Ellington Credit Co 10-K

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 and other 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 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 acquire and manage corporate collateralized loan obligations, or "CLOs." 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 and credit risk transfer securities. We believe that being able to combine Agency RMBS with non-Agency RMBS and other mortgage- and real estate-related asset classes, along with opportunistic investments in CLOs, enables us to balance a range of risks. We were initially formed through a strategic venture among affiliates of Ellington Management Group, L.L.C., an investment management firm and registered investment adviser with a 29-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." We are externally managed and advised by our Manager, an affiliate of Ellington. From our inception until August 2021, the Blackstone Funds had held special non-voting membership interests in the holding company that owns our Manager. In August 2021, an Ellington affiliate purchased these 57 special non-voting membership interests from the Blackstone Funds. We use leverage in our strategies and to date have financed our assets exclusively through repurchase agreements, which we account for as collateralized borrowings. As of December 31, 2023, we had outstanding borrowings under repurchase agreements in the amount of $729.5 million with 19 counterparties; 93% of such borrowings were collateralized by Agency RMBS. 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, 2023, our book value per share was $7.32 as compared to $8.40 as of December 31, 2022, respectively. Trends and Recent Market Developments Market Overview • After increasing the target range for the federal funds rate by a cumulative 4.25% in 2022, the U.S. Federal Reserve, or the "Federal Reserve," slowed the pace of its interest rate hikes in 2023. In 2023, at its January/February meeting, the Federal Reserve raised the target range by 25 basis points to 4.50%–4.75%, which was its smallest increase since March 2022. In March 2023, in response to stress in the banking system, which included the failures of Silicon Valley Bank and Signature Bank, the Federal Deposit Insurance Corporation, or "FDIC," took steps to guarantee all deposits of those two failed banks, including deposits above the standard limit of $250,000. Meanwhile, concerns around the solvency of Credit Suisse Group AG prompted the Swiss Government to provide liquidity assistance and other financial support in conjunction with a merger of Credit Suisse Group AG into UBS Group AG. In addition, the Federal Reserve announced additional liquidity support through the creation of the Bank Term Funding Program, which provided loans with terms of up to one year to banks and other eligible depository institutions for qualified collateral, which included U.S. Treasury securities and Agency RMBS, at their par values. Other central banks around the world also announced plans to increase liquidity to financial institutions. Later in March 2023, at its monthly meeting, the Federal Reserve declared that the "U.S. banking system is sound and resilient" and increased the target range for the federal funds rate by an additional 25 basis points to 4.75%–5.00%. Next, the Federal Reserve increased the target range by an additional 25 basis points in May 2023, paused in June, increased by an additional 25 basis points in July to a range of 5.25%–5.50%, and then maintained that range at each of its meetings from September through December, noting in December that "inflation has eased over the past year but remains elevated." In a dovish shift, the Summary of Economic Projections released by the Federal Reserve in December implied three interest rate cuts in 2024. However, minutes from the December 2023 meeting released in early January 2024 revealed that during the meeting Federal Reserve participants "reaffirmed that it would be appropriate for policy to remain at a restrictive stance for some time until inflation was clearly moving down," seemingly lowering the likelihood of a cut during the first quarter of 2024. Throughout 2023, the Federal Reserve continued to reinvest only principal payments that exceeded monthly caps of $60 billion on U.S. Treasury securities and $35 billion on Agency RMBS. • Interest rates were highly volatile during much of 2023, and many parts of the yield curve continued to be inverted. After falling in January, interest rates increased in February and early March, particularly short-term interest rates, as the yield on the 2-year U.S. Treasury surpassed 5% for the first time since June 2007. Then, in mid-March 2023, concerns about the stress in the banking system spurred a flight to safety, which drove interest rates down significantly. Overall, the yield on the 2-year U.S. Treasury decreased by 40 basis points to 4.03% in the first quarter, while the yield on the 10-year U.S. Treasury decreased by 41 basis points to 3.47%. Interest rate volatility spiked in mid-March 2023, with the MOVE Index surpassing its COVID-related highs and reaching its highest level since 2008. After trading in a relatively tight range in April and early May of 2023, interest rates rose steadily in the latter half of the second quarter, and the inversion of the yield curve deepened. Overall, the yield on the 2-year U.S. Treasury increased by 87 basis points to 4.90%, quarter over quarter, while the yield on the 10-year U.S. Treasury increased by 58 37 basis points to 3.84%. Meanwhile, interest rate volatility, as measured by the MOVE Index, declined during the quarter, particularly in June 2023 following the resolution of the federal government's debt ceiling dispute. In the third quarter of 2023, interest rates increased, particularly long-term interest rates, which caused the inversion of the yield curve to subside somewhat. The yield on the 2-year U.S. Treasury increased by 15 basis points quarter over quarter to 5.04%, while the yield on the 10-year U.S. Treasury increased by 73 basis points quarter over quarter to 4.57%. Toward the end of the quarter, the 2-year U.S. Treasury yield reached its highest level since July 2006, and the 10-year U.S. Treasury yield reached its highest level since October 2007. Meanwhile, interest rate volatility, as measured by the MOVE Index, remained elevated throughout the quarter. In the fourth quarter, interest rates reversed course and began to decline, as the market anticipated the conclusion of the Federal Reserve's interest rate hiking cycle. For the quarter, the yield on the 2-year U.S. Treasury decreased by 79 basis points to 4.25%, while the 10-year U.S. Treasury yield decreased by 69 basis points to 3.88%. The MOVE Index increased modestly from the previous quarter. For the full year 2023, the 2-year U.S. Treasury yield decreased by 18 basis points, while the 10-year yield increased by 1 basis point. • Secured Overnight Financing Rates, or "SOFR" rates, rose sharply from the start of the year through July 31, 2023, with one-month term SOFR increasing by 96 basis points to 5.32% and three-month term SOFR rising by 78 basis points to 5.37%. Beginning in August 2023, SOFR rates were relatively stable with one-month term SOFR ending the year