Overview
We are an investment firm that focuses on acquiring and holding a levered portfolio of mortgage investments. Our mortgage investments generally consist of agency MBS and mortgage credit investments. Our agency MBS consist of residential mortgage pass-through certificates for which the principal and interest payments are guaranteed by either a GSE, such as Fannie Mae and Freddie Mac, or by aU.S. government agency, such asGinnie Mae . Our mortgage credit investments may include investments in mortgage loans secured by either residential or commercial real property or MBS collateralized by such mortgage loans, which we refer to as non-agency MBS. The principal and interest of our mortgage credit investments are not guaranteed by a GSE orU.S. government agency.
We believe we leverage prudently our investment portfolio, as we seek to increase potential returns to our shareholders. We fund our investments primarily through short-term financing arrangements, principally through repurchase agreements. We enter into various hedging transactions to mitigate the interest rate sensitivity of our cost of borrowing and the value of our fixed-rate mortgage investment portfolio.
We intend to elect to be taxed as a REIT under the Internal Revenue Code upon filing our tax return for our taxable year endedDecember 31, 2019 . As a REIT we are required to distribute annually 90% of our REIT taxable income (subject to certain adjustments). So long as we continue to qualify as a REIT, we will generally not be subject toU.S. federal or state corporate income taxes on our taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute 100% of our taxable income, although we will not be required to do so. We intend to make distributions of our taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. For our tax years endedDecember 31, 2018 and earlier, we were taxed as a C corporation forU.S. federal tax purposes.
We are a
Factors that Affect our Results of Operations and Financial Condition
Our business is materially affected by a variety of industry and economic factors, including:
• conditions in the global financial markets and economic conditions generally;
• changes in interest rates and prepayment rates; • conditions in the real estate and mortgage markets;
• actions taken by the
Treasury and foreign central banks; • changes in laws and regulations and industry practices; and • other market developments.
Current Market Conditions and Trends
The 10-yearU.S. Treasury rate was 1.92% as ofDecember 31, 2019 , a 77 basis point decrease from the prior year end. TheU.S. interest rate curve, measured as the spread between the 2-year and 10-yearU.S. Treasury rate, continued to flatten during most of the 2019 year, inverting for a period of time and reaching a low of negative five basis points inAugust 2019 , before steepening to 35 basis points as ofDecember 31, 2019 . The spread in rates between 10-yearU.S. Treasuries and interest rate swaps narrowed four basis points during the year with the 10-year swap rate ending at 1.90%. Interest rate and market volatility were at heightened levels during 2019. The decline in mortgage rates, elevated prepayment expectations, flattening of the interest rate curve, reducedFederal Reserve support for agency MBS and other factors led to widening of the spread between the market yield on agency MBS and benchmark interest rates during 2019, resulting in the pricing of agency MBS underperforming interest rate hedges. Following a two-year period in which theFederal Open Market Committee ("FOMC") raised its target federal funds rate by 200 basis points, theFOMC lowered its target federal funds rate 25 basis points three times during 2019 to a current range of 1.50% to 1.75%. After its meeting onDecember 11, 2019 , theFOMC maintained its target range for the federal funds rate at 1.50% to 1.75%, commenting that, in its judgment, the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near its symmetric 2% objective. Based on federal fund futures prices, market participants currently expect that theFOMC will lower the target federal funds rate by 25 basis points up to two times over the next twelve months. 35
-------------------------------------------------------------------------------- Earlier in 2019, theFOMC stated that it would modify its previously announced balance sheet normalization policy of gradually decreasing its reinvestment ofU.S. Treasury securities and agency MBS. After its meeting onDecember 11, 2019 , theFOMC reaffirmed that it will reinvest all principal payments received on itsU.S. Treasury securities and agency MBS holdings; however, principal payments received from its agency MBS will be reinvested inU.S. Treasury securities at a level to maintain its overall holdings inU.S. Treasury securities with any excess principal payments received reinvested in agency MBS. Starting the week ofSeptember 16, 2019 , the overnight rate for repurchase agreement ("repo") financing ofU.S. Treasury securities spiked meaningfully intraday from a rate in the low two percent range to a high in the nine percent range primarily due to a scarcity of bank reserves compared with the amount ofU.S. Treasury bonds in the market. Market participants have attributed this imbalance in the amount of available bank reserves compared toU.S. Treasury bond supply to a multiple of factors, including theFederal Reserve's reversal of its quantitative easing policy leading to a reduction in theFederal Reserve's balance sheet, increased federal government borrowing andU.S. Treasury bond issuances to fund federal budget deficits, and large cash payments reducing the amount of available reserves such as corporate quarterly income tax payments and the monthly settlement ofU.S. Treasury security auctions. In response, theFederal Reserve immediately increased bank reserves by offering repo financing forU.S. Treasury and mortgage securities in order to keep the federal funds rate in its target range and stabilize the overnight repo rate. OnDecember 11, 2019 , theFOMC announced that it will continue to conduct overnight and term repo operations through at leastJanuary 2020 , and that it will also purchase shorter-termU.S. Treasury bills at least into the second quarter of 2020 to maintain over time ample reserve balances at or above the level that prevailed in earlySeptember 2019 . Prepayment speeds in the fixed-rate residential mortgage market during 2019 increased from the prior year driven primarily by an increase in refinancing volumes due to a decrease in mortgage rates. Housing prices continued to improve as evidenced by the Standard & Poor's CoreLogic Case-ShillerU.S. National Home Price NSA index reporting a 3.3% annual gain inOctober 2019 and the overall index reaching a historical high. The favorable economy, moderate mortgage rates and low supply of homes for sale have driven continued gains in housing, although the increase in housing prices is beginning to moderate. However, reduced affordability is beginning to reduce sales of both new and existing single-family homes. The following table presents certain key market data as of the dates indicated: December 31, March 31, June 30, September 30, December 31, Change - 2018 2018 2019 2019 2019 2019 to 2019 30-Year FNMA Fixed Rate MBS (1) 2.5%$ 94.30 $ 97.55 $ 99.27 $ 99.58$ 98.92 $ 4.62 3.0% 97.36 99.58 100.80 101.55 101.39 4.03 3.5% 99.83 101.39 102.20 102.64 102.86 3.03 4.0% 101.83 102.86 103.33 103.80 104.02 2.19 4.5% 103.45 104.17 104.48 105.33 105.30 1.85 FNMA Current Coupon vs. 10-year Swap Rate 79 bps 70 bps 78 bps 105 bps 82 bps 3 bps U.S. Treasury Rates (UST) 2-year UST 2.49 % 2.26 % 1.75 % 1.62 % 1.57 % -92 bps 3-year UST 2.46 % 2.21 % 1.71 % 1.56 % 1.61 % -85 bps 5-year UST 2.51 % 2.23 % 1.77 % 1.54 % 1.69 % -82 bps 7-year UST 2.59 % 2.31 % 1.88 % 1.61 % 1.83 % -76 bps 10-year UST 2.69 % 2.41 % 2.01 % 1.66 % 1.92 % -77 bps 30-year UST 3.02 % 2.82 % 2.53 % 2.11 % 2.39 % -63 bps 2-year to 10-year UST Spread 20 bps 15 bps 26 bps 4 bps 35 bps 15 bps Interest Rate Swap Rates 2-year Swap 2.66 % 2.38 % 1.81 % 1.63 % 1.70 % -96 bps 3-year Swap 2.59 % 2.31 % 1.74 % 1.55 % 1.69 % -90 bps 5-year Swap 2.57 % 2.28 % 1.77 % 1.50 % 1.73 % -84 bps 7-year Swap 2.62 % 2.32 % 1.84 % 1.51 % 1.80 % -82 bps 10-year Swap 2.71 % 2.41 % 1.96 % 1.56 % 1.90 % -81 bps 30-year Swap 2.84 % 2.58 % 2.21 % 1.71 % 2.09 % -75 bps 2-year Swap to 2-year UST Spread 17 bps 12 bps 6 bps 1 bps 13 bps -4 bps 10-year Swap to 10-year UST Spread 2 bps 0 bps -5 bps -10 bps -2 bps -4 bps London Interbank Offered Rates (LIBOR) 1-month LIBOR 2.50 % 2.49 % 2.40 % 2.02 % 1.76 % -74 bps 3-month LIBOR 2.81 % 2.60 % 2.32 % 2.09 % 1.91 % -90 bps 36
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(1) Generic 30-year FNMA TBA price information, sourced from Bloomberg, provided
for illustrative purposes only and is not meant to be reflective of the fair
value of securities held by the Company.
