Angel Oak Mortgage REIT, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis should be read in conjunction with our historical consolidated financial statements and the notes thereto appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis, including information with respect to our business strategies, our expectations regarding the future performance of our business, and the other non-historical statements contained herein, are forward-looking statements. Our actual results may differ materially from those anticipated in any forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and “Special Note Regarding Forward-Looking Statements” elsewhere in this Annual Report on Form 10-K. General Angel Oak Mortgage, Inc. is a real estate finance company focused on acquiring and investing in first lien non-QM loans and other mortgage-related assets in the U.S. mortgage market. Our strategy is to make credit-sensitive investments primarily in newly-originated first lien non-QM loans that are primarily made to higher-quality non-QM loan borrowers and primarily sourced from Angel Oak’s proprietary mortgage lending platform, Angel Oak Mortgage Lending, which operates through wholesale and retail channels and has a national origination footprint. We also may invest in other residential mortgage loans, RMBS, and other mortgage-related assets, which, together with non-QM loans and investments other than U.S. Treasury Bills, we refer to as our target assets. Further, we may identify and acquire our target assets through the secondary market when market conditions and asset prices are conducive to making attractive purchases. Our objective is to generate attractive risk-adjusted returns for our stockholders, through cash distributions and capital appreciation, across interest rate and credit cycles. We are externally managed and advised by our Manager, a registered investment adviser under the Investment Advisers Act of 1940 and an affiliate of Angel Oak Capital, a leading alternative credit manager with market leadership in mortgage credit that includes asset management, lending and capital markets. Angel Oak Capital was established in 2009 and had approximately $14.2 billion in assets under management as of December 31, 2021 across its private credit strategies, public funds, and separately managed accounts, including approximately $9.7 billion of mortgage‑related assets. Angel Oak Mortgage Lending is a market leader in non‑QM loan production and, as of December 31, 2021, had originated over $12.9 billion in total non‑QM loan volume since its inception in 2011. Angel Oak is headquartered in Atlanta and has over 900 employees across its enterprise. Through our relationship with our Manager, we benefit from Angel Oak’s vertically integrated platform and in‑house expertise, providing us with the resources that we believe are necessary to generate attractive risk‑adjusted returns for our stockholders. Angel Oak Mortgage Lending provides us with proprietary access to non‑QM loans, as well as transparency over the underwriting process and the ability to acquire loans with our desired credit and return profile. We believe our ability to identify and acquire target assets through the secondary market is bolstered by Angel Oak’s experience in the mortgage industry and expertise in structured credit investments. In addition, we believe we have significant competitive advantages due to Angel Oak’s analytical investment tools, extensive relationships in the financial community, financing and capital structuring skills, investment surveillance capabilities, and operational expertise. We have elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31, 2019. Commencing with our taxable year ended December 31, 2019, we believe that we have been organized and operated, and we intend to continue to operate in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code of 1986 (the “Code”). Our qualification as a REIT, and maintenance of such qualification, depends on our ability to meet, on a continuing basis, various complex requirements under the Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels, and the concentration of ownership of our stock. We also intend to operate our business in a manner that will allow us to maintain our exclusion from regulation as an investment company under the Investment Company Act. Our common stock commenced trading on the New York Stock Exchange on June 17, 2021. We expect to derive our returns primarily from the difference between the interest we earn on loans we make and our cost of capital, as well as the returns from bonds, including risk retention securities, that are retained after securitizing the underlying loan collateral. Trends and Recent Developments Overall macroeconomic environment and its effect on us The 2021 macroeconomic environment was more favorable than that of the 2020 macroeconomic environment. Although the U.S. economy was still being affected by the COVID-19 pandemic in 2021, the impact of COVID-19 on the economy shifted from economic shutdowns and a lack of economic activity to a release of pent-up consumer demand, which included demand for housing and mortgages. Interest rates decreased in 2021, resulting in many homeowners either refinancing existing mortgages or trading up in housing stock and obtaining a newly originated mortgage. The effects of this overall interest rate decrease was somewhat offset by the lack of availability of housing stock in many areas of the U.S., and a dramatic increase in the cost of building materials, particularly lumber, which constrained home building activity to some extent, as well as resulted in an increase in home prices in many areas of the U.S. 57 Homeowner prepayment activities (which include refinancing an existing mortgage, as referred to above) may have had a negative impact on some of the bonds that we hold from older securitizations, as we typically hold the lower junior and XS (interest only) tranches of bonds from a securitization, and the payoff of a mortgage within a securitization results in less interest available to be allocated to the XS bonds. This prepayment activity on the part of homeowners is not likely to affect our newer securitizations, as a homeowner in a more newly-originated mortgage is likely to have a mortgage rate closer to the current lower interest rates. The Federal Reserve Bank of the U.S. has indicated that it plans to increase interest rates in the near term. We believe that an increase in interest rates from the current historically low levels is unlikely to significantly affect demand for non-QM mortgages. An increase in interest rates may cause interest rate spreads to widen, which may negatively impact the valuation of our whole loan portfolio, as wider interest rate spreads generally cause a decrease in the value of whole loans originated at lower interest rates. However, holding whole loans originated at higher interest rates generally has the effect of increasing our net interest income, and prepayment speeds will generally slow for existing securitizations, which will also increase our net interest income as we primarily hold lower and interest only tranches of securitized bonds that we have issued. Initial Public Offering On June 21, 2021, we completed our initial public offering (“IPO”) of 7,200,000 shares of common stock, $0.01 par value per share (“common stock”), at a public offering price of $19.00 per share for total proceeds of approximately $136.8 million, excluding the underwriting discounts and commissions and offering expenses of the IPO, each of which was paid by Angel Oak Capital, pursuant to the Registration Statement filed with the SEC under the Securities Act. Concurrently with the completion of the IPO, we sold an additional 2,105,263 shares of common stock to CPPIB Credit Investments Inc. in a private placement at $19.00 per share, for total proceeds of approximately $40.0 million. Our investment performance We had strong performance from the most substantial asset classes of our target investments of both our non-QM whole loan portfolio, RMBS portfolio, and CMBS portfolio for the year ended December 31, 2021. Our non-QM whole loan portfolio generated increased net interest income, partially offset by unrealized losses on the portfolio, which were driven by mark-to-market losses due to yield spread widening. The RMBS portfolio and CMBS portfolio results were supported by year-over-year unrealized gains in this asset class. The non-QM portfolio unrealized losses are reflected in net income, while the RMBS and CMBS portfolios’ unrealized gains are reflected in other comprehensive income. Purchases of whole loans since IPO and our 2021 securitizations Since the closing of the IPO, through December 31, 2021, we purchased $1.4 billion in residential whole loans. In 2021, we issued two new securitizations, AOMT 2021-4 and AOMT 2021-7, securitizing a total of $703.5 million of unpaid principal balance of seasoned residential non-QM mortgage loans. These securitizations were the first securitizations that we issued as the sole participant. We own and hold the call rights on the XS tranche of bonds, which is the “controlling class” of the bonds. Given the accounting rules surrounding these types of transactions, we have consolidated these securitizations on our consolidated balance sheets, maintaining the residential mortgage loans held in the securitization trust and the related financing obligation thereto on our consolidated balance sheet for the year ended December 31, 2021. Subsequent to December 31, 2021, we issued a new securitization, AOMT 2022-1, securitizing a total of $537.6 million of unpaid principal balance of seasoned residential non-QM mortgage loans. As of the closing of AOMT 2022-1, we have securitized over $1.2 billion of non-QM loans since the closing of the IPO. Our securitizations prior to 2021 were securitization transactions for which we did not meet the accounting rules to be considered a “primary beneficiary” of the applicable securitization vehicle, and therefore, for these prior securitizations, the bonds retained in the securitization are held on our consolidated balance sheets as of December 31, 2021 and 2020. New whole loan financing facilities In 2021, we entered into three new financing facilities, one of which was a committed financing facility. The new financing facilities afforded us $650.0 million of additional borrowing capacity, for a total capacity of $1.3 billion with which to execute our core strategy of purchasing whole loans and retaining them until securitized. Key Financial Metrics As a real estate finance company, we believe the key financial measures and indicators for our business are Distributable Earnings, Distributable Earnings Return on Average Equity and book value per share. Distributable Earnings 58 Distributable Earnings is a non‑GAAP measure and is defined as net income (loss) allocable to common stockholders as calculated in accordance with GAAP, excluding (1) unrealized gains and losses on our aggregate portfolio, and realized gains (losses) on derivatives, (2) impairment losses, (3) extinguishment of debt, (4) non-cash equity compensation expense, (5) the incentive fee earned by our Manager, (6) realized gains or losses on swap terminations and (7) certain other nonrecurring gains or losses. We believe that the presentation of Distributable Earnings provides investors with a useful measure to facilitate comparisons of financial performance among our REIT peers, but has important limitations. We believe Distributable Earnings as described above helps evaluate our financial performance without the impact of certain transactions but is of limited usefulness as an analytical tool. As a