at 5.35% and three-month term SOFR ending the year at 5.33%. Many of our financing costs are based on SOFR. • Mortgage rates moved in sympathy with long-term interest rates during 2023. The Freddie Mac survey 30-year mortgage rate declined from 6.41% at the start of the year to 5.95% in mid-January, and then steadily rose to 6.74% in early March, before declining to 6.24% by the end of the first quarter. From there, mortgage rates rose steadily for much of 2023, with the Freddie Mac 30-year mortgage rate peaking at 7.79% on October 26 th , its highest level since October 2000. The survey rate then reversed course and fell sharply over the final two months of 2023, declining to 6.42% on December 28 th , approximately where it started the year. After reaching a 25-year low at the end of 2022, the Mortgage Bankers Association's Refinance Index increased by 53% in the first quarter of 2023, before declining through the end of November, driven by higher mortgage rates. The index temporarily rose in mid-December 2023 with lower mortgage rates, and declined again toward the end of December 2023. Overall, the index increased by 15% year over year but remained at historically depressed levels. Prepayment speeds also remained at historically low levels throughout 2023. The Fannie Mae 30-year MBS registered a CPR of 4.5 in December 2023, unchanged year over year, reaching a 2023 low of 3.7 in January and a 2023 high of 6.4 in June. • Despite higher mortgage rates for much of 2023, the S&P CoreLogic Case-Schiller US National Home Price NSA Index increased by 5.5% during the year. The National Association of Realtors Housing Affordability Index declined by 7% during 2023, as higher mortgage rates and record home prices continued to stress housing affordability. • U.S. real GDP increased at an annualized rate of 2.2% in the first quarter, 2.1% in the second quarter, 4.9% in the third quarter, and an estimated annualized rate of 3.2% in the fourth quarter. Meanwhile, the unemployment rate remained low throughout 2023, starting the year at 3.5% and registering 3.7% as of year end. • Inflation, while still elevated, declined during each of the first six months of 2023. The year-over-year percentage change in the Consumer Price Index for All Urban Consumers ("CPI-U"), not seasonally adjusted, declined from 6.4% in January 2023 to 3.0% in June 2023. Year-over-year inflation then increased again in the third quarter of 2023, registering 3.7% in September, before declining modestly in the fourth quarter, registering 3.4% in December. • After a historically difficult year in 2022, MBS performance was mixed in 2023. Following strong absolute and relative performance in January 2023, MBS performance reversed course in mid-February and especially in March, as concerns in the banking sector caused volatility to surge. Overall for the first quarter of 2023, the Bloomberg Barclays U.S. MBS Index ("BB MBS Index") generated a positive return of 2.53% but a negative excess return (on a duration-adjusted basis) of (0.50%) relative to the Bloomberg Barclays U.S. Treasury Index. In the second quarter of 2023, the BB MBS Index generated a negative return of (0.66%) but a positive excess return of 0.79%, driven by strong outperformance in June. For the third quarter, the BB MBS Index posted a negative return of (4.13%) and a negative excess return of (0.88%) relative to the Bloomberg Barclays U.S. Treasury Index, driven by underperformance of the mortgage basis in September 2023. That underperformance continued into October, but over the final two months of the year, volatility declined and yield spreads tightened and overall for the fourth quarter of 2023, the BB MBS Index 59 generated a positive return of 7.31% and an excess return of 1.26%. For the full year 2023, the BB MBS Index generated a positive return of 5.05% and an excess return of 0.68%. • Similarly, after negative performance in 2022, the Bloomberg Barclays U.S. Corporate Bond Index ("BB IG Index") generated positive results on both an absolute and relative basis in 2023, driven by strong results in the fourth quarter of 2023. For the full year 2023, the BB IG Index generated a return of 8.52% on an absolute basis and an excess return of 4.55%. Meanwhile, the Bloomberg Barclays U.S. Corporate High Yield Bond Index ("BB HY Index") generated positive returns in each quarter of 2023 on both an absolute and relative basis. For the full year 2023, the BB HY Index generated a positive return of 13.45% and an excess return of 8.86%. • U.S. equities were also volatile during 2023, but performed well overall for the year, with the Dow Jones Industrial Average increasing by 13.7%, the S&P 500 rising by 24.2%, and the NASDAQ up 43.4%. Meanwhile, London's FTSE 100 index increased by 3.8% for the year, and the MSCI World global equity index increased by 21.8%. The VIX volatility index spiked in mid-March 2023 in response to the stress in the banking system and again in late September and October, before falling through year end. Portfolio Overview and Outlook As of December 31, 2023, our mortgage-backed securities portfolio consisted of $706.0 million of fixed-rate Agency "specified pools," $7.1 million of Agency RMBS backed by adjustable rate mortgages, or "Agency ARMs", $14.9 million of Agency reverse mortgage pools, $7.4 million of Agency interest-only securities, or "Agency IOs", $9.4 million of non-Agency RMBS, and $11.3 million of non-Agency interest-only securities, or "non-Agency IOs". 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 government-sponsored refinancing programs, and mortgages with various other characteristics. The size of our Agency RMBS holdings decreased by 16% to $728.0 million as of December 31, 2023, compared to $863.3 million as of December 31, 2022. The decline was driven by paydowns and net sales, primarily during the second half of the year. Over the course of the year, our holdings of non-Agency RMBS decreased by 25% to $9.4 million, while our holdings of interest-only securities increased by 7% to $18.7 million. In addition, during the second half of the year, we started rotating a portion of our investment capital to corporate CLOs. As of December 31, 2023 our holdings of corporate CLO investments totaled $17.4 million. CLOs are a form of asset-backed security collateralized by syndicated corporate loans. We could continue to increase our capital allocation to CLO mezzanine debt and CLO equity investments, based on market opportunities or other factors. Our debt-to-equity ratio, adjusted for unsettled purchases and sales, decreased to 5.3:1 as of December 31, 2023, as compared to 7.6:1 as of December 31, 2022. The decline was primarily due to a decrease in borrowings on our smaller Agency RMBS portfolio and significantly higher shareholders' equity, partially offset by a small increase in borrowings on our CLO portfolio. 