Recent Regulatory Activity
Fannie Mae and Freddie Mac commenced their "Single Security Initiative" onJune 3, 2019 . The Single Security Initiative is a joint initiative of Fannie Mae and Freddie Mac, under the direction of the Federal Housing Finance Committee, to develop a common MBS (referred to as a "Uniform MBS" or "UMBS") to facilitate the combination of the separate TBA markets of each of the respective GSEs into a single, larger and more liquid market. Existing Freddie Mac pass-through MBS issued prior toJune 3, 2019 have a 45-day delay remittance cycle, in which principal and interest payments are remitted to holders 45 days after such payments are due on the underlying mortgage loans, while Fannie Mae MBS have a 55-day delay remittance cycle. As a means to conform existing Freddie Mac MBS to Fannie Mae MBS, Freddie Mac began offering holders of existing Freddie Mac MBS the option to exchange their 45-day delay MBS for a 55-day delay "mirror" MBS which is ultimately collateralized by the same pool of loans as the original 45-day delay MBS for which it was exchanged. For each 45-day MBS that a holder elects to exchange, at the time of the exchange, Freddie Mac will provide an upfront cash payment to the holder as compensation for the prospective 10-day monthly payment delay. We may elect in the future to exchange some, or potentially all, of our existing Freddie Mac 45-day delay MBS for mirror 55-day delay MBS, depending upon our evaluation of the economics of the compensation payment, among other considerations. Any exchanges of Freddie Mac MBS that we may ultimately elect to perform are not expected to materially impact our financial performance or operations. InJanuary 2014 , theConsumer Financial Protection Bureau ("CFPB") final rule became effective for a qualified mortgage as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as the "QM rule." A qualified mortgage is a mortgage that meets certain requirements for lender protection and secondary trading. In general, a qualified mortgage (i) contains less risky loan features, such as interest-only periods, negative amortization or balloon payments, (ii) has limits on origination points and fees, (iii) has certain legal protection for lenders, and (iv) has debt-to-income ratio limits. However, the QM rule contained an exemption from the debt-to-income ratio limits for mortgages eligible for purchase by either Fannie Mae or Freddie Mac, commonly referred to as the "QM patch," which is set to expire onJanuary 10, 2021 . OnJuly 25, 2019 , theCFPB announced that it plans to allow the QM patch to expire on its scheduled expiration date. However, onJanuary 17, 2020 , the Director of theCFPB issued a letter to members ofCongress stating that theCFPB intends to propose replacing the debt-to-income ratio limit requirement of a qualified mortgage with an alternative measure of a borrower's ability to repay, and theCFPB may extend the QM patch beyond its scheduled expiration date to accommodate the implementation of any proposed rulemaking. If the QM patch were to expire, it is expected that the number of mortgage loans eligible to be purchased by Fannie Mae or Freddie Mac would decrease which could result in a decrease in the GSE's market share while also potentially increasing the market share of non-agency MBS issuers. OnMarch 27, 2019 ,President Trump issued a memorandum directing the Secretary of theTreasury to develop a plan for administrative and legislative reforms to achieve the following housing reform goals: (i) ending the conservatorships of Fannie Mae and Freddie Mac upon the completion of specific reforms; (ii) facilitating competition in the housing finance market; (iii) establishing regulation of the GSEs in order to safeguard the safety and soundness of GSEs and minimizes the risks they pose to the financial stability ofthe United States ; and (iv) providing that the Federal government is properly compensated for any explicit or implicit support it provides the GSEs or the secondary housing finance market. OnSeptember 5, 2019 , theU.S. Treasury released its plan of recommended legislative and administrative reforms to the housing finance system to achieve the goals outlined in the Presidential memorandum. Since the release of theU.S. Treasury's plan of recommended reforms to the housing finance system, there have been preliminary actions taken to advance the goals in the plan of recapitalizing and ending the government conservatorship of the GSEs. First, onSeptember 27, 2019 , the FHFA andU.S. Treasury entered into an agreement that permits Fannie Mae and Freddie Mac to retain up to$25 billion and$20 billion , respectively, in capital. As part of the agreement, the liquidation preference of theU.S. Treasury's senior preferred stock positions in Fannie Mae and Freddie Mac will be increased by a commensurate amount until the liquidation preferences increase by$22 billion for Fannie Mae and$17 billion for Freddie Mac. Second, onOctober 4, 2019 , the FHFA released a solicitation for advisory services to assist in the formulation and potential implementation of a roadmap to responsibly end the conservatorships of the GSEs.
We expect vigorous debate and discussion in a number of areas, including
residential housing and mortgage reform, fiscal policy, monetary policy and
healthcare, to continue over the next few years; however, we cannot be certain
if or when any specific proposal or policy might be announced, emerge from
committee or be approved by
LIBOR Transition 37 -------------------------------------------------------------------------------- OnJuly 27, 2017 , theU.K. Financial Conduct Authority announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021, which could either cause LIBOR to stop publication immediately or cause LIBOR's regulator to determine that its quality had degraded to the degree that it is no longer representative of its underlying market. TheU.S. Federal Reserve , in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of largeU.S. financial institutions, is considering replacingU.S. dollar LIBOR with the Secured Overnight Financing Rate ("SOFR"), a new index calculated by short-term repurchase agreements backed byU.S. Treasury securities. TheFederal Reserve Bank of New York began publishing SOFR rates inApril 2018 . The likely market transition away from LIBOR and towards SOFR is expected to be gradual and complicated. There are significant differences between LIBOR and SOFR, such as LIBOR being an unsecured lending rate while SOFR is a secured lending rate, and LIBOR reflects term rates at different maturities while SOFR is an overnight rate. These and other differences create the potential for basis risk between the two rates. The impact of any basis risk between LIBOR and SOFR may negatively affect our operating results. Any of these alternative methods may result in interest rates that are either higher or lower than if LIBOR were available in its current form, which could have a material adverse effect on our results. We are party to various financial instruments which include LIBOR as a reference rate. As ofDecember 31, 2019 , these financial instruments include interest rate swap agreements, a mortgage loan investment, and preferred stock and unsecured notes issued by the Company. As ofDecember 31, 2019 , we had$2,985 million notional amount of interest rate swaps outstanding, including$1,335 million notional amount of interest rate swaps that expire after 2021. Under the terms of our interest rate swap agreements, we make semiannual interest payments based upon a fixed interest rate and receive quarterly interest payments based upon the prevailing three-month LIBOR on the date of reset. All of our existing interest rate swap agreements are centrally cleared by theChicago Mercantile Exchange ("CME") which acts as the calculation agent with the terms and conditions of each interest rates swap agreement defined in the CME Rulebook and supplemented by the rules published by theInternational Swaps and Derivative Association, Inc. ("ISDA"). The fallback terms of our current interest rate swap agreements were not designed to cover a permanent discontinuation of LIBOR. Under the terms of the current ISDA definitions, if the publication of LIBOR is not available, the current fallback is for the calculation agent to obtain quotations for what LIBOR should be from major banks in the interbank market. If LIBOR is permanently discontinued, it is possible that major banks would be unwilling and/or unable to give such quotations. Even if quotations were available in the near-term after the permanent discontinuation, it is unlikely that they will be available for each future reset date over the remaining tenor of our interest rate swap agreements. ISDA is currently leading an effort to amend its definitions to include fallbacks for an alternative reference rate that would apply upon the permanent discontinuation of LIBOR. It is anticipated that the amended ISDA definitions would include a statement identifying the objective triggers that would activate a fallback alternative interest rate provision and a description of the fallback alternative interest rate, which is expected to be SOFR adjusted for the fact that SOFR is an overnight rate and the various premia included within LIBOR. It is expected that the CME Rulebook would incorporate any amendments to the ISDA definitions. However, under the terms of the CME Rulebook, if a fallback to an alternative interest rate has not been triggered under future amended ISDA definitions, the CME as the calculation agent has the sole discretion to select an alternative interest rate if it determines that LIBOR is no longer representative of its underlying market. As ofDecember 31, 2019 , we had$15.0 million of junior subordinated debt outstanding that require quarterly interest payments at three-month LIBOR plus a spread of 2.25% to 3.00% and matures between 2033 and 2035. Under the terms of the indenture agreement for the notes, if the publication of LIBOR is not available, the current fallback is for the independent calculation agent to obtain quotations for what LIBOR should be from major banks in the interbank market. If the calculation agent is unable to obtain such quotations, then the LIBOR in effect for future interest payments would be LIBOR in effect for the immediately preceding interest payment period. As ofDecember 31, 2019 , we had a$45.0 million mortgage loan investment that bears interest at one-month LIBOR plus a spread of 4.25% with a LIBOR floor of 2.00%. The loan matures onDecember 30, 2021 with a one-year extension available at the option of the borrower. Under the terms of the loan agreement, if the administrative agent of the loan determines that LIBOR cannot be determined and LIBOR has been succeeded by an alternative floating rate index (i) that is commonly accepted by market participants as an alternative to LIBOR as determined by the administrative agent, (ii) that is publicly recognized by ISDA as an alternative to LIBOR, and (iii) for which ISDA has approved an amendment to hedge agreements generally providing such floating rate index as a standard alternative to LIBOR, then the administrative agent would use such alternative floating rate index as the fallback rate. If the administrative agent determines that no alternative rate index is available, then the fallback interest rate would be based on the prime rate plus an applicable spread. As ofDecember 31, 2019 , we had 1,200,000 shares of 8.250% Series C Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock ("Series C Preferred Stock") outstanding with a liquidation preference of$30.0 million . The Series C Preferred Stock is entitled to receive a cumulative cash dividend (i) from and including the original issue to, but excluding,March 30, 2024 at a fixed rate of 8.250% per annum of the$25.00 per share liquidation preference, and (ii) from and includingMarch 30, 2024 , at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum of the$25.00 liquidation preference. Under the terms of our Articles of Incorporation, if the publication of LIBOR is not available, the current fallback is for the Company to obtain quotations for what 38
-------------------------------------------------------------------------------- LIBOR should be from major banks in the interbank market. If we are unable to obtain such quotations, we are required to appoint an independent calculation agent, which will determine LIBOR based on sources it deems reasonable in its sole discretion. If the calculation agent is unable or unwilling to determine LIBOR, then the LIBOR in effect for future dividend payments would be LIBOR in effect for the immediately preceding dividend payment period. Notwithstanding the foregoing paragraph, if we determine that LIBOR has been discontinued, we will appoint an independent calculation agent to determine whether there is an industry accepted substitute or successor base rate to three-month LIBOR. If the calculation agent determines that there is an industry accepted substitute or successor base rate, the calculation agent shall use such substitute or successor base rate. If the calculation agent determines that there is not an accepted substitute or successor base rate, then the calculation agent will follow the original fallback language in the previous paragraph. At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or any other reforms to LIBOR that may be implemented in theU.K. or elsewhere. Uncertainty as to the nature of such potential changes, alternative reference rates or other reforms may adversely affect the market for or value of any securities on which the interest or dividend is determined by reference to LIBOR, loans, derivatives and other financial obligations or on our overall financial condition or results of operations. More generally, any of the above changes or any other consequential changes to LIBOR or any other "benchmark" as a result of international, national or other proposals for reform or other initiatives or investigations, or any further uncertainty in relation to the timing and manner of implementation of such changes, could have a material adverse effect on the value of and return on any securities based on or linked to a "benchmark."
