Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Executive Summary
We are a Maryland real estate investment trust, or "REIT," formed in August 2012 that specializes in acquiring, investing in, and managing residential mortgage- and real estate-related assets. Our primary objective is to generate attractive current yields and risk-adjusted total returns for our shareholders by making investments that we believe compensate us appropriately for the risks associated with them. We seek to attain this objective by constructing and actively managing a portfolio consisting primarily of residential mortgage-backed securities, or "RMBS," for which the principal and interest payments are guaranteed by a U.S. government agency or a U.S. government-sponsored entity, or "Agency RMBS," and, to a lesser extent, RMBS that do not carry such guarantees, or "non-Agency RMBS," such as RMBS backed by prime jumbo, Alternative A-paper, mortgage loans that are not deemed "qualified mortgage," or "QM," loans under the rules of the Consumer Financial Protection Bureau, or "non-QM loans," mortgages on single-family-rental properties, manufactured housing, and subprime residential mortgage loans. We also may opportunistically acquire other types of mortgage- and real estate-related asset classes, such as commercial mortgage-backed securities, or "CMBS," residential mortgage loans, mortgage servicing rights, or "MSRs," and credit risk transfer securities, or "CRTs." We believe that being able to combine Agency RMBS with non-Agency RMBS and other mortgage- and real estate-related asset classes enables us to balance a range of mortgage-related risks.
We were formed through an initial strategic venture among affiliates of Ellington Management Group, L.L.C., an investment management firm and registered investment adviser with a 26-year history of investing in a broad spectrum of residential and commercial mortgage-backed securities, or "MBS," and related derivatives, with an emphasis on the RMBS market, and the Blackstone Tactical Opportunity Funds, or the "Blackstone Funds." As of December 31, 2020, the Blackstone Funds owned approximately 26.8% of our outstanding common shares. We are externally managed and advised by our Manager, an affiliate of Ellington.
We use leverage in our Agency RMBS strategy and, while we have not done so meaningfully to date, we may use leverage in our non-Agency RMBS strategy as well, although we expect such leverage to be lower. We have financed our purchases of Agency RMBS exclusively through repurchase agreements, which we account for as collateralized borrowings. As of December 31, 2020, we had outstanding borrowings under repurchase agreements in the amount of $1.0 billion with 15 counterparties.
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We have elected to be taxed as a REIT for U.S. federal income tax purposes. Accordingly, we generally will not be subject to U.S. federal income taxes on our taxable income that we distribute currently to our shareholders as long as we maintain our qualification as a REIT. We intend to conduct our operations so that neither we nor any of our subsidiaries is required to register as an investment company under the Investment Company Act of 1940, as amended, or the "Investment Company Act."
As of December 31, 2020, our book value per share was $13.48, as compared to $12.91 as of December 31, 2019.
Trends and Recent Market Developments
Market Overview
• After lowering the target range for the federal funds rate three times in 2019, the U.S. Federal Reserve, or "Federal Reserve," elected to maintain its target range of 1.50%–1.75% at its January 2020 meeting, but noted concerns about the spread of the novel coronavirus disease ("COVID-19") in its minutes. As the first quarter of 2020 progressed and COVID-19 spread, economic activity declined as countries around the world implemented social-distancing restrictions; unemployment claims surged and GDP growth forecasts were revised downward as the market began to price in a global recession. In March, macroeconomic conditions worsened, and financial markets experienced extreme volatility and dislocations. In response, the Federal Reserve implemented two emergency interest rate cuts totaling 150 basis points, resumed its asset purchases at an unprecedented pace, added additional liquidity to repo markets, and formed several credit facilities to stabilize markets. The White House and U.S. Congress passed three rounds of stimulus packages, culminating in the $2 trillion CARES Act on March 27th, the largest emergency spending bill in history. In April, the Federal Reserve expanded many of its stimulus programs to provide up to $2.3 trillion in additional capital. Similarly, central banks and governments around the globe responded swiftly and aggressively with interest rate cuts, quantitative easing programs, and stimulus packages.
While these efforts were successful in stabilizing markets, the negative economic impact of COVID-19 persisted, and the Federal Reserve continued its accommodative monetary policy throughout the rest of 2020, including maintaining its target range of 0.00%–0.25% for the federal funds rate; purchasing significant amounts of U.S. Treasury securities, Agency RMBS, and other eligible collateral pursuant to the asset purchase programs it outlined earlier in the year; and extending or expanding several of its liquidity support programs. At its final meeting of 2020, in December, the Federal Reserve noted that "the COVID-19 pandemic is causing tremendous human and economic hardship across the United States and around the world. Economic activity and employment have continued to recover but remain well below their levels at the beginning of the year." The Federal Reserve reiterated that it "is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals." The Federal Reserve also directed the Open Market Desk to increase its holdings of Treasury securities by $80 billion per month, and of Agency RMBS by $40 billion per month.
Finally, just prior to year end 2020, Congress and the administration approved an additional $900 billion of COVID-related stimulus and economic aid.
• Interest rates dropped dramatically during the first quarter of 2020, as the spread of COVID-19 prompted a flight to safety. Between February 12th and March 9th, the 10-year U.S. Treasury yield plummeted 109 basis points to a record low of 0.54%, before rebounding to 1.19% less than two weeks later, and then declining to 0.67% as of March 31st. U.S. Treasury yields fell across the yield curve over the course of the quarter, with yields on 3-month Treasury bills down 148 basis points, yields on the 2-year U.S. Treasury down 132 basis points, and yields on the 10-year U.S. Treasury down 125 basis points. On March 9th, the MOVE index, which measures U.S. interest rate volatility, reached its highest point since the 2008-2009 financial crisis.
During the second and third quarters, interest rate volatility subsided considerably and U.S. Treasury yields continued to hover near all-time lows. During this six-month period, the 10-year U.S. Treasury yield traded in a remarkably tight 39-basis-point rage, compared to a 134-basis-point range in the first quarter. At September 30th, the 10-year U.S. Treasury yield was 0.68%, virtually unchanged from March 31st and only 14 basis points above the record low reached in March. After reaching its highest point since the 2008–2009 financial crisis in March, the MOVE index had reverted to pre-COVID-19 levels by mid-April and continued to decline through the third quarter, hitting an all-time low at the end of September.
During the fourth quarter, long-term interest rates rose modestly and the U.S. Treasury yield curve steepened, with the 10-year U.S. Treasury yield increasing 23 basis points to finish the year at 0.91%, and the 2-year U.S. Treasury yield up just 1 basis point to 0.12%. The yield spread between the 2-year and 10-year U.S. Treasury increased to 79 basis
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points from 56 basis points at the end of the third quarter. The MOVE index increased modestly in October, before reverting to lower levels in November and December.
• Mortgage rates declined during each quarter of 2020, setting new all-time lows at several points during the year. Over the course of the year, the Freddie Mac survey 30-year mortgage declined 107 basis points to 2.67% at December 31, 2020. Refinancing applications surged with the declining mortgage rates. On March 6th, the Mortgage Bankers Association's Refinance Index, which measures refinancing application volumes, increased 79% to its highest level since April 2009. Although refinancing applications declined after March, they remained elevated throughout the year, at levels not seen since 2013. Overall Fannie Mae 30-year MBS prepayments increased steadily during the year, from a CPR of 17.0 in December 2019 to an 8-year high of 37.2 CPR in October 2020, before finishing the year at 35.6 CPR.
• In connection with the Federal Reserve actions, LIBOR rates, which drive many of our financing costs, declined sharply during the first half of 2020. Between December 31, 2019, and June 30, 2020, one-month LIBOR declined 160 basis points to 0.16%, and three-month LIBOR fell 161 basis points to 0.30%. LIBOR rates remained low during the second half of the year, with one-month LIBOR finishing the year at 0.14% and three-month LIBOR at 0.24%.