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, 2023, 93% of our borrowings were secured by Agency RMBS. As of December 31, 2023, we had cash and cash equivalents of $38.5 million, in addition to other unencumbered assets of $22.9 million. This compares to cash and cash equivalents of $34.8 million and other unencumbered assets of $2.9 million as of December 31, 2022. The first quarter of 2023 began on a constructive note with interest rates and volatility declining and Agency RMBS yield spreads tightening in January. However, markets reversed course in mid-February on renewed anxiety over inflation and what the Federal Reserve’s response would be. Then in March, turmoil in the banking system put further pressure on Agency yield spreads. Overall, Agency RMBS underperformed U.S. Treasury securities and interest rate swaps (which are the primary instruments we use to hedge our interest rate risk) in the first quarter with the most pronounced underperformance coming on sub-5% coupon RMBS, where our Agency RMBS was concentrated, due to concerns over future selling from distressed regional banks. FDIC-directed sales of RMBS from failed regional banks commenced at the start of the second quarter of 2023, which pressured yield spreads but also drove strong RMBS demand into May, even as interest rate volatility remained elevated. Then in June, yield spreads tightened following the resolution of the debt ceiling dispute, and Agency RMBS outperformed hedging instruments for the quarter. In the third quarter of 2023, Agency RMBS faced the significant headwinds of elevated market volatility and rising long-term interest rates, resulting in wider yield spreads and Agency RMBS underperformance relative to hedging instruments. 60 In the fourth quarter of 2023, interest rates and volatility increased in October, which drove yield spreads wider in most fixed income sectors, including Agency RMBS. Markets then reversed course, however, with interest rates and volatility declining, and yield spreads tightening, through year end. Overall for the fourth quarter, Agency RMBS outperformed hedging instruments, with lower and intermediate coupon RMBS exhibiting the most pronounced outperformance. Overall, we had positive net income in the Agency RMBS strategy for the year, driven by net gains on our interest rate hedges, which exceeded net losses on our Agency RMBS and negative net interest income. Average pay-ups on our specified pool portfolio decreased to 1.01% as of December 31, 2023, as compared to 1.26% as of December 31, 2022. During the year, we continued to hedge interest rate risk primarily through the use of interest rate swaps, and to a lesser extent, short positions in TBAs, U.S. Treasury securities, and futures. We ended the year with a net long TBA position on a notional basis, but a net short 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 change in market value under a standard parallel move in interest rates. In the fourth quarter, our newly established corporate CLO portfolio contributed positively to our results, driven by net interest income and net gains. Similar to Agency RMBS, yield spreads on most CLOs widened in October before tightening in November and December, finishing the fourth quarter tighter overall. Finally, our non-Agency RMBS portfolio and interest-only securities generated strong results for the year, driven by net interest income and net gains. 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 shareholders' equity attributable to our mortgage-related strategies—slightly declined during the year. The decrease was driven by lower leverage employed in our mortgage-related strategies at December 31, 2023, despite having a net long TBA position as of December 31, 2023 as compared to a net short TBA position as of December 31, 2022. 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 in relation to the portion of our overall shareholders' equity employed in our mortgage-related strategies. 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 Long (Short) TBA Underlying Market Value (1) Net Mortgage Assets-to-Equity Ratio ($ In thousands) December 31, 2023 $ 107,422 $ (78,285) $ 756,131 $ 36,679 6.5:1 September 30, 2023 68,064 (116,747) 822,718 (36,149) 7.2:1 June 30, 2023 117,009 (243,532) 920,714 (102,485) 7.0:1 March 31, 2023 66,488 (221,497) 925,531 (131,188) 6.9:1 December 31, 2022 81,759 (258,253) 893,301 (149,982) 6.6:1 (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, 2023, September 30, 2023, June 30, 2023, March 31, 2023, and December 31, 2022. Three-Month Period Ended December 31, 2023 September 30, 2023 June 30, 2023 March 31, 2023 December 31, 2022 Three-Month Constant Prepayment Rates (1) 6.8 7.3 7.4 4.3 6.1 (1) Excludes recent purchases of fixed rate Agency specified pools with no prepayment history. 61 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, 2023 and 2022. December 31, 2023 December 31, 2022 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: 1.50-1.99 $ — $ — — $ 3,608 $ 3,153 27 2.50–2.99 3,794 3,550 52 3,764 3,497 41 3.00–3.49 4,829 4,645 103 15,596 14,746 50 3.50–3.99 9,960 9,684 92 12,627 12,244 78 4.00–4.49 10,013 9,918 60 11,712 11,539 52 4.50–4.99 51 50 167 146 145 155 Total 15-year fixed-rate mortgages 28,647 27,847 78 47,453 45,324 56 20-year fixed-rate mortgages: 2.00–2.49 4,063 3,502 42 4,750 4,038 30 2.50–2.99 — — — 1,852 1,625 29 3.00–3.49 1,147 1,045 46 1,362 1,236 34 4.00–4.49 1,255 1,225 41 1,500 1,447 29 4.50–4.99 491 489 63 563 554 51 5.00–5.49 577 583 64 785 791 52 6.50–6.99 991 1,019 6 — — — Total 20-year fixed-rate mortgages 8,524 7,863 41 10,812 9,691 33 30-year fixed-rate mortgages: 2.00–2.49 4,614 3,687 38 48,278 39,718 22 2.50–2.99 37,503 32,160 36 96,776 82,982 26 3.00–3.49 76,869 68,695 59 175,838 156,401 32 3.50–3.99 111,327 104,283 73 125,167 116,561 76 4.00–4.49 134,317 129,181 72 164,444 157,268 58 4.50–4.99 124,152 122,062 51 123,176 120,663 48 5.00–5.49 106,323 105,851 28 86,820 86,325 25 5.50–5.99 39,423 39,801 19 8,567 8,710 38 6.00–6.49 18,084 18,478 14 10,610 10,887 7 6.50–6.99 44,898 46,096 7 2,147 2,239 — Total 30-year fixed-rate mortgages 697,510 670,294 49 841,823 781,754 44 Total fixed-rate Agency RMBS $ 734,681 $ 706,004 50 $ 900,088 $ 836,769 44 For the year ended December 31, 2023, we had total net realized and unrealized gains on our Agency securities of $0.2 million, or $0.01 per share. Our Agency portfolio turnover was approximately 87% for the year ended December 31, 2023 and we recognized net realized losses of $(59.2) million. For the year ended December 31, 2023, we continued to hedge interest rate risk primarily through the use of interest rate swaps, and to a lesser extent, short positions in TBAs, U.S. Treasury securities, and futures. We had total net realized and unrealized gains of $10.8 million, or $0.73 per share, on our interest rate hedging portfolio, as sharply rising interest rates in the 62 second and third quarters of the year drove a significant gain on our interest rate hedges during those periods. These gains were partially offset by net losses in the first and fourth quarters, driven by declining interest rates. These gains exclude net realized and unrealized gains of $0.6 million, or $0.04 per share, on our long TBAs held for investment. We ended the year with a net long TBA position on a notional basis, but a net short TBA position as measured by 10-year equivalents. Ten-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 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. We may also selectively hedge our corporate CLO and/or non-Agency RMBS investments; as of December 31, 2023, we had a small credit hedge position in place. After giving effect to dividends declared during the year ended December 31, 2023 of $0.96 per share, our book value per share decreased to $7.32 as of December 31, 2023, from $8.40 as of December 31, 2022, and we had a negative economic return of (1.4)% for the year ended December 31, 2023. Economic return for a period is computed by adding back dividends declared during the period to ending book value per share, and comparing that amount to book value per share as of the beginning of the period. 