Portfolio Overview
The following table summarizes our mortgage investment portfolio at fair value
as of
December 31, 2019 December 31, 2018 Agency MBS: Specified agency MBS $ 3,768,496 $ 3,982,106 Net long agency TBA dollar roll positions (1) - - Total agency MBS 3,768,496 3,982,106 Mortgage credit investments: Non-agency MBS 33,501 24 Mortgage loans 45,000 - Total mortgage credit investments 78,501 24 Total mortgage investments $ 3,846,997 $ 3,982,130
(1) Represents the fair value of the agency MBS which underlie our TBA forward
purchase and sale commitments executed as dollar roll transactions. In
accordance with GAAP, our TBA forward purchase and sale commitments are
reflected on the consolidated balance sheets as a component of "derivative
assets, at fair value" and "derivative liabilities, at fair value," with a
collective net asset carrying value of
Agency MBS Investment Portfolio
Our specified agency MBS consisted of the following as ofDecember 31, 2019 (dollars in thousands): Weighted Average Unpaid Net Unamortized Expected Principal Purchase Amortized Net Unrealized Remaining Balance Premiums Cost Basis Gain (Loss) Fair Value Market Price Coupon Life 30-year fixed rate: 2.5%$ 118,954 $ 675$ 119,629 $ (1,458 ) $ 118,171 $ 99.34 2.50% 8.4 3.0% 1,377,252 35,860 1,413,112 (5,182 ) 1,407,930 102.23 3.00% 7.2 3.5% 1,154,885 35,422 1,190,307 10,791 1,201,098 104.00 3.50% 5.2 4.0% 738,732 24,440 763,172 19,969 783,141 106.01 4.00% 5.0 4.5% 240,634 11,451 252,085 6,057 258,142 107.28 4.50% 4.8 5.5% 12 - 12 2 14 112.61 5.50% 5.9
Total/weighted-average
6.0 39 --------------------------------------------------------------------------------
Weighted Average Unpaid Net Unamortized Expected Principal Purchase Amortized Net Unrealized Remaining Balance Premiums Cost Basis Gain (Loss) Fair Value Market Price Coupon Life Fannie Mae$ 1,522,569 $ 44,240$ 1,566,809 $ 14,107 $ 1,580,916 $ 103.83 3.46 % 6.0 Freddie Mac 2,107,900 63,608 2,171,508 16,072 2,187,580 103.78 3.44 % 5.9
Total/weighted-average
103.80 3.45 % 6.0 The actual annualized prepayment rate for the Company's agency MBS was 10.66% for the year endedDecember 31, 2019 compared to 9.42% for the year endedDecember 31, 2018 . As ofDecember 31, 2019 , the Company's agency MBS was comprised of securities specifically selected for their relatively lower propensity for prepayment, which includes approximately 74% in specified pools of low balance loans while the remainder includes specified pools of loans originated in certain geographical areas, loans refinanced through theU.S. Government sponsored Home Affordable Refinance Program or with other characteristics selected for their relatively lower propensity for prepayment. Our agency MBS investment portfolio may also include net long TBA positions, which are primarily the result of executing sequential series of "dollar roll" transactions that are settled on a net basis. In accordance with GAAP, we account for our net long TBA positions as derivative instruments. As ofDecember 31, 2019 , we did not have any net long TBA agency positions.
Mortgage Credit Investment Portfolio
Our mortgage credit investment portfolio was comprised of a$45.0 million commercial mortgage loan and$33.5 million of non-agency MBS collateralized primarily by commercial mortgage loans, all of which were acquired during the fourth quarter of 2019. The Company's non-agency MBS investments as ofDecember 31, 2019 consisted primarily of investments collateralized by either a pool of small balance commercial mortgage loans or a single asset commercial mortgage loan.
Economic Hedging Instruments
The Company attempts to hedge a portion of its exposure to interest rate fluctuations associated with its agency MBS primarily through the use of interest rate hedging instruments. Specifically, these interest rate hedging instruments are intended to economically hedge changes, attributable to changes in benchmark interest rates, in agency MBS fair values and future interest cash flows on the Company's short-term financing arrangements. During 2019, the interest rate hedging instruments primarily used by the Company were centrally cleared interest rate swap agreements and exchange-traded 10-yearU.S. Treasury note futures. The Company's interest rate swap agreements represent agreements to make semiannual interest payments based upon a fixed interest rate and receive quarterly variable interest payments based upon the prevailing three-month LIBOR on the date of reset. Information about the Company's outstanding interest rate swap agreements in effect as ofDecember 31, 2019 is as follows (dollars in thousands): Weighted-average: Fixed Variable Net Receive Remaining Notional Amount Pay Rate
Receive Rate (Pay) Rate Life (Years) Years to maturity: Less than 3 years
$ 2,050,000 1.77% 1.92% 0.15% 1.6 3 to less than 7 years 510,000 1.61% 1.92% 0.31% 6.0 7 to less than 10 years 400,000 2.24% 1.91% (0.33)% 9.5 10 or more years 25,000 2.96% 1.90% (1.06)% 28.2 Total / weighted-average$ 2,985,000 1.81% 1.92% 0.11% 3.6 In addition to interest rate swap agreements, the Company may also use exchange-tradedU.S. Treasury note futures that are short positions that mature on a quarterly basis. Upon the maturity date of these futures contracts, the Company has the option to either net settle each contract in cash in an amount equal to the difference between the current fair value of the underlyingU.S. Treasury note and the contractual sale price inherent to the futures contract, or to physically settle the contract by delivering the underlyingU.S. Treasury note. As ofDecember 31, 2019 , the Company had no outstandingU.S. Treasury note futures. 40
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Results of Operations Net Interest Income Net interest income determined in accordance with GAAP primarily represents the interest income recognized from our specified agency MBS and mortgage credit investments (including the amortization of purchase premiums and accretion of purchase discounts), net of the interest expense incurred from repurchase agreement financing arrangements or other short- and long-term borrowing transactions. Net interest income determined in accordance with GAAP does not include TBA agency MBS dollar roll income, which we believe represents the economic equivalent of net interest income generated from our investments in non-specified fixed-rate agency MBS, nor does it include the net interest income or expense of our interest rate swap agreements, which are not designated as hedging instruments for financial reporting purposes. In our consolidated statements of comprehensive income prepared in accordance with GAAP, TBA agency MBS dollar roll income and the net interest income or expense from our interest rate swap agreements are reported as a component of the overall periodic change in the fair value of derivative instruments within the line item "gain (loss) from derivative instruments, net" of the "investment gain (loss), net" section.
Investment Gain (Loss), Net
"Investment gain (loss), net" primarily consists of periodic changes in the fair value (whether realized or unrealized) of the Company's mortgage investments and periodic changes in the fair value (whether realized or unrealized) of derivative instruments.
General and Administrative Expenses
"Compensation and benefits expense" includes base salaries, annual cash incentive compensation, and non-cash stock-based compensation. Annual cash incentive compensation is based on meeting estimated annual performance measures and discretionary components. Non-cash stock-based compensation includes expenses associated with stock-based awards granted to employees, including the Company's performance share units to named executive officers that are earned only upon the attainment of Company performance measures over the relevant measurement period.
"Other general and administrative expenses" primarily consists of the following:
• professional services expenses, including accounting, legal and consulting
fees; • insurance expenses, including liability and property insurance; • occupancy and equipment expense, including rental costs for our
facilities, and depreciation and amortization of equipment and software;
• fees and commissions related to transactions in interest rate derivative
instruments; •Board of Director fees; and
• other operating expenses, including information technology expenses,
business development costs, public company reporting expenses, proxy solicitation expenses, corporate registration fees, local license taxes, office supplies and other miscellaneous expenses. 41
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Comparison of the years ended
The following table presents the net income (loss) available (attributable) to
common stock reported for the years ended
Year Ended December 31, 2019 2018 Interest income$ 123,478 $ 130,953 Interest expense 97,250 84,825 Net interest income 26,228 46,128 Investment advisory fee income 332 - Investment gain (loss), net 2,197 (123,822 ) General and administrative expenses 15,015
13,370
Income (loss) before income taxes 13,742 (91,064 ) Income tax provision - 733 Net income (loss) 13,742 (91,797 ) Dividend on preferred stock (2,600 ) (590 )
Net income (loss) available (attributable) to common stock 11,142
(92,387 ) Diluted earnings (loss) per common share$ 0.31 $ (3.18 ) Weighted-average diluted common shares outstanding 35,833 29,052 GAAP Net Interest Income Net interest income determined in accordance with GAAP ("GAAP net interest income") decreased$19.9 million , or 43.2%, from$46.1 million for the year endedDecember 31, 2018 to$26.2 million for the year endedDecember 31, 2019 . The decrease from the comparative period is primarily attributable to a 40 basis point increase in the average interest costs of our short-term secured financing arrangements (due primarily to an increase in prevailing benchmark short-term interest rates) as well as lower average leverage and portfolio volumes. The components of GAAP net interest income from our mortgage investment portfolio is summarized in the following table for the periods indicated (dollars in thousands): Year Ended December 31, 2019 2018 Average Income Yield Average Income Yield Balance (Expense) (Cost) Balance (Expense) (Cost) Agency MBS$ 3,961,257 $ 122,227 3.09 %$ 4,199,274 $ 130,258 3.10 % Mortgage credit investments 2,703 192 7.10 % - - - Other - 1,059 - 695$ 3,963,960 123,478 3.12 %$ 4,199,274 130,953 3.12 % Short-term secured debt$ 3,690,093 (92,200 ) (2.46 )%$ 3,817,870 (79,812 ) (2.06 )% Long-term unsecured debt 74,225 (5,050 ) (6.80 )%
74,001 (5,013 ) (6.77 )%
$ 3,764,318 (97,250 ) (2.55 )%$ 3,891,871 (84,825 ) (2.15 )% Net interest income/spread (1)$ 26,228 0.66 %$ 46,128 1.06 % Net interest margin (1) 0.79 % 1.22 % (1) Net interest income/spread and net interest margin excludes interest on long-term unsecured debt. 42
-------------------------------------------------------------------------------- The effects of changes in the composition of our investments on our GAAP net interest income from our mortgage investment activities are summarized below (dollars in thousands): Year Ended December 31, 2019 vs. Year Ended December 31, 2018 Rate Volume Total Change Agency MBS$ (647 ) $ (7,384 ) $ (8,031 )
Mortgage credit investments - 192 192 Other 364 - 364 Short-term secured debt (14,997 ) 2,609
(12,388 )
Long-term unsecured debt (23 ) (14 ) (37 )$ (15,303 ) $ (4,597 ) $ (19,900 )
Economic Net Interest Income
Economic net interest income, a non-GAAP financial measure, represents the interest income earned net of the interest expense incurred from all of our interest bearing financial instruments as well as the agency MBS which underlie, and are implicitly financed through, our TBA dollar roll transactions. Economic net interest income is comprised of the following: (i) net interest income determined in accordance with GAAP, (ii) TBA agency MBS "dollar roll" income, and (iii) net interest income earned or expense incurred from interest rate swap agreements. We believe that economic net interest income assists investors in understanding and evaluating the financial performance of the Company's long-term-focused, net interest spread-based investment strategy, prior to the deduction of core general and administrative expenses. For a full description of each of the three aforementioned components of economic net interest income, see "Non-GAAP Core Operating Income" below.
