8.3 GSE CRT 15.6 20.1 6.6 Weighted average CPR 14.2 18.1 5.7 48
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The following table presents net premium amortization recognized on our MBS and
GSE CRT portfolio for the three months ended
Three Months Ended March 31, $ in thousands, except share data 2020 2019 Agency RMBS (20,913) (12,194) Agency CMBS (1,666) (531) Non-Agency CMBS 5,058 3,031 Non-Agency RMBS 2,698 3,922 GSE CRT (1,750) (1,178) Net (premium amortization) discount accretion (16,573) (6,950) Net premium amortization increased$9.6 million for the three months endedMarch 31, 2020 compared to the same period in 2019 primarily due to faster prepayment speeds on Agency RMBS. Higher premium amortization was partially offset by discount accretion on purchases of non-Agency CMBS over the last twelve months. Our interest income is subject to interest rate risk. Refer to Item 3. "Quantitative and Qualitative Disclosures about Market Risk" for more information relating to interest rate risk and its impact on our operating results. Interest Expense and Cost of Funds The table below presents the components of interest expense for the three months endedMarch 31, 2020 and 2019: Three Months Ended March 31, $ in thousands 2020 2019 Interest Expense Interest expense on repurchase agreement borrowings 89,109 107,726
Amortization of net deferred (gain) loss on de-designated interest rate swaps
(10,067) (5,851) Repurchase agreements interest expense 79,042 101,875 Secured loans 6,646 11,144 Total interest expense 85,688 113,019 We have historically entered into repurchase agreements to finance the majority of our target assets. These agreements are secured by our mortgage-backed and credit risk transfer securities. These agreements are generally settled on a short-term basis, usually from one to six months, and bear interest at rates that have historically moved in close relationship to LIBOR. At each settlement date, we typically refinance each repurchase agreement at the market interest rate at that time. Our interest expense on repurchase agreement borrowings decreased$18.6 million for the three months endedMarch 31, 2020 compared to 2019 due to lower average borrowings and a lower average cost of funds reflecting decreases in the federal funds interest rate. Average borrowings decreased primarily due to repayment of$11.2 billion of repurchase agreements with proceeds from asset sales due to financial market disruption caused by the COVID-19 pandemic as previously discussed in this Management's Discussion and Analysis of Financial Condition and Results of Operations. Average borrowings also decreased due to repayment of$300.0 million of secured loans inFebruary 2020 due to a scheduled maturity. Our repurchase agreement interest expense as reported in our condensed consolidated statement of operations includes amortization of net deferred gains and losses on de-designated interest rate swaps as summarized in the table above. Amortization of net deferred gains on de-designated interest rate swaps decreased our total interest expense by$10.1 million during the three months endedMarch 31, 2020 and$5.9 million during the three months endedMarch 31, 2019 . Amounts recorded in AOCI before we discontinued cash flow hedge accounting for our interest rate swaps are reclassified to interest expense on repurchase agreements on the condensed consolidated statements of operations as interest is accrued and paid on the related repurchase agreements over the remaining life of the interest rate swap agreements. We increased the amount of gains and losses reclassified as a decrease to interest expense during the three months endedMarch 31, 2020 by$4.2 million because it is probable that the original forecasted repurchase agreement transactions will not occur by the end of the originally specified time period. During the next twelve months, we estimate that$19.1 million of net deferred gains on de-designated interest rate swaps will be reclassified from other comprehensive income and recorded as a decrease to interest expense. During the three months endedMarch 31, 2020 , interest expense for our secured loans decreased$4.5 million compared to the same period in 2019 due to lower borrowing rates and repayment of$300.0 million of secured loans inFebruary 2020 . 49
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Borrowing rates on our secured loans are based on the three-month FHLB swap rate plus a spread. For the three months endedMarch 31, 2020 , the weighted average borrowing rate on our secured loans was 1.83% as compared to 2.70% for the three months endedMarch 31, 2019 . Our total interest expense during the three months endedMarch 31, 2020 decreased$27.3 million from the same period in 2019 primarily due to the$23.1 million decrease in interest expense on repurchase agreements borrowings and secured loans in the 2020 period as discussed above. The table below presents information related to our borrowings and cost of funds for the three months endedMarch 31, 2020 and 2019: Three Months Ended March 31, $ in thousands 2020 2019 Average Borrowings(1): Agency RMBS (2) 8,521,865 11,664,156 Agency CMBS 3,523,998 1,074,917 Non-Agency CMBS (2) 3,049,547 2,663,941 Non-Agency RMBS 689,249 886,554 GSE CRT 722,179 717,482 Loan participation interest 25,159 41,072 Total average borrowings 16,531,997 17,048,122 Maximum borrowings during the period (3) 23,132,234 18,474,387 Average Cost of Funds (4): Agency RMBS (2) 2.30 % 2.59 % Agency CMBS 2.17 % 2.64 % Non-Agency CMBS (2) 2.34 % 3.24 % Non-Agency RMBS 2.67 % 3.54 % GSE CRT 2.54 % 3.49 % Loan participation interest 3.52 % 4.15 % Cost of funds 2.07 % 2.65 % Effective cost of funds (non-GAAP measure) (5) 2.02 % 2.68 % (1)Average borrowings for each period are based on weighted month-end balances. (2)Agency RMBS and non-Agency CMBS average borrowings and average cost of funds include borrowings under repurchase agreements and secured loans. (3)Amount represents the maximum borrowings at month-end during each of the respective periods. (4)Average cost of