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 quantitative tightening, shifting central bank and government policies, regulatory changes, and disruptive technological developments, exhibits high levels of interest rate risk, prepayment risk (including extension risk), financing and liquidity risk. Financing For the year ended December 31, 2023, our average repo borrowing cost increased to 5.18%, as compared to 1.40% for the year ended December 31, 2022. This increase in average repo borrowing cost was the result of a sharp increase in short-term interest rates during the year ended December 31, 2023. As of December 31, 2023 and December 31, 2022, the weighted average borrowing rate on our repurchase agreements was 5.58% and 3.70%, respectively. 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 5.4:1 as of December 31, 2023, as compared to 7.5:1 as of December 31, 2022. Adjusted for unsettled purchases and sales, our debt-to equity ratio was 5.3:1 as of December 31, 2023, as compared to 7.6:1 as of December 31, 2022. The decline was primarily due to a decrease in borrowings on our smaller Agency RMBS portfolio (reflecting in part the ongoing rotation of investment capital from RMBS to corporate CLOs) and significantly higher shareholders' equity. 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. The preparation of our consolidated financial statements in accordance with U.S. 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 reporting period. Our critical accounting estimates are those which require assumptions to be made about matters that are highly uncertain. Actual results could differ from those estimates and such differences could have a material impact on our financial condition and/or results of operations. 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 the experience of our Manager and Ellington 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 for a complete discussion of our significant accounting policies. We have identified our most critical accounting estimates to be the following: Valuation : We have elected the fair value option for the vast majority of our assets and liabilities for which such election is permitted, as provided for under ASC 825, Financial Instruments ("ASC 825"). 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 63 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. Purchase and sales transactions are generally recorded on trade date. Realized and unrealized gains and losses are calculated based on identified cost. 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 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. Because of the inherent uncertainty of valuation, the estimated fair value of our financial instruments may differ significantly from the values that would have been used had a ready market for the financial instruments existed, and the differences could be material to our consolidated financial statements. The determination of estimated fair value of those of our financial instruments that are not traded in an active market requires the use of both macroeconomic and microeconomic assumptions and/or inputs, which are generally based on current market and economic conditions. Changes in market and/or economic conditions could have a significant adverse effect on the estimated fair value of our financial instruments. Changes to assumptions, including assumed market yields, may significantly impact the estimated fair value of our investments. Our valuations are sensitive to changes in interest rates; see the interest rate sensitivity analysis included in Item 3. Quantitative and Qualitative Disclosures about Market Risk in this Annual Report on Form 10-K for further information. 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 generally amortize premiums and accrete discounts on our fixed-income investments using the effective interest method. For certain of our securities, for purposes of estimating future expected cash flows, management uses assumptions including, but not limited to, assumptions for future prepayment rates, default rates, and loss severities (each of which may in turn incorporate various macroeconomic assumptions, such as future housing prices, GDP growth rates, and unemployment rates). These assumptions require the use of a significant amount of judgment. Any resulting changes in effective yield are recognized prospectively based on the current amortized cost of the investment as adjusted for credit impairment, if any. The effective yield on our debt securities that are deemed to be of high credit quality (including Agency RMBS, exclusive of interest only securities) can be significantly impacted by our estimate of future prepayments. Future prepayment rates are difficult to predict. We estimate prepayment rates over the remaining life of our securities using models that generally incorporate the forward yield curve, current mortgage rates, mortgage rates on the outstanding loans, age and size of the outstanding loans, and other factors. We compare estimated prepayments to actual prepayments on a quarterly basis, and effective yields are recalculated retroactive to the time of purchase. When differences arise between our previously calculated effective yields and our current calculated effective yields, a catch-up adjustment, or "Catch-up Amortization Adjustment," is made to interest income to reflect the cumulative impact of the changes in effective yields. For the years ended December 31, 2023 and 2022, we recognized a Catch-up Amortization Adjustment of $(0.1) million and $3.1 million, respectively. The Catch-up Amortization Adjustment is reflected as an increase (decrease) to interest income on the Consolidated Statement of Operations. 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 and are generally not subject to corporate-level federal and state income tax on net income we distribute to our shareholders within the prescribed time frames. 