The components of our economic net interest income are summarized in the following table for the periods indicated (dollars in thousands):
Year Ended December 31, 2019 2018 Average Income Yield Average Income Yield Balance (Expense) (Cost) Balance (Expense) (Cost) Agency MBS$ 3,961,257 $ 122,227 3.09 %$ 4,199,274 $ 130,258 3.10 % Mortgage credit investments 2,703 192 7.10 % - - TBA dollar rolls (1) 493,482 4,470 0.91 % 1,138,229 20,929 1.84 % Other - 1,059 - 695 Short-term secured debt 3,690,093 (92,200 ) (2.46 )% 3,817,870 (79,812 ) (2.06 )% Interest rate swaps (2) 2,955,989 15,087 0.51 % 3,457,218 6,266 0.18 % Long-term unsecured debt 74,225 (5,050 ) (6.80 )% 74,001 (5,013 ) (6.77 )% Economic net interest income/margin (3)$ 45,785 1.14 %$ 73,323 1.47 %
(1) TBA dollar roll average balance (average cost basis) is based upon the
contractual price of the initial TBA purchase trade of each individual
series of dollar roll transactions. TBA dollar roll income is net of implied financing costs.
(2) Interest rate swap cost represents the weighted average net receive (pay)
rate in effect for the period, adjusted for "price alignment interest"
income earned or expense incurred on cumulative variation margin paid or
received, respectively.
(3) Economic net interest margin excludes interest on long-term unsecured debt.
The effects of changes in the composition of our investments on our economic net interest income from our mortgage investment and related funding and hedging activities are summarized below (dollars in thousands): 43 --------------------------------------------------------------------------------
Year Ended December 31, 2019 vs. Year Ended December 31, 2018 Rate Volume Total Change Agency MBS$ (647 ) $ (7,384 ) $ (8,031 ) Mortgage credit investments - 192 192 TBA dollar rolls (4,604 ) (11,855 ) (16,459 ) Other 364 - 364 Short-term secured debt (14,997 ) 2,609
(12,388 )
Interest rate swaps 9,730 (909 )
8,821
Long-term unsecured debt (23 ) (14 ) (37 )$ (10,177 ) $ (17,361 ) $ (27,538 ) Economic net interest income for the year endedDecember 31, 2019 decreased relative to the prior year primarily due to lower average leverage and portfolio volumes and higher financing costs on the unhedged portion of our short-term secured financing arrangements and implied TBA financing (driven primarily by an increase in prevailing benchmark short-term interest rates).
Investment Advisory Fee Income
We formed a wholly-owned subsidiary,Rock Creek Investment Advisors, LLC ("Rock Creek"), which was approved as a registered investment adviser and is regulated under the Investment Advisers Act of 1940, as amended (the "Advisers Act"), in the fourth quarter of 2018 and commenced operations inDecember 2018 . Rock Creek provides investment advisory services to institutional clients on a separate account basis by investing primarily in agency MBS. Rock Creek earns investment management fee income based upon a percentage of the capital funded by a client to its separate managed account. During the year endedDecember 31, 2019 , we recognized$0.3 million in investment advisory fee income.
Investment Gain (Loss), Net
As prevailing longer-term interest rates increase (decrease), the fair value of our investments in fixed rate agency MBS and TBA commitments generally decreases (increases). Conversely, the fair value of our interest rate derivative hedging instruments increases (decreases) in response to increases (decreases) in prevailing interest rates. While our interest rate derivative hedging instruments are designed to mitigate the sensitivity of the fair value of our agency MBS portfolio to fluctuations in interest rates, they are not generally designed to mitigate the sensitivity of our net book value to spread risk, which is the risk of an increase of the market spread between the yield on our agency MBS and the benchmark yield onU.S. Treasury securities or interest rate swaps. Accordingly, irrespective of fluctuations in interest rates, an increase (decrease) in MBS spreads will generally result in the underperformance (outperformance) of the values of agency MBS relative to interest rate hedging instruments. The following table presents information about the gains and losses recognized due to the changes in the fair value of our trading investments, which include agency MBS and mortgage credit investments, TBA transactions, and interest rate hedging instruments for the periods indicated (dollars in thousands): Year EndedDecember 31, 2019 2018
Gains (losses) on agency MBS investments, net
(114,480 ) Losses on mortgage credit investments, net (152 ) (42 ) TBA commitments, net: TBA dollar roll income 4,470
20,929
Other gains (losses) from TBA commitments, net 15,904 (64,627 ) Total gains (losses) on TBA commitments, net 20,374 (43,698 ) Interest rate derivatives: Net interest income on interest rate swaps 15,087
6,266
Other (losses) gains from interest rate derivative instruments, net
(161,651 )
27,775
Total (losses) gains on interest rate derivatives, net (146,564 ) 34,041 Other, net 358 357 Investment gain (loss), net$ 2,197 $ (123,822 ) 44
-------------------------------------------------------------------------------- During the years endedDecember 31, 2019 and 2018, agency MBS spreads widened which resulted in the underperformance of our investments in agency MBS and TBA commitments relative to our interest rate hedging instruments.
General and Administrative Expenses
General and administrative expenses increased by$1.6 million , or 11.9%, from$13.4 million for the year endedDecember 31, 2018 to$15.0 million for the year endedDecember 31, 2019 . Compensation and benefits expensed increased by$1.9 million , or 22.9%, from$8.3 million for the year endedDecember 31, 2018 to$10.2 million for the year endedDecember 31, 2019 . The increase in compensation and benefits expenses is primarily attributable to a reversal of$1.9 million of expense recognized in prior periods due to a reduction in the number of employee long-term performance oriented stock-based compensation units expected to vest based on deterioration in performance metrics recognized for the year endedDecember 31, 2018 with no comparable reversal recognized for the year endedDecember 31, 2019 . Other general and administrative expenses decreased by$0.2 million , or 4.0%, from$5.0 million for the year endedDecember 31, 2018 to$4.8 million for the year endedDecember 31, 2019 .
Income Tax Provision
OnDecember 27, 2018 , our Board of Directors approved a plan for us to elect to be taxed and to operate in a manner that will allow us to qualify as a REIT forU.S. federal income tax purposes commencing with our taxable year endingDecember 31, 2019 . So long as we continue to qualify as a REIT, we will generally not be subject toU.S. federal or state corporate income taxes on our taxable income to the extent that we distribute 100% of our taxable income to our shareholders on a timely basis. For taxable years endedDecember 31, 2018 and prior, we were subject to taxation as a corporation under Subchapter C of the Internal Revenue Code.
Comparison of the years ended
The following table presents the total comprehensive income (loss) reported for the years endedDecember 31, 2018 and 2017, respectively (dollars in thousands, except per share amounts): Year Ended December 31, 2018 2017 Interest income$ 130,953 $ 121,248 Interest expense 84,825 51,514 Net interest income 46,128 69,734 Investment (loss) gain, net (123,822 ) 5,874 General and administrative expenses 13,370
18,570
(Loss) income before income taxes (91,064 ) 57,038 Income tax provision 733 39,603 Net (loss) income (91,797 ) 17,435 Dividend on preferred stock (590 ) (251 ) Net (loss) income (attributable) available to common stock (92,387 )
17,184
Diluted (loss) earnings per common share $ (3.18 ) $
0.66
Weighted-average diluted common shares outstanding 29,052 26,011 GAAP Net Interest Income GAAP net interest income decreased$23.6 million , or 33.9%, from$69.7 million for the year endedDecember 31, 2017 to$46.1 million for the year endedDecember 31, 2018 . The decrease from the comparative period is primarily attributable to a 90 basis point increase in the average interest costs of our short-term secured financing arrangements due primarily to an increase in prevailing benchmark short-term interest rates, partially offset by an increase in the average asset yields of our specified agency MBS due to reinvestments from portfolio repositioning and monthly paydowns into higher current investment yields as a result of a rise in long-term interest rates and widening agency MBS spreads.