• U.S. real GDP declined at an annualized rate of 5.0% in the first quarter and then 31.4% in the second quarter, reflecting the negative impact of the COVID-19 pandemic and associated measures to contain it. The GDP growth rate bounced back in the third quarter, increasing at estimated annualized rates of 33.4%, before slowing in the fourth quarter to an estimated annualized rate of 4.1%.
• The sudden and significant decline in economic activity and implementation of social-distancing restrictions caused unemployment claims to rise significantly in 2020. U.S. employers reported a reduction of 701,000 jobs in March, and unemployment claims surged to 38.5 million in the second quarter. The unemployment rate spiked to 11.1% at June 30th, from 4.4% at March 31st. Unemployment claims totaled 14.1 million in the third quarter and 10.3 million in the fourth quarter, both down significantly from the second quarter but still well above historical averages. The unemployment rate dropped to 6.7% at December 31st, down from 7.8% at September 30th, 11.1% at June 30th and 14.8% at the April 30th peak. However, the U.S. lost 140,000 jobs in December, the first month of net job losses since the spring, which muddled the outlook going forward.
• With the economic slowdown and spike in unemployment, forbearance rates on residential mortgages rose during the first half of 2020. According to the Mortgage Bankers Association, the total forbearance rate increased most significantly during the month of April, from 2.7% as of March 29th to 7.5% as of April 26th, before rising further to 8.5% as of May 31st, plateauing during June, and then finishing the second quarter at 8.4%. Forbearance rates on residential mortgages declined steadily during the third and fourth quarters, driven by the economic recovery and an improving employment picture, even as many stimulus measures expired. According to the Mortgage Bankers Association, the total forbearance rate decreased from 8.4% at the end of June, to 6.9% at the end of September, and to 5.5% as of January 3, 2021.
• Yield spreads on most fixed income assets widened sharply in the first half of March. For Agency RMBS, the heightened levels of interest rate volatility, together with concerns of a liquidity crunch in the private sector, exacerbated fundamental concerns about a surge in prepayments from the decline in mortgage rates; while for credit assets, the negative macroeconomic developments raised concerns about a potential surge in future credit losses within many sectors. Across virtually all credit-sensitive fixed income asset classes, repo financing stresses and sharp declines in asset prices severely reduced liquidity, and prompted forced selling from many market participants experiencing liquidity problems, which further contributed to price declines and yield spread widening. This selling was particularly acute in structured credit assets, but even Agency RMBS, despite their creditworthiness, experienced significant yield spread widening in sympathy. As described above, central banks and governments around the globe responded swiftly and aggressively with interest rate cuts, quantitative easing programs, and stimulus packages; these actions succeeded in stabilizing markets for the balance of 2020.
• The Bloomberg Barclays US MBS Index ("BB MBS Index") generated a positive return for each quarter of 2020, finishing the year with a 3.87% return, but a slight negative excess return (on a duration-adjusted basis) of (0.17)% relative to the Bloomberg Barclays U.S. Treasury Index. Notably, during the extreme market volatility experienced in March, the intra-month negative excess return reached an extreme of (2.22)% as of March 19th, before actions by the Federal Reserve caused yield spreads on Agency RMBS to retighten. Additionally, after underperforming in the first quarter, pay-ups on Agency specified pools performed exceptionally well during the rest of 2020.
• For the first quarter, the Bloomberg Barclays US Corporate Bond Index ("BB IG Index") generated a loss of 3.63% and a negative excess return of (13.50)%, while the Bloomberg Barclays U.S. Corporate High Yield Bond Index ("BB HY Index") generated a loss of (12.68)% and a negative excess return of (17.03)%. Each index generated both positive returns and positive excess returns during each of the subsequent three quarters, however. For the full year, the BB IG
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Index generated a 9.89% return, and a positive excess return of 0.49%; while the BB HY Index generated a 7.11% return and positive excess return of 2.25%.
• During the first quarter, U.S. equities had their worst quarter since the 2008–2009 financial crisis, with the Dow Jones Industrial Average ("DJIA") declining 23%, the S&P down 20%, and the NASDAQ down 14%. Stock markets were highly volatile during the quarter, as the S&P 500 declined 34% between February 19th and March 23rd, and then increased 18% over the next three days. Because of rapid price declines that tripped market "circuit breakers," trading was halted temporarily on the major U.S. stock exchanges on four trading days during the quarter. The CBOE Volatility Index, which measures expected moves in the S&P 500 index, registered an all-time high of 82.69 on March 16th. London's FTSE 100 declined 25%, while the MSCI World global equity index declined 21%.
Despite the continuing negative economic impacts of COVID-19, U.S. equities rebounded dramatically in the second quarter, with the DJIA and S&P 500 indexes posting their biggest quarterly gains since 1998 and offsetting most of the losses suffered in March, amidst optimism over the reopening of the economy, possible additional stimulus measures, and advances on COVID-19 treatments and a possible vaccine. The DJIA rose 17.8% and the S&P 500 rose 20.0% quarter over quarter, while the tech-heavy NASDAQ composite index increased 30.6%. Equity volatility declined during the second quarter, but remained higher than pre-COVID-19 levels. The CBOE Volatility Index steadily declined for most of the second quarter, finishing at 30.43 at June 30th. Meanwhile, London's FTSE 100 index increased 8.8% quarter over quarter, while the MSCI World global equity index rebounded by 18.8% over the same period.
The strong performance of equities continued into the second half of the year, driven by record-low interest rates, expectations of additional stimulus, advances on a possible COVID-19 vaccine, as well as continued outperformance by the tech sector.
In July, the tech-heavy NASDAQ composite index closed at an all-time high, while in August, the S&P 500 reversed all of its losses for the year and reached a new all-time high as well. Performance waned in September amidst a tech selloff and dimming hopes for new stimulus, but U.S. equities still posted a strong third quarter. Quarter over quarter, the S&P 500 rose 8.5%, the DJIA 7.6%, and the NASDAQ 11%. The CBOE Volatility Index, which measures expected moves in the S&P 500 index, increased moderately in September but remained at levels well below those seen in March and April. Meanwhile, London's FTSE 100 index decreased 4.9% and the MSCI World global equity index rose 7.5%, over the same period.
In the second half of October, U.S. equities slumped and equity volatility increased in response to fading stimulus hopes and an accelerating number of COVID-19 cases. However, in November and December, stocks rallied following the U.S. presidential election and in response to advances in the development of COVID-19 vaccines as well as the passage of an additional stimulus package. During December, each of the S&P 500, DJIA, and NASDAQ indexes set fresh new highs; and for the full year, these indexes gained 16%, 7%, and 44%, respectively. After rising in October, the VIX volatility index declined steadily into year end.
Portfolio Overview and Outlook
As of December 31, 2020, our mortgage-backed securities portfolio consisted of $962.8 million of fixed-rate Agency "specified pools," $20.4 million of Agency RMBS backed by adjustable rate mortgages, or "Agency ARMs," $67.5 million of Agency reverse mortgage pools, $13.0 million of Agency interest only securities, or "Agency IOs," and $17.6 million of non-Agency RMBS. Specified pools are fixed-rate Agency pools consisting of mortgages with special characteristics, such as mortgages with low loan balances, mortgages backed by investor properties, mortgages originated through the government-sponsored "Making Homes Affordable" refinancing programs, and mortgages with various other characteristics.
In March 2020, in light of the heightened levels of market volatility and systemic liquidity risk, we proactively reduced the size of our Agency portfolio, thereby bolstering our liquidity and lowering our leverage. By reducing our Agency portfolio in an orderly and measured way, we avoided forced asset sales. Our Agency RMBS portfolio decreased by 25% to $1.043 billion as of March 31, 2020, as compared to $1.393 billion as of December 31, 2019.