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 64 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. As of December 31, 2023, the REIT had a net operating loss carry-forward of approximately $39 million. See Note 2 to our consolidated financial statements for additional details on income taxes. Recent Accounting Pronouncements Refer to the notes to our consolidated financial statements for a description of relevant recent accounting pronouncements. Financial Condition Investment portfolio The following tables summarize our securities portfolio as of December 31, 2023 and 2022: December 31, 2023 December 31, 2022 ($ 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 Portfolio: Agency RMBS (2) 15-year fixed-rate mortgages $ 28,647 $ 27,847 97.21 $ 28,765 100.41 $ 47,453 $ 45,324 95.51 $ 48,899 103.05 20-year fixed-rate mortgages 8,524 7,863 92.25 9,033 105.97 10,812 9,691 89.63 11,508 106.44 30-year fixed-rate mortgages 697,510 670,294 96.10 682,379 97.83 841,823 781,754 92.86 849,168 100.87 ARMs 7,127 7,119 99.89 8,060 113.09 8,696 8,663 99.62 9,595 110.34 Reverse mortgages 14,406 14,874 103.25 16,589 115.15 17,506 17,852 101.98 19,659 112.30 Total Agency RMBS 756,214 727,997 96.27 744,826 98.49 926,290 863,284 93.20 938,829 101.35 Agency IOs n/a 7,415 n/a 6,607 n/a n/a 9,313 n/a 9,212 n/a Total Agency 735,412 751,433 872,597 948,041 Credit Portfolio: CLO Notes 16,876 14,491 85.87 14,441 85.57 — — — — — CLO Equity n/a 2,926 n/a 2,947 n/a — — — — — Non-Agency RMBS (2) 9,953 9,409 94.53 8,189 82.28 16,895 12,566 74.38 12,414 73.48 Non-Agency IOs n/a 11,310 n/a 8,700 n/a n/a 8,138 n/a 6,289 n/a Preferred equity securities — — — — — n/a 208 n/a 202 n/a Total Credit 38,136 34,277 20,912 18,905 U.S. Treasury securities sold short — — — — — (500) (498) 99.60 (499) 99.80 Reverse repurchase agreements — — — — — 499 499 100.00 499 100.00 Total $ 773,548 $ 785,710 $ 893,510 $ 966,946 (1) Expressed as a percentage of the current principal balance. (2) Excludes IOs. As of December 31, 2023, 89% of our invested capital was allocated to mortgage-related securities and 11% was allocated to corporate CLOs. The majority of our mortgage-related securities are Agency RMBS, which include investments in Agency pools and Agency collateralized mortgage obligations, or "CMOs." Our most prevalent method of financing RMBS is through short-term repos, which generally have maturities of 364 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. 65 Financial Derivatives The following table summarizes our portfolio of financial derivative holdings as of December 31, 2023 and 2022: (In thousands) December 31, 2023 December 31, 2022 Financial derivatives–assets, at fair value: TBA securities purchase contracts $ 654 $ — TBA securities sale contracts — 3,568 Fixed payer interest rate swaps 67,719 65,202 Fixed receiver interest rate swaps 3,622 — Futures 2,284 — Total financial derivatives–assets, at fair value 74,279 68,770 Financial derivatives–liabilities, at fair value: TBA securities purchase contracts (13) (664) TBA securities sale contracts (1,863) — Fixed payer interest rate swaps (4,182) — Fixed receiver interest rate swaps (576) (2,373) Futures (63) (82) Credit Default Swaps (632) — Total financial derivatives–liabilities, at fair value (7,329) (3,119) Total $ 66,950 $ 65,651 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 364 days and carry interest rates that are determined by reference to a benchmark rate such as SOFR 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 contracts 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 a benchmark rate such as SOFR. To the extent that the benchmark rates used to calculate the payments we receive on our interest rate swaps continue to be highly correlated with our repo borrowing costs, our interest rate swap contracts should 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. In the case of TBAs, many 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 and certain other risks, we also hold net long positions in certain TBA securities as a means of acquiring exposure to Agency RMBS. 66 Credit Risk Hedging We also selectively enter into credit-hedging positions in order to protect against adverse credit events with respect to our CLO and/or non-Agency RMBS investments, subject to maintaining our qualification as a REIT. Our credit hedging portfolio can vary significantly from period to period, and can encompass a wide variety of financial instruments, including corporate debt or equity-related instruments, RMBS- or CMBS-related instruments, or instruments involving other markets. Our hedging instruments can include both "single-name" instruments (i.e., instruments referencing one underlying entity or security) and hedging instruments referencing indices. Currently, our credit hedges consist of CDS on corporate bond indices, although there are periods of time where we have no credit hedges in place. 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, 2023 and 2022. We had no other borrowings outstanding. December 31, 2023 December 31, 2022 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) (In thousands) 30 days or less $ 713,678 5.56 % 17 $ 563,926 4.01 % 14 31-60 days 6,131 6.69 46 210,569 2.73 44 61-90 days 9,734 6.47 67 67,960 4.16 72 Total $ 729,543 5.58 % 17 $ 842,455 3.70 % 26 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. As of December 31, 2023 and 2022, our total debt-to-equity ratio was 5.4:1 and 7.5:1, respectively. Collateral transferred with respect to our outstanding repo borrowings, including net cash collateral posted or (received), had an aggregate fair value of $0.8 billion and $0.9 billion, as of December 31, 2023 and December 31, 2022, 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. Shareholders' Equity As of December 31, 2023, our shareholders' equity increased to $136.2 million from $112.4 million as of December 31, 2022. This increase principally consisted of net proceeds from the issuance of shares of $33.6 million and a net gain of $4.6 million, partially offset by dividends declared of $14.5 million. As of December 31, 2023, our book value per share was $7.32, as compared to $8.40 as of December 31, 2022. 67 Results of Operations for the Years Ended December 31, 2023 and 2022 The following table summarizes our results of operations for the years ended December 31, 2023 and 2022: Year Ended December 31, (In thousands except for per share amounts) 2023 2022 Interest Income (Expense) Interest income $ 42,549 $ 35,006 Interest expense (45,256) (14,820) Net interest income (expense) (2,707) 20,186 Expenses Management fees to affiliate 1,804 1,758 Other operating expenses 3,731 3,370 Total expenses 5,535 5,128 Other Income (Loss) Net realized and change in net unrealized gains (losses) on securities 3,171 (152,785) Net realized and change in net unrealized gains (losses) on financial derivatives 9,630 107,529 Total Other Income (Loss) 12,801 (45,256) Net Income (Loss) $ 4,559 $ (30,198) Net Income (Loss) Per Common Share $ 0.31 $ (2.29) Net Income (Loss) Net income (loss) for the year ended December 31, 2023 was $4.6 million, as compared to $(30.2) million for the year ended December 31, 2022. The reversal in our results of operations year over year was primarily due to a total other income in the current period as compared to a total other loss in the prior period. Gains in the current year were partially offset by a significant increase in interest expense, primarily as a result of higher financing costs stemming from the significant increase in short-term interest rates during 2023. Interest Income Our portfolio as of both December 31, 2023 and 2022 consisted primarily of Agency RMBS, and to a lesser extent, non-Agency RMBS, and as of December 31, 2023, CLO investments. Before interest expense, we earned approximately $38.8 million and $33.4 million in interest income on these securities for the years ended December 31, 2023 and 2022, respectively. The year-over-year increase in interest income primarily resulted from higher asset yields on both our Agency and credit portfolios and to a lesser extent higher average holdings on our credit portfolio, partially offset by lower