The components of GAAP net interest income from our MBS portfolio is summarized in the following table for the periods indicated (dollars in thousands):
45
-------------------------------------------------------------------------------- Year Ended December 31, 2018 2017 Average Income Yield Average Income Yield Balance (Expense) (Cost) Balance (Expense) (Cost) Agency MBS$ 4,199,274 $ 130,258 3.10 %$ 4,258,079 $ 120,968 2.84 % Other - 695 - 280$ 4,199,274 130,953 3.12 %$ 4,258,079 121,248 2.85 % Short-term secured debt$ 3,817,870 (79,812 ) (2.06 )%$ 3,950,139 (46,648 ) (1.16 )% Long-term unsecured debt 74,001 (5,013 ) (6.77 )%
73,778 (4,866 ) (6.60 )%
$ 3,891,871 (84,825 ) (2.15 )%$ 4,023,917 (51,514 ) (1.26 )% Net interest income/spread (1)$ 46,128 1.06 %$ 69,734 1.69 % Net interest margin (1) 1.22 % 1.75 %
(1) Net interest income/spread and net interest margin excludes interest on
long-term unsecured debt.
The effects of changes in the composition of our investments on our GAAP net interest income from our MBS investment activities are summarized below (dollars in thousands): Year Ended December 31, 2018 vs. Year Ended December 31, 2017 Rate Volume Total Change Agency MBS$ 10,961 $ (1,671 ) $ 9,290 Other 415 - 415
Short-term secured debt (34,685 ) 1,521
(33,164 )
Long-term unsecured debt (132 ) (15 ) (147 )$ (23,441 ) $ (165 ) $ (23,606 )
Economic Net Interest Income
Economic net interest income, a non-GAAP financial measure, represents the interest income earned net of the interest expense incurred from all of our interest bearing financial instruments as well as the agency MBS which underlie, and are implicitly financed through, our TBA dollar roll transactions. Economic net interest income is comprised of the following: (i) net interest income determined in accordance with GAAP, (ii) TBA agency MBS "dollar roll" income, and (iii) net interest income earned or expense incurred from interest rate swap agreements. We believe that economic net interest income assists investors in understanding and evaluating the financial performance of the Company's long-term-focused, net interest spread-based investment strategy, prior to the deduction of core general and administrative expenses. For a full description of each of the three aforementioned components of economic net interest income, see "Non-GAAP Core Operating Income" below.
The components of our economic net interest income are summarized in the following table for the periods indicated (dollars in thousands):
Year Ended December 31, 2018 2017 Income Income Average Balance (Expense) Yield (Cost) Average Balance (Expense) Yield (Cost) Agency MBS$ 4,199,274 $ 130,258 3.10 %$ 4,258,079 $ 120,968 2.84 % TBA dollar rolls (1) 1,138,229 20,929 1.84 % 985,610 21,291 2.16 % Other - 695 - 280 Short-term secured debt 3,817,870 (79,812 ) (2.06 )% 3,950,139 (46,648 ) (1.16 )% Interest rate swaps (2) 3,457,218 6,266 0.18 % 3,472,936 (17,334 ) (0.50 )% Long-term unsecured debt 74,001 (5,013 ) (6.77 )% 73,778 (4,866 ) (6.60 )% Economic net interest income/margin (3)$ 73,323 1.47 %$ 73,691 1.50 % 46
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(1) TBA dollar roll average balance (average cost basis) is based upon the
contractual price of the initial TBA purchase trade of each individual
series of dollar roll transactions. TBA dollar roll income is net of implied financing costs.
(2) Interest rate swap cost represents the weighted average net receive (pay)
rate in effect for the period, adjusted for "price alignment interest"
income earned or expense incurred on cumulative variation margin paid or
received, respectively.
(3) Economic net interest margin excludes interest on long-term unsecured debt.
The effects of changes in the composition of our investments on our economic net interest income from our MBS investment and related funding and hedging activities are summarized below (dollars in thousands):
Year Ended December 31, 2018 vs. Year Ended December 31, 2017 Rate Volume Total Change Agency MBS$ 10,961 $ (1,671 ) $ 9,290 TBA dollar rolls (3,659 ) 3,297 (362 ) Other 415 - 415
Short-term secured debt (34,685 ) 1,521
(33,164 )
Interest rate swaps 23,522 78
23,600
Long-term unsecured debt (132 ) (15 ) (147 )$ (3,578 ) $ 3,210 $ (368 ) Economic net interest income for the year endedDecember 31, 2018 decreased relative to the prior year primarily due to higher financing costs on the unhedged portion of our short-term secured financing arrangements and implied TBA financing driven primarily by an increase in prevailing benchmark short-term interest rates, partially offset by higher average portfolio balances primarily driven by deployment of capital raised during the periods and an increase in the average asset yields of our specified agency MBS.
Investment Gain (Loss), Net
As prevailing longer-term interest rates increase (decrease), the fair value of our investments in fixed rate agency MBS and TBA commitments generally decreases (increases). Conversely, the fair value of our interest rate derivative hedging instruments increases (decreases) in response to increases (decreases) in prevailing interest rates. While our interest rate derivative hedging instruments are designed to mitigate the sensitivity of the fair value of our agency MBS portfolio to fluctuations in interest rates, they are not generally designed to mitigate the sensitivity of our net book value to spread risk, which is the risk of an increase of the market spread between the yield on our agency MBS and the benchmark yield onU.S. Treasury securities or interest rate swaps. Accordingly, irrespective of fluctuations in interest rates, an increase (decrease) in MBS spreads will generally result in the underperformance (outperformance) of the values of agency MBS relative to interest rate hedging instruments. The following table presents information about the gains and losses recognized due to the changes in the fair value of our agency MBS, TBA transactions, and interest rate derivative instruments for the periods indicated (dollars in thousands): Year Ended December 31, 2018 2017 (Losses) gains on trading investments, net$ (114,522 ) $ 2,424 TBA commitments, net: TBA dollar roll income 20,929
21,291
Other losses from TBA commitments, net (64,627 ) (4,580 ) Total (losses) gains on TBA commitments, net (43,698 ) 16,711 Interest rate derivatives: Net interest income (expense) on interest rate swaps 6,266 (17,334 ) Other gains from interest rate derivative instruments, net 27,775 3,847 Total gains (losses) on interest rate derivatives, net 34,041 (13,487 ) Other, net 357 226 Investment (loss) gain, net$ (123,822 ) $ 5,874 During the year endedDecember 31, 2018 , agency MBS spreads widened meaningfully which resulted in the underperformance of our investments in agency MBS and TBA commitments relative to our interest rate hedging instruments. During the year ended 47
--------------------------------------------------------------------------------December 31, 2017 , agency MBS spreads tightened modestly which resulted in the outperformance of our investments in agency MBS and TBA commitments relative to our interest rate hedging instruments.
General and Administrative Expenses
General and administrative expenses decreased by$5.2 million , or 28.0%, from$18.6 million for the year endedDecember 31, 2017 to$13.4 million for the year endedDecember 31, 2018 . Compensation and benefits expensed decreased by$4.9 million , or 37.1%, from$13.2 million for the year endedDecember 31, 2017 to$8.3 million for the year endedDecember 31, 2018 . The decrease in compensation and benefits expenses for the year endedDecember 31, 2018 is mostly attributable to decreases in employee long-term performance oriented stock-based compensation and annual cash incentive compensation. Employee stock-based compensation decreased by$3.1 million for the year endedDecember 31, 2018 compared to the prior year primarily due to the Company not expecting to achieve certain performance measures. Employee annual cash incentive compensation decreased$1.8 million during the year endedDecember 31, 2018 as compared to the prior year due to not achieving specific annual performance measures and overall Company performance. Other general and administrative expenses decreased by$0.4 million , or 7.4%, from$5.4 million for the year endedDecember 31, 2017 to$5.0 million for the year endedDecember 31, 2018 .
Income Tax Provision
For our taxable years endedDecember 31, 2018 and earlier, we were subject to taxation as a corporation under Subchapter C of the Internal Revenue Code. For our taxable year endedDecember 31, 2018 , we had NOL andNCL carryforwards that allowed us to eliminate any income tax liability for the year. OnDecember 27, 2018 , our Board of Directors approved a plan for us to elect to be taxed and to operate in a manner that will allow us to qualify as a REIT under the Internal Revenue Code commencing with our taxable year endingDecember 31, 2019 . Since all significant actions necessary for us to qualify as a REIT effectiveJanuary 1, 2019 were met as ofDecember 31, 2018 , we eliminated our deferred assets and liabilities as of that date. Accordingly, our income tax provision for the year endedDecember 31, 2018 of$733 consists primarily of the elimination of our net deferred tax asset as of the beginning the year. For our taxable year endedDecember 31, 2017 , we had NOL andNCL carryforwards that allowed us to eliminate any income tax liability for the year except for the taxable income subject to the federal alternative minimum tax. For the year endedDecember 31, 2017 , we recognized an income tax provision of$39.6 million , which includes an increase in the valuation allowance against the deferred tax assets of$16.8 million . During the year endedDecember 31, 2017 , we determined that we should record a full valuation allowance against our deferred tax assets that are capital in nature consisting of ourNCL carryforwards and temporary GAAP to tax differences that are expected to result in capital losses in future periods. The increase to the valuation allowance during the year endedDecember 31, 2017 is attributable primarily to the determination to record a full valuation allowance instead of a partial valuation allowance against our deferred tax assets that are capital in nature.
Non-GAAP Core Operating Income
In addition to the results of operations determined in accordance with GAAP, we reported "non-GAAP core operating income." We define core operating income as "economic net interest income" and investment advisory fee income less "core general and administrative expenses."