REIT, we are generally required to distribute at least 90% of our annual REIT taxable income and to pay U.S. federal income tax at the regular corporate rate to the extent that we annually distribute less than 100% of such taxable income. Given these requirements and our belief that dividends are generally one of the principal reasons that stockholders invest in our common stock, generally we intend to attempt to pay dividends to our stockholders in an amount equal to our REIT taxable income, if and to the extent authorized by our Board of Directors. Distributable Earnings is one of a number of factors considered by our Board of Directors in declaring dividends and, while not a direct measure of REIT taxable income, over time, the measure can be considered a useful indicator of our dividends. Distributable Earnings should not be viewed in isolation and is not a substitute for net income computed in accordance with GAAP. Our methodology for calculating Distributable Earnings may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and as a result, our Distributable Earnings may not be comparable to similar measures presented by other REITs. We also use Distributable Earnings to determine the management and incentive fees payable to our Manager pursuant to the Management Agreement. Distributable Earnings were approximately $34.2 million and $2.9 million for the years ended December 31, 2021 and 2020, respectively. The table below sets forth a reconciliation of net income allocable to common stockholder(s), calculated in accordance with GAAP, to Distributable Earnings for the years ended December 31, 2021 and 2020: December 31, 2021 December 31, 2020 (in thousands) Net income allocable to common stockholder(s) $ 21,098 $ 721 Adjustments: Net other-than-temporary credit impairment losses — — Net realized and unrealized (gains) losses on derivatives 7,688 257 Net unrealized (gains) losses on residential loans 1,956 1,371 Net unrealized (gains) losses on residential loans in securitization trust 1,949 — Net unrealized (gains) losses on commercial loans (231) 517 Net unrealized (gains) losses on financial instruments at fair value — 14 (Gains) losses on extinguishment of debt — — Non-cash equity compensation expense 1,715 — Incentive fee earned by our Manager — — Realized gains (losses) on terminations of interest rate swaps — — Total other non-recurring (gains) losses — — Distributable Earnings $ 34,175 $ 2,880 59 Distributable Earnings Return on Average Equity Distributable Earnings Return on Average Equity is a non-GAAP measure and is defined as annual or annualized Distributable Earnings divided by average total common stockholders’ equity. We believe that the presentation of Distributable Earnings Return on Average Equity provides investors with a useful measure to facilitate comparisons of financial performance among our REIT peers, but has important limitations. Additionally, we believe Distributable Earnings Return on Average Equity provides investors with additional detail on the Distributable Earnings generated by our invested equity capital. We believe Distributable Earnings Return on Average Equity as described above helps evaluate our financial performance without the impact of certain transactions but is of limited usefulness as an analytical tool. Therefore, Distributable Earnings Return on Average Equity should not be viewed in isolation and is not a substitute for net income computed in accordance with GAAP. Our methodology for calculating Distributable Earnings Return on Average Equity may differ from the methodologies employed by other REITs to calculate the same or similar supplemental performance measures, and as a result, our Distributable Earnings Return on Average Equity may not be comparable to similar measures presented by other REITs. Set forth below is our computation of Distributable Earnings Return on Average Equity for the years ended December 31, 2021 and 2020: December 31, 2021 December 31, 2020 ($ in thousands) Distributable Earnings $ 34,175 $ 2,880 Average total common stockholder(s)’ equity $ 369,749 $ 171,485 Distributable Earnings Return on Average Equity 9.24 % 1.68 % Book Value per Share The following table sets forth the calculation of our book value per share as of December 31, 2021 and 2020: December 31, 2021 December 31, 2020 (in thousands except for share and per share data) Total stockholder(s)’ equity $ 491,390 $ 248,309 Preferred stock (101) (101) Stockholder(s)’ equity, net of preferred stock $ 491,289 $ 248,208 Number of shares outstanding at period end 25,227,328 15,724,050 Book value per share $ 19.47 $ 15.79 Results of Operations Our results of operations presented herein for the year ended December 31, 2021 and the comparable year ended December 31, 2020 do not reflect the expenses typically associated with being a public company for full reporting periods, including increased insurance, legal, and accounting fees, full periods of equity compensation expense, expenses incurred in complying with the reporting and other requirements of the Securities Exchange Act of 1934, the payment of a base management fee to our Manager as a result of differences in the way fees and expense reimbursements are calculated under the Management Agreement compared to the pre-IPO management agreement as among us, our Manager and Angel Oak Mortgage Fund, LP (“Angel Oak Mortgage Fund”), our sole common stockholder prior the IPO (the “pre-IPO management agreement”), and the payment of increased directors’ fees for our independent directors. Additionally, pursuant to the Management Agreement, we are required to reimburse our Manager for its operating expenses, including third‑party expenses, incurred on our behalf; and our Manager will also be entitled to reimbursement for costs of the wages, salaries, and benefits incurred by our Manager for our dedicated Chief Financial Officer and Treasurer and a proportionate amount of the costs of the wages, salaries, and benefits of our Chief Executive Officer and President (who, after the completion of the IPO, has dedicated a substantial majority of his business time to us) based on the percentage of his business time spent on our matters, and any other dedicated or partially dedicated employees based on the percentage of each such person’s working time spent on matters related to us. 60 Year Ended December 31, 2021, Compared to the Year Ended December 31, 2020 The following table sets forth a summary of our results of operations for the years ended December 31, 2021 and 2020: December 31, 2021 December 31, 2020 (in thousands) INTEREST INCOME, NET Interest income $ 60,555 $ 40,820 Interest expense 11,476 7,499 NET INTEREST INCOME 49,079 33,321 REALIZED AND UNREALIZED LOSSES, NET Net realized loss on mortgage loans, derivative contracts, RMBS, and CMBS (4,926) (20,793) Net unrealized loss on mortgage loans and derivative contracts (2,392) (2,144) TOTAL REALIZED AND UNREALIZED LOSSES, NET (7,318) (22,937) EXPENSES Operating expenses 6,060 1,680 Due diligence and transaction costs 2,551 356 Stock compensation 1,715 — Operating expenses incurred with affiliate 2,828 1,742 Securitization costs — 2,527 Management fee incurred with affiliate 5,894 3,343 Total operating expenses 19,048 9,648 INCOME BEFORE INCOME TAXES 22,713 736 Income tax expense 1,600 — NET INCOME 21,113 736 Preferred dividends (15) (15) NET INCOME ALLOCABLE TO COMMON STOCKHOLDER(S) $ 21,098 $ 721 Other comprehensive income (loss) 4,039 (4,593) TOTAL COMPREHENSIVE INCOME (LOSS) $ 25,137 $ (3,872) 61 Net Interest Income The following table sets forth the components of net interest income for the years ended December 31, 2021 and 2020: December 31, 2021 December 31, 2020 (in thousands) Interest income Interest income / expense Average balance Interest income / expense Average balance Residential mortgage loans $ 25,705 $ 544,440 $ 13,013 $ 232,075 Residential mortgage loans in securitization trusts 7,709 153,158 — — Commercial mortgage loans 641 9,284 1,940 28,979 RMBS 24,221 264,095 25,415 118,174 CMBS 2,266 11,142 295 1,359 U.S. Treasury Bills 7 58,076 110 118,069 Other interest income 6 32,050 47 42,300 Total interest income 60,555 40,820 Interest expense Notes payable 8,682 350,919 6,624 189,212 Non-recourse securitization obligation, collateralized by residential mortgage loans 2,457 141,133 — — Repurchase facilities 337 209,502 875 136,835 Total interest expense 11,476 7,499 Net interest income $ 49,079 $ 33,321 Net interest income for the years ended December 31, 2021 and 2020 was $49.1 million and $33.3 million, respectively. Net interest income increased due to the increase in the average portfolio balance for the year ended December 31, 2021 as compared to the year ended December 31, 2020, primarily due to the composition of the portfolio during December 31, 2021 having a higher average balance of residential mortgage loans and residential mortgage loans held in securitization trusts, which increased the interest income in these portfolios. Our RMBS portfolio’s average balance increased due to whole pool loan RMBS purchased at quarter-end dates which were sold in the months following the quarter end dates. Accordingly, the increase in the average balance of our RMBS portfolio did not substantially affect the net interest income earned from RMBS. Total Realized and Unrealized Gains (Losses) The components of total realized and unrealized gains (losses), net for the years ended December 31, 2021 and 2020 are set forth as follows: December 31, 2021 December 31, 2020 (in thousands) Realized gain on securitization $ — $ 2,946 Unrealized loss on residential loans held in securitization trusts (3,427) — Realized loss on RMBS, net (15,113) (9,629) Realized loss on CMBS (971) — Realized gain (loss) on interest rate futures 13,253 (14,076) Realized and unrealized loss on TBAs (1,255) — Realized and unrealized gain (loss) on residential mortgage loans 378 (1,396) Realized and unrealized gain (loss) on commercial mortgage loans 355 (517) Realized and unrealized loss on U.S. Treasury Bills (8) (8) Unrealized depreciation on interest rate futures (530) (257) Total realized and unrealized gains (losses), net $ (7,318) $ (22,937) 62 For the years ended December 31, 2021 and 2020, total realized and unrealized gains (losses), net were $(7.3) million and $(22.9) million, respectively. During the year ended December 31, 2020, we experienced market volatility in interest rate futures due to the COVID-19 pandemic. The year ended December 31, 2021 presented a less volatile market environment as substantially all the credit and asset valuation issues related to the financial effects of the COVID-19 pandemic had lessened. During the year ended December 31, 2021, we experienced increased realized losses on our RMBS portfolio due to prepayment speeds on IO bonds, which increased compared to 2020. Our interest rate futures, as a partial economic hedge against residential loan valuations, performed as expected and more than offset the unrealized losses experienced in our portfolio of residential loans held in securitization trusts. Also during the year ended December 31, 2021, our accounting treatment of securitization transactions changed as we became the primary beneficiary for the securitization transactions entered into during 2021 (AOMT 2021-4 and AOMT 2021-7), and thus, consolidated the VIEs of those securitization entities and recognized no realized gain or loss on those transactions. We did recognize unrealized losses on these assets from mark-to-market activity, as the loans in these VIEs are still held on our balance sheet. For comparative purposes, we were not considered the primary beneficiary of securitization transactions entered into in 2020 (AOMT 