As the year progressed and economic uncertainty remained high, we maintained a smaller Agency portfolio, lower debt-to-equity ratio, and higher cash balance, relative to our historical averages. For the full year 2020, our Agency RMBS holdings decreased approximately 24% to $1.064 billion as of December 31, 2020, from $1.393 billion as of December 31, 2019.
In contrast to our Agency RMBS portfolio, we significantly increased our non-Agency RMBS holdings following the market distress of March and April. During the second quarter of 2020, we opportunistically purchased approximately $40 million of non-Agency RMBS at depressed prices, and as the year progressed and prices recovered, we sold the majority of
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these investments at substantial gains. For the full year 2020, our non-Agency RMBS holdings increased by 99% to $17.6 million from $8.9 million. We expect to continue to vary our allocation to non-Agency RMBS as market opportunities change over time.
The increase in our shareholders' equity during the year, combined with the decline in the size of our overall RMBS portfolio, caused our debt-to-equity ratio, adjusted for unsettled purchases and sales, to decrease to 6.1:1 as of December 31, 2020 from 8.1:1 as of December 31, 2019. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, capital markets activities, and the timing of security purchase and sale transactions. As of December 31, 2020, substantially all of our borrowings were secured by specified pools.
As of December 31, 2020, we had cash and cash equivalents of $58.2 million, along with other unencumbered assets of approximately $47.4 million. This compares to cash and cash equivalents of $35.4 million and unencumbered assets of $53.6 million held by us at December 31, 2019.
During the first half of March, with heightened interest rate volatility and a flight to the safe haven of U.S. Treasury securities, yield spreads on Agency RMBS widened significantly. As a result, we received margin calls under our financing arrangements that were higher than typical historical levels. We satisfied all of these margin calls. Actions by the Federal Reserve during the second half of March helped stabilize the market for Agency RMBS, causing yield spreads to tighten significantly.
For the first quarter of 2020, the precipitous decline in interest rates and high levels of interest rate volatility generated net realized and unrealized losses on our hedges, and while our Agency RMBS assets did appreciate in price, they significantly underperformed our hedges. Furthermore, TBAs outperformed specified pools, depressing pay-ups on our specified pool portfolio. Pay-ups are price premiums for specified pools relative to their TBA counterparts, and generally reflect, among other factors, the prepayment protection that specified pools provide. As a result, we experienced a significant net loss for the first quarter.
In the second quarter, forceful actions by the Federal Reserve continued to stabilize the market for Agency RMBS, and our Agency portfolio performed exceptionally well, driven by significantly higher pay-ups on our specified pools.
Our Agency strategy continued to perform well in the second half of 2020, driven by continued strong performance from our specified pools, and solid net interest income. During most of 2020, mortgage rates declined and actual and expected prepayment rates rose, which benefited pay-ups on our prepayment-protected specified pools. Average pay-ups on our specified pools increased to 2.40% as of December 31, 2020, as compared to 1.77% 1 as of December 31, 2019.
1 Conformed to current period calculation methodology.
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As the year progressed, we also increased our holdings of long TBAs held for investment, which we concentrated in current coupon production. These investments performed well, driven by Federal Reserve purchasing activity. Finally, our opportunistic investments in non-Agency RMBS generated excellent results for the year.
With the decline in our overall RMBS portfolio and the increase in our shareholders' equity during the year, and despite a smaller net notional short TBA position, our net mortgage assets-to-equity ratio—which we define as the net aggregate market value of our mortgage-backed securities (including the underlying market values of our long and short TBA positions) divided by total shareholders' equity—was considerably lower at the end of 2020 as compared to the end of 2019. From time to time, in response to market opportunities and other factors, we increase or decrease our net mortgage assets-to-equity ratio by varying the sizes of our net short TBA position and/or our long RMBS portfolio. The following table summarizes our net mortgage assets-to-equity ratio and provides additional details, for the last five quarters, to illustrate this fluctuation.
Notional Amount of Long TBAs Notional Amount of Short TBAs Fair Value of Mortgage-backed Securities Net Short TBA Underlying Market Value (1)
Net Mortgage Assets-to-Equity Ratio
($ In thousands)
December 31, 2020 $ 317,890 $ (459,613) $ 1,081,380 $ (156,326) 5.6:1
September 30, 2020 359,430 (551,853) 1,113,620 (208,952) 5.6:1
June 30, 2020 319,280 (529,888) 1,154,047 (229,102) 5.9:1
March 31, 2020 53,800 (303,388) 1,050,521 (266,536) 5.6:1
December 31, 2019 70,447 (246,955) 1,401,778 (183,369) 7.6:1
(1) Market value represents the current market value of the underlying Agency RMBS (on a forward delivery basis) as of period end.
We expect to continue to target specified pools that, taking into account their particular composition and based on our prepayment projections, should: (1) generate attractive yields relative to other Agency RMBS and U.S. Treasury securities, (2) have less prepayment sensitivity to government policy shocks, and/or (3) create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months, when actual prepayment experience can be observed. We believe that our research team, proprietary prepayment models, and extensive databases remain essential tools in our implementation of this strategy.
The following table summarizes prepayment rates for our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) for the three-month periods ended December 31, 2020, September 30, 2020, June 30, 2020, March 31, 2020, and December 31, 2019.
Three-Month Period Ended
December 31, 2020 September 30,
2020 June 30, 2020 March 31, 2020 December 31, 2019
Three-Month Constant Prepayment Rates 21.0% 21.4% 18.0% 15.4% 14.9%
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The following table provides details about the composition of our portfolio of fixed-rate specified pools (excluding those backed by reverse mortgages) as of December 31, 2020 and 2019.
December 31, 2020 December 31, 2019 (1)
Coupon (%) Current Principal Fair Value Weighted Average Loan Age (Months) Current Principal Fair Value Weighted
Average Loan
Age (Months)
(In thousands) (In thousands)
Fixed-rate Agency RMBS:
15-year fixed-rate mortgages:
2.50–2.99 $ 16,385 $ 17,236 42 $ 4,900 $ 4,953 40
3.00–3.49 14,001 14,824 37 33,474 34,537 62
3.50–3.99 25,113 27,177 50 110,637 115,902 31
4.00–4.49 21,529 23,347 33 23,480 24,944 22
4.50–4.99 550 575 135 859 895 123
Total 15-year fixed-rate mortgages 77,578 83,159 42 173,350 181,231 36
20-year fixed-rate mortgages:
2.00–2.49 32,333 33,633 4 — — —
2.50–2.99 3,212 3,382 5 — — —
3.00–3.49 2,496 2,647 10 — — —
4.00–4.49 2,161 2,492 5 — — —
4.50–4.99 1,300 1,417 27 — — —
5.00–5.49 1,057 1,192 28 1,276 1,385 16
Total 20-year fixed-rate mortgages 42,559 44,763 6 1,276 1,385 16
30-year fixed-rate mortgages:
2.50–2.99 16,361 17,383 3 — — —
3.00–3.49 98,654 105,085 28 35,314 36,169 43
3.50–3.99 245,320 266,547 51 216,421 227,606 45
4.00–4.49 191,033 209,502 55 335,843 356,323 36
4.50–4.99 146,843 162,645 49 230,635 246,829 32
5.00–5.49 54,804 61,719 51 124,558 134,235 27
5.50–5.99 7,890 8,951 49 45,374 48,674 19
6.00–6.49 2,658 3,049 27 8,306 9,042 15
Total 30-year fixed-rate mortgages 763,563 834,881 48 996,451 1,058,878 35
Total fixed-rate Agency RMBS $ 883,700 $ 962,803 45 $ 1,171,077 $ 1,241,494 35
(1) Conformed to current period presentation.
For the year ended December 31, 2020, we had total net realized and unrealized gains on our Agency RMBS of $27.0 million, or $2.19 per share. Our Agency RMBS portfolio turnover was 64% for the year ended December 31, 2020, and we recognized net realized gains of $11.8 million.