Economic Net Interest Income
Economic net interest income, a non-GAAP financial measure, represents the interest income earned net of the interest expense incurred from all of our interest bearing financial instruments as well as the agency MBS which underlie, and are implicitly financed through, our TBA dollar roll transactions. Economic net interest income is comprised of the following: (i) net interest income determined in accordance with GAAP, (ii) TBA agency MBS "dollar roll" income, and (iii) net interest income earned or expense incurred from interest rate swap agreements. We believe that economic net interest income assists investors in understanding and evaluating the financial performance of the Company's long-term-focused, net interest spread-based investment strategy, prior to the deduction of core general and administrative expenses.
• Net interest income determined in accordance with GAAP. Net interest income
determined in accordance with GAAP primarily represents the interest income
recognized from our specified agency MBS and mortgage credit investments
(including the amortization of purchase premiums and accretion of purchase
discounts), net of the interest expense incurred from repurchase agreement
financing arrangements or other short- and long-term borrowing transactions.
48
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• TBA agency MBS dollar roll income. Dollar roll income represents the
economic equivalent of net interest income (implied interest income net of
financing costs) generated from our investments in non-specified fixed-rate
agency MBS, executed through sequential series of forward-settling purchase
and sale transactions that are settled on a net basis (known as "dollar
roll" transactions). Dollar roll income is generated as a result of delaying, or "rolling," the settlement of a forward-settling purchase of a TBA agency MBS by entering into an offsetting "spot" sale with the same
counterparty prior to the settlement date, net settling the "paired-off"
positions in cash, and contemporaneously entering another forward-settling
purchase with the same counterparty of a TBA agency MBS of the same
essential characteristics for a later settlement date at a price discount
relative to the spot sale. The price discount of the forward-settling
purchase relative to the contemporaneously executed spot sale reflects
compensation for the interest income (inclusive of expected prepayments)
that, at the time of sale, is expected to be foregone as a result of
relinquishing beneficial ownership of the MBS from the settlement date of
the spot sale until the settlement date of the forward purchase, net of
implied repurchase financing costs. We calculate dollar roll income as the
excess of the spot sale price over the forward-settling purchase price, and
recognize this amount ratably over the period beginning on the settlement
date of the sale and ending on the settlement date of the forward purchase.
In our consolidated statements of comprehensive income prepared in
accordance with GAAP, TBA agency MBS dollar roll income is reported as a
component of the overall periodic change in the fair value of TBA forward
commitments within the line item "gain (loss) from derivative instruments,
net" of the "investment gain (loss), net" section. From time to time, we may enter into forward-settling TBA agency MBS sale commitments (known as a "net short" TBA position) as a means of economically hedging a portion of the interest rate sensitivity of our agency MBS investment portfolio. When we delay (or "roll") the settlement of a net short TBA position, the price discount of the forward-settling sale relative to the contemporaneously executed spot purchase results in an implied net interest expense (i.e., "dollar roll expense"). In our presentation of non-GAAP core operating income, we present TBA dollar roll income net of any implied net interest expense that resulted from rolling the settlement of net short TBA positions.
• Net interest income earned or expense incurred from interest rate swap
agreements. We utilize interest rate swap agreements to economically hedge a
portion of our exposure to variability in future interest cash flows,
attributable to changes in benchmark interest rates, associated with future
roll-overs of our short-term financing arrangements. Accordingly, the net interest income earned or expense incurred (commonly referred to as "net
interest carry") from our interest rate swap agreements in combination with
interest expense recognized in accordance with GAAP represents our effective
"economic interest expense." In our consolidated statements of comprehensive
income prepared in accordance with GAAP, the net interest income earned or
expense incurred from interest rate swap agreements is reported as a
component of the overall periodic change in the fair value of derivative
instruments within the line item "gain (loss) from derivative instruments,
net" of the "investment gain (loss), net" section.
Core General and Administrative Expenses
Core general and administrative expenses are non-interest expenses reported within the line item "total general and administrative expenses" of the consolidated statements of comprehensive income less stock-based compensation expense. For the year endedDecember 31, 2019 , core general and administrative expenses exclude a non-recurring expense related to a one-time out-of-period payment made in 2019 for a business, professional and occupation license tax fromArlington County, Virginia for the 2018 tax year. Refer to "Note 11. Income Taxes" for further information about the business, professional and occupation license tax and the associated payment made in 2019.
Non-GAAP Core Operating Income
The following table presents our computation of non-GAAP core operating income for the periods indicated (amounts in thousands, except per share amounts):
49 --------------------------------------------------------------------------------
For the Year Ended December 31, 2019 2018 2017 GAAP net interest income$ 26,228 $ 46,128 $ 69,734 TBA dollar roll income 4,470 20,929 21,291 Interest rate swap net interest income (expense) 15,087 6,266 (17,334 ) Economic net interest income 45,785 73,323
73,691
Investment advisory fee income 332 - - Core general and administrative expenses (11,747 ) (12,534 ) (14,644 ) Preferred stock dividend (2,600 ) (590 ) (251 ) Non-GAAP core operating income$ 31,770 $ 60,199
Non-GAAP core operating income per diluted common share $ 0.89$ 2.06 $ 2.26 Weighted average diluted common shares outstanding 35,833 29,269 26,011 The following table provides a reconciliation of GAAP pre-tax net income (loss) to non-GAAP core operating income for the periods indicated (amounts in thousands): For the Year Ended December 31, 2019 2018 2017 GAAP net income (loss) before income taxes$ 13,742 $ (91,064 ) $ 57,038 Add (less): Total investment (gain) loss, net (2,197 ) 123,822 (5,874 ) Stock-based compensation expense 2,780 836 3,926 Preferred stock dividend (2,600 ) (590 ) (251 ) Non-recurring expense 488 - - Add back: TBA dollar roll income 4,470 20,929 21,291 Interest rate swap net interest income (expense) 15,087 6,266 (17,334 ) Non-GAAP core operating income$ 31,770 $ 60,199 $ 58,796 Non-GAAP core operating income is used by management to evaluate the financial performance of the Company's long-term-focused, net interest spread-based investment strategy and core business activities over periods of time as well as assist with the determination of the appropriate level of periodic dividends to common stockholders. In addition, we believe that non-GAAP core operating income assists investors in understanding and evaluating the financial performance of the Company's long-term-focused, net interest spread-based investment strategy and core business activities over periods of time as well as its earnings capacity. Periodic fair value gains and losses recognized with respect to our mortgage investments and economic hedging instruments, which are reported in line item "total investment gain (loss), net" of our consolidated statements of comprehensive income, are excluded from the computation of non-GAAP core operating income as such gains on losses are not reflective of the economic interest income earned or interest expense incurred from our interest-bearing financial assets and liabilities during the indicated reporting period. Because our long-term-focused investment strategy for our mortgage investment portfolio is to generate a net interest spread on the leveraged assets while prudently hedging periodic changes in the fair value of those assets attributable to changes in benchmark interest rates, we generally expect the fluctuations in the fair value of our mortgage investments and economic hedging instruments to largely offset one another over time. A limitation of utilizing this non-GAAP financial measure is that the effect of accounting for "non-core" events or transactions in accordance with GAAP does, in fact, reflect the financial results of our business and these effects should not be ignored when evaluating and analyzing our financial results. For example, the economic cost or benefit of hedging instruments other than interest rate swap agreements, such asU.S. Treasury note futures or options, do not affect the computation of non-GAAP core operating income. In addition, our calculation of non-GAAP core operating income may not be comparable to other similarly titled measures of other companies. Therefore, we believe that non-GAAP core operating income should be considered as a supplement to, and in conjunction with, net income and comprehensive income determined in accordance with GAAP. Furthermore, there may be differences between non-GAAP core operating income and taxable income determined in accordance with the Internal Revenue Code. As a REIT, we are required to distribute at least 90% of our REIT taxable income (subject to certain adjustments) to qualify as a REIT and all of our taxable income in order to not be subject to anyU.S. federal or state corporate income taxes. Accordingly, non-GAAP core operating income may not equal our distribution requirements as a REIT. 50
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Liquidity and Capital Resources
Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay borrowings, fund investments, meet margin calls on our short-term borrowings and hedging instruments, and for other general business purposes. Our primary sources of funds for liquidity consist of existing cash balances, short-term borrowings (for example, repurchase agreements), principal and interest payments from our mortgage investments, and proceeds from sales of mortgage investments. Other sources of liquidity include proceeds from the offering of common stock, preferred stock, debt securities, or other securities registered pursuant to our effective shelf registration statement filed with theSecurities and Exchange Commission ("SEC"). Liquidity, or ready access to funds, is essential to our business. Perceived liquidity issues may affect our counterparties' willingness to engage in transactions with us. Our liquidity could be impaired due to circumstances that we may be unable to control, such as a general market disruption or an operational problem that affects us or third parties. Further, our ability to sell assets may be impaired if other market participants are seeking to sell similar assets at the same time. If we cannot obtain funding from third parties our results of operations could be negatively impacted. As ofDecember 31, 2019 , our debt-to-equity leverage ratio was 11.2 to 1 measured as the ratio of the sum of our total debt to our shareholders' equity as reported on our consolidated balance sheet. In evaluating our liquidity and leverage ratios, we also monitor our "at risk" short-term financing to investable capital ratio. Our "at risk" short-term financing to investable capital ratio is measured as the ratio of the sum of our short-term secured financing (i.e. repurchase agreement financing), net payable or receivable for unsettled sales of securities and net contractual forward price of our TBA commitments less our cash and cash equivalents compared to our investable capital. Our investable capital is calculated as the sum of our stockholders' equity and long-term unsecured debt. As ofDecember 31, 2019 , our "at risk" short-term secured financing to investable capital ratio was 8.7 to 1.