average holdings on our Agency RMBS portfolio. The Catch-up Amortization Adjustment causes variability in our interest income and portfolio yields. For the year ended December 31, 2023, we had a negative Catch-up Amortization Adjustments of approximately $(0.1) million, which decreased interest income. For the year ended December 31, 2022, we had a positive Catch-up Amortization Adjustments of approximately $3.1 million, which increased interest income. Excluding the Catch-up Amortization Adjustments, the weighted average yield of our overall portfolio was 4.09% and 2.80% for the years ended December 31, 2023 and 2022, 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, 2023 and 2022: Agency (1) Credit (1) Total (1) (In thousands) Interest Income Average Holdings Yield Interest Income Average Holdings Yield Interest Income Average Holdings Yield Year ended December 31, 2023 $ 36,186 $ 928,386 3.90 % $ 2,645 $ 22,678 11.66 % $ 38,831 $ 951,064 4.08 % Year ended December 31, 2022 $ 31,866 $ 1,067,399 2.99 % $ 1,558 $ 14,115 11.04 % $ 33,424 $ 1,081,514 3.09 % (1) Amounts exclude interest income on cash and cash equivalents (including when posted as margin), long U.S. Treasury securities, and reverse repurchase agreements. 68 Interest Expense For the years ended December 31, 2023 and 2022, 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 years ended December 31, 2023 and 2022 was $45.3 million and $14.8 million, respectively, which primarily consisted of interest expense on our repo borrowings. The year-over-year increase in our total interest expense resulted mainly from higher financing costs stemming from the significant increase in short-term interest rates. The following table provides details of our borrowings under repurchase agreements for the years ended December 31, 2023 and 2022: Year Ended December 31, 2023 Year Ended December 31, 2022 Average Borrowed Funds Interest Expense Average Cost of Funds Average Borrowed Funds Interest Expense Average Cost of Funds (In thousands) Repurchase Agreements: Agency RMBS $ 822,543 $ 42,386 5.15 % $ 982,375 $ 13,398 1.36 % Credit 15,497 1,015 6.55 % 9,686 313 3.23 % Subtotal (1) 838,040 43,401 5.18 % 992,061 13,711 1.38 % U.S. Treasury securities 16,023 849 5.30 % 15,246 394 2.58 % Total $ 854,063 $ 44,250 5.18 % $ 1,007,307 $ 14,105 1.40 % (1) Excludes U.S. Treasury securities. Adjusted Cost of Funds Among other instruments, we use interest rate swaps and U.S. Treasury securities to hedge against the risk to our borrowings of rising interest rates. 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 net interest (income) expense we incur on our positions in U.S. Treasury securities, and express the total as a percentage of our average outstanding repurchase agreement borrowings on yield-bearing assets (excluding U.S. Treasury securities). The following table details the components of our adjusted cost of funds (1)(2) for the years ended December 31, 2023 and 2022: Year Ended December 31, 2023 Year Ended December 31, 2022 (In thousands) Average Borrowed Funds (3) Interest Expense (Benefit) Average Cost of Funds Average Borrowed Funds (3) Interest Expense (Benefit) Average Cost of Funds Repurchase Agreements: Agency RMBS $ 822,543 $ 42,386 5.15 % $ 982,375 $ 13,398 1.36 % Credit 15,497 1,015 6.55 % 9,686 313 3.23 % Subtotal (4) 838,040 43,401 5.18 % 992,061 13,711 1.38 % Adjustments: Net interest (income) expense related to U.S. Treasury securities (5) 9 — % 298 0.03 % Net periodic expense (benefit) paid or payable on interest rate swaps (21,078) (2.52) % (1,908) (0.19) % Total Adjusted Cost of Funds $ 838,040 $ 22,332 2.66 % 992,061 12,101 1.22 % (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) Conformed to current period presentation. (3) Excludes average borrowed funds related to repurchase agreements collateralized by U.S. Treasury securities. (4) Excludes U.S. Treasury securities. (5) Includes interest expense from repurchase agreements collateralized by U.S. Treasury securities and from positions in short U.S. Treasury securities and interest income from reverse repurchase agreements collateralized by U.S. Treasury securities and from positions in long U.S. Treasury securities. 69 For the year ended December 31, 2023, the weighted average yield on our Agency RMBS and credit portfolios excluding the impact of the Catch-up Amortization Adjustment was 4.09%, while our total adjusted average cost of funds, including interest rate swaps and net short U.S. Treasury securities, was 2.66%, resulting in a net interest margin of 1.43%. By comparison, for the year ended December 31, 2022, the weighted average yield of our portfolio of Agency and non-Agency RMBS excluding the impact of the Catch-up Amortization Adjustment was 2.80%, while our total adjusted average cost of funds, including interest rate swaps and short U.S. Treasury securities, was 1.22%, resulting in a net interest margin of 1.58%. Management Fees For each of the years ended December 31, 2023 and 2022, our management fee expense was approximately $1.8 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, includes professional fees, compensation expense, insurance expense, and various other operating expenses included on the Consolidated Statement of Operations incurred in connection with the operation of our business. For the years ended December 31, 2023 and 2022, our other operating expenses were approximately $3.7 million and $3.4 million, respectively. The increase in other operating expenses for the year ended December 31, 2023 was primarily due to an increase in professional fees. 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, 2023, Other income (loss) was $12.8 million, consisting of net realized and unrealized gains of $9.6 million and $3.2 million on our financial derivatives and securities, respectively. Net realized and unrealized gains of $9.6 million on our financial derivatives consisted of net realized and unrealized gains of $8.3 million on our TBAs and $2.6 million on our interest rate swaps, partially offset by net realized and unrealized losses of $(0.8) million on our U.S Treasury futures and $(0.4) million on our credit default swaps. The net gain on our financial derivatives was primarily the result of sharply rising interest rates in the second and third quarters of the year. These gains were partially offset by net losses in the first and fourth quarters, driven by declining interest rates. Net realized and unrealized gains of $3.2 million on our securities consisted primarily of net realized and unrealized gains of $1.5 million on our non-Agency RMBS and $1.4 million on our U.S. Treasury securities. For the year ended December 31, 2022, Other income (loss) was $(45.3) million, consisting primarily of net realized and unrealized losses of $(152.8) million on our securities, which were partially offset by net realized and unrealized gains of $107.5 million on our financial derivatives. Net realized and unrealized losses of $(152.8) million on our securities consists primarily of net realized and unrealized losses of $(156.2) million on our Agency RMBS, driven by significantly lower asset prices year over year due to rising interest rates and widening yield spreads. The net realized and unrealized gains on our financial derivatives of $107.5 