During the year ended December 31, 2020, we continued to hedge interest rate risk, primarily through the use of interest rate swaps, and to a lesser extent through the use of short positions in TBAs, U.S. Treasury securities, and futures. We had total net realized and unrealized losses of $(21.8) million, or $(1.77) per share, on our interest rate hedging portfolio, as interest rates declined precipitously during the year. We increased the amount of long TBAs held for investment during the year, especially in lower coupon TBAs. In conjunction with these investments, we ended the year with a small net short overall TBA position on a notional basis but a small net long overall TBA position as measured by 10-year equivalents. 10-year equivalents for a group of positions represent the amount of 10-year U.S. Treasury securities that would be expected to experience a similar
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change in market value under a standard parallel move in interest rates. The relative makeup of our interest rate hedging portfolio can change materially from period to period.
After giving effect to dividends during the year ended December 31, 2020 of $1.12 per share, our book value per share increased to $13.48 as of December 31, 2020, from $12.91 as of December 31, 2019, and we had an economic return of 13.1% for the year ended December 31, 2020. Economic return is computed by adding back dividends declared to ending book value per share, and comparing that amount to book value per share as of the beginning of the quarter.
Our net Agency premium as a percentage of the fair value of our specified pool holdings is one metric that we use to measure the overall prepayment risk of our specified pool portfolio. Net Agency premium represents the total premium (excess of market value over outstanding principal balance) on our specified pool holdings less the total premium on net short TBA positions. The lower our net Agency premium, the less we believe that our specified pool portfolio is exposed to market-wide increases in Agency RMBS prepayments. As of December 31, 2020 and 2019, our net Agency premium as a percentage of fair value of our specified pool holdings was approximately 6.8% and 5.3%, respectively. Excluding TBA positions, our Agency premium as a percentage of fair value was approximately 8.2% and 5.8% as of December 31, 2020 and 2019, respectively. Our Agency premium percentage and net Agency premium percentage may fluctuate from period to period based on a variety of factors, including market factors such as interest rates and mortgage rates, and, in the case of our net Agency premium percentage, based on the degree to which we hedge prepayment risk with short TBAs. We believe that our focus on purchasing pools with specific prepayment characteristics provides a measure of protection against prepayments.
We believe that our adaptive and active style of portfolio management is well suited to the current MBS market environment, which, especially given the current effects and future uncertainties related to the COVID-19 pandemic, exhibits high levels of interest rate risk, prepayment risk, financing and liquidity risk, shifting central bank and government policies, regulatory changes, and disruptive technological developments.
Financing
For the year ended December 31, 2020, our average repo borrowing cost decreased to 0.91% as compared to 2.52% for the year ended December 31, 2019. The year-over-year decline in average repo borrowing cost was due to a significant decrease in short-term interest rates as well as a significant decline in financing spreads as measured against LIBOR. As of December 31, 2020, the weighted average borrowing rate on our repurchase agreements declined to 0.25% from 2.00% as of December 31, 2019.
While large banks still dominate the repo market, non-bank firms, not subject to the same regulations as banks, are active in providing repo financing. Most of our outstanding repo financing is still provided by banks and bank affiliates; however, we have also entered into repo agreements with non-bank dealers.
Our debt-to-equity ratio was 6.1:1 as of December 31, 2020, as compared to 8.1:1 as of December 31, 2019. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, capital markets activities, and the timing of security purchase and sale transactions.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America, or "U.S. GAAP," and Regulation S-X. Entities in which we have a controlling financial interest, through ownership of the majority of the entities' voting equity interests, or through other contractual rights that give us control, are consolidated by us. All inter-company balances and transactions have been eliminated.
Certain of our critical accounting policies require management 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 reporting period. Actual results could differ from those estimates. We believe that all of the decisions and assessments upon which our consolidated financial statements are based were reasonable at the time made based upon information available to us at that time. We rely on our Manager and Ellington's experience and analysis of historical and current market data in order to arrive at what we believe to be reasonable estimates. See Note 2 of the notes to our consolidated financial statements included in this Annual Report on Form 10-K for a complete discussion of our significant accounting policies. We have identified our most critical accounting policies to be the following:
Valuation : For financial instruments that are traded in an "active market," the best measure of fair value is the quoted market price. However, many of our financial instruments are not traded in an active market. Therefore, management generally uses third-party valuations when available. If third-party valuations are not available, management uses other valuation techniques, such as the discounted cash flow methodology. Summary descriptions, for the various categories of financial
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instruments, of the valuation methodologies management uses in determining fair value of our financial instruments are detailed in Note 2 of the notes to our consolidated financial statements. Management utilizes such methodologies to assign a good faith fair value (the estimated price that, in an orderly transaction at the valuation date, would be received to sell an asset, or paid to transfer a liability, as the case may be) to each such financial instrument.
See the notes to our consolidated financial statements for more information on valuation techniques used by management in the valuation of our assets and liabilities.
Accounting for Securities : Investments in mortgage-backed securities are recorded on trade date. We have chosen to make a fair value election pursuant to ASC 825-10, Financial Instruments , for our mortgage-backed securities portfolio. Electing the fair value option allows us to record changes in fair value in our Consolidated Statement of Operations, which, in our view, more appropriately reflects the results of our operations for a particular reporting period as all securities activities will be recorded in a similar manner. As such, the mortgage-backed securities are recorded at fair value on our Consolidated Balance Sheet and the period change in fair value is recorded in current period earnings on our Consolidated Statement of Operations as a component of Change in net unrealized gains (losses) on securities.
Realized gains or losses on sales of mortgage-backed securities are included in Net realized gains (losses) on securities on the Consolidated Statement of Operations, and are recorded at the time of disposition. The cost of positions sold is calculated based on identified cost. Principal write-offs are generally treated as realized losses.
Interest Income : Coupon interest income on investment securities is accrued based on the outstanding principal balance and the current coupon rate on each security. We amortize purchase premiums and accrete purchase discounts on our fixed income investments using the effective interest method.
Our accretion of discounts and amortization of premiums on securities for U.S. federal and other tax purposes is likely to differ from the accounting treatment under U.S. GAAP of these items as described above.
See the Note 2 of the notes to our consolidated financial statements for more information on the assumptions and methods that we use to amortize purchase premiums and accrete purchase discounts.
Income Taxes : We made an election to be taxed as a REIT for U.S. federal income tax purposes. As a REIT, we generally are not subject to corporate-level federal and state income tax on net income we distribute to our shareholders within the prescribed timeframes. To qualify as a REIT, we must meet a number of organizational and operational requirements, including a requirement to distribute at least 90% of our taxable income to our shareholders. Even if we qualify as a REIT, we may be subject to certain federal, state, local and foreign taxes on our income and property, and to federal income and excise taxes on our undistributed taxable income. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal, state, and local income taxes and may be precluded from qualifying as a REIT for the four taxable years following the year in which we fail to qualify as a REIT.
We follow the authoritative guidance on accounting for and disclosure of uncertainty on tax positions, which requires management to determine whether a tax position is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. For uncertain tax positions, the tax benefit to be recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. We did not have any unrecognized tax benefits resulting from tax positions related to the current period or our open tax years. In the normal course of business, we may be subject to examination by federal, state, local, and foreign jurisdictions, where applicable, for the current period and our open tax years. We may take positions with respect to certain tax issues which depend on legal interpretation of facts or applicable tax regulations. Should the relevant tax regulators successfully challenge any such positions, we might be found to have a tax liability that has not been recorded in the accompanying consolidated financial statements. Also, management's conclusions regarding the authoritative guidance may be subject to review and adjustment at a later date based on changing tax laws, regulations, and interpretations thereof. There were no amounts accrued for penalties or interest as of or during the periods presented in the consolidated financial statements included in this Annual Report on Form 10-K.
Recent Accounting Pronouncements
Refer to the notes to our consolidated financial statements for a description of relevant recent accounting pronouncements.