2020-3 and AOMT 2020-SBC1), and thus, recognized a gain in 2020 on those transactions as we did not consolidate those VIEs. Expenses Operating Expenses For the years ended December 31, 2021 and 2020, our operating expenses were $6.1 million and $1.7 million, respectively. The increase in operating expenses during the year ended December 31, 2021 was due to an increase in costs due to being a newly-public company, including increased insurance, audit, and legal fees. We also experienced an increase in loan administration costs, commensurate with an increase in the number of loans in our portfolio during the comparative period. Due Diligence and Transaction Costs For the years ended December 31, 2021 and 2020, our due diligence and transaction costs were $2.6 million and $0.4 million, respectively. The increase in these costs was due to whole loan acquisition diligence costs, which increased over the comparative period as we purchased significantly more whole loans during the year ended December 31, 2021 as compared to the year ended December 31, 2020. We purchased both affiliate-originated and third party-originated whole loans during the year ended December 31, 2021, while during the year ended December 31, 2020, we purchased no third party-originated whole loans and our affiliated mortgage originators largely paused mortgage originations from mid-March 2020 to September 2020 as a result of uncertain economic conditions due to the economic effects of the COVID-19 pandemic. Stock Compensation For the year ended December 31, 2021, our stock compensation expense was $1.7 million. We did not have any stock compensation expense for the year ended December 31, 2020 as no grants were made in 2020. In connection with the IPO in June 2021, we issued restricted stock awards to key employees of Angel Oak, including our Manager, as well as the independent directors on our Board of Directors. All awards discussed further were issued with a grant date of June 21, 2021. Restricted stock awards granted to our Board of Directors vest on the one year anniversary of the grant date, while restricted stock awards granted to key employees of Angel Oak, including our Manager, vest in three equal annual installments commencing on the one year anniversary of the grant date. We believe our 2021 Equity Incentive Plan is designed to motivate and retain individuals who are responsible for the attainment of our core long-term performance goals. We plan on issuing restricted stock or other similar awards, such as restricted stock units or performance shares, on an annual basis to continue to compensate these key individuals. Operating Expenses Incurred with Affiliate For the years ended December 31, 2021 and 2020, our operating expenses incurred with affiliate were $2.8 million and $1.7 million, respectively. These expenses were primarily due to the allocated time of partially and fully dedicated employees’ compensation being reimbursed by us, which increased over the comparative period due to more fully partially and fully dedicated employees’ time being allocated to us. Securitization expenses During the year ended December 31, 2021, we did not incur any securitization expenses, as we were the sole participant in the securitizations of two consolidated VIEs (AOMT 2021-7 and AOMT 2021-4) which required capitalization of securitization costs, which are included as a contra-liability to the financing obligation recognized on our consolidated balance sheet as of December 31, 2021. This contra-liability amortizes over a two-year period, and the amortization for the year ended December 31, 2021 was $0.3 million. 63 During the year ended December 31, 2020, we were not considered the primary beneficiary of securitization transactions entered into in 2020 (AOMT 2020-3 and AOMT 2020-SBC1), and thus, recognized securitization expenses of $2.5 million on those transactions as we did not consolidate those VIEs. Management Fee Incurred with Affiliate Prior to the completion of the IPO, we were required to pay our Manager, in cash, a management fee pursuant to the pre-IPO management agreement. The management fee payable under the pre-IPO management agreement was calculated based on the Actively Invested Capital (as defined in the pre-IPO management agreement) of the limited partners in Angel Oak Mortgage Fund, which we believe is reflective of a typical management fee payable by a private investment vehicle. The pre-IPO management agreement terminated on the completion of the IPO, and we and the Operating Partnership subsequently entered into the Management Agreement with our Manager effective as of the completion of the IPO. Pursuant to the Management Agreement, our Manager is entitled to a base management fee, which is calculated based on our Equity (as defined in the Management Agreement), and an incentive fee based on certain performance criteria, as well as a termination fee in certain cases and reimbursement of certain expenses as described in the Management Agreement. For the years ended December 31, 2021 and 2020, our management fee incurred with affiliate was $5.9 million and $3.3 million, respectively. The increase is due to the increase in our average equity for the year ended December 31, 2021 as compared to the same period in 2020. Income Taxes Our income tax liability for the year ended December 31, 2021 reflects an income tax provision based on our expectation of current income taxes incurred on activities relating to income derived from our taxable REIT subsidiary (“TRS”). We did not incur any tax liability for the year ended December 31, 2020. 64 Our Portfolio As of December 31, 2021, our portfolio consisted of approximately $2.2 billion of residential mortgage loans, RMBS, and other target assets. “Target assets” as presented below includes the total investment portfolio excluding U.S. Treasury Bills. The following table sets forth additional information regarding our portfolio, including the manner in which our equity capital was allocated among investment types, as of December 31, 2021: Fair Value Collateralized Debt Allocated Capital % of Total Capital Portfolio: ($ in thousands) Residential mortgage loans $ 1,061,912 $ 852,961 $ 208,951 42.5 % Residential mortgage loans in securitization trust 667,365 616,557 50,808 10.3 % Commercial mortgage loans 18,664 447 18,217 3.7 % Total whole loan portfolio $ 1,747,941 $ 1,469,965 $ 277,976 56.5 % Investment securities RMBS $ 485,634 $ 360,501 $ 125,133 25.5 % CMBS 10,756 — 10,756 2.2 % U.S. Treasury Bills 249,999 248,750 1,249 0.3 % Total investment securities $ 746,389 $ 609,251 $ 137,138 28.0 % Total investment portfolio $ 2,494,330 $ 2,079,216 $ 415,114 84.5 % Target assets $ 2,244,331 $ 1,830,466 $ 413,865 84.2 % Cash $ 40,801 $ — $ 40,801 8.3 % Other assets and liabilities 35,475 — 35,475 7.2 % Total $ 2,570,606 $ 2,079,216 $ 491,390 100.0 % 65 As of December 31, 2020, our portfolio consisted of approximately $308.2 million of residential mortgage loans, RMBS, and other target assets. “Target assets” as presented below includes the total investment portfolio excluding U.S. Treasury Bills. The following table sets forth additional information regarding our portfolio including the manner in which our equity capital was allocated among investment types, as of December 31, 2020: Fair Value Collateralized Debt Allocated Capital % of Total Capital Portfolio: ($ in thousands) Residential mortgage loans $ 142,030 $ 80,345 $ 61,685 24.8 % Commercial mortgage loans 7,466 1,560 5,906 2.4 % Total whole loan portfolio $ 149,496 $ 81,905 $ 67,591 27.2 % Investment securities RMBS $ 149,936 $ 28,673 $ 121,263 48.8 % CMBS 8,796 — 8,796 3.5 % U.S. Treasury Bills 149,995 149,618 377 0.2 % Total investment securities $ 308,727 $ 178,291 $ 130,436 52.5 % Total investment portfolio $ 458,223 $ 260,196 $ 198,027 79.8 % Target assets $ 308,228 $ 110,578 $ 197,650 79.6 % Cash $ 43,569 $ — $ 43,569 17.5 % Other assets and liabilities 6,713 — 6,713 2.7 % Total $ 508,505 $ 260,196 $ 248,309 100.0 % Residential Mortgage Loans The following table sets forth additional information on the residential mortgage loans in our portfolio as of December 31, 2021: Portfolio Range Portfolio Weighted Average ($ in thousands) Unpaid principal balance (“UPB”) $48 - $3,410 $506 Interest rate 2.75% - 9.25% 4.49% Maturity date 10/1/2036 - 12/1/2061 4/20/2053 FICO score at loan origination 521 - 823 740 LTV at loan origination 12% - 95% 70% DTI at loan origination 1.60% - 59.06% 27% Percentage of first lien loans N/A 100% Percentage of loans 90+ days delinquent (based on UPB) N/A 0.30% 66 The following table sets forth additional information on the residential mortgage loans in our portfolio as of December 31, 2020: Portfolio Range Portfolio Weighted Average ($ in thousands) UPB $32 - $2,357 $489 Interest rate 3.88% - 10.75% 5.95% Maturity date 11/2048 - 1/2061 10/2050 FICO score at loan origination 500 - 811 733 LTV at loan origination 5% - 90% 75% DTI at loan origination 3% - 50% 35% Percentage of first lien loans N/A 99.90% Percentage of loans 90+ days delinquent (based on UPB) N/A 10.70% The following table sets forth the information regarding the underlying collateral of our residential loans held in securitization trusts as of December 31, 2021 (1) : ($ in thousands) UPB $642,951 Number of loans 1494 Weighted average loan coupon 4.98% Average loan amount 433 Weighted average LTV at loan origination and deal date 72% Weighted average credit score at loan origination and deal date 741 Current 3-month CPR 35.1 Percentage of loans 90+ days delinquent (based on UPB) 0.13 (1) We did not have any residential loans held in securitization trusts as of December 31, 2020. The following chart illustrates the geographic distribution of the underlying collateral of our residential loans held in securitization trusts as of December 31, 2021: 67 The following charts illustrate the distribution of the credit scores and interest rates by the number of loans in our residential mortgage loan portfolio as of December 31, 2021: The following charts illustrate the distribution of the credit scores and interest rates by the number of loans in our residential mortgage loan portfolio as of December 31, 2020: 68 The following charts illustrate additional characteristics of our residential mortgage loans in our portfolio that we owned directly as of December 31, 2021, based on the product profile, borrower profile and geographic location (percentages are based on the aggregate unpaid principal balance of such loans): Characteristics of Our Residential Mortgage Loans as of December 31, 2021: Note: No state in “Other” represents more than a 3% concentration of the residential mortgage loans in our portfolio that we owned directly as of December 31, 2021. 69 The following charts illustrate additional characteristics of the residential mortgage loans in our portfolio that we owned directly as of December 31, 2020, based on the product profile, borrower profile and geographic location (percentages are based on the aggregate unpaid principal balance of such loans): Characteristics of Our Residential Mortgage Loans as of December 31, 2020: (1) No state in “Other” represents more than a 3% concentration of the residential mortgage loans in our portfolio that we owned directly as of December 31, 2020. 