funds is calculated by dividing annualized interest expense excluding amortization of net deferred gain (loss) on de-designated interest rate swaps by our average borrowings. (5)For a reconciliation of cost of funds to effective cost of funds, see "Non-GAAP Financial Measures." Total average borrowings decreased$516.1 million in the three months endedMarch 31, 2020 compared to 2019 primarily because we repaid$11.2 billion of repurchase agreements and$300.0 million of secured loans in the three months endedMarch 31, 2020 as discussed above. Our average cost of funds decreased 58 basis points for three months endedMarch 31, 2020 versus 2019 primarily due to decreases in the federal funds rate over the past twelve months. Our average borrowings for the three months endedMarch 31, 2020 are not indicative of our future interest expense because we repaid the$11.2 billion of repurchase agreements referred to above during the latter part ofMarch 2020 . In addition, we repaid the balance of our repurchase agreements onMay 7, 2020 and an additional$512.5 million of secured loans as ofApril 30, 2020 . 50
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Net Interest Income The table below presents the components of net interest income for the three months endedMarch 31, 2020 and 2019: Three Months Ended March 31, $ in thousands 2020 2019 Interest Income Mortgage-backed and credit risk transfer securities 185,536 185,492 Commercial and other loans 1,163 1,582 Total interest income 186,699 187,074 Interest Expense Interest expense on repurchase agreement borrowings 89,109 107,726
Amortization of net deferred (gain) loss on de-designated interest rate swaps
(10,067) (5,851) Repurchase agreements interest expense 79,042 101,875 Secured loans 6,646 11,144 Total interest expense 85,688 113,019 Net interest income 101,011 74,055 Net interest rate margin 2.12 % 1.26 % Our net interest income, which equals interest income less interest expense, totaled$101.0 million (March 31, 2019 :$74.1 million ) for the three months endedMarch 31, 2020 . The increase in net interest income for the three months endedMarch 31, 2020 was primarily due to a lower cost of funds driven by cuts in the federal funds interest rate as discussed above. Our net interest rate margin, which equals the yield on our average assets for the period less the average cost of funds for the period, was 2.12% (March 31, 2019 : 1.26%) for the three months endedMarch 31, 2020 . The increase in net interest rate margin for the three months endedMarch 31, 2020 compared to the same period in 2019 was primarily due to decreases in the federal funds rate throughout 2019 that had a greater impact on our average cost of funds than on our average earning asset yields. Our cost of funds on all of our borrowings is influenced by changes in short term interest rates, whereas approximately 86% of the Company's investments were fixed rate assets as ofMarch 31, 2020 . Gain (Loss) on Investments, net The table below summarizes the components of gain (loss) on investments, net for the three months endedMarch 31, 2020 and 2019: Three Months Ended March 31, $ in thousands 2020 2019 Net realized gains (losses) on sale of investments (4,285) (11,115)
Impairment of investments the Company intends to sell or more likely than not will be required to sell before recovery of amortized cost basis
(78,834) - Other-than-temporary impairment losses - (1,776)
Net unrealized gains (losses) on MBS accounted for under the fair value option
(514,503) 280,039
Net unrealized gains (losses) on GSE CRT accounted for under the fair value option
(152,369) 1,234
Net unrealized gains (losses) on commercial loan and loan participation interest
(5,492) - Total gain (loss) on investments, net (755,483) 268,382 As previously discussed, we experienced unprecedented market conditions as a result of the global COVID-19 pandemic during the three months endedMarch 31, 2020 . To generate liquidity and reduce leverage, we sold MBS and GSE CRTs for cash proceeds of$16.2 billion (March 31, 2019 :$734.8 million ) and realized net losses of$4.3 million (March 31, 2019 : net losses of$11.1 million ). A portion of these sales were involuntary liquidations at significantly distressed market prices as certain of our repurchase agreement counterparties seized and sold our securities when we were unable to meet margin calls onMarch 23, 2020 . We recorded$78.8 million of impairment on non-Agency RMBS and CMBS securities during the three months endedMarch 31, 2020 because we intended to sell or more likely than not would be required to sell the securities before recovery of amortized cost basis. We still held these securities as ofMarch 31, 2020 . We assess our investment securities for credit losses 51
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and impairment on a quarterly basis. For additional information regarding our accounting policy for credit losses and impairment, refer to Note 2 - "Summary of Significant Accounting Policies" of our condensed consolidated financial statements included in Part I. Item 1. of this Quarterly Report. We have elected the fair value option for all of our RMBS interest-only securities, our MBS purchased on or afterSeptember 1, 2016 and our GSE CRTs purchased on or afterAugust 24, 2015 . Under the fair value option, changes in fair value are recognized in income in the condensed consolidated statements of operations and are reported as a component of gain (loss) on investments, net. As ofMarch 31, 2020 ,$5.3 billion (December 31, 2019 :$17.4 billion ) or 65% (December 31, 2019 : 80%) of our MBS and GSE CRT are accounted for under the fair value option. Our percentage of MBS and GSE CRTs accounted for under the fair value option declined as ofMarch 31, 2020 due to sales of securities accounted for under the fair value option during the three months endedMarch 31, 2020 . We recorded net unrealized losses on our MBS portfolio accounted for under the fair value option of$514.5 million in the three months endedMarch 31, 2020 compared to net unrealized gains