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Financial Condition
Investment portfolio
The following tables summarize our securities portfolio as of December 31, 2020 and 2019:
December 31, 2020 December 31, 2019
(In thousands) Current Principal Fair Value Average Price (1)
Cost Average Cost (1)
Current Principal Fair Value Average Price (1)
Cost Average Cost (1)
Agency RMBS (2)
15-year fixed-rate mortgages $ 77,578 $ 83,159 $ 107.19 $ 80,144 $ 103.31 $ 173,350 $ 181,231 $ 104.55 $ 176,848 $ 102.02
20-year fixed-rate mortgages 42,559 44,763 105.18 44,247 103.97 1,276 1,385 108.54 1,356 106.27
30-year fixed-rate mortgages 763,563 834,881 109.34 799,360 104.69 996,451 1,058,878 106.26 1,041,550 104.53
ARMs 19,459 20,442 105.05 19,981 102.68 32,122 33,255 103.53 33,049 102.89
Reverse mortgages 61,653 67,474 109.44 65,494 106.23 91,560 99,934 109.15 98,407 107.48
Total Agency RMBS 964,812 1,050,719 108.90 1,009,226 104.60 1,294,759 1,374,683 106.17 1,351,210 104.36
Non-Agency RMBS 23,140 17,612 76.11 15,369 66.42 10,947 8,851 80.85 6,924 63.25
Total RMBS (2)
987,952 1,068,331 108.14 1,024,595 103.71 1,305,706 1,383,534 105.96 1,358,134 104.02
Agency IOs n/a 13,049 n/a 15,434 n/a n/a 18,244 n/a 17,795 n/a
Total mortgage-backed securities 1,081,380 1,040,029 1,401,778 1,375,929
U.S. Treasury securities sold short — — — — — (2,100) (2,070) 98.57 (2,070) 98.57
Reverse repurchase agreements — — — — — 2,084 2,084 100.00 2,084 100.00
Total $ 1,081,380 $ 1,040,029 $ 1,401,792 $ 1,375,943
(1) Represents the dollar amount (not shown in thousands) per $100 of current principal of the price or cost for the security.
(2) Excludes Agency IOs.
The majority of our capital is allocated to our Agency RMBS strategy, which includes investments in Agency pools and Agency collateralized mortgage obligations, or "CMOs." As of both December 31, 2020 and 2019, investments in non-Agency RMBS constituted a relatively small portion of our total investments.
Our most prevalent method of financing RMBS is through short-term repos, which generally have maturities of 180 days or less. The weighted average lives of the RMBS that we own are generally much longer. Consequently, the weighted average term of our repurchase agreement financings will almost always be substantially shorter than the expected average maturity of our RMBS. This mismatch in maturities, together with the uncertainty of RMBS prepayments, and other potential changes in timing and/or amount of cash flows on our RMBS assets, creates the risk that changes in interest rates will cause our financing costs with respect to our RMBS to increase relative to the income on our RMBS over the term of our investments.
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Financial Derivatives
The following table summarizes our portfolio of financial derivative holdings as of December 31, 2020 and 2019:
(In thousands) December 31, 2020 December 31, 2019
Financial derivatives–assets, at fair value:
TBA securities purchase contracts $ 1,720 $ 48
TBA securities sale contracts — 74
Fixed payer interest rate swaps 457 3,543
Fixed receiver interest rate swaps 614 81
Futures — 434
Total financial derivatives–assets, at fair value 2,791 4,180
Financial derivatives–liabilities, at fair value:
TBA securities purchase contracts — (71)
TBA securities sale contracts (699) (233)
Fixed payer interest rate swaps (5,208) (1,632)
Fixed receiver interest rate swaps (377) (15)
Futures (346) (96)
Total financial derivatives–liabilities, at fair value (6,630) (2,047)
Total $ (3,839) $ 2,133
Pursuant to our hedging program, we engage in a variety of interest rate hedging activities that are designed to reduce the interest rate risk with respect to the liabilities incurred to acquire or hold RMBS. These interest rate hedges generally seek to reduce the interest rate sensitivity of our liabilities or, in other words, reduce the volatility of our financing cost over time attributable to interest rate changes. Our interest rate hedging transactions may include:
• Interest rate swaps (a contract exchanging a variable rate for a fixed rate, or vice versa);
• Interest rate swaptions (options to enter into interest rate swaps at a future date);
• TBA forward contracts on Agency pass-through certificates;
• Short sales of U.S. Treasury securities;
• Eurodollar and U.S. Treasury futures; and
• Other derivatives.
We generally enter into these transactions to offset the potential adverse effects of rising interest rates on short-term repurchase agreements. Our repurchase agreements generally have maturities of up to 180 days and carry interest rates that are determined by reference to LIBOR or correlated benchmark rates for those same periods. As each then-existing fixed-rate repo borrowing matures, it will generally be replaced with a new fixed-rate repo borrowing based on market interest rates established at that future date.
In the case of interest rate swaps, most of our agreements are structured such that we receive payments based on a variable interest rate and make payments based on a fixed interest rate. The variable interest rate on which payments are received is generally calculated based on various reset mechanisms for LIBOR. To the extent that our future repo borrowing costs continue to be highly correlated with LIBOR, our LIBOR-based interest rate swap agreements help to reduce the variability of our overall repo borrowing costs, thus reducing risk to the extent we hold fixed-rate assets that are financed with repo borrowings. While for the time being we are continuing to enter into LIBOR-based interest rate swap agreements, we are currently considering entering into SOFR-based interest rate swap agreements as well.
In the case of TBAs, most of our positions are short TBA positions with negative duration, meaning that should interest rates rise, the value of the short position would be expected to increase. This expected increase in value would then serve to offset corollary expected increases in our current and/or future borrowing costs under our repurchase agreements, and so in this manner our short TBA positions serve as a hedge against potential increases in interest rates. While we use TBAs to hedge interest rate risk, we also hold net long positions in certain TBA securities as a means of acquiring exposure to Agency RMBS.
As of December 31, 2019, we held short positions in U.S. Treasury securities, with a total principal amount of $2.1 million and a fair value of $2.1 million; we did not hold short positions in U.S. Treasury securities as of December 31, 2020.
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The composition and relative mix of our hedging instruments may vary from period to period given the amount of our liabilities outstanding or anticipated to be entered into, the overall market environment and our view as to which instruments best enable us to execute our hedging goals.
Leverage
The following table summarizes our outstanding liabilities under repurchase agreements as of December 31, 2020 and 2019. We had no other borrowings outstanding.
December 31, 2020 December 31, 2019
Weighted Average Weighted Average
Remaining Days to Maturity Borrowings Outstanding Interest Rate Remaining Days to Maturity Borrowings Outstanding Interest Rate Remaining Days to Maturity
(In thousands)
30 days or less $ 307,544 0.27 % 15 $ 513,092 2.10 % 15
31-60 days 541,104 0.23 44 549,541 1.91 45
61-90 days 92,314 0.26 74 233,639 1.97 74
121-150 days 2,371 0.27 126 — — —
151-180 days 53,150 0.32 162 — — —
181-360 days 18,762 0.26 257 — — —
Total $ 1,015,245 0.25 % 48 $ 1,296,272 2.00 % 39
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. In response to the significant volatility of the first quarter caused by the COVID-19 pandemic, we strategically reduced the size of our portfolio in order to lower our leverage and enhance our liquidity position, and have continued to maintain a leverage ratio lower than we have historically. As of December 31, 2020 and 2019, our total debt-to-equity ratio was 6.1:1 and 8.1:1, respectively. Collateral transferred with respect to our outstanding repo borrowings, including net cash collateral posted, as of December 31, 2020 and 2019 had an aggregate fair value of $1.1 billion and $1.3 billion, respectively. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, capital markets conditions, and the timing of security purchase and sale transactions.
As of December 31, 2020, we had cash and cash equivalents of $58.2 million, along with other unencumbered assets of approximately $47.4 million.