million consisted of net realized and unrealized gains of $64.4 million on our interest rate swaps, $22.2 million on our net short positions in TBAs, and $20.9 million on our U.S. Treasury futures. The net gains on our financial derivatives were primarily the result of the significant increase in interest rates, and in the case of short positions in TBAs, also of widening yields spreads. Adjusted Distributable Earnings We calculate Adjusted Distributable Earnings as net income (loss), excluding realized and change in net unrealized gains and (losses) on securities and financial derivatives, and excluding other income or loss items that are of a non-recurring nature, if any. Adjusted Distributable Earnings includes net realized and change in net unrealized gains (losses) associated with periodic settlements on interest rate swaps. Adjusted Distributable Earnings also excludes the effect of the Catch-up Amortization Adjustment on interest income. The Catch-up Amortization Adjustment is a quarterly adjustment to premium amortization or discount accretion 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 quarter to quarter. Adjusted Distributable Earnings is a supplemental non-GAAP financial measure. We believe that the presentation of Adjusted Distributable Earnings provides information useful to investors, because: (i) we believe that it is a useful indicator of both current and projected long-term financial performance, in that it excludes the impact of certain current period earnings components that we believe are less useful in forecasting long-term performance and dividend-paying ability; (ii) we use it to evaluate the effective net yield provided by our portfolio, after the effects of financial leverage; and (iii) we believe that presenting Adjusted Distributable Earnings assists our investors in measuring and evaluating our operating performance, and 70 comparing our operating performance to that of our residential mortgage REIT peers. Our calculation of Adjusted Distributable Earnings may differ from the calculation of similarly titled non-GAAP financial measures by our peers, with the result that these non-GAAP financial measures might not be directly comparable; Adjusted Distributable Earnings excludes certain items, such as most realized and unrealized gains and losses, that may impact the amount of cash that is actually available for distribution. In addition, because Adjusted Distributable Earnings is an incomplete measure of our financial results and differs from net income (loss) computed in accordance with U.S. GAAP, it should be considered supplementary to, and not as a substitute for, net income (loss) computed in accordance with U.S. GAAP. Furthermore, Adjusted Distributable Earnings is different from REIT taxable income. As a result, the determination of whether we have met the requirement to distribute at least 90% of our annual REIT taxable income (subject to certain adjustments) to its shareholders, in order to maintain qualification as a REIT, is not based on whether we have distributed 90% of our Adjusted Distributable Earnings. In setting our dividend, our Board of Trustees considers our earnings, liquidity, financial condition, REIT distribution requirements, and financial covenants, along with other factors that the Board of Trustees may deem relevant from time to time. The following table reconciles, for the years ended December 31, 2023 and 2022, Adjusted Distributable Earnings to the line on the Consolidated Statement of Operations entitled Net Income (Loss), which we believe is the most directly comparable U.S. GAAP measure: Year Ended December 31, (In thousands except for share amounts) 2023 2022 Net Income (Loss) $ 4,559 $ (30,198) Adjustments: Net realized (gains) losses on securities 58,103 73,682 Change in net unrealized (gains) losses on securities (61,274) 79,103 Net realized (gains) losses on financial derivatives (28,562) (48,996) Change in net unrealized (gains) losses on financial derivatives 18,932 (58,533) Net realized gains (losses) on periodic settlements of interest rate swaps 7,388 626 Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps 13,690 1,282 Non-recurring expenses 102 — Negative (positive) component of interest income represented by Catch-up Amortization Adjustment 62 (3,144) Subtotal 8,441 44,020 Adjusted Distributable Earnings $ 13,000 $ 13,822 Weighted Average Shares Outstanding 14,875,314 13,163,106 Adjusted Distributable Earnings Per Share $ 0.87 $ 1.05 Liquidity and Capital Resources Liquidity refers to our ability to generate and obtain adequate amounts of cash to meet our requirements, including repaying our borrowings, funding and maintaining RMBS and other assets, paying dividends, and other general business needs. Our short-term (the 12 months following period end) and long-term (beyond 12 months from period end) 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 securities and proceeds from the sale of securities), 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. 71 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, 2023 and 2022, we had $729.5 million and $842.5 million outstanding under our repurchase agreements, respectively. As of December 31, 2023, our outstanding repurchase agreements were with 19 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, 2023 and 2022, the weighted average contractual haircut applicable to the assets that serve as collateral for our outstanding repo borrowings was 5.7% and 5.5%, respectively. 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, 2023 $ 729,543 $ 781,615 $ 787,217 September 30, 2023 811,180 877,620 900,511 June 30, 2023 875,030 880,957 883,043 March 31, 2023 875,670 876,846 897,629 December 31, 2022 842,455 899,752 881,401 September 30, 2022 938,046 928,942 940,321 June 30, 2022 950,339 1,070,229 1,087,826 March 31, 2022 1,211,163 1,133,738 1,211,163 December 31, 2021 1,064,835 1,068,384 1,088,712 September 30, 2021 1,062,197 1,114,820 1,140,182 June 30, 2021 1,135,497 1,166,954 1,196,779 March 31, 2021 1,106,724 1,040,521 1,106,724 As of December 31, 2023, we had an aggregate amount at risk under our repurchase agreements with 19 counterparties of $50.1 million. As of December 31, 2022, we had an aggregate amount at risk under our repurchase agreements with 17 counterparties of $49.8 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, 2023 and 2022 does not include $0.5 million and $1.5 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 master trade agreements 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, 2023, we had an aggregate amount at risk under our derivative contracts, excluding TBAs, with three counterparties of approximately $26.0 million. As of December 31, 2022, we had an aggregate amount at risk under our derivatives contracts, excluding TBAs, with three counterparties of approximately $24.5 million. 