of$280.0 million in the three months endedMarch 31, 2019 . Net unrealized losses in the three months endedMarch 31, 2020 reflect lower interest rates and wider interest rate spreads on our Agency and non-Agency assets. We also recorded net unrealized losses on our GSE CRT portfolio accounted for under the fair value option of$152.4 million in the three months endedMarch 31, 2020 compared to net unrealized gains of$1.2 million in the three months endedMarch 31, 2019 . Net unrealized losses in the three months endedMarch 31, 2020 reflect declines in valuations due to wider interest rate spreads. We recorded an unrealized loss of$3.8 million on our loan participation interest and an unrealized loss of$1.7 million on our commercial loan in the three months endedMarch 31, 2020 . We valued our loan participation interest based on the price that we sold the participation interest for onApril 1, 2020 . We valued our commercial loan based upon a valuation from an independent pricing service. Equity in Earnings (Losses) ofUnconsolidated Ventures For the three months endedMarch 31, 2020 , we recorded equity in earnings of unconsolidated ventures of$170,000 (March 31, 2019 : equity in earnings of$692,000 ). We recorded equity in earnings for the three months endedMarch 31, 2020 and 2019 primarily due to realized and unrealized gains on the underlying portfolio investments. Gain (Loss) on Derivative Instruments, net Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements on our floating rate repurchase agreements and secured loans. To accomplish these objectives, we primarily use interest rate derivative instruments, including interest rate swaps andU.S. Treasury futures contracts as part of our interest rate risk management strategy. We also use currency forward contracts to help mitigate the potential impact of changes in foreign currency exchange rates on our unconsolidated joint venture investment denominated in Euros. The tables below summarize our realized and unrealized gain (loss) on derivative instruments, net for the following periods: $ in thousands
Three Months Ended
Derivative Realized gain (loss) Contractual net Gain (loss) on not designated as on derivative interest income Unrealized gain derivative instruments, hedging instrument instruments, net (expense) (loss), net net Interest Rate Swaps (904,704) 11,924 (18,532) (911,312) Currency Forward Contracts 484 - 49 533 Total (904,220) 11,924 (18,483) (910,779) 52
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$ in thousands
Three Months Ended
Derivative Realized gain (loss) Contractual net Gain (loss) on not designated as on derivative interest income Unrealized gain derivative instruments, hedging instrument instruments, net (expense) (loss), net net Interest Rate Swaps (165,884) 4,509 12,991 (148,384) Futures Contracts (66,688) - 12,944 (53,744) Currency Forward Contracts 185 - 483 668 Total (232,387) 4,509 26,418 (201,460) During the three months endedMarch 31, 2020 , we terminated existing swaps with a notional amount of$107.7 billion and entered into new swaps with a notional amount of$93.7 billion to hedge repurchase agreement debt associated with purchases of Agency RMBS and Agency CMBS securities. We did not have any interest rate swap contracts as ofMarch 31, 2020 . We terminated all of our remaining interest rate swaps inMarch 2020 as we positioned our portfolio in response to unprecedented market conditions associated with the COVID-19 pandemic. Our exposure to interest rate risk decreased as we sold Agency assets and repaid borrowings. We realized a net loss of$904.7 million for the three months endedMarch 31, 2020 , respectively, on interest rate swaps primarily due to falling interest rates. As ofDecember 31, 2019 , we held the following interest rate swaps whereby we receive interest at a one-month and three-month LIBOR rate: $ in thousands As of December 31, 2019 Average Fixed Pay Average Receive Derivative instrument
Notional Amounts Rate Rate Average Maturity (Years) Interest Rate Swaps 14,000,000 1.47 % 1.79 % 5.2 We were not a party to any futures contracts in the three months endedMarch 31, 2020 . During the three months endedMarch 31, 2019 , we settled futures contracts with a notional amount of$1.7 billion . We realized a net loss of$66.7 million on the settlement of futures contracts for the three months endedMarch 31, 2019 due to falling interest rates. Daily variation margin payment for futures is characterized as settlement of the derivative itself rather than collateral and is recorded as a realized gain or loss in our condensed consolidated statement of operations. Realized and Unrealized Credit Derivative Income (Loss), net The table below summarizes the components of realized and unrealized credit derivative income (loss), net for the three months endedMarch 31, 2020 and 2019. Three Months Ended March 31, $ in thousands 2020 2019 GSE CRT embedded derivative coupon interest 4,718 5,350 Gain (loss) on settlement of GSE CRT embedded derivatives 2,283 - Change in fair value of GSE CRT embedded derivatives (40,053) 2,534
Total realized and unrealized credit derivative income (loss), net
(33,052) 7,884 In the three months endedMarch 31, 2020 , we recorded a decrease of$40.9 million in realized and unrealized credit derivative income (loss), net compared to the same periods in 2019. The decrease was primarily driven by a decline in the fair value of our GSE CRT embedded derivatives in the three months endedMarch 31, 2020 as asset prices dropped due to spread widening. 53