70 Commercial Mortgage Loans The following table provides additional information on the commercial mortgage loans in our portfolio as of December 31, 2021: Portfolio Range Portfolio Weighted Average ($ in thousands) UPB $244 - $4,300 $1,700 Interest rate 5.75% - 8.38% 6.25% Loan term 1.42 - 28.18 years 8.36 years LTV at loan origination 46.7% - 75.0% 59.8% The following table provides additional information on the commercial mortgage loans in our portfolio as of December 31, 2020: Portfolio Range Portfolio Weighted Average ($ in thousands) UPB $77 - $4,300 $646 Interest rate 5.66% - 8.38% 5.58% Loan term 2.42 - 29.2 years 14.3 years LTV at loan origination 38.6% - 75.0% 54.7% 71 The following charts illustrate the geographic location of the commercial mortgage loans in our portfolio that we owned directly as of December 31, 2021 and December 31, 2020 (percentages are based on the aggregate unpaid principal balance of such loans): Geographic Diversification of Our Commercial Mortgage Loans as of December 31, 2021: Geographic Diversification of Our Commercial Mortgage Loans as of December 31, 2020: RMBS In March 2019, we participated in our first securitization transaction pursuant to which we contributed to AOMT 2019‑2 non‑QM loans with a carrying value of approximately $255.7 million that we had accumulated and held on our balance sheet. We received bonds from AOMT 2019‑2 with a fair value of approximately $55.8 million, including approximately $33.0 million in risk retention securities (representing 5% of each class of the bonds issued as part of the transaction). Additionally, in July 2019, we participated in a second securitization transaction pursuant to which we contributed to AOMT 2019‑4 non‑QM loans with a carrying value of approximately $147.4 million that we had accumulated and held on our balance sheet, and we received bonds from AOMT 2019‑4 with a fair value of approximately $16.8 million. Furthermore, in November 2019, we participated in a third securitization transaction pursuant to which we contributed to AOMT 2019‑6 non‑QM loans with a carrying value of approximately $104.3 million that we had accumulated and held on our balance sheet, and we received bonds from AOMT 2019‑6 with a fair value of approximately $10.7 million. In June 2020, we participated in a fourth securitization transaction pursuant to which we contributed to AOMT 2020‑3 non‑QM loans with a carrying value of approximately $482.9 million that we had accumulated and held on our balance sheet. We received bonds from 72 AOMT 2020‑3 with a fair value of approximately $66.5 million, including approximately $23.0 million in horizontal risk retention securities (representing 5% of the fair value of the securities and other interests issued as part of the transaction). Certain information regarding the mortgage loans underlying our portfolio of RMBS issued in AOMT securitization transactions is set forth below as of December 31, 2021, unless otherwise stated: AOMT 2019-2 AOMT 2019-4 AOMT 2019-6 AOMT 2020-3 ($ in thousands) UPB of loans $183,489 $184,793 $206,392 $262,383 Number of loans 586 604 743 757 Weighted average loan coupon 7.082 % 7.066 % 6.441 % 5.905 % Average loan amount $313 $306 $278 $347 Weighted average LTV at loan origination and deal date 75 % 73 % 71 % 74 % Weighted average credit score at loan origination and deal date 695 703 716 717 Current 3-month CPR (1) 44.89 % 50.89 % 45.08 % 43.61 % 90+ day delinquency (as a % of UPB) 12.33 % 8.86 % 5.31 % 3.82 % Fair value of first loss piece (2) $13,634 $4,019 $2,334 $26,447 Investment thickness (3) 18.95 % 8.61 % 6.20 % 11.82 % (1) CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. (2) Represents the fair value of the securities we hold in the first loss tranche in each securitization. (3) Represents the average size of the subordinate securities we own as investments in each securitization relative to the average overall size of the securitization. Certain information regarding the mortgage loans underlying our portfolio of RMBS issued in AOMT securitization transactions is set forth below as of December 31, 2020, unless otherwise stated: AOMT 2019-2 AOMT 2019-4 AOMT 2019-6 AOMT 2020-3 ($ in thousands) UPB of loans $337,323 $334,129 $379,535 $442,314 Number of loans 1049 1031 1262 1189 Weighted average loan coupon 7.01 % 6.99 % 6.47 % 5.86 % Average loan amount $331 $340 $307 $381 Weighted average LTV at loan origination and deal date 78 % 78 % 75 % 74 % Weighted average credit score at loan origination and deal date 712 707 715 721 Current 3-month CPR (1) 31.60 % 27.40 % 32.30 % 28.80 % 90+ day delinquency (as a % of UPB) 15.90 % 15.70 % 11.20 % 2.43 % Fair value of first loss piece (2) $12,897 $3,415 $2,029 $23,507 Investment thickness (3) 10.00 % 4.50 % 3.30 % 6.80 % (1) CPR is a method of expressing the prepayment rate for a mortgage pool that assumes that a constant fraction of the remaining principal is prepaid each month or year. (2) Represents the fair value of the securities we hold in the first loss tranche in each securitization. (3) Represents the average size of the subordinate securities we own as investments in each securitization relative to the average overall size of the securitization. 73 The following table provides certain information with respect to our RMBS portfolio received in AOMT securitization transactions and acquired from other third parties as of December 31, 2021: RMBS Repurchase Debt Allocated Capital AOMT Third Party RMBS Total AOMT Third Party RMBS Total AOMT Third Party RMBS Total (in thousands) Senior $ 3,076 $ — $ 3,076 $ 4,089 $ — $ 4,089 $ (1,013) $ — $ (1,013) Mezzanine 2,178 — 2,178 1,631 — 1,631 547 — $ 547 Subordinate 80,058 10,292 90,350 — — — 80,058 10,292 $ 90,350 Interest only / excess 15,052 2,923 17,975 — — — 15,052 2,923 $ 17,975 Whole pool — 372,055 372,055 — 354,781 354,781 — 17,274 $ 17,274 Total $ 100,364 $ 385,270 $ 485,634 $ 5,720 $ 354,781 $ 360,501 $ 94,644 $ 30,489 $ 125,133 The following table provides certain information with respect to our RMBS portfolio received in AOMT securitization transactions and acquired from other third parties as of December 31, 2020: RMBS Repurchase Debt Allocated Capital AOMT Third Party RMBS Total AOMT Third Party RMBS Total AOMT Third Party RMBS Total (in thousands) Senior $ 11,477 $ 6,820 $ 18,297 $ 11,936 $ — $ 11,936 $ (459) $ 6,820 $ 6,361 Mezzanine 2,207 — 2,207 1,633 — 1,633 574 — 574 Subordinate 78,830 18,784 97,614 15,104 — 15,104 63,726 18,784 82,510 Interest only / excess 31,818 — 31,818 — — — 31,818 — 31,818 Whole pool — — — — — — — — — Total $ 124,332 $ 25,604 $ 149,936 $ 28,673 $ — $ 28,673 $ 95,659 $ 25,604 $ 121,263 The following table sets forth information with respect to our RMBS ending balances, at fair value, as of December 31, 2021: Senior Mezzanine Subordinate Interest Only Whole Pool Total (in thousands) Beginning fair value $ 18,297 $ 2,207 $ 97,614 $ 31,818 $ — $ 149,936 Acquisitions: Secondary market purchases of AOMT securities — — 2,209 — — 2,209 Third party securities — — 5,122 7,485 1,466,854 1,479,461 Effect of principal payments / called deals (15,029) — (19,576) (3,781) (1,096,112) (1,134,498) IO and excess servicing prepayments — — — (17,355) — (17,355) Changes in fair value, net (192) (29) 4,981 (192) 1,313 5,881 Ending fair value $ 3,076 $ 2,178 $ 90,350 $ 17,975 $ 372,055 $ 485,634 74 The following table sets forth information with respect to our RMBS ending balances, at fair value, as of December 31, 2020: Senior Mezzanine Subordinate Interest Only Total (in thousands) Beginning fair value $ 19,060 $ 2,237 $ 31,679 $ 24,016 $ 76,992 Acquisitions: Retained from AOMT securitizations — — 40,380 26,140 66,520 Secondary market purchases of AOMT securities — — 5,663 — 5,663 Third party securities 6,880 — 18,098 — 24,978 Effect of principal payments / called deals (7,709) — (2,377) — (10,086) IO and excess servicing prepayments — — — (9,672) (9,672) Changes in fair value, net 66 (30) 4,171 (8,666) (4,459) Ending fair value $ 18,297 $ 2,207 $ 97,614 $ 31,818 $ 149,936 The following chart illustrates the geographic diversification of the loans underlying our portfolio of RMBS issued in AOMT securitization transactions as of December 31, 2021 (percentages are based on the aggregate unpaid principal balance of such loans): Geographic Diversification of Loans Underlying Our Portfolio of RMBS Issued in AOMT Securitization Transactions (as of December 31, 2021) Note: No state in “Other” represents more than a 4% concentration of the loans underlying our portfolio of RMBS issued in AOMT securitization transactions as of December 31, 2021. 75 The following chart illustrates the geographic diversification of the loans underlying our portfolio of RMBS issued in AOMT securitization transactions as of December 31, 2020 (percentages are based on the aggregate unpaid principal balance of such loans): Geographic Diversification of Loans Underlying Our Portfolio of RMBS Issued in AOMT Securitization Transactions (as of December 31, 2020) (1) No state in “Other” represents more than a 4% concentration of the loans underlying our portfolio of RMBS issued in AOMT securitization transactions as of December 31, 2020. 76 CMBS In November 2020, we participated in a securitization transaction of a pool of small balance commercial mortgage loans consisting of mortgage loans secured by commercial properties pursuant to which we contributed to AOMT 2020-SBC1 commercial mortgage loans with a carrying value of approximately $31.2 million that we had accumulated and held on our balance sheet, and we received bonds from AOMT 2020-SBC1 with a fair value of approximately $8.9 million. Certain information regarding the commercial mortgage loans underlying our portfolio of commercial mortgage-backed securities “CMBS” issued in the AOMT 2020-SBC1 securitization transaction is shown below as of December 31, 2021 and December 31, 2020: December 31, 2021 December 31, 2020 ($ in thousands) UPB of loans $140,360 $179,789 Number of loans 189 234 Weighted average loan coupon 7.4 % 7.4 % Average loan amount $743 $768 Weighted average LTV at loan origination and deal date 58.4 % 62.3 % The following table provides certain information with respect to the CMBS we received in connection with the AOMT 2020-SBC1 securitization transactions as of December 31, 2021 and December 31, 2020: December 31, 2021 December 31, 2020 CMBS Repurchase Debt Allocated Capital CMBS Repurchase Debt Allocated Capital (in thousands) Senior $ — $ — $ — $ — $ — $ — Mezzanine — — — — — — Subordinate 7,993 — 7,993 5,766 — 5,766 Interest only / excess 2,763 — 2,763 3,031 — 3,031 Total $ 10,756 $ — $ 10,756 $ 8,797 $ — $ 8,797 Liquidity and Capital Resources Overview Liquidity is a measurement of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund our investments and operating costs, make distributions to our stockholders, and satisfy other general business needs. Our financing sources currently include capital contributions from our investors prior to the IPO, the proceeds from the IPO and concurrent private placement, payments of principal and interest we receive on our investment portfolio, unused borrowing capacity under our in‑place loan financing lines and repurchase facilities, and securitizations of our whole loans. Going forward, we may also utilize other types of borrowings, including bank credit facilities and warehouse lines of credit, among others. We may also seek to raise additional capital through public or private offerings of equity, equity-related, or debt securities, depending upon market conditions. The use of any particular source of capital and funds will depend on market conditions, availability of these sources, and the investment opportunities available to us. We have used and expect to continue to use loan financing lines to finance the acquisition and accumulation of mortgage loans or other mortgage‑related assets pending their eventual securitization. Upon accumulating an appropriate amount of assets, we have financed and expect to continue to finance a substantial portion of our mortgage loans utilizing fixed rate term securitization funding that provides long‑term financing for our mortgage loans and locks in our cost of funding, regardless of future interest rate movements. Securitizations may either take the form of the issuance of securitized bonds or the sale of “real estate mortgage investment conduit” securities backed by mortgage loans or other assets, with the securitization proceeds being used in part to repay pre-existing loan financing lines and repurchase facilities. We have sponsored and participated in securitization transactions with other entities that are managed by Angel Oak, and may continue to do so in the future, along with sponsoring sole securitization transactions. We believe these identified sources of financing will be adequate for purposes of meeting our short‑term (within one year) and our longer‑term liquidity needs. We cannot predict with certainty the specific transactions we will undertake to generate sufficient liquidity to meet our obligations as they come due. We will adjust our plans as appropriate in response to changes in our expectations and any potential changes in market conditions. 