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 72 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, 2023, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with seven counterparties of approximately $1.7 million. As of December 31, 2022, in connection with our forward settling TBA and Agency pass-through certificates, we had an aggregate amount at risk with eight counterparties of approximately $4.6 million. Amounts at risk in connection with our forward settling TBA and Agency pass-through certificates represent the excess, if any, for each counterparty of the net fair value of the forward settling 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 forward settling contracts plus our collateral held directly by the counterparty, there is no amount at risk for the particular counterparty. As of December 31, 2023, we had cash and cash equivalents of $38.5 million. The timing and frequency of distributions will be determined by our Board of Trustees based upon a variety of factors deemed relevant by our trustees, including restrictions under applicable law, our capital requirements, and the REIT requirements of the Code. 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, 2023: Dividend Per Share Dividend Amount Declaration Date Record Date Payment Date (In thousands) $ 0.08 $ 1,488 December 7, 2023 December 29, 2023 January 25, 2024 0.08 1,332 November 7, 2023 November 30, 2023 December 26, 2023 0.08 1,307 October 6, 2023 October 31, 2023 November 27, 2023 0.08 1,270 September 7, 2023 September 29, 2023 October 25, 2023 0.08 1,258 August 7, 2023 August 31, 2023 September 25, 2023 0.08 1,209 July 10, 2023 July 31, 2023 August 25, 2023 0.08 1,150 June 7, 2023 June 30, 2023 July 25, 2023 0.08 1,115 May 8, 2023 May 31, 2023 June 26, 2023 0.08 1,106 April 10, 2023 April 28, 2023 May 25, 2023 0.08 1,106 March 7, 2023 March 31, 2023 April 25, 2023 0.08 1,103 February 7, 2023 February 28, 2023 March 27, 2023 0.08 1,096 January 9, 2023 January 31, 2023 February 27, 2023 73 Year Ended December 31, 2022: Dividend Per Share Dividend Amount Declaration Date Record Date Payment Date (In thousands) $ 0.08 $ 1,070 December 7, 2022 December 30, 2022 January 25, 2023 0.08 1,063 November 7, 2022 November 30, 2022 December 27, 2022 0.08 1,060 October 6, 2022 October 31, 2022 November 25, 2022 0.08 1,060 September 8, 2022 September 30, 2022 October 25, 2022 0.08 1,058 August 4, 2022 August 31, 2022 September 26, 2022 0.08 1,046 July 8, 2022 July 29, 2022 August 25, 2022 0.08 1,046 June 7, 2022 June 30, 2022 July 25, 2022 0.08 1,049 May 2, 2022 May 31, 2022 June 27, 2022 0.10 1,311 April 7, 2022 April 29, 2022 May 25, 2022 0.10 1,311 March 7, 2022 March 31, 2022 April 25, 2022 0.10 1,311 February 7, 2022 February 28, 2022 March 25, 2022 0.10 1,311 January 7, 2022 January 31, 2022 February 25, 2022 On January 8, 2024, the Board of Trustees approved a monthly dividend in the amount of $0.08 per share payable on February 26, 2024 to shareholders of record as of January 31, 2024. On February 7, 2024, the Board of Trustees approved a monthly dividend in the amount of $0.08 per share payable on March 25, 2024 to shareholders of record as of February 29, 2024. On March 7, 2024, the Board of Trustees approved a monthly dividend in the amount of $0.08 per share payable on April 25, 2024 to shareholders of record as of March 29, 2024. At those times when cash flows from our operating activities are insufficient to fund our dividend payments, we fund such dividend payments through cash flows from our investing and/or financing activities, and in some cases from additional cash on hand. The following paragraphs summarize our cash flows for the years ended December 31, 2023 and 2022. For the year ended December 31, 2023, our operating activities used net cash of $10.0 million and our investing activities provided net cash of $85.7 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 $91.4 million. Thus our operating and investing activities, when combined with our net repo financing activities, used net cash of $15.7 million. We also received proceeds from the issuance of common shares, net of commissions and offering costs paid of $33.6 million. We also used $14.1 million to pay dividends. As a result of these activities, there was an increase in our cash holdings of $3.7 million, from $34.8 million as of December 31, 2022 to $38.5 million as of December 31, 2023. For the year ended December 31, 2022, our operating activities provided net cash of $22.4 million and our investing activities provided net cash of $110.5 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 $155.0 million. Thus our operating and investing activities, when combined with our net repo financing activities, used net cash of $22.0 million. We also received net proceeds from the issuance of common shares, net of commissions and offering costs paid of $2.0 million. We used $13.9 million to pay dividends, and $0.3 million to repurchase common shares. As a result of these activities, there was a decrease in our cash holdings of $34.2 million, from $69.0 million as of December 31, 2021 to $34.8 million as of December 31, 2022. On April 2, 2021, we implemented an "at-the-market" offering program, or "ATM program," by entering into equity distribution agreements with third party sales agents under which we are authorized to offer and sell up to $75.0 million of common shares from time to time. The 2021 ATM program was terminated in connection with the establishment of the 2023 ATM program, hereinafter defined. On November 14, 2023, we implemented an “at the market” offering program, or the "2023 ATM program," by entering into equity distribution agreements with third party sales agents under which we are authorized to offer and sell up to $100.0 million of common shares from time to time. In the aggregate, under the 2021 ATM program and 2023 ATM program, during the year ended December 31, 2023, we issued 5,183,037 common shares which provided $33.6 million of net proceeds after $0.5 million of commissions and $0.2 million of offering costs. As of December 31, 2023, we had $85.9 million of common shares available to be issued remaining under the 2023 ATM program. From commencement 74 of the 2023 ATM program through March 1, 2024, we issued 3,480,148 common shares under the 2023 ATM program, which provided $21.2 million of net proceeds after $0.2 million of commissions and $0.2 million of offering costs. 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. Under the current repurchase program adopted on June 13, 2018, we have repurchased 474,192 common shares through May 12, 2023 at an average price per share of $9.21 and an aggregate cost of $4.4 million, and have authorization to repurchase an additional 725,808 common shares. We did not purchase any shares under this program during the year ended December 31, 2023. 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, 2023 and 2022, there were no repurchase agreements and reverse repurchase agreements reported on a net basis on the Consolidated Balance Sheet. As of December 31, 2023, we had $729.5 million of outstanding borrowings with 19 counterparties. Off-Balance Sheet Arrangements As of December 31, 2023, 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 generally influence our performance more than does inflation. Our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation. However, elevated long-term inflation could adversely impact the performance of our investment portfolio, or the prices of our investments, or both. For example, if higher inflation is not matched by an increase in wages, inflation could cause the real income of the borrowers whose loans underlie our non-Agency RMBS to decline. 75