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Net Loss on Extinguishment of Debt As discussed in Note 7 - "Borrowings" of our condensed consolidated financial statements include in Part I. Item 1. of this report on Form 10-Q, certain of our counterparties seized and sold securities that we had posted as collateral for our repurchase agreements betweenMarch 23, 2020 andMarch 31, 2020 . We recorded early termination and legal fees paid to our counterparties that were associated with the termination of these repurchase agreements as a loss on extinguishment of debt in our condensed consolidated statement of operations. Other Investment Income (Loss), net Our other investment income (loss), net during the three months endedMarch 31, 2020 and 2019 primarily consists of quarterly dividends from FHLBI stock. We are required to purchase and hold a certain amount of FHLBI stock, which is based, in part, upon the outstanding principal balance of secured advances from the FHLBI. We earn dividend income on our investment in FHLBI stock, and the amount of our dividend income varies based upon the number of shares that we are required to own and the dividend declared per share. Expenses We incurred management fees of$11.0 million (March 31, 2019 :$9.5 million ) for the three months endedMarch 31, 2020 . Management fees increased for the three months endedMarch 31, 2020 compared to the same period in 2019 due to a higher management fee base. Our management fees are calculated quarterly in arrears. Our management fee will be lower in the three months endedJune 30, 2020 because the majority of realized losses on our derivative contracts and unrealized losses on our investments due to spread widening did not occur untilMarch 2020 . Realized losses on sales of investments in the three months endedJune 30, 2020 will further reduce the management fee base in the three months endedSeptember 30, 2020 . Refer to Note 11 - "Related Party Transactions" of our condensed consolidated financial statements for a discussion of our relationship with our Manager and a description of how our fees are calculated. Our general and administrative expenses not covered under our management agreement amounted to$3.1 million (March 31, 2019 :$2.3 million ) for the three months endedMarch 31, 2020 . General and administrative expenses primarily consist of directors and officers insurance, legal costs, accounting, auditing and tax services, filing fees, and miscellaneous general and administrative costs. General and administrative costs were higher for the three months endedMarch 31, 2020 compared to the same period in 2019 primarily due to fees paid for third-party legal and advisory services in connection with navigating market disruption associated with the COVID-19 pandemic totaling$1.1 million . Net Income (Loss) attributable to Common Stockholders For the three months endedMarch 31, 2020 , our net loss attributable to common stockholders was$1.6 billion (March 31, 2019 :$127.7 million net income attributable to common stockholders) or$10.38 basic and diluted net loss per average share available to common stockholders (March 31, 2019 :$1.05 basic and diluted net income per average share available to common stockholders). The change in net income (loss) attributable to common stockholders was primarily due to (i) net losses on derivative instruments of$910.8 million in the 2020 period compared to net losses on derivative instruments of$201.5 million in the 2019 period; (ii) a net loss on investments of$755.5 million in the 2020 period compared to a net gains on investments of$268.4 million in the 2019 period; (iii) credit derivative net losses of$33.1 million in the 2020 period compared to credit derivative net income of$7.9 million in the 2019 period; and (iv) a$27.0 million increase in net interest income. For further information on the changes in net gains (loss) on derivative instruments, net gain (loss) on investments, realized and unrealized credit derivative income (loss), net and net interest income, see preceding discussion under "Gain (Loss) on Derivative Instruments, net," "Gain (Loss) on Investments, net," "Realized and Unrealized Credit Derivative Income (Loss), net," and "Net Interest Income." 54
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Non-GAAP Financial Measures We have historically used the following non-GAAP financial measures to analyze the Company's operating results and believe these financial measures are useful to investors in assessing our performance as further discussed below: •core earnings (and by calculation, core earnings per common share), •effective interest income (and by calculation, effective yield), •effective interest expense (and by calculation, effective cost of funds), •effective net interest income (and by calculation, effective interest rate margin), and •repurchase agreement debt-to-equity ratio. The most directly comparableU.S. GAAP measures are: •net income (loss) attributable to common stockholders (and by calculation, basic earnings (loss) per common share), •total interest income (and by calculation, earning asset yields), •total interest expense (and by calculation, cost of funds), •net interest income (and by calculation, net interest rate margin), and •debt-to-equity ratio. We are not presenting core earnings for the three months endedMarch 31, 2020 ("first quarter 2020 core earnings") because core earnings excludes the material adverse impact that the market disruption caused by the COVID-19 pandemic has had on our financial condition. In addition, first quarter 2020 core earnings are not indicative of the reduced earnings potential of our current investment portfolio. We intend to resume reporting core earnings when its presentation provides a useful measure of our portfolio's earning capacity. We are also not presenting a repurchase agreement debt-to-equity ratio because this ratio as ofMarch 31, 2020 is not indicative of how we have historically managed our business prior to the market disruption caused by the COVID-19 pandemic. In addition, we do not have any repurchase agreements as of the date of this release. The non-GAAP financial measures used by management should be analyzed in conjunction withU.S. GAAP financial measures and should not be considered substitutes forU.S. GAAP financial measures. In addition, the non-GAAP financial measures may not be comparable to similarly titled non-GAAP financial measures of our peer companies. Effective Interest Income / Effective Yield / Effective Interest Expense / Effective Cost of Funds / Effective Net Interest Income / Effective