77 Description of Existing Financing Arrangements As of December 31, 2021, we were a party to six loan financing lines, which permitted borrowings in an aggregate amount of up to $1.3 billion. Borrowings under these agreements may be used to purchase whole loans for securitization or loans purchased for long‑term investment purposes. A description of each loan financing line is set forth as follows: Nomura Loan Financing Line. On December 6, 2018, we and one of our subsidiaries entered into a master repurchase agreement with Nomura Corporate Funding Americas, LLC (“Nomura”). We are considered the “Seller” under this agreement. From time to time, we and one of our subsidiaries have amended such master repurchase agreement with Nomura. Pursuant to the agreement, we and our subsidiary may sell to Nomura, and later repurchase, up to $300.0 million aggregate borrowings on mortgage loans. The agreement expires on August 5, 2022, unless terminated earlier pursuant to the terms of the agreement. However, we are permitted to extend the expiration date by up to 364 additional days, subject to certain conditions being satisfied. The principal amount paid by Nomura for each eligible mortgage loan is based on a percentage of both the market value, unpaid principal balance and acquisition price of the mortgage loan (generally ranging from 65% to 92%, depending on the type of loan and certain other factors and subject to certain other adjustments). Pursuant to the agreement, Nomura retains the right to determine the market value of the mortgage loan collateral for certain mortgage loans in its sole and absolute discretion. Additionally, Nomura is under no obligation to purchase the eligible mortgage loans we offer to sell to them. Upon our or our subsidiary’s repurchase of the mortgage loan, we are, or our subsidiary is, required to repay Nomura the adjusted principal amount related to such mortgage loan plus accrued and unpaid interest at a rate based on the sum of (1) the greater of (a) one-month LIBOR or three‑month LIBOR (depending on the type of mortgage loan) and (b) the applicable LIBOR floor, and (2) a spread generally ranging from 1.70% to 3.50% depending on the type of loan. The agreement requires us to maintain various financial and other covenants, such as that: (1) adjusted tangible net worth on an aggregate basis must not be less than the sum of 50% of our adjusted tangible net worth as of the date of the agreement plus 50% of any future capital raised by us; (2) adjusted tangible net worth must not decline more than 25% in any rolling three month period or 35% in any rolling twelve month period; (3) the ratio of indebtedness to adjusted tangible net worth must not exceed 7:1; and (4) liquidity, on an aggregate basis, must exceed the greater of 5% of the aggregate purchase price and $2.0 million. The agreement contains margin call provisions that provide Nomura with certain rights in the event of a decline in the market value of the purchased mortgage loans. Under these provisions, Nomura may require us or our subsidiary to transfer cash and/or additional eligible mortgage loans with an aggregate market value sufficient to eliminate any margin deficit resulting from such a decline. In addition, the agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross‑defaults, material adverse effects, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the agreement and Nomura’s right to liquidate the mortgage loans then subject to the agreement. We and our subsidiary are also required to pay certain customary fees to Nomura and to reimburse Nomura for certain costs and expenses incurred in connection with Nomura’s structuring, management and ongoing administration of the agreement. Banc of California Loan Financing Line. On December 21, 2018, we and our subsidiary entered into a master repurchase agreement with Banc of California, National Association (“Banc of California”). We are considered a “Seller” under this agreement. From time to time, we and one of our subsidiaries have amended such master repurchase agreement with Banc of California. Pursuant to the agreement, we or our subsidiary may sell to Banc of California, and later repurchase, up to $50.0 million aggregate borrowings on mortgage loans. The agreement was set to expire on March 16, 2022, unless terminated earlier pursuant to the terms of the agreement; however, the agreement was amended on March 7, 2022 to expire on March 16, 2023, unless terminated earlier pursuant to the terms of the agreement. Additionally, the amendment increased the aggregate purchase price limit to $75.0 million from $50.0 million, and beginning March 8, 2022, provided that interest will accrue on any new transactions under the Loan Financing Line at a rate based on Term SOFR (which is defined as the forward-looking term rate based on the Secured Overnight Financing Rate for a corresponding tenor of one month) plus an additional spread. The principal amount paid by Banc of California for each mortgage loan is based on the lesser of (1) a percentage of the original principal amount of the mortgage loan (ranging from 75% to 97%) and (2) a percentage of its take‑out commitment (97%) or $4.0 million, depending on the loan type. Pursuant to the agreement, Banc of California retains the right to determine the market value of the mortgage loan collateral in its sole discretion. During the year ended December 31, 2021, upon our or our subsidiary’s repurchase of the mortgage loan, we are, or our subsidiary is, required to repay Banc of California the principal amount related to such mortgage loan plus accrued and unpaid interest at a rate (determined based on the type of loan) equal to the sum of (1) the greater of (A) a specified minimum rate (ranging from 3.50% to 4.13%) and (B) one‑month LIBOR plus a spread ranging from 2.50% to 3.13%, and (2) in the case of loans with maturities over 364 days, the seasoned spread of 1.0%. As discussed above, the LIBOR reference rate was changed to SOFR beginning March 8, 2022 and going forward. 78 The agreement requires us to maintain various financial and other covenants, which include: (1) a minimum tangible net worth of $40.0 million consolidated; (2) minimum liquidity of $5.0 million; (3) a maximum ratio of total liabilities to tangible net worth of 10:1; and (4) we must attain positive net income, determined in accordance with GAAP, as of the last day of each calendar quarter, commencing with the quarter ended June 30, 2021, for the prior four (4) consecutive fiscal quarters then ending. The agreement contains margin call provisions that provide Banc of California with certain rights in the event of a decline in the market value of the purchased mortgage loans. Under these provisions, Banc of California may require us or our subsidiary to transfer cash and/or additional eligible mortgage loans with an aggregate market value sufficient to eliminate any margin deficit resulting from such a decline. In addition, the agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross‑defaults, material adverse effects, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the agreement and Banc of California’s right to liquidate the mortgage loans then subject to the agreement. We and our subsidiary are also required to pay certain customary fees to Banc of California and to reimburse Banc of California for certain costs and expenses incurred in connection with Banc of California’s structuring, management and ongoing administration of the agreement. Deutsche Bank Loan Financing Line. On February 13, 2020, we and our subsidiary entered into a master repurchase agreement with Deutsche Bank, AG (“Deutsche Bank”). We are considered a “Seller” under this agreement. From time to time, we and one of our subsidiaries have amended such master repurchase agreement with Deutsche Bank. Pursuant to the agreement, we or our subsidiary may sell to Deutsche Bank, and later repurchase, up to $250.0 million aggregate borrowings on mortgage loans. The agreement, as amended previously, was set to expire on February 11, 2022. On February 4, 2022, the agreement was amended to expire on February 2, 2024, unless terminated earlier pursuant to the terms of the agreement. The principal amount paid by Deutsche Bank for each mortgage loan is based on a percentage of the market value, cost‑basis value or unpaid principal balance of the mortgage loan (generally ranging from 60% to 92%, depending on the type of loan and certain other factors and subject to certain other adjustments). Pursuant to the agreement, Deutsche Bank retains the right to determine the market value of the mortgage loan collateral in its sole good faith discretion. Additionally, Deutsche Bank is under no obligation to purchase the eligible mortgage loans we offer to sell to them. Prior to the February 2, 2024 amendment, upon our or our subsidiary’s repurchase of the mortgage loan, we or our subsidiary were required to repay Deutsche Bank the principal amount related to such mortgage loan plus accrued and unpaid interest at a rate (determined based on the type of loan) equal to the sum of (1) the greater of (A) 0.00% and (B) one‑month LIBOR and (2) a spread generally ranging from 2.00% to 3.25%. Pursuant to the amendment executed on February 4, 2022, interest will now accrue on any outstanding balance under the Master Repurchase Agreement at a rate based on Term SOFR (which is defined as the forward-looking term rate based on the Secured Overnight Financing Rate for a corresponding tenor of one month). Previously, interest accrued at a rate based on one-month LIBOR. Additionally, the agreement was also amended to remove any draw fees; and adjust the pricing rate whereby upon the Company’s or the subsidiary’s repurchase of a mortgage loan, the Company or the subsidiary is required to repay Deutsche Bank the principal amount related to such mortgage loan plus accrued and unpaid interest at a rate (determined based on the type of loan) equal to the sum of (A) the greater of (i) 0.00% and (ii) Term SOFR and (B) a spread generally ranging from 2.20% to 3.45%. The agreement requires us to maintain various financial and other covenants, which include: (1) our adjusted tangible net worth must be an amount at least equal to the greater of (A) $100.0 million and (B) 20% of the maximum aggregate purchase price limit; (2) our adjusted tangible net worth on the last day of any calendar quarter shall not decline by (A) 20% or more from the adjusted tangible net worth as of the last day of the immediately prior calendar quarter or (B) 40% or more from the adjusted tangible net worth as of the last day of the calendar quarter that is twelve months prior to such calendar quarter; (3) our liquidity must at least equal the greater of (A) $5.0 million and (B) 3.0% of the outstanding purchase price for such mortgage loans transferred to Deutsche Bank; and (4) our indebtedness to our adjusted tangible net worth must not exceed 5.5:1. The agreement contains margin call provisions that provide Deutsche Bank with certain rights in the event of a decline in the market value or cost‑basis value of the purchased mortgage loans. Under these provisions, Deutsche Bank may require us or our subsidiary to transfer cash sufficient to eliminate any margin deficit resulting from such a decline. In addition, the agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross‑defaults, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the agreement and Deutsche Bank’s right to liquidate the mortgage loans then subject to the agreement. We and our subsidiary are also required to pay certain customary fees to Deutsche Bank and to reimburse Deutsche Bank for certain costs and expenses incurred in connection with Deutsche Bank’s structuring, management and ongoing administration of the agreement. 