Shareholders' Equity
As of December 31, 2020, our shareholders' equity increased to $166.4 million from $160.8 million as of December 31, 2019. This increase principally consisted of net income of $20.1 million, partially offset by dividends declared of $(13.8) million and common shares repurchased of $(1.0) million. As of December 31, 2020, our book value per share was $13.48, as compared to $12.91 as of December 31, 2019.
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Results of Operations for the Years Ended December 31, 2020 and 2019
The following table summarizes our results of operations for the years ended December 31, 2020 and 2019:
Year Ended December 31,
(In thousands except for per share amounts) 2020 2019
Interest Income (Expense)
Interest income $ 27,320 $ 43,846
Interest expense (9,965) (35,276)
Net interest income 17,355 8,570
Expenses
Management fees to affiliate 2,357 2,365
Other operating expenses 3,469 2,923
Total expenses 5,826 5,288
Other Income (Loss)
Net realized and change in net unrealized gains (losses) on securities
27,742 51,511
Net realized and change in net unrealized gains (losses) on financial derivatives
(19,159) (32,537)
Total Other Income (Loss) 8,583 18,974
Net Income (Loss) $ 20,112 $ 22,256
Net Income (Loss) Per Common Share $ 1.63 $ 1.79
Core Earnings
Core Earnings consists of net income (loss), excluding realized and change in net unrealized gains and (losses) on securities and financial derivatives, and excluding, if applicable, any non-recurring items of income or loss. Core Earnings also excludes the effect of the Catch-up Premium Amortization Adjustment on interest income. The Catch-up Premium Amortization Adjustment is a quarterly adjustment to premium amortization triggered by changes in actual and projected prepayments on our Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). The adjustment is calculated as of the beginning of each quarter based on our then-current assumptions about cashflows and prepayments, and can vary significantly from period to period. Core Earnings includes net realized and change in net unrealized gains (losses) associated with periodic settlements on interest rate swaps.
Core Earnings is a supplemental non-GAAP financial measure. We believe that Core Earnings provides information useful to investors because it is a metric that we use to assess our performance and to evaluate the effective net yield provided by the portfolio. Moreover, one of our objectives is to generate income from the net interest margin on the portfolio, and Core Earnings is used to help measure the extent to which this objective is being achieved. In addition, we believe that presenting Core Earnings enables our investors to measure, evaluate and compare our operating performance to that of our peer companies. However, because Core Earnings is an incomplete measure of our financial results and differs from net income (loss) computed in accordance with GAAP, it should be considered as supplementary to, and not as a substitute for, net income (loss) computed in accordance with GAAP.
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The following table reconciles, for the years ended December 31, 2020 and 2019, Core Earnings to the line on the Consolidated Statement of Operations entitled Net Income (Loss), which we believe is the most directly comparable GAAP measure:
Year Ended December 31,
(In thousands except for share amounts) 2020 2019
Net Income (Loss) $ 20,112 $ 22,256
Adjustments:
Net realized (gains) losses on securities (12,117) (2,280)
Change in net unrealized (gains) losses on securities (15,625) (49,231)
Net realized (gains) losses on financial derivatives 13,204 38,975
Change in net unrealized (gains) losses on financial derivatives 5,955 (6,438)
Net realized gains (losses) on periodic settlements of interest rate swaps (810) 1,262
Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps
(134) 850
Deferred offering costs expensed 351 —
Negative (positive) component of interest income represented by Catch-up Premium Amortization Adjustment 4,619 5,903
Subtotal (4,557) (10,959)
Core Earnings $ 15,555 $ 11,297
Weighted Average Shares Outstanding 12,353,246 12,461,054
Core Earnings Per Share $ 1.26 $ 0.91
Results of Operations for the Years Ended December 31, 2020 and 2019
Net Income (Loss)
Net income (loss) for the year ended December 31, 2020 was $20.1 million, as compared to $22.3 million for the year ended December 31, 2019. The decrease in net income year over year was primarily due to a decrease in total other income partially offset by an increase in net interest income.
Interest Income
Our portfolio as of both December 31, 2020 and 2019 consisted primarily of Agency RMBS, and to a lesser extent, non-Agency RMBS. Before interest expense, we earned approximately $26.9 million and $42.4 million in interest income on these securities for the years ended December 31, 2020 and 2019, respectively. The year-over-year decrease in interest income primarily resulted from lower average holdings in our Agency RMBS portfolio and lower overall average asset yields. The Catch-up Premium Amortization Adjustment causes variability in our interest income and portfolio yields. For the years ended December 31, 2020 and 2019, we had a negative Catch-up Premium Amortization Adjustment of approximately $(4.6) million and $(5.9) million, respectively, which decreased interest income. Excluding the Catch-up Premium Amortization Adjustments, the weighted average yield of our overall portfolio was 2.82% and 3.29% for the years ended December 31, 2020 and 2019, respectively.
The following table details our interest income, average holdings of yield-bearing assets, and weighted average yield based on amortized cost for the years ended December 31, 2020 and 2019:
Agency (1)
Non-Agency (1)
Total (1)
(In thousands) Interest Income Average Holdings Yield Interest Income Average Holdings Yield Interest Income Average Holdings Yield
Year ended December 31, 2020 $ 25,337 $ 1,095,537 2.31 % $ 1,552 $ 20,837 7.45 % $ 26,889 $ 1,116,374 2.41 %
Year ended December 31, 2019 $ 41,487 $ 1,461,487 2.84 % $ 892 $ 7,763 11.49 % $ 42,379 $ 1,469,250 2.88 %
(1) Amounts exclude interest income on cash and cash equivalents (including when posted as margin) and long U.S. Treasury securities.
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Interest Expense
For the years ended December 31, 2020 and 2019, the majority of interest expense that we incurred was related to our repo borrowings, which we use to finance our assets. We also incur interest expense in connection with our short positions in U.S. Treasury securities as well as on our counterparties' cash collateral held by us. Our total interest expense for the year ended December 31, 2020 was $10.0 million, of which $9.7 million represented interest expense on our repo borrowings and $0.2 million represented interest expense related primarily to our short positions in U.S. Treasury securities. Our total interest expense for the year ended December 31, 2019 was $35.3 million, of which $34.6 million represented interest expense on our repo borrowings and $0.6 million represented interest expense related primarily to our short positions in U.S. Treasury securities. The year-over-year decrease in our total interest expense resulted mainly from lower rates on our repo borrowings stemming from the decrease in short-term interest rates, as well as lower average outstanding borrowings.
The following table shows information related to our average cost of funds (1) for the years ended December 31, 2020 and 2019:
Repurchase
Agreements Interest Rate
Swaps (2)
Short U.S. Treasury Securities (2)
Total (2)
Average Borrowed Funds Interest Expense Average
Cost of
Funds Net periodic expense paid or payable Average
Cost of
Funds Interest expense Average
Cost of
Funds Interest and net periodic expense paid or payable Average
Cost of
Funds
(In thousands)
Year ended December 31, 2020 $ 1,071,352 $ 9,706 0.91 % $ 899 0.08 % $ 218 0.02 % $ 10,823 1.01 %
Year ended December 31, 2019 $ 1,376,089 $ 34,640 2.52 % $ (2,103) (0.15) % $ 621 0.04 % $ 33,158 2.41 %
(1) This metric does not take into account other instruments that we use to hedge interest rate risk, such as TBAs, swaptions, and futures.
(2) As an alternative cost of funds measure, we add to our repo borrowing cost the net periodic amounts paid or payable by us on our interest rate swaps and the interest expense we incur on our short positions in U.S. Treasury securities, and express the total as a percentage of our average outstanding repurchase agreement borrowings.