Interest Rate Margin We calculate effective interest income (and by calculation, effective yield) asU.S. GAAP total interest income adjusted for GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net. We include our GSE CRT embedded derivative coupon interest in effective interest income because GSE CRT coupon interest is not accounted for consistently underU.S. GAAP. We account for GSE CRTs purchased prior toAugust 24, 2015 as hybrid financial instruments, but we have elected the fair value option for GSE CRTs purchased on or afterAugust 24, 2015 . UnderU.S. GAAP, coupon interest on GSE CRTs accounted for using the fair value option is recorded as interest income, whereas coupon interest on GSE CRTs accounted for as hybrid financial instruments is recorded as realized and unrealized credit derivative income (loss). We add back GSE CRT embedded derivative coupon interest to our total interest income because we consider GSE CRT embedded derivative coupon interest a current component of our total interest income irrespective of whether we elected the fair value option for the GSE CRT or accounted for the GSE CRT as a hybrid financial instrument. We calculate effective interest expense (and by calculation, effective cost of funds) asU.S. GAAP total interest expense adjusted for contractual net interest income (expense) on our interest rate swaps that is recorded as gain (loss) on derivative instruments, net and the amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense. We view our interest rate swaps as an economic hedge against increases in future market interest rates on our floating rate borrowings. We add back the net payments we make on our interest rate swap agreements to our totalU.S. GAAP interest expense because we use interest rate swaps to add stability to interest expense. We exclude the amortization of net deferred gains (losses) on de-designated interest rate swaps from our calculation of effective interest expense because we do not consider the amortization a current component of our borrowing costs. 55
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We calculate effective net interest income (and by calculation, effective interest rate margin) asU.S. GAAP net interest income adjusted for contractual net interest income (expense) on our interest rate swaps that is recorded as gain (loss) on derivative instruments, amortization of net deferred gains (losses) on de-designated interest rate swaps that is recorded as repurchase agreements interest expense and GSE CRT embedded derivative coupon interest that is recorded as realized and unrealized credit derivative income (loss), net. We believe the presentation of effective interest income, effective yield, effective interest expense, effective cost of funds, effective net interest income and effective interest rate margin measures, when considered together withU.S. GAAP financial measures, provide information that is useful to investors in understanding our borrowing costs and operating performance. The following tables reconcile total interest income to effective interest income and yield to effective yield for the following periods: Three Months EndedMarch 31, 2020 2019 $ in thousands Reconciliation
Yield/Effective Yield Reconciliation Yield/Effective Yield Total interest income 186,699 4.19 % 187,074 3.91 % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 4,718 0.10 % 5,350 0.11 % Effective interest income 191,417 4.29 % 192,424 4.02 % Our effective interest income decreased$1.0 million in the three months endedMarch 31, 2020 versus the same period in 2019 due to lower average earning assets. Our average earning assets decreased to$17.8 billion for the three months endedMarch 31, 2020 from$19.2 billion primarily because we sold MBS and GSE CRTs inMarch 2020 for cash proceeds of$16.2 billion due to disruption in the financial markets caused by the COVID-19 pandemic as previously discussed. The following tables reconcile total interest expense to effective interest expense and cost of funds to effective cost of funds for the following periods. Three Months Ended March 31, 2020 2019 Cost of Funds / Cost of Funds / Effective Cost of Effective Cost of $ in thousands Reconciliation Funds Reconciliation Funds Total interest expense 85,688 2.07 % 113,019
2.65 % Add (Less): Amortization of net deferred gain (loss) on de-designated interest rate swaps
10,067 0.24 % 5,851 0.14 % Add (Less): Contractual net interest expense (income) on interest rate swaps recorded as gain (loss) on derivative instruments, net (11,924) (0.29) % (4,509) (0.11) % Effective interest expense 83,831 2.02 % 114,361 2.68 % Our effective interest expense and effective cost of funds decreased during the three months endedMarch 31, 2020 compared to the same period in 2019 primarily due to lower interest expense paid on our repurchase agreements as well as higher net interest income earned on our interest rate swaps. We paid interest expense of$85.7 million during the three months endedMarch 31, 2020 compared to$113.0 million for the same period in 2019 due to lower average borrowings and a lower federal funds target interest rate. We earned contractual net interest income on interest rate swaps of$11.9 million during the three months endedMarch 31, 2020 compared to$4.5 million for the same period in 2019. Our higher contractual net interest income on interest rate swaps was driven by falling interest rates. For further information on interest expense and cost of funds, see the preceding discussion under "Interest Expense and Cost of Funds". 56
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The following tables reconcile net interest income to effective net interest income and net interest rate margin to effective interest rate margin for the following periods. Three Months Ended March 31, 2020 2019 Net Interest Rate Net Interest Rate Margin / Margin / Effective Effective Interest Rate Interest Rate $ in thousands Reconciliation Margin Reconciliation Margin Net interest income 101,011 2.12 % 74,055