Cash Flows
As ofDecember 31, 2019 , our cash and cash equivalents totaled$19.6 million representing a net decrease of$7.1 million from$26.7 million as ofDecember 31, 2018 . Cash provided by operating activities of$46.5 million during 2019 was attributable primarily to net interest income less our general and administrative expenses. Cash provided by investing activities of$53.5 million during 2019 relates primarily to proceeds from sales and principal receipts on our agency MBS, partially offset by purchases of agency MBS and mortgage credit investments and net payments for settlements and deposits for margin on our interest rate derivative instruments. Cash used in financing activities of$107.1 million during 2019 relates primarily to net repayments of repurchase agreements used to finance a portion of our mortgage investment portfolio and dividend payments to stockholders, partially offset by proceeds received from issuances of common and preferred stock.
Sources of Funding
We believe that our existing cash balances, net investments in mortgage investments, cash flows from operations, borrowing capacity, and other sources of liquidity will be sufficient to meet our cash requirements for at least the next twelve months. We may, however, seek debt or equity financings, in public or private transactions, to provide capital for corporate purposes and/or strategic business opportunities, including possible acquisitions, joint ventures, alliances or other business arrangements which could require substantial capital outlays. Our policy is to evaluate strategic business opportunities, including acquisitions and divestitures, as they arise. There can be no assurance that we will be able to generate sufficient funds from future operations, or raise sufficient debt or equity on acceptable terms, to take advantage of investment opportunities that become available. Should our needs ever exceed these sources of liquidity, we believe that substantially most of our investments could be sold, in most circumstances, to provide cash. However, we may be required to sell our assets in such instances at depressed prices. As ofDecember 31, 2019 , liquid assets consisted primarily of cash and cash equivalents of$19.6 million , unencumbered agency MBS of$98.4 million at fair value and unencumbered non-agency MBS of$2.7 million at fair value. Cash equivalents consist primarily of money market funds invested in debt obligations of theU.S. government.Debt Capital Long-Term Unsecured Debt As ofDecember 31, 2019 , we had$74.3 million of total long-term debt, net of unamortized debt issuance costs of$1.0 million . Our trust preferred debt with a principal amount of$15.0 million outstanding as ofDecember 31, 2019 accrue and require the payment of interest quarterly at three-month LIBOR plus 2.25% to 3.00% and mature between 2033 and 2035. Our 6.625% Senior Notes due 2023 with a principal amount of$25.0 million outstanding as ofDecember 31, 2019 accrue and require payment of interest quarterly at an annual rate of 6.625% and mature onMay 1, 2023 . Our 6.75% Senior Notes due 2025 with a principal amount of$35.3 million outstanding as ofDecember 31, 2019 accrue and require payment of interest quarterly at an annual rate of 6.75% and mature onMarch 15, 2025 . 51
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Repurchase Agreements
We have short-term financing facilities that are structured as repurchase agreements with various financial institutions to fund our investments in mortgage investments. We have obtained, and believe we will be able to continue to obtain, short-term financing in amounts and at interest rates consistent with our financing objectives. Funding for mortgage investments through repurchase agreements continues to be available to us at rates we consider to be attractive from multiple counterparties. Our repurchase agreements include provisions contained in the standard master repurchase agreement as published by theSecurities Industry and Financial Markets Association ("SIFMA") and may be amended and supplemented in accordance with industry standards for repurchase facilities. Certain of our repurchase agreements include financial covenants, with which the failure to comply would constitute an event of default under the applicable repurchase agreement. Similarly, each repurchase agreement includes events of insolvency and events of default on other indebtedness as similar financial covenants. As provided in the standard master repurchase agreement as typically amended, upon the occurrence of an event of default or termination, the applicable counterparty has the option to terminate all repurchase transactions under such counterparty's repurchase agreement and to demand immediate payment of any amount due from us to the counterparty. Under our repurchase agreements, we may be required to pledge additional assets to our repurchase agreement counterparties in the event the estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral (commonly referred to as a "margin call"), which may take the form of additional securities or cash. Margin calls on repurchase agreements collateralized by our mortgage investments primarily result from events such as declines in the value of the underlying mortgage collateral caused by factors such as rising interest rates or prepayments. Our repurchase agreements generally provide that valuations for mortgage investments securing our repurchase agreements are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances and under certain of our repurchase agreements, our lenders have the sole discretion to determine the value of the mortgage investments securing our repurchase agreements. In such instances, our lenders are required to act in good faith in making determinations of value. Our repurchase agreements generally provide that in the event of a margin call, we must provide additional securities or cash on the same business day that the margin call is made if the lender provides us notice prior to the margin notice deadline on such day. To date, we have not had any margin calls on our repurchase agreements that we were not able to satisfy with either cash or additional pledged collateral. However, should we encounter increases in interest rates or prepayments, margin calls on our repurchase agreements could result in a material adverse change in our liquidity position. Our repurchase agreement counterparties apply a "haircut" to the value of the pledged collateral, which means the collateral is valued, for the purposes of the repurchase agreement transaction, at less than fair value. Upon the renewal of a repurchase agreement financing at maturity, a lender could increase the "haircut" percentage applied to the value of the pledged collateral, thus reducing our liquidity. Our repurchase agreements generally mature within 30 to 60 days, but may have maturities as short as one day and as long as one year. In the event that market conditions are such that we are unable to continue to obtain repurchase agreement financing for our mortgage investments in amounts and at interest rates consistent with our financing objectives, we may liquidate such investments and may incur significant losses on any such sales of mortgage investments. 52
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The following table provides information regarding our outstanding repurchase agreement borrowings as of dates and periods indicated (dollars in thousands):
December 31, 2019 December 31, 2018 Pledged with agency MBS: Repurchase agreements outstanding $ 3,560,139 $
3,721,629
Agency MBS collateral, at fair value (1) 3,741,399 3,931,232 Net amount (2) 181,260 209,603 Weighted-average rate 2.10 % 2.72 % Weighted-average term to maturity 23.7 days 17.3 days Pledged with non-agency MBS: Repurchase agreements outstanding $ 21,098 $ - Non-agency MBS collateral, at fair value 30,747 - Net amount (2) 9,649 - Weighted-average rate 3.11 % - Weighted-average term to maturity 8.1 days - Total MBS: Repurchase agreements outstanding $ 3,581,237 $
3,721,629
MBS collateral, at fair value (1) 3,772,146 3,931,232 Net amount (2) 190,909 209,603 Weighted-average rate 2.11 % 2.72 % Weighted-average term to maturity 23.6 days 17.3 days
(1) As of
MBS sale commitments which is included in the line item "sold securities
receivable" in the accompanying consolidated balance sheets. Net amount
represents the value of collateral in excess of corresponding repurchase
obligation. The amount of collateral at-risk is limited to the outstanding
repurchase obligation and not the entire collateral balance.
(2) Net amount represents the value of collateral in excess of corresponding
repurchase obligation. The amount of collateral at-risk is limited to the
outstanding repurchase obligation and not the entire collateral balance.
To limit our exposure to counterparty risk, we diversify our repurchase agreement funding across multiple counterparties and by counterparty region. As ofDecember 31, 2019 , we had outstanding repurchase agreement balances with 16 counterparties and have master repurchase agreements in place with a total of 18 counterparties located throughoutNorth America ,Europe andAsia . As ofDecember 31, 2019 , no more than 6.0% of our stockholders' equity was at risk with any one counterparty, with the top five counterparties representing 25.9% of our stockholders' equity. The table below includes a summary of our repurchase agreement funding by number of counterparties and counterparty region as ofDecember 31, 2019 : Number of Percent of Repurchase Counterparties Agreement Funding North America 10 63.0 % Europe 2 15.2 % Asia 4 21.8 % 16 100.0 % Derivative Instruments In the normal course of our operations, we are a party to financial instruments that are accounted for as derivative financial instruments including (i) interest rate hedging instruments such as interest rate swaps,U.S. Treasury note futures, put and call options onU.S. Treasury note futures, Eurodollar futures, interest rate swap futures and options on agency MBS, and (ii) derivative instruments that economically serve as investments such as TBA purchase and sale commitments.
Interest Rate Hedging Instruments
We exchange cash variation margin with the counterparties to our interest rate hedging instruments at least on a daily basis based upon daily changes in fair value as measured by the central clearinghouse through which those derivatives are cleared. In addition, the central clearinghouse requires market participants to deposit and maintain an "initial margin" amount which is determined by the clearinghouse and is generally intended to be set at a level sufficient to protect the clearinghouse from the maximum estimated single-day price movement in that market participant's contracts. However, the futures commission merchants ("FCMs") through which we conduct trading of our cleared and exchanged-traded hedging instruments may require incremental initial 53 -------------------------------------------------------------------------------- margin in excess of the clearinghouse's requirement. The clearing exchanges have the sole discretion to determine the value of our hedging instruments for the purpose of setting initial and variation margin requirements or otherwise. In the event of a margin call, we must generally provide additional collateral on the same business day. To date, we have not had any margin calls on our hedging agreements that we were not able to satisfy. However, if we encounter significant decreases in long-term interest rates, margin calls on our hedging agreements could result in a material adverse change in our liquidity position.
As of
December 31, 2019 Notional Amount Collateral Deposit Interest rate swaps$ 2,985,000 $ 37,122 The FCMs through which we conduct trading of our hedging instruments may limit their exposure to us (due to an inherent one business day lag in the variation margin exchange process) by applying a maximum "ceiling" on their level of risk, either overall and/or by instrument type. The FCMs generally use the amount of initial margin that we have posted with them as a measure of their level of risk exposure to us. We currently have FCM relationships with four large financial institutions. To date, among our four FCM arrangements, we have had sufficient excess capacity above and beyond what we believe to be a sufficient and appropriate hedge position. However, if our FCMs substantially lowered their risk exposure thresholds, we could experience a material adverse change in our liquidity position and our ability to hedge appropriately.