For the years ended December 31, 2020 and 2019, average one-month LIBOR was 0.52% and 2.22%, respectively. For the years ended December 31, 2020 and 2019, average six-month LIBOR was 0.69% and 2.32%, respectively. For the year ended December 31, 2020, the weighted average yield of our portfolio of Agency and non-Agency RMBS excluding the impact of the Catch-up Premium Amortization Adjustment was 2.82%, while our total average cost of funds, including interest rate swaps and short U.S. Treasury securities, was 1.01%, resulting in a net interest margin of 1.81%. By comparison, for the year ended December 31, 2019, the weighted average yield of our Agency and non-Agency RMBS excluding the impact of the Catch-up Premium Amortization Adjustment was 3.29%, while our average cost of funds, including interest rate swaps and short U.S. Treasury securities, was 2.41%, resulting in a net interest margin of 0.88%.
Management Fees
For each of the years ended December 31, 2020 and 2019, our management fee expense was approximately $2.4 million. Management fees are calculated based on our shareholders' equity at the end of each quarter.
Other Operating Expenses
Other operating expenses, as presented above, include professional fees, compensation expense, insurance expense, and various other expenses incurred in connection with the operation of our business. For the years ended December 31, 2020 and 2019, our other operating expenses were approximately $3.5 million and $2.9 million, respectively. The increase in other operating expenses for the year ended December 31, 2020 was primarily due to an increase in professional fees resulting from deferred offering costs that were expensed during the year as well as an increase in compensation expense.
Other Income (Loss)
Other income (loss) consists of net realized and net change in unrealized gains (losses) on securities and financial derivatives. For the year ended December 31, 2020, Other income (loss) was $8.6 million, consisting primarily of net realized and change in net unrealized gains of $27.0 million on our Agency RMBS and $3.2 million on our non-Agency RMBS, which were partially offset by net realized and change in net unrealized losses of $(2.7) million on our short U.S. Treasury securities and $(19.2) million on our financial derivatives. The gains on our Agency RMBS holdings were mainly driven by appreciation of our fixed rate specified pools in response to declining interest rates. For the year ended December 31, 2020, as measured by
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sales and excluding paydowns, we turned over approximately 64% of our Agency RMBS portfolio and, as a result of these sales, we generated net realized gains of $11.8 million on our Agency RMBS portfolio. For the year ended December 31, 2020, we had net realized and change in net unrealized losses on our financial derivatives of $(19.2) million, which consisted of net realized and change in net unrealized losses of $(16.9) million on our interest rate swaps and $(6.6) million on our futures, which were partially offset by net realized and change in net unrealized gains of $4.4 million on our TBAs. The net losses on our financial derivatives were largely incurred during the three-month period ended March 31, 2020, when interest rates declined sharply and were highly volatile during the market stresses caused by the spread of the COVID-19 pandemic.
Other income (loss) for the year ended December 31, 2019 was $19.0 million, consisting of net realized and change in net unrealized gains of $51.5 million on our securities, primarily our Agency RMBS, partially offset by net realized and change in net unrealized losses of $(32.5) million on our financial derivatives. The increase in prices on our Agency RMBS holdings, primarily as a result of the decrease in interest rates during the year ended December 31, 2019, led to significant gains on our securities portfolio. The decrease in interest rates also led to losses on our interest rate hedges, including net realized and unrealized losses of $(21.5) million on our interest rate swaps, $(5.8) million on our futures, and $(5.1) million on our TBAs. For the year ended December 31, 2019, as measured by sales and excluding paydowns, we turned over approximately 52% of our Agency RMBS portfolio and, as a result of these sales, we generated net realized gains of $2.8 million on our Agency RMBS portfolio.
Liquidity and Capital Resources
Liquidity refers to our ability to meet our cash needs, including repaying our borrowings, funding and maintaining RMBS and other assets, paying dividends, and other general business needs. Our short-term (one year or less) and long-term liquidity requirements include acquisition costs for assets we acquire, payment of our management fee, compliance with margin requirements under our repurchase agreements, TBA and other financial derivative contracts, repayment of repurchase agreement borrowings to the extent we are unable or unwilling to extend our repurchase agreements, the payment of dividends, and payment of our general operating expenses. Our capital resources primarily include cash on hand, cash flow from our investments (including monthly principal and interest payments received on our RMBS and proceeds from the sale of RMBS), borrowings under repurchase agreements, and proceeds from equity offerings. We expect that these sources of funds will be sufficient to meet our short-term and long-term liquidity needs.
We borrow funds in the form of repurchase agreements. The terms of our repo borrowings are predominantly governed by Master Repurchase Agreements, or "MRAs," which generally conform to the terms in the standard master repurchase agreement as published by the Securities Industry and Financial Markets Association as to repayment and margin requirements. In addition, each lender may require that we include supplemental terms and conditions to the standard master repurchase agreement. Typical supplemental terms and conditions include the addition of or changes to provisions relating to margin calls, net asset value requirements, cross default provisions, certain key person events, changes in corporate structure, and requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction. These provisions may differ for each of our lenders.
As of December 31, 2020 and 2019, we had $1.0 billion and $1.3 billion outstanding under our repurchase agreements, respectively. As of December 31, 2020, our outstanding repurchase agreements were with 15 counterparties.
The amounts borrowed under our repurchase agreements are generally subject to the application of "haircuts." A haircut is the percentage discount that a repo lender applies to the market value of an asset serving as collateral for a repo borrowing, for the purpose of determining whether such repo borrowing is adequately collateralized. As of December 31, 2020 and 2019, the weighted average contractual haircut applicable to the assets that serve as collateral for our outstanding repo borrowings was 5.3% and 4.9%, respectively.
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The following table details total outstanding borrowings, average outstanding borrowings, and the maximum outstanding borrowings at any month end for each quarter under repurchase agreements for the past twelve quarters.
Quarter Ended Borrowings
Outstanding at
Quarter End Average
Borrowings Outstanding Maximum Borrowings Outstanding at Any Month End
(In thousands)
December 31, 2020 $ 1,015,245 $ 1,033,128 $ 1,050,840
September 30, 2020 1,061,640 1,030,402 1,096,065
June 30, 2020 909,821 941,242 920,712
March 31, 2020 (1)
1,109,342 1,281,507 1,308,377
December 31, 2019 1,296,272 1,301,270 1,319,839
September 30, 2019 1,337,984 1,369,722 1,374,080
June 30, 2019 1,442,043 1,412,434 1,442,043
March 31, 2019 1,427,147 1,422,333 1,427,147
December 31, 2018 1,481,561 1,456,905 1,481,561
September 30, 2018 1,500,632 1,506,855 1,515,617
June 30, 2018 1,537,216 1,530,734 1,537,216
March 31, 2018 1,589,319 1,588,515 1,590,790
(1) For the quarter ended March 31, 2020 in response to significant volatility and heightened risks in the financial markets as a result of the spread of COVID-19, we significantly reduced our outstanding borrowings to lower leverage and increase our liquidity.
As of December 31, 2020, we had an aggregate amount at risk under our repurchase agreements with 15 counterparties of $53.7 million. As of December 31, 2019, we had an aggregate amount at risk under our repurchase agreements with 15 counterparties of $62.9 million. Amounts at risk represent the excess, if any, for each counterparty of the fair value of collateral held by such counterparty over the amounts outstanding under repurchase agreements. If the amounts outstanding under repurchase agreements with a particular counterparty are greater than the collateral held by the counterparty, there is no amount at risk for the particular counterparty. Amounts at risk under our repurchase agreements as of December 31, 2020 and 2019 does not include $2.9 million and $0.9 million, respectively, of net accrued interest receivable, which is defined as accrued interest on securities held as collateral less interest payable on cash borrowed.
Our derivatives are predominantly subject to bilateral collateral arrangements or clearing in accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the "Dodd-Frank Act." We may be required to deliver or receive cash or securities as collateral upon entering into derivative transactions. Changes in the relative value of derivative transactions may require us or the counterparty to post or receive additional collateral. Entering into derivative contracts involves market risk in excess of amounts recorded on our balance sheet. In the case of cleared derivatives, the clearinghouse becomes our counterparty and the future commission merchant acts as an intermediary between us and the clearinghouse with respect to all facets of the related transaction, including the posting and receipt of required collateral.