1.26 % Add (Less): Amortization of net deferred (gain) loss on de-designated interest rate swaps
(10,067) (0.24) % (5,851) (0.14) % Add: GSE CRT embedded derivative coupon interest recorded as realized and unrealized credit derivative income (loss), net 4,718 0.10 % 5,350 0.11 % Add (Less): Contractual net interest income (expense) on interest rate swaps recorded as gain (loss) on derivative instruments, net 11,924 0.29 % 4,509 0.11 % Effective net interest income 107,586 2.27 % 78,063 1.34 % Effective net interest income and effective interest rate margin for the three months endedMarch 31, 2020 increased from the same period in 2019 primarily due to lower average borrowings, lower effective interest expense driven by cuts in the federal funds interest rate and higher contractual net interest income on interest rate swaps as previously discussed. Liquidity and Capital Resources Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to pay dividends, fund investments, repay borrowings and fund other general business needs. Our primary sources of funds for liquidity consist of the net proceeds from our common and preferred equity offerings, net cash provided by operating activities, proceeds from repurchase agreements and other financing arrangements and future issuances of equity and/or debt securities. The COVID-19 pandemic-driven disruptions in the real estate, mortgage and financial markets have negatively affected and are expected to continue to negatively affect our liquidity. Under the terms of our repurchase agreements and secured loans, our lenders have the contractual right to mark the underlying securities that we post as collateral to fair value as determined in their sole discretion. In addition, our lenders have the contractual right to increase the "haircut", or percentage amount by which collateral value must exceed the amount of borrowings, as market conditions become more volatile. As a result of significant spread widening in both Agency and non-Agency securities inMarch 2020 , valuations of our portfolio assets declined sharply in a short period of time, leading to an exceptional increase in the frequency and magnitude of margin calls. Additionally, our lenders raised required haircuts on our collateral for new repurchase agreements, driving further liquidity needs. We sold portfolio assets in order to generate liquidity, in many cases at significantly distressed market prices. These events have required us to maintain higher levels of cash and unencumbered assets. See Part I. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations and Part II. Other Information - Item 1A. Risk Factors in this Quarterly Report for more information on how the COVID-19 pandemic has impacted and may continue to impact our liquidity and capital resources. We held cash, cash equivalents and restricted cash of$365.0 million atMarch 31, 2020 (March 31, 2019 :$83.5 million ). As previously discussed, we increased our cash, cash equivalents and restricted cash balances atMarch 31, 2020 to improve our liquidity in light of market disruption created by the COVID-19 pandemic. Our operating activities provided net cash of$110.0 million for the three months endedMarch 31, 2020 (March 31, 2019 :$68.4 million ). Our investing activities provided net cash of$11.6 billion in the three months endedMarch 31, 2020 compared to net cash used by investing activities of$3.5 billion in the three months endedMarch 31, 2019 . Our primary source of cash from investing activities for the three months endedMarch 31, 2020 was proceeds from sales of MBS and GSE CRTs of$16.2 billion (March 31, 2019 :$734.8 million ) to improve liquidity. We also generated$636.5 million from principal payments of MBS and GSE CRTs during the three months endedMarch 31, 2020 (March 31, 2019 :$300.2 million ). Prior to disruption in the financial markets caused by the COVID-19 pandemic, we invested$4.4 billion in MBS and GSE CRTs during the three months endedMarch 31, 2020 (2019:$4.3 billion ). We used cash of$904.2 million to terminate derivative contracts in the three months endedMarch 31, 2020 (March 31, 2019 :$232.4 million ) as we sold our Agency securities and our sensitivity to interest rates decreased. 57
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Our financing activities used net cash of$11.6 billion for the three months endedMarch 31, 2020 primarily because we repaid our repurchase agreement borrowings with proceeds from asset sales (2019: net cash provided by financing activities of$3.4 billion ). We repaid net repurchase agreement borrowing of$11.2 billion (March 31, 2019 : net proceeds provided$3.2 billion ). In addition, we repaid$300.0 million of secured loans from the FHLBI upon their maturity onFebruary 11, 2020 . We also used cash of$74.8 million for the three months endedMarch 31, 2020 (March 31, 2019 :$58.0 million ) to pay dividends. Proceeds from issuance of common stock provided$347.3 million for the three months endedMarch 31, 2020 (March 31, 2019 :$259.0 million ). As ofMarch 31, 2020 , the average margin requirement (weighted by borrowing amount), or the percentage amount by which the collateral value must exceed the loan amount (also referred to as the "haircut") under our repurchase agreements was 5.2% for Agency RMBS, 5.4% for Agency CMBS, 17.1% for non-Agency RMBS, 20.7% for GSE CRT and 21.0% for non-Agency CMBS. Across our repurchase agreement facilities, the haircuts ranged from a low of 5.0% to a high of 8.0% for Agency RMBS, a low of 5.0% to a high of 10.0% for Agency CMBS, a low of 8.0% to a high of 35.0% for non-Agency RMBS, a low of 13.0% to a high of 50.0% for GSE CRT and a low of 10.0% to a high of 40.0% for non-Agency CMBS. Our repurchase agreement counterparties increased haircuts during the three months endedMarch 31, 2020 as financial conditions deteriorated and the fair value of our securities became more difficult to determine. Forward-Looking Statements Regarding Liquidity As previously discussed, we repaid all of our repurchase agreement borrowings onMay 7, 2020 and reduced the balance of our secured loans