79 Goldman Loan Financing Line. On March 5, 2021, we and our subsidiary entered into a master repurchase agreement with Goldman Sachs Bank USA (“Goldman”). We are considered a “Seller” under this agreement. Pursuant to the agreement, we or our subsidiary may sell to Goldman, and later repurchase, up to $200.0 million aggregate borrowings on mortgage loans. The agreement was set to expire on March 5, 2022, unless terminated earlier pursuant to the terms of the agreement; however, was extended on March 2, 2022 to expire on March 5, 2023, unless terminated earlier pursuant to the terms of the agreement. The principal amount paid by Goldman for each eligible mortgage loan is based on a percentage of the outstanding principal balance of the mortgage loan or the market value of the mortgage loan (generally ranging from 75% to 85%, depending on the type of loan), whichever is less. Pursuant to the agreement, Goldman retains the right to determine the market value of the mortgage loan collateral in its sole good faith discretion and in a commercially reasonable manner. The loan financing line is marked‑to‑market at fair value. Additionally, Goldman is under no obligation to purchase the eligible mortgage loans we offer to sell to them. During the years ended December 31, 2021 and 2020, upon our or our subsidiary’s repurchase of the mortgage loan, we were, or our subsidiary was, required to repay Goldman the principal amount related to such mortgage loan plus accrued interest generally at a rate based on three‑month LIBOR plus 2.25%. On January 1, 2022, the LIBOR-based index was replaced by reference to the sum of Compounded SOFR and a SOFR adjustment of 20 basis points. Compounded SOFR is determined on a one-month basis and is defined as a daily rate as determined by Goldman to be the “USD-SOFR-Compound” rate as defined in the International Swaps and Derivatives Association, Inc. definitions. The agreement requires us to maintain various financial and other covenants, such as that: (1) our minimum tangible net worth of must not decline 20% or more in the previous 30 days, 25% or more in the previous 90 days, or 35% or more in the previous year, or fall below 50% of our tangible net worth as of September 30, 2018 plus 50% of any capital contributions made after that date; (2) our minimum liquidity must not fall below the greatest of (x) the product of 5% and the aggregate repurchase price as of such date of determination, (y) $5 million and (z) any other amount of liquidity that we have covenanted to maintain in any other note, indenture, loan agreement, guaranty, swap agreement or any other contract, agreement or transaction (including, without limitation, any repurchase agreement, loan and security agreement, or similar credit facility or agreement for borrowed funds); and (3) the maximum ratio of our and our subsidiaries’ total indebtedness to tangible net worth must not be greater than 5:1. The agreement contains margin call provisions that provide Goldman with certain rights in the event of a decline in the market value of the purchased mortgage loans. Under these provisions, Goldman may require us or our subsidiary to transfer cash sufficient to eliminate any margin deficit resulting from such a decline. In addition, the agreement contains events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross‑defaults, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the principal amount outstanding under the agreement and Goldman’s right to liquidate the mortgage loans then subject to the agreement. We and our subsidiary are also required to pay certain customary fees to Goldman and to reimburse Goldman for certain costs and expenses incurred in connection with Goldman’s structuring, management and ongoing administration of the agreement. Veritex Financing Line. On August 16, 2021, we and our subsidiaries entered into a non-mark-to-market $50.0 million committed financing facility with Veritex Community Bank (“Veritex”) through the execution of a Loan and Security Agreement (the “Loan and Security Agreement”) and a Promissory Note (the “Promissory Note” and together with the Loan and Security Agreement, the “Facility Documents”) among those subsidiaries and Veritex. Pursuant to the Facility Documents, Veritex agreed to make one or more advances to one or more of the subsidiaries of the Company (together, the “Borrowers”) secured by mortgage loans, notes and related collateral (the “Veritex Financing Line”). On February 11, 2022, the Company amended the financing facility to increase the size of the financing facility to $75.0 million from $50.0 million. The Veritex Financing Line expires, and amounts outstanding under the Veritex Financing Line will mature, on August 16, 2023, subject to certain exceptions. The amount advanced by Veritex for each eligible loan is based on the unpaid principal balance of the loan, the loan-to-value ratio of the loan and the FICO score of the borrower and ranges from 80.00% to 92.50% depending on the type of loan and the aforementioned criteria. Prior to the February 11, 2022 amendment, the interest rate on any outstanding balance under the Facility Documents is the greater of (1) the sum of (A) one-month LIBOR and (B) 2.30%, and (2) 3.13%. After the February 11, 2022 amendment, interest will accrue on any outstanding balance at a rate based on Term SOFR plus a margin equal to 2.41% per annum; provided that the interest rate may not be less than 3.125% per annum. The obligations of the Borrowers under the Facility Documents are guaranteed by the Company pursuant to a Guaranty Agreement (the “Guaranty”) executed contemporaneously with the Facility Documents. In addition, the Company is subject to various financial and other covenants, including, as of the last day of any fiscal quarter: (1) the Company’s tangible net worth must be at least equal to $150.0 million; (2) the Company’s ratio of (A) EBITDA to (B) debt service shall be at least equal to 1.25 to 1.0 for such quarter; (3) the Company’s ratio of total liabilities to total tangible net worth must not exceed 5.5 to 1.0; and (4) the Company’s liquidity must at least equal $5.0 million. In addition, the Facility Documents contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, bankruptcy or insolvency proceedings and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of 80 transaction and include acceleration of the principal amount outstanding under the Facility Documents and Veritex’s right to liquidate the collateral then subject to the Facility Documents. The Borrowers are also required to pay certain customary fees to Veritex and to reimburse Veritex for certain costs and expenses incurred in connection with Veritex’s management and ongoing administration of the Veritex Financing Line. Barclays Financing Line. On September 20, 2021, we and one of our subsidiaries (the “Subsidiary”) entered into a $400.0 million repurchase facility (the “Barclays Financing Line”) with Barclays Bank PLC (“Barclays”) through the execution of a Master Repurchase Agreement (the “Master Repurchase Agreement”) between the Subsidiary and Barclays. Pursuant to the Master Repurchase Agreement, the Subsidiary may sell certain securities to Barclays representing whole loan assets and later repurchase such securities from Barclays. The Master Repurchase Agreement expires on September 20, 2022, unless terminated earlier pursuant to the terms of the Master Repurchase Agreement. On January 27, 2022, this repurchase facility was amended to to state that interest will accrue on any outstanding balance at a rate based on Term SOFR and increase the maximum purchase price permitted under the Master Repurchase Agreement to $550.0 million from $400.0 million, which is subject to reduction to $400.0 million upon the earlier to occur of (1) the issuance of securities pursuant to a securitization of the assets underlying the Master Repurchase Agreement and (2) March 30, 2022. The amount expected to be advanced by Barclays is generally in line with other similar agreements that the Company or one of its subsidiaries has entered into, which is a percentage of the unpaid principal balance or market value of the asset depending on the type of underlying asset. Prior to the January 27, 2022 amendment, the interest rate on any outstanding balance under the Master Repurchase Agreement that the Subsidiary was required to pay Barclays was generally in line with other similar agreements that the Company or one of its subsidiaries has entered into, where the interest rate was equal to the sum of (1) a spread ranging from 1.70% to 3.50%, determined based on the type of underlying asset, and (2) one-month or three-month LIBOR. Additionally, Barclays is under no obligation to purchase the securities we offer to sell to them. The obligations of the Subsidiary under the Master Repurchase Agreement are guaranteed by the Company pursuant to a Guaranty (the “Guaranty”) executed contemporaneously with the Master Repurchase Agreement. In addition, and similar to other repurchase agreements that the Company has entered into, the Company is subject to various financial and other covenants, including those relating to (1) declines in tangible net worth; (2) a maximum ratio of indebtedness to tangible net worth; and (3) minimum liquidity. In addition, the Master Repurchase Agreement and Guaranty contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, insolvency and other events of default customary for this type of transaction. The remedies for such events of default are also customary for this type of transaction and include the acceleration of the amounts outstanding under the Master Repurchase Agreement and Barclays’ right to liquidate the purchased securities then subject to the Master Repurchase Agreement. The Subsidiary is also required to pay certain customary fees to Barclays and to reimburse Barclays for certain costs and expenses incurred in connection with Barclays’ management and ongoing administration of the Master Repurchase Agreement. The following table sets forth the details of our financing lines as of each of December 31, 2021 and 2020: Drawn Amount Line of Credit Facility Limit Base Interest Rate Interest Rate Spread December 31, 2021 December 31, 2020 ($ in thousands) Barclays Bank PLC (1) $ 400,000 1 month LIBOR 1.70% - 3.50% $ 362,899 N/A Nomura Corporate Funding Americas, LLC (2) 300,000 1 month or 3 month LIBOR 1.70% - 3.50% 103,149 $ 8,011 Deutsche Bank, AG (3) 250,000 1 month LIBOR 2.00% - 3.25% 231,981 34,905 Goldman Sachs Bank USA (4) 200,000 3 month LIBOR 2.25% 109,283 N/A Banc of California, National Association (5) 50,000 1 month LIBOR 2.50% - 3.13% 34,838 38,989 Veritex Community Bank (6) 50,000 1 month LIBOR 2.30% 11,258 N/A Total $ 1,250,000 $ 853,408 $ 81,905 (1) On September 20, 2021, the Company entered into a $400.0 million repurchase facility with Barclays Bank PLC which expires on September 20, 2022. On January 27, 2022, this repurchase facility was amended to to state that interest will accrue on any outstanding balance at a rate based on Term SOFR and increase the maximum purchase price permitted under the Master Repurchase Agreement to $550.0 million from $400.0 million, which is subject to reduction to $400.0 million upon the earlier to occur of (1) the issuance of securities pursuant to a securitization of the assets underlying the Master Repurchase Agreement and (2) March 30, 2022. (2) On August 6, 2021, this facility was amended to extend the expiration date from December 3, 2021 to August 5, 2022, add the one-month LIBOR as a base interest rate for certain loans, and change the interest rate spread to 1.70% (from 1.75%) to 3.50%. 