As of December 31, 2020, we had an aggregate amount at risk under our derivative contracts, excluding TBAs, with two counterparties of approximately $5.1 million. We also had $3.9 million of initial margin for cleared over-the-counter, or "OTC," derivatives posted to central clearinghouses as of that date. As of December 31, 2019, we had an aggregate amount at risk under our derivatives contracts, excluding TBAs, with two counterparties of approximately $10.4 million. We also had $9.0 million of initial margin for cleared OTC derivatives posted to central clearinghouses as of that date. Amounts at risk under our derivatives contracts represent the excess, if any, for each counterparty of the fair value of our derivative contracts plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the financial derivatives plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty.
We purchase and sell TBAs and Agency pass-through certificates on a when-issued or delayed delivery basis. The delayed delivery for these securities means that these transactions are more prone to market fluctuations between the trade date and the ultimate settlement date, and therefore are more vulnerable, especially in the absence of margining arrangements with respect to these transactions, to increasing amounts at risk with the applicable counterparties. As of December 31, 2020, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with four counterparties of approximately $3.5 million. As of December 31, 2019, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with five counterparties of approximately $1.2 million. Amounts at risk in connection with our forward settling TBA and Agency pass-through certificates represent the excess, if any,
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for each counterparty of the net fair value of the forward settling securities plus our collateral held directly by the counterparty less the counterparty's collateral held by us. If a particular counterparty's collateral held by us is greater than the aggregate fair value of the forward settling securities plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty.
Earlier this year, in response to the significant volatility caused by the COVID-19 pandemic, we strategically reduced the size of our portfolio in order to lower our leverage and enhance our liquidity position. As of December 31, 2020, the size of our portfolio and our debt-to-equity ratio remained lower than our historical averages, while our cash and cash equivalents remained higher than our historical averages.
We held cash and cash equivalents of approximately $58.2 million and $35.4 million as of December 31, 2020 and 2019, respectively.
We may declare dividends based on, among other things, our earnings, our financial condition, the REIT qualification requirements of the Internal Revenue Code of 1986, as amended, our working capital needs and new opportunities. The declaration of dividends to our shareholders and the amount of such dividends are at the discretion of our Board of Trustees. The following table sets forth the dividend distributions authorized by the Board of Trustees for the periods indicated below:
Year Ended December 31, 2020
Dividend
Per Share Dividend Amount Declaration Date Record Date Payment Date
(In thousands)
First Quarter $ 0.28 $ 3,449 March 4, 2020 March 31, 2020 April 27, 2020
Second Quarter 0.28 3,450 June 10, 2020 June 30, 2020 July 27, 2020
Third Quarter 0.28 3,454 September 10, 2020 September 30, 2020 October 26, 2020
Fourth Quarter 0.28 3,456 December 17, 2020 December 31, 2020 January 25, 2021
Year Ended December 31, 2019
Dividend
Per Share Dividend Amount Declaration Date Record Date Payment Date
(In thousands)
First Quarter $ 0.34 $ 4,239 March 4, 2019 March 29, 2019 April 25, 2019
Second Quarter 0.28 3,491 June 11, 2019 June 28, 2019 July 25, 2019
Third Quarter 0.28 3,485 September 11, 2019 September 30, 2019 October 25, 2019
Fourth Quarter 0.28 3,488 December 13, 2019 December 31, 2019 January 27, 2020
For the year ended December 31, 2020, our operating activities provided net cash of $24.4 million and our investing activities provided net cash of $304.1 million. Our repo activity used to finance our purchase of securities (including repayments, in conjunction with the sales of securities, of amounts borrowed under our repurchase agreements as well as collateral posted in connection with our repo activity) used net cash of $290.8 million. Thus our operating and investing activities, when combined with our net repo financing activities, provided net cash of $37.6 million. We used $13.8 million to pay dividends and $1.0 million to repurchase common shares. As a result of these activities, there was an increase in our cash holdings of $22.8 million, from $35.4 million as of December 31, 2019 to $58.2 million as of December 31, 2020.
For the year ended December 31, 2019, our operating activities provided net cash of $17.5 million and our investing activities provided net cash of $221.9 million. Our repo activity used to finance our purchase of securities (including repayments, in conjunction with the sales of securities, of amounts borrowed under our repurchase agreements as well as collateral posted in connection with our repo activity) used net cash of $206.4 million. Thus our operating and investing activities, when combined with our net repo financing activities, provided net cash of $33.0 million. We used $15.5 million to pay dividends and $0.7 million to repurchase common shares. As a result of these activities, there was an increase in our cash holdings of $16.8 million, from $18.6 million as of December 31, 2018 to $35.4 million as of December 31, 2019.
On June 13, 2018, our Board of Trustees approved the adoption of a share repurchase program under which we are authorized to repurchase up to 1.2 million common shares. The program, which is open-ended in duration, allows us to make repurchases from time to time on the open market or in negotiated transactions, including through Rule 10b5-1 plans. Repurchases are at our discretion, subject to applicable law, share availability, price and our financial performance, among other considerations. During the year ended December 31, 2020, we repurchased 136,142 common shares at an average price
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per share of $7.24 and a total cost of $1.0 million. Under the current repurchase program adopted on June 13, 2018, we have repurchased 434,171 common shares through March 5, 2021 at an average price per share of $9.45 and an aggregate cost of $4.1 million, and have authorization to repurchase an additional 765,829 common shares.
Based on our current portfolio, amount of free cash on hand, debt-to-equity ratio and current and anticipated availability of credit, we believe that our capital resources will be sufficient to enable us to meet anticipated short-term and long-term liquidity requirements.
We are not required by our investment guidelines to maintain any specific debt-to-equity ratio, and we believe that the appropriate leverage for the particular assets we hold depends on the credit quality and risk of those assets, as well as the general availability and terms of stable and reliable financing for those assets.
Contractual Obligations and Commitments
We are a party to a management agreement with our Manager. Pursuant to that agreement, our Manager is entitled to receive a management fee based on shareholders' equity, reimbursement of certain expenses and, in certain circumstances, a termination fee. Such fees and expenses do not have fixed and determinable payments. For a description of the management agreement provisions, see Note 9 to our consolidated financial statements.
We enter into repurchase agreements with third-party broker-dealers whereby we sell securities to such broker-dealers at agreed-upon purchase prices at the initiation of the repurchase agreements and agree to repurchase such securities at predetermined repurchase prices and termination dates, thus providing the broker-dealers with an implied interest rate on the funds initially transferred to us by the broker-dealers. We may enter into reverse repurchase agreements with third-party broker-dealers whereby we purchase securities under agreements to resell at an agreed-upon price and date. In general, we most often will enter into reverse repurchase agreement transactions in order to effectively borrow securities that we can then deliver to counterparties to whom we have made short sales of the same securities. The implied interest rates on the repurchase agreements and reverse repurchase agreements we enter into are based upon competitive market rates at the time of initiation. Repurchase agreements and reverse repurchase agreements that are conducted with the same counterparty may be reported on a net basis if they meet the requirements of ASC 210-20, Balance Sheet, Offsetting . As of both December 31, 2020 and 2019, there were no repurchase agreements and reverse repurchase agreements reported on a net basis on the Consolidated Balance Sheet.
As of December 31, 2020, we had $1.0 billion of outstanding borrowings with 15 counterparties.
Off-Balance Sheet Arrangements
As of December 31, 2020, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide funding to any such entities. As such, we are not materially exposed to any market, credit, liquidity, or financing risk that could arise if we had engaged in such relationships.
Inflation
Virtually all of our assets and liabilities are interest rate-sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.