from$1.35 billion atMarch 31, 2020 to$837.5 million as ofMay 31, 2020 . As ofMay 31, 2020 , our investment portfolio is primarily composed of credit assets that are financed by FHLBI. Our secured loans are due byDecember 2020 , and we intend to repay FHLBI with proceeds from sales of assets that are currently collateralizing our secured loans. We have approximately$540 million of unencumbered securities as ofMay 31, 2020 and unrestricted cash of$272.5 million . We intend to finance the purchase of new Agency investments with a moderate amount of repurchase agreement borrowings or other financing arrangements. We will determine the amount of leverage on new investments based upon the type of investment and market conditions at the time of investment. Based upon our current portfolio, existing borrowing arrangements and anticipated proceeds from sales of assets that are currently collateralizing our secured loans, we believe that cash flow from operations, and available borrowing capacity will be sufficient to enable us to meet anticipated short-term (one year or less) liquidity requirements to fund our investment activities, pay fees under our management agreement, fund our required distributions to stockholders and fund other general corporate expenses. Our ability to meet our long-term (greater than one year) liquidity and capital resource requirements will be subject to obtaining additional debt financing. We may increase our capital resources by obtaining long-term credit facilities or through public or private offerings of equity or debt securities, possibly including classes of preferred stock, common stock, senior or subordinated notes and convertible notes. Such financing will depend on market conditions for capital raises and our ability to invest such offering proceeds. If we are unable to renew, replace or expand our sources of financing on substantially similar terms, it may have an adverse effect on our business and results of operations. Contractual Obligations We have entered into an agreement with our Manager under which our Manager is entitled to receive a management fee and the reimbursement of certain operating expenses incurred on our behalf. The management fee is calculated and payable quarterly in arrears in an amount equal to 1.50% of our stockholders' equity, per annum. Refer to Note 11 - "Related Party Transactions" of our condensed consolidated financial statements for additional information on how our management fee is calculated. Our Manager uses the proceeds from its management fee in part to pay compensation to its officers and personnelwho , notwithstanding that certain of those individuals are also our officers, receive no cash compensation directly from us. We are required to reimburse our Manager for operating expenses related to us incurred by our Manager, including certain salary expenses and other expenses relating to legal, accounting, due diligence and other services. Our reimbursement obligation is not subject to any dollar limitation. Refer to Note 11 - "Related Party Transactions" of our condensed consolidated financial statements for details of our reimbursements to our Manager. 58
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As of
Payments Due by Period Less than 1 After 5 $ in thousands Total year 1-3 years 3-5 years years Repurchase agreements (1) 6,287,746 6,287,746 - - - Secured loans (2) 1,350,000 100,000 - - 1,250,000 Interest expense on repurchase agreements (3) 11,596 11,596 - -
-
Interest expense on secured loans (2) (3) 84,800 33,343 30,936 19,594 927 Total (4) 7,734,142 6,432,685 30,936 19,594 1,250,927 (1)We repaid all of our repurchase agreements as ofMay 7, 2020 . (2)The FHLBI modified the terms of our secured loans in the second quarter of 2020 as discussed in Note 15 - "Subsequent Events". The balance of our secured loans is due byDecember 2020 . (3)Interest expense is calculated based on variable rates in effect atMarch 31, 2020 . (4)Excluded from total contractual obligations are the amounts due to our Manager under the management agreement, as those obligations do not have fixed and determinable payments. The above table does not include total commitments of approximately$510.2 million to fund the purchase of Agency CMBS securities because those securities are reported as an investment related payable in our condensed consolidated balance sheet as ofMarch 31, 2020 . We have sold our Agency CMBS holdings as of the filing date of this Quarterly Report. Off-Balance Sheet Arrangements We have committed to invest up to$125.1 million in unconsolidated ventures that are sponsored by an affiliate of our Manager. As ofMarch 31, 2020 ,$118.7 million of our commitment to these unconsolidated ventures had been called. We are committed to fund$6.4 million in additional capital to fund future investments and cover future expenses should they occur. As ofMarch 31, 2020 , we had an unfunded commitment on a loan participation interest in a secured loan of$49.6 million . We sold our loan participation interest onApril 1, 2020 and no longer have any future financing commitments related to this loan participation interest. Dividends To maintain our qualification as a REIT,U.S. federal income tax law generally requires that we distribute at least 90% of our REIT taxable income annually, determined without regard to the deduction for dividends paid and excluding net capital gains. We must pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our taxable income. Before we pay any dividend, whether forU.