81 (3) On June 21, 2021, this facility was amended to increase the facility limit from $150.0 million to $250.0 million. This facility expires on February 11, 2022. On February 4, 2022, this facility was amended to state that interest will accrue on any outstanding balance at a rate based on Term SOFR. Additionally, the agreement was amended to (1) adjust the initial termination date of the Master Repurchase Agreement from February 11, 2022 to February 2, 2024; (2) remove any draw fees; and (3) adjust the pricing rate whereby upon the Company’s or the Subsidiary’s repurchase of a mortgage loan, the Company or the Subsidiary is required to repay Deutsche Bank the principal amount related to such mortgage loan plus accrued and unpaid interest at a rate (determined based on the type of loan) equal to the sum of (A) the greater of (i) 0.00% and (ii) Term SOFR and (B) a spread generally ranging from 2.20% to 3.45%. (4) This agreement was entered into on March 5, 2021, and was set to expire on March 5, 2022. On January 1, 2022, the agreement was amended to replace a LIBOR-based index rate with a SOFR-based index rate. On March 2, 2022, the agreement was extended to expire on March 5, 2023, unless terminated earlier pursuant to the terms of the agreement. (5) This agreement was set to expire on March 16, 2022. On March 7, 2022, the agreement was amended to expire on March 16, 2023, unless terminated earlier pursuant to the terms of the agreement. Additionally, the amendment increased the aggregate purchase price limit to $75.0 million from $50.0 million, and beginning March 8, 2022, provided that interest will accrue on any new transactions under the Loan Financing Line at a rate based on Term SOFR (which is defined as the forward-looking term rate based on the Secured Overnight Financing Rate for a corresponding tenor of one month) plus an additional spread. (6) On August 16, 2021, the Company entered into a financing facility with Veritex Community Bank, which expires on August 16, 2023. On February 11, 2022, the Company amended the financing facility to (1) increase the size of the financing facility to $75.0 million from $50.0 million, and (2) interest will accrue on any outstanding balance at a rate based on Term SOFR plus a margin equal to 2.41% per annum; provided that the interest rate may not be less than 3.125% per annum. Short‑Term Repurchase Facilities. In addition to our existing loan financing lines, we employ short‑term repurchase facilities to borrow against U.S. Treasury securities, securities issued by AOMT, Angel Oak’s securitization platform, and other securities we may acquire in accordance with our investment guidelines. As of December 31, 2021, there was approximately $609.3 million outstanding under these repurchase facilities, with a weighted average interest rate of 0.15%. The following table sets forth certain characteristics of our short-term repurchase facilities as of December 31, 2021 and 2020: December 31, 2021 Repurchase Agreements Amount Outstanding Weighted Average Interest Rate Weighted Average Remaining Maturity (Days) ($ in thousands) U.S Treasury Bills $ 248,750 0.12 % 6 RMBS 360,501 0.16 % 18 Total $ 609,251 0.15 % 13 December 31, 2020 Repurchase Agreements Amount Outstanding Weighted Average Interest Rate Weighted Average Remaining Maturity (Days) ($ in thousands) U.S Treasury Bills $ 149,618 0.25 % 19 RMBS 28,673 1.40 % 19 Total $ 178,291 0.44 % 19 82 The following table presents the amounts of collateralized borrowings outstanding under repurchase facilities as of the end of each quarter, the average amount of collateralized borrowings outstanding under repurchase facilities during the quarter and the highest balance of any month end during the quarter: Quarter End Quarter End Balance Average Balance in Quarter Highest Month-End Balance in Quarter (in thousands) Q1 2020 $ 578,860 $ 85,822 $ 578,860 Q2 2020 587,375 69,712 587,375 Q3 2020 50,541 139,439 50,541 Q4 2020 178,291 41,866 178,291 Q1 2021 27,796 57,470 27,796 Q2 2021 787,176 407,486 787,176 Q3 2021 489,287 173,265 489,287 Q4 2021 609,251 206,897 609,251 We utilize short‑term repurchase facilities on our RMBS portfolio and to finance assets for REIT asset test purposes. Over time, the need to purchase securities for REIT asset test purposes will be reduced as we obtain and participate in additional securitizations and acquire assets directly for investment purposes. We will continue to use repurchase facilities on our RMBS portfolio to add additional leverage which increases the yield on those assets. Our use of repurchase facilities is generally highest at the end of any particular quarter, as shown in the table above, where the quarter-end balance and the highest month-end balance in each quarter are equivalent. We may continue to purchase securities for REIT asset test purposes, although it is expected that, in the future, we may need to purchase fewer (or no) securities as we participate in additional securitizations and retain our pro rata share of securities issued in securitization transactions or acquire assets directly into the Operating Partnership. Securitization Transactions In November 2021, we were the sole participant in a securitization transaction of a pool of residential mortgage loans, a substantial majority of which were non‑QM loans originated by our affiliate mortgage origination companies, secured primarily by first liens on one‑to‑four family residential properties. In the transaction, AOMT 2021-7 issued approximately $386.9 million in face value of bonds. We used the proceeds of the securitization transaction to repay outstanding debt of approximately $331.8 million and retained cash of $39.8 million, which was used to acquire additional non‑QM loans, pay down repurchase facilities, and acquire other target assets. We own and hold the call rights on the XS tranche of bonds, which is the “controlling class” of the bonds. Given the accounting rules surrounding this type of transaction, we have consolidated the AOMT 2021-7 securitization on our consolidated balance sheet, maintaining the residential mortgage loans held in the securitization trust and the related financing obligation thereto on our consolidated balance sheet as of December 31, 2021. In August 2021, we were the sole participant in a securitization transaction of a pool of residential mortgage loans, a substantial majority of which were non‑QM loans originated by our affiliate mortgage origination companies, secured primarily by first liens on one‑to‑four family residential properties. In the transaction, AOMT 2021-4 issued approximately $316.6 million in face value of bonds. We used the proceeds of the securitization transaction to repay outstanding debt of approximately $249.0 million and retained cash of $55.8 million, which was used to acquire additional non‑QM loans, pay down repurchase facilities, and acquire other target assets. We own and hold the call rights on the XS tranche of bonds, which is the “controlling class” of the bonds. Given the accounting rules surrounding this type of transaction, we have consolidated the AOMT 2021-4 securitization on our consolidated balance sheet, maintaining the residential mortgage loans held in the securitization trust and the related financing obligation thereto on our consolidated balance sheet as of December 31, 2021. In June 2020, we participated in a securitization transaction of a pool of residential mortgage loans, a substantial majority of which were non‑QM loans, secured primarily by first or second liens on one‑to‑four family residential properties. In the transaction, AOMT 2020‑3 issued approximately $530.3 million in face value of bonds. We served as the “sponsor” (as defined in the U.S. Risk Retention Rules) of the transaction, contributing non‑QM loans with a carrying value of approximately $482.9 million that we had accumulated and held on our balance sheet to AOMT 2020‑3. We received bonds from AOMT 2020‑3 with a fair value of approximately $66.5 million, including approximately $23.0 million in horizontal risk retention securities (representing 5% of the fair value of the securities and other interests issued as part of the transaction). We used the proceeds of the securitization transaction to repay outstanding debt of approximately $394.4 million and retained cash of $42.3 million, which was used to acquire additional non‑QM loans, pay down repurchase facilities, and acquire other target assets. 83 We, along with other Angel Oak managed entities, have also participated together in a commercial mortgage loan securitization. In November 2020, we participated in a securitization transaction of a pool of small balance commercial mortgage loans consisting of mortgage loans secured by commercial properties. In the transaction, AOMT 2020-SBC1 issued approximately $164.3 million in face value of bonds. We contributed commercial mortgage loans with a carrying value of approximately $31.2 million that we had accumulated and held on our balance sheet to AOMT 2020-SBC1, and we received bonds from AOMT 2020-SBC1 with a fair value of approximately $8.9 million. We used the proceeds of the securitization transaction to repay outstanding debt of approximately $16.6 million and retained cash of $8.2 million, which was used to acquire additional non-QM loans and other target assets. An affiliate of Wells Fargo Securities, LLC, one of the underwriters in this offering, serves as the securities administrator for AOMT 2020-SBC1 and is responsible for, among other things, calculating and making distributions to the securitization’s certificate holders. Leverage and Hedging Strategies We finance our assets with what we believe to be a prudent amount of leverage, which will vary from time to time based upon the particular characteristics of our portfolio, availability of financing and market conditions. Subject to maintaining our qualification as a REIT and maintaining our exclusion from regulation as an investment company under the Investment Company Act, we expect to utilize various derivative instruments and other hedging instruments to mitigate interest rate risk, credit risk and other risks. For example, we may opportunistically enter into hedging transactions with respect to interest rate exposure on one or more of our assets or liabilities. Any such hedging transactions could take a variety of forms, including the use of derivative instruments such as interest rate swap contracts, index swap contracts, interest rate cap or floor contracts, futures or forward contracts, and options. Cash Flows For the Years Ended December 31, 2021 December 31, 2020 (in