TBA Dollar Roll Transactions
TBA dollar roll transactions represent a form of off-balance sheet financing accounted for as derivative instruments. In a TBA dollar roll transaction, we do not intend to take physical delivery of the underlying agency MBS and will generally enter into an offsetting position and net settle the paired-off positions in cash. However, under certain market conditions, it may be uneconomical for us to roll our TBA contracts into future months and we may need to take or make physical delivery of the underlying securities. If we were required to take physical delivery to settle a long TBA contract, we would have to fund our total purchase commitment with cash or other financing sources and our liquidity position could be negatively impacted. Our TBA commitments and our commitments to purchase and sell specified agency MBS are subject to master securities forward transaction agreements published bySIFMA as well as supplemental terms and conditions with each counterparty. Under the terms of these agreements, we may be required to pledge collateral to our counterparty in the event the fair value of our agency MBS commitments decline and such counterparty demands collateral through a margin call. Margin calls on agency MBS commitments are generally caused by factors such as rising interest rates or prepayments. Our agency MBS commitments provide that valuations for our commitments and any pledged collateral are to be obtained from a generally recognized source agreed to by both parties. However, in certain circumstances, our counterparties have the sole discretion to determine the value of the agency MBS commitment and any pledged collateral. In such instances, our counterparties are required to act in good faith in making determinations of value. In the event of a margin call, we must generally provide additional collateral on the same business day. Equity Capital
Common Equity Distribution Agreements
OnFebruary 22, 2017 , we entered into separate common equity distribution agreements with equity sales agentsJMP Securities LLC ,FBR Capital Markets & Co. ,JonesTrading Institutional Services LLC andLadenburg Thalmann & Co. Inc. pursuant to which we may offer and sell, from time to time, up to 6,000,000 shares of our Class A common stock. OnAugust 10, 2018 , we entered into separate amendments to the equity distribution agreements with equity sales agentsJMP Securities LLC ,B. Riley FBR, Inc. (formerly,FBR Capital Markets & Co. ),JonesTrading Institutional Services LLC andLadenburg Thalmann & Co. Inc. pursuant to which we may offer and sell, from time to time, up to 12,597,423 shares of our Class A common stock. Pursuant to the common equity distribution agreements, shares of our common stock may be offered and sold through the equity sales agents in transactions that are deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions.
As of
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Preferred Stock
As ofDecember 31, 2019 , we had Series B Preferred Stock outstanding with a liquidation preference of$8.9 million . The Series B Preferred Stock is publicly traded on theNew York Stock Exchange under the ticker symbol "AI PrB." The Series B Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series B Preferred Stock have no voting rights, except under limited conditions and are entitled to receive a cumulative cash dividend at a rate of 7.00% per annum of their$25.00 per share liquidation preference (equivalent to$1.75 per annum per share). Shares of Series B Preferred Stock are redeemable at$25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared) exclusively at our option commencing onMay 12, 2022 or earlier upon the occurrence of a change in control. Dividends are payable quarterly in arrears on the 30th day of each December, March, June and September, when and as declared. We have declared and paid all required quarterly dividends on our Series B Preferred Stock to date. As ofDecember 31, 2019 , we had Series C Preferred Stock outstanding with a liquidation preference of$30.0 million . The Series C Preferred Stock is publicly traded on theNew York Stock Exchange under the ticker symbol "AI PrC." The Series C Preferred Stock has no stated maturity, is not subject to any sinking fund and will remain outstanding indefinitely unless repurchased or redeemed by us. Holders of Series C Preferred Stock have no voting rights except under limited conditions and will be entitled to receive cumulative cash dividends (i) from and including the original issue date to, but excluding,March 30, 2024 at a fixed rate equal to 8.250% per annum of the$25.00 per share liquidation preference (equivalent to$2.0625 per annum per share) and (ii) from and includingMarch 30, 2024 , at a floating rate equal to three-month LIBOR plus a spread of 5.664% per annum. Shares of Series C Preferred Stock are redeemable at$25.00 per share, plus accumulated and unpaid dividends (whether or not authorized or declared) exclusively at our option commencing onMarch 30, 2024 or earlier upon the occurrence of a change in control or under circumstances where it is necessary to preserve our qualification as a REIT. Under certain circumstances upon a change of control, the Series C Preferred Stock is convertible into shares of the Company's common stock. Dividends will be payable quarterly in arrears on the 30th day of March, June, September and December of each year, when and as declared. We have declared and paid all required quarterly dividends on our Series C Preferred Stock to date.
Preferred Equity Distribution Agreement
OnMay 16, 2017 , we entered into an equity distribution agreement withJonesTrading Institutional Services LLC , pursuant to which we may offer and sell, from time to time, up to 1,865,000 shares of our Series B Preferred Stock. OnMarch 21, 2019 , we entered into an amended and restated equity distribution agreement withJonesTrading Institutional Services LLC ,B. Riley FBR, Inc. ,Compass Point Research and Trading, LLC andLadenburg Thalmann & Co. Inc. , pursuant to which we may offer and sell, from time to time, up to 1,647,370 shares of our Series B Preferred Stock. Pursuant to the Series B preferred equity distribution agreement, shares of our Series B Preferred stock may be offered and sold through the preferred equity sales agents in transactions that are deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act of 1933, including sales made directly on the NYSE or sales made to or through a market maker other than on an exchange or, subject to the terms of a written notice from us, in privately negotiated transactions.
As of
Common Share Repurchase Program
Our Board of Directors authorized the Repurchase Program pursuant to which we may repurchase up to 2.0 million shares of our Class A common stock. As ofDecember 31, 2019 , 1,951,305 shares of Class A common stock remain available for repurchase under the repurchase program.
REIT Distribution Requirements
Commencing with our taxable year endingDecember 31, 2019 , we intend to elect to be taxed as a REIT under the Internal Revenue Code. As a REIT, we are required to distribute annually 90% of our REIT taxable income (subject to certain adjustments) to our shareholders. So long as we continue to qualify as a REIT, we will generally not be subject toU.S. Federal or state corporate income taxes on our taxable income that we distribute to our shareholders on a timely basis. At present, it is our intention to distribute 100% of our taxable income, although we will not be required to do so. We intend to make distributions of our taxable income within the time limits prescribed by the Internal Revenue Code, which may extend into the subsequent taxable year. 55
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Contractual Obligations
We have contractual obligations to make future payments in connection with
long-term unsecured debt and non-cancelable lease agreements and other
contractual commitments. The following table sets forth these contractual
obligations by fiscal year as of
2020 2021 2022 2023 2024 Thereafter Total Long-term debt maturities $ - $ - $ -$ 25,000 $ -$ 50,300 $ 75,300 Interest on long-term debt (1) 4,750 4,750 4,750 3,922 3,094 7,361 28,627 Minimum rental commitments 52 65 55 - - - 172$ 4,802 $ 4,815 $ 4,805 $ 28,922 $ 3,094 $ 57,661 $ 104,099
(1) Includes interest on (i)
annual interest rate of 6.625% that will mature on
million of Senior Notes due 2025 with a fixed annual interest rate of 6.75%
that will mature on
of trust preferred debt with variable interest rates indexed to three-month
LIBOR and reset quarterly. Interest on trust preferred debt is based upon a
weighted-average interest rate of 4.74%, which represents the
weighted-average contractual interest rate in effect as of
The trust preferred debt will mature beginning in
2035.
Off-Balance Sheet Arrangements and Other Commitments
As ofDecember 31, 2019 , we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance, or special purpose or variable interest entities ("VIEs"), established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Our economic interests held in unconsolidated VIEs are limited in nature to those of a passive holder of MBS issued by a securitization trust. As ofDecember 31, 2019 , we had not consolidated for financial reporting purposes any securitization trusts as we do not have the power to direct the activities that most significantly impact the economic performance of such entities. Further, as ofDecember 31, 2019 , we had not guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities. See Note 15 to our consolidated financial statements under "Item 8 - Financial Statements and Supplementary Data."
Critical Accounting Estimates
The preparation of financial statements in accordance with GAAP requires the Company to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Although the Company bases these estimates and assumptions on historical experience and all other information available as of the time that the financial statements are prepared, such estimates frequently require management to exercise significant subjective judgment about matters that are inherently uncertain. Actual results may differ from these estimates, which could have a significant and potentially adverse effect on our financial condition, results of operations, and cash flows. A summary of our significant accounting policies is included in "Note 3. Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements. Our most critical accounting estimates, which are those accounting estimates that require the highest degree of management judgment due to the inherent level of estimation uncertainty, relate to the measurement of the fair value of our investments in mortgage investments and income taxes.
Fair Value of Investments in MBS
Inputs to fair value measurements of the Company's investments in MBS include price estimates obtained from third-party pricing services. In determining fair value, third-party pricing services use a market approach. The inputs used in the fair value measurements performed by the third-party pricing services are based upon readily observable transactions for securities with similar characteristics (such as issuer/guarantor, coupon rate, stated maturity, and collateral pool characteristics) occurring on the measurement date. The Company makes inquiries of the third party pricing sources to understand the significant inputs and assumptions used to determine prices. The Company reviews the various third-party fair value estimates and performs procedures to validate their reasonableness, including comparison to recent trading activity for similar securities and an overall review for consistency with market conditions observed as of the measurement date. Changes in the market environment that may occur over the holding period of our MBS investments may cause the gains or losses that are ultimately realized to differ from those currently recognized in our consolidated financial statements based upon their current valuations. 56
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Recently Issued Accounting Pronouncements
Refer to "Note 3. Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements for a summary of recently issued accounting pronouncements and their effect on our consolidated financial statements.
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