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on our repurchase agreements and other debt payable. If our cash available for distribution is less than our taxable income, we could be required to sell assets or borrow funds to make cash distributions, or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities. As discussed above, our distribution requirements are based on REIT taxable income rather thanU.S. GAAP net income. The primary differences between our REIT taxable income andU.S. GAAP net income are: (i) unrealized gains and losses on investments that we have elected the fair value option for that are included in currentU.S. GAAP income but are excluded from taxable income until realized or settled; (ii) gains and losses on derivative instruments that are included in currentU.S. GAAP net income but are excluded from taxable income until realized; and (iii) temporary differences related to amortization of premiums and discounts on investments. For additional information regarding the characteristics of our dividends, refer to Note 12 - "Stockholders' Equity" of our annual report on Form 10-K for the year endedDecember 31, 2019 . Inflation Virtually all of our assets and liabilities are sensitive to interest rates. As a result, interest rates and other factors influence our performance far more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Unrelated Business Taxable Income We have not engaged in transactions that would result in a portion of our income being treated as unrelated business taxable income. 59
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Exposure to Financial Counterparties We historically finance a substantial portion of our investment portfolio through repurchase agreements. Under these agreements, we pledge assets from our investment portfolio as collateral. Additionally, certain counterparties may require us to provide cash collateral in the event the market value of the assets declines to maintain a contractual repurchase agreement collateral ratio. If a counterparty were to default on its obligations, we would be exposed to potential losses to the extent the fair value of collateral pledged by us to the counterparty including any accrued interest receivable on such collateral exceeded the amount loaned to us by the counterparty plus interest due to the counterparty. As ofMarch 31, 2020 , two counterparties held collateral that exceeded the amounts borrowed under the related repurchase agreements by more than$70.5 million , or 5% of our stockholders' equity. We repaid all of our repurchase agreement borrowings inMay 2020 and do not have any repurchase agreement borrowings as of the filing date of this Quarterly Report. The following table summarizes our exposure to counterparties by geographic concentration as ofMarch 31, 2020 . Repurchase Agreement $ in thousands Number of Counterparties Financing Exposure North America 10 3,763,424 440,519 Europe (excluding United Kingdom) 5 1,140,260 137,350 Asia 3 447,803 43,529 United Kingdom 4 936,259 115,482 Total 22 6,287,746 736,880 Other Matters We believe that we satisfied each of the asset tests in Section 856(c)(4) of the Internal Revenue Code of 1986, as amended (the "Code") for the period endedMarch 31, 2020 , and that our proposed method of operation will permit us to satisfy the asset tests, gross income tests, and distribution and stock ownership requirements for our taxable year that will end onDecember 31, 2020 . At all times, we intend to conduct our business so that neither we nor ourOperating Partnership nor the subsidiaries of ourOperating Partnership are required to register as an investment company under the 1940 Act. If we were required to register as an investment company, then our use of leverage would be substantially reduced. Because we are a holding company that conducts our business through ourOperating Partnership and theOperating Partnership's wholly-owned or majority-owned subsidiaries, the securities issued by these subsidiaries that are excepted from the definition of "investment company" under Section 3(c)(1) or Section 3(c)(7) of the 1940 Act, together with any other investment securities theOperating Partnership may own, may not have a combined value in excess of 40% of the value of theOperating Partnership's total assets (exclusive ofU.S. government securities and cash items) on an unconsolidated basis, which we refer to as the 40% test. This requirement limits the types of businesses in which we are permitted to engage in through our subsidiaries. In addition, we believe neither we nor theOperating Partnership are considered an investment company under Section 3(a)(1)(A) of the 1940 Act because they do not engage primarily or hold themselves out as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through theOperating Partnership's wholly-owned or majority-owned subsidiaries, we and theOperating Partnership are primarily engaged in the non-investment company businesses of these subsidiaries.IAS Asset I LLC and certain of theOperating Partnership's other subsidiaries that we may form in the future rely upon the exclusion from the definition of "investment company" under the 1940 Act provided by Section 3(c)(5)(C) of the 1940 Act, which is available for entities "primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate." This exclusion generally requires that at least 55% of each subsidiary's portfolio be comprised of qualifying assets and at least 80% be comprised of qualifying assets and real estate-related assets (and no more than 20% comprised of miscellaneous assets). ("percentage tests"). TheSEC staff has issued a "no-action" letter in which it confirmed that it would not recommend enforcement action if an issuer continues to rely on the exclusion provided by Section 3(c)(5)(C) of the 1940 Act if the issuer does not meet the percentage tests if: (1) the inability to meet those tests is the result of the sale of an underlying asset; (2) proceeds from the sale are invested in government securities, certificates of deposit, or other securities appropriate for the purpose of preserving value pending the investment of the proceeds in assets that meet the percentage tests; and (3) the issuer intends to purchase assets that meet the percentage tests as soon as possible but generally within one year. (Medidentic Mortgage Investors ,SEC No-Action Letter (May 23, 1984 )). In light of this analysis, we believe that as ofMarch 31, 2020 , we conducted our business so as not to be regulated as an investment company under the 1940 Act. 60
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