thousands) Cash flows provided by (used in) operating activities $ (1,567,946) $ 34,409 Cash flow used in investing activities $ (460,484) $ (52,436) Cash flows provided by financing activities $ 2,034,766 $ 54,798 Net increase (decrease) in cash and restricted cash $ 6,336 $ 36,771 Operating cash flows of $(1.6) billion for the year ended December 31, 2021 as compared to $34.4 million for the year ended December 31, 2020 were primarily due to the purchase of additional residential mortgage loans during the year ended December 31, 2021. Investing cash flows of $(460.5) million for the year ended December 31, 2021 as compared to $(52.4) million for the year ended December 31, 2020 were primarily due to the purchase of AOMT and other non-Agency RMBS during the year ended December 31, 2021, along with certain quarter-end purchases of whole pool Agency RMBS and U.S. Treasury securities, which was partially offset by sales of the whole pool Agency RMBS and U.S. Treasury securities subsequent to quarter-end. Financing cash flows of $2.0 billion for the year ended December 31, 2021 as compared to $54.8 million for the year ended December 31, 2020. This increase was due to proceeds from securitization activities (AOMT 2021-4 and AOMT 2021-7), and borrowings on notes payable and repurchase facilities, as well as proceeds received from the IPO, contributions received from our former sole stockholder, and proceeds received from our private placement concurrent with the IPO. Cash Flows - Residential and Commercial Loan Classification Residential loan activity is recognized in the statement of cash flows as an operating activity, as our residential mortgage loans are generally held for a short period of time with the intent to securitize these loans. Commercial mortgage loan activity is recognized in the statement of cash flows as an investing activity, as our commercial mortgage loan portfolio is generally deemed to be held for investing purposes. Recent Accounting Pronouncements Refer to the notes to our consolidated financial statements included in Part II, Item 8, Footnote 2, of this Annual Report on Form 10-K for a discussion of recent accounting pronouncements and any expected impact on us. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. Actual results could differ from those estimates. We expect quarter-to-quarter GAAP earnings volatility 84 from our business activities. This volatility can occur for a variety of reasons, particularly changes in the fair values of consolidated assets and liabilities. In addition, the amount or timing of our reported earnings may be impacted by technical accounting issues and estimates. Management discusses the ongoing development and selection of the critical accounting policies as set forth below with the Audit Committee of our Board of Directors: Fair Value Measurements We report various investments at fair value, including certain eligible financial instruments elected to be accounted for under the fair value option. A fair value measurement represents the price at which an orderly transaction would occur between willing market participants at the measurement date. This definition of fair value focuses on exit price and prioritizes the use of market-based inputs over entity-specific inputs when determining fair value. Inputs may be observable or unobservable. • Observable inputs are inputs that reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity. • Unobservable inputs are inputs that reflect the reporting entity’s own assumptions. A fair value hierarchy for inputs is implemented in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs are used when available. The availability of valuation techniques and the ability to attain observable inputs can vary from investment to investment and are affected by a wide variety of factors, including the type of investment, whether the investment is newly issued and not yet established in the marketplace, the liquidity of markets, and other characteristics particular to the transaction. The fair value hierarchy is categorized into three broad levels based on the inputs as follows: Level 1 — Valuations based on unadjusted, quoted prices in active markets for identical assets or liabilities. Level 2 — Valuations based on quoted prices in an inactive market, or whose values are based on models — but the inputs to those models are observable either directly or indirectly for substantially the full term of the assets and liabilities. Level 2 inputs include the following: a) Quoted prices for similar assets and liabilities in active markets (e.g., restricted stock); b) Quoted prices for identical or similar assets and liabilities in non-active markets (e.g., corporate and municipal bonds); c) Pricing models whose inputs are observable for substantially the full term of the assets and liabilities (e.g., OTC derivatives); and d) Pricing models whose inputs are derived principally from or corroborated by observable market data through correlation or other means for substantially the full term of the asset or liability (e.g., residential and commercial mortgage-related assets, including whole loans, securities, and derivatives). Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement. Valuation of these assets is typically based on our Manager's own assumptions or expectations based on the best information available. The degree of judgment exercised in determining fair value is greatest for investments categorized in Level 3. The inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the actual level is determined based on the level of inputs that is most significant to the fair value measurement in its entirety. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Because of the inherent uncertainty of valuation, those estimated values may be materially higher or lower than the values that would have been used had a ready market for the investments existed. Accordingly, the degree of judgment exercised in determining fair value is greatest for investments categorized in Level 3. Transfers, if any, between levels are determined by us on the first day of the reporting period. Valuation estimates are subject to uncertainty due to inherently subjective valuation inputs. The most significant valuation estimates to us are those for residential mortgage loans and Non-Agency RMBS, as those two categories of assets are the largest assets on our balance sheet subject to Level 2 or Level 3 valuation estimates. The assumptions regarding valuations for the asset categories are described as follows: • Residential Mortgage Loans - The Company recognizes residential mortgage loans at fair value. The fair value of the residential mortgage loans is predominantly based on trading activity observed in the marketplace, provided by a third‑party pricing service. The third‑party pricing service obtains comparative pricing from banks, brokers, hedge funds, REITs and from its own 85 brokerage business. The third‑party pricing service also maintains a spread matrix created from trading levels observed in the secondary market and from indications of holding values in client investments. The spreads are meant to depict the required spread demanded by investors in the current environment. The matrix is segregated by loan structure type (hybrid arm, fixed rate, home equity line of credit, second lien, pay option arm, etc.), delinquency status, and loan to value strata. Significant matrix inputs are analyzed at the loan level. The performing residential mortgage loans are categorized as Level 2 in the fair value hierarchy, while non‑performing loans are categorized as Level 3 given their limited marketability and availability of observable valuation inputs. Both Level 2 and Level 3 loans matrix inputs include collateral behavioral models including prepayment rates, default rates, loss severity, and discount rates. • Non‑Agency RMBS (“Non‑Agency”) - Non‑Agencies consist of investments in collateralized mortgage obligations. The Company utilizes Price Serve , Bank of America’s independent fixed income pricing service, as the primary valuation source for the investments. Price Serve obtains its price quotes from actual sales or quotes for sale of the same or similar securities and/or provides model‑based valuations that consider inputs derived from recent market activity including default rates, conditional prepayment rates, loss severity, expected yield to maturity, baseline DM/Yield, recovery assumptions, tranche type, collateral coupon, age and loan size and other inputs specific to each security. These quotes are most reflective of the price that would be achieved if the security was sold to an independent third party on the date of the consolidated financial statements. Non‑Agencies are categorized in Level 2 of the fair value hierarchy. Variable Interest Entities A VIE is defined as an entity in which equity investors (1) do not have the characteristics of a controlling financial interest, and/or (2) do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. A VIE is required to be consolidated by its primary beneficiary, which is defined as the party that has both (a) the power to control the activities that most significantly impact the VIE's economic performance and (b) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. For VIEs that do not have substantial on-going activities, the power to direct the activities that most significantly impact the VIE’s economic performance may be determined by an entity’s involvement with the design and structure of the VIE. VIEs for which we are considered to be the primary beneficiary: Determining the primary beneficiary of a VIE requires judgment. We determined that for the securitizations we consolidate, our ownership provides us with the obligation to absorb losses or the right to receive benefits from the VIE that could be significant to the VIE. In addition, we have the power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance, or power, such as rights to replace the servicer without cause or we were determined to have power in connection with our involvement with the structure and design of the VIE. The securitization trusts are structured as entities that receive principal and interest on the underlying collateral and distribute those payments to the security holders. The assets held by the securitization entities are restricted in that they can only be used to fulfill the obligations of the securitization entity. Our risks associated with our involvement with these VIEs are limited to our risks and rights as a holder of the security we have retained as well as certain risks which may occur when the we act as either the sponsor and/or depositor of and the seller, directly or indirectly to, the securitization entities. Our interest in the assets held by consolidated securitization vehicles, which are consolidated on our consolidated balance sheets, is restricted by the structural provisions of these trusts, and a recovery of our investment in the vehicles will be limited by each entity’s distribution provisions. The liabilities of the securitization vehicles, which are also consolidated on our consolidated balance sheets, are non-recourse to us, and can only be satisfied using proceeds from each securitization vehicle’s respective asset pool. The assets of securitization entities are comprised of RMBS or residential mortgage loans. VIEs for which we are not considered to be the primary beneficiary: We perform ongoing reassessments of whether changes in the facts and circumstances regarding our involvement with a VIE causes our consolidation conclusion to change. 